Words from the (investment) wise for the week that was (August 11 – 17, 2008)
Almost exactly a year after the advent of the credit debacle, the term “credit crunch” squeezed into Britain’s Chambers dictionary, defined as “a sudden and drastic reduction in the availability of credit”.
Fittingly, the past week witnessed market participants focusing anew on deteriorating global growth prospects, arguing that slower growth and belt-tightening times could reduce inflation pressures.
A wave of weak data hit the global economic headlines during the week. Real GDP growth in the Eurozone contracted by 0.2% in the second quarter, the first decline since record-keeping for the Euro area commenced in 1995. Germany and France, the two largest economies of the group, recorded declines in GDP of 0.5% and 0.3% respectively. The UK economy is on the verge of a recession, facing its gloomiest outlook since the early 1990s. Japan, the world’s second largest economy, also contracted by 0.6% in the second quarter.
The notion that the US was further along the slowdown process than foreign economies, and an expectation that interest rate differentials could narrow in favor of the US dollar, resulted in continued strength in the greenback, further weakness in commodities, lower bond yields and mixed stock markets.
BCA Research said: “… lower energy prices, if sustained, should begin to help cool inflation fears. … inflation lags economic growth by several quarters and the economy continues to slow. … inflation fears should gradually recede.”
Further evidence that worries about inflation were decreasing was seen by implied inflation in the US, as derived from Treasury Inflation-protected Securities (TIPS), falling to their lowest level since January.
Regarding the inflation/deflation debate, Richard Russell (Dow Theory Letters) weighed in with the following comment: “With credit being restricted, a second and very serious danger surfaces. That danger is asset deflation. The very thought of asset deflation sends chills of fear up Fed chief Ben Bernanke’s spine. Credit contraction, asset deflation – shades of the Great Depression.”
Next, a tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. As expected, “economy”, “prices”, “inflation”, “bank”, “credit” and “dollar” were the words most often used in financial reports.
The mystery of where the markets are heading continues, reminding me of physicist Niels Bohr’s quotation: “Tomorrow is going to be wonderful, because tonight I do not understand anything.” (Hat tip: Paul Kedrosky’s Infectious Greed.)
“Very frankly, I can’t come to a firm conclusion as to whether we’re dealing with a bull or a bear market. Sometimes you just have to wait and allow the market to tell its story. Remember, we may be in a hurry, but the market never is,” said 84-year old Richard Russell.
As mentioned previously, investors should brace themselves for a lengthy convalescence period, where a shift in central bank policy to targeting GDP growth rather than inflation is part of the patient’s eventual recuperation. However, in the short term I still give the nascent stock market rallies the benefit of the doubt provided the mid-July lows are sustained. Always be on the alert for new leadership groups and ensure that the earnings and valuation fundamentals stack up before committing money to the market.
Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance round-up.
Economic reports released in the US during the past week were mixed and included the following:
• The July Senior Loan Officer Opinion Survey from the Fed indicated further tightening in lending standards over the previous three months. About 60% of large banks indicated tighter standards for commercial and industrial loans from the previous survey. Three-quarters of banks reported tightening standards on prime mortgage loans since the spring and the share of banks tightening standards on credit-card loans has more than doubled since the last survey.
• Total retail sales inched down 0.1% in July, following a revised 0.3% gain in June (originally 0.1%) as a decline in sales at auto dealers offset strong growth elsewhere. Sales excluding autos rose by 0.4% after gaining 0.9% in June.
• The top-line Consumer Price Index increased by 0.8% for the month and 5.6% for the year in July compared with 1.1% for the month and 4.9% for the year in June. The core CPI rate of inflation remained level at 0.3% for July, the same as in June, though the core rate of inflation for the year was 2.5% in July compared with 2.4% in June. Energy increased by 4% for the month in July compared with 6.6% in June, whereas food prices increased by 0.9% for the month compared with 0.8% in June.
• Industrial production rose by a better than expected 0.2% in July. Manufacturing and mining output improved during the month, while utilities production declined sharply. Overall, the report was similar to the industrial production reports seen so far this year: a soft reading, though not of the magnitude normally seen in recessions.
Almost one-third of US homeowners who bought in the last five years now owe more on their mortgages than their properties are worth, according to Zillow.com, an Internet provider of home valuations. Also, delinquency rates on single-family mortgages have reached their highest level on record (the Fed started tracking the statistics in 1991), pushing up the delinquency rate on all loans held by US banks.
Hat tip: Barry Ritholtz’s The Big Picture
Summarizing the US economic situation, Asha Bangalore (Northern Trust) said: “Tax rebate dollars supported economic growth in the US in the second quarter. By the next FOMC meeting on September 16, the FOMC will have another month’s data for inflation, employment, and retail sales. Employment and retail sales should continue to show weakness and headline inflation will likely be considerably lower. Therefore, the Fed is firmly on hold.”
As mentioned above, the incoming reports in the Eurozone and Japan strongly point to weakening economic conditions, as shown by contracting real GDP growth in the Eurozone and Japan in the following chart:
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 14, 2008.
WEEK’S ECONOMIC REPORTS
Source: Yahoo Finance, August 15, 2008.
Next week’s economic highlights in the US, courtesy of Northern Trust, include the following:
1. Producer Price Index (August 19): The Producer Price Index for Finished Goods is expected to have risen by 0.5% in July. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in June. Consensus: +0.5%, core PPI +0.2%.
2. Housing Starts (August 19): Permit extensions for new single-family homes fell by 3.0% in June, but rose for that of multi-family homes. The weakness in the housing market, particularly the large inventory of unsold homes, points to a reduction of housing starts in July (940,000 versus 1.066 million in June). Consensus: 950,000.
3. Leading Indicators (August 21): Interest rate spread and consumer expectations are the only two components likely to make a positive contribution in July. Stock prices, money supply, initial jobless claims, and building permits are expected to make negative contributions. Forecasts of money supply and orders of consumer durables and non-defense capital goods are used in the initial estimate. The manufacturing workweek and vendor deliveries held steady in July. The net impact is a 0.2% drop in the leading index during July. Consensus: -0.2% versus -0.1% in June.
4. Other reports: NAHB Survey (August 19), Philadelphia Fed Survey (August 21).
A summary of the release dates of economic reports in the UK, Eurozone, Japan and China is provided here. It is important to keep an eye on growth trends in these economies for clues on, among others, which way the US dollar is going to move and how strongly.
Source: Wall Street Journal Online, August 17, 2008.
Mounting concerns about the German and Japanese economies heading for recession resulted in the XETRA Dax Index (-1.8%) and the Nikkei 225 Average (-1.1%) being the worst performers among developed markets.
The emerging markets category saw large declines by China (-6.0%), Brazil ( 4.1%), Hong Kong (-3.3%) and India (-2.9%), whereas solid gains were registered by Turkey (+3.0%), Pakistan (+3.5%) and Russia (+3.6%). Notwithstanding the past week’s gains, the Russian Trading System Index is still down a hefty 28.2% from its record high of mid-May.
The US stock markets were mixed as shown by the major index movements: Dow Jones -0.6% (YTD -12.1%), S&P 500 Index +0.1% (YTD -11.6%), Nasdaq Composite Index +1.6% (YTD 7.5%) and Russell 2000 Index +2.6% (YTD -1.7%).
The outperformance of small caps is significant as they have a history of often turning up before large caps at market bottoms. A breakout through the June high should be positive for the entire market.
The Russell 2000 Index and the Nasdaq Composite Index are trading above both their 50- and 200-day moving averages, whereas the Dow Jones Industrial Index and S&P 500 Index are flirting with their 50-day averages and still have some work to do in order to breach the important 200-day line – often used as an indicator of the primary trend.
Retailers were a notable pocket of strength despite persistent debate about the consumer’s demise in the face of high food and gas prices, falling home values, rising unemployment and tighter credit conditions. For the week, the S&P Retail Index jumped by 4.8%, bringing its gain since the July 15 low to 23.6%.
Several retailers, including Wal-Mart (WMT), Kohl’s (KSS), J.C. Penney (JCP) and Nordstrom (JWN), posted better-than-expected second quarter earnings results, although most expressed caution about the outlook for the third quarter and/or full year.
On the other end of the scale, the financial sector (-2.8%) was the week’s worst sector performer, falling on omnipresent concerns about credit market conditions and low levels of business activity. This caused several broking firms to slash earnings estimates for leading investment bank Goldman Sachs (GS). Also, a warning from JP Morgan Chase (JPM) that it had seen a substantial deterioration in trading conditions since the end of the second quarter, acted as another trigger for the selling interest.
Leading the way, the UK ten-year Gilt yield declined by 10 basis points to 4.58% and the German ten-year Bund yield by 11 basis points to 4.15%. The Japanese ten-year bond yield closed unchanged at 1.47% after hitting a four-month low of 1.515% on Thursday.
The ten-year US Treasury Note also dropped – by 8 basis points to 3.86% – as investors turned to the perceived safety of government bonds amid continued selling of mortgage securities.
US mortgage rates declined somewhat, with the 15-year fixed rate and the 5-year ARM both 3 basis points lower at 6.05% and 6.03% respectively.
Money-market rates rose on the back of strong demand for one- and three-month money lent by the Fed and the ECB.
Bloomberg reported that Goldman Sachs reversed course on its dollar forecast, saying the greenback has “bottomed” as global growth weakens, oil prices decline and the US trade balance improves. “The fundamental picture for the dollar has improved substantially in recent weeks,” Goldman’s Thomas Stolper wrote in a research note.
The past week saw the greenback rising against the euro (+1.6% – a six-month high), the British pound (+2.9% – a two-year peak), the Swiss franc (+1.3% – a six-month high), the Japanese yen (+0.8% – a five-month high) and the Australian dollar (+2.5% – a seven-month high).
Sterling has come under strong selling pressure as pessimism about the UK economic picture intensified, resulting in an 11-day losing streak – the longest stretch of consecutive down-days in 35 years.
The following chart illustrates the US dollar’s accent against various currencies over the past month:
West Texas Intermediate crude traded at $113.9 a barrel on Friday, extending its five-week decline from a record $147.27 to 29.3%.
The rallying US dollar and reduced concerns about inflation resulted in gold bullion falling below the $800 level on Friday for the first time since December 2007. The yellow metal plunged by 8.4% over the week, with silver (-15.7%), platinum (-11.0%) and palladium (-14.4%) also at the forefront of the selling orders.
Agricultural commodities were the only category registering gains last week as a result of reassurance from the US Department of Agriculture on this year’s harvest. CBOT September corn rose by 6.3%, wheat by 8.1% and soyabeans by 2.4%.
Putting a more positive spin on commodities’ fall from grace, Frank Holmes (US Global Investors) said: “This commodities sell-off, which began in July and has continued into August, also corresponds to the long-term seasonal cycle in which prices for many commodities tend to bottom out in late summer before rebounding in the fall.”
Now for a few news items and some words and charts from the investment wise that will hopefully assist with navigating our portfolios through the treacherous investment waters. In the meantime, remember that the emphasis in these times should be on return of capital rather than return on capital.
The Wall Street Journal: Forecasting survey indicates further slowdown
Click here for the full report.
Source: Phil Izzo, The Wall Street Journal, August 14, 2008.
Financial Times: Fund managers forecast global recession
“Almost one-quarter of the fund managers questioned by Merrill in August for its monthly survey said the global economy was already in recession and almost half expect the world economy to contract over the next 12 months.
“However, inflation fears are fading after the recent fall in oil prices.
“In an extraordinary reversal, a net 18% of the survey’s respondents said they expected global core inflation to fall over the next 12 months. Two months ago, a net 33% thought inflation would rise.
“‘Fears about stagflation are starting to give way to fears that the (global) economy is in for a period of below-trend growth and below-trend inflation,’ said David Bowers, of Absolute Strategy Research and independent consultant to Merrill’s fund managers surveys.
“Mr Bowers said it was ‘crystal clear’ that fund managers did not believe analysts’ profit forecasts with a net 83% describing earnings estimates for the coming year as ‘too high’.
“But as the economic downturn spreads to Europe and Japan, enthusiasm for US assets has been rediscovered by fund managers with 53% expecting the dollar to appreciate and 38% planning to overweight US equities over the next twelve months. Both readings are record highs.
“The fall in oil prices has prompted a partial unwinding of the highly popular ‘long’ energy ‘short’ financials trade.
“Among European fund managers, the net overweight position in the oil and gas sector has fallen sharply, from 62% in June to 11% in August. Meanwhile, the net underweight in banks has shrunk from 62% in June to 40%.”
Source: Chris Flood, Financial Times, August 13, 2008.
Times Online: Why the Russia-Georgia conflict matters to the West
“The names of the flashpoints may be unfamiliar, the territory remote and the dispute parochial, but the battle under way will have important repercussions beyond the region.
“The outcome of the struggle will determine the course of Russia’s relations with its neighbours, will shape Dmitri Medvedev’s presidency, could alter the relationship between the Kremlin and the West and crucially could decide the fate of Caspian basin energy supplies.
“It was known that a serious confrontation had been building up. British Intelligence predicted this year that a war in the Caucasus was probable. The focus was Georgia, the West’s main ally in the region and the only export route for Caspian oil and gas outside Kremlin control.
“Part of the responsibility must lie with President Saakashvili. The US-educated Geogian leader has rightly been praised for turning around his country’s dire economy, transforming the Soviet-style army into a modern Western force and standing up to the Kremlin.
“On paper the small Georgian military is no match for the might of Russia. But Mr Saakashvili has calculated that his friends in the West, notably America and Britain, will protect him.
“… Russia has made clear in word and deed that it will do anything to prevent Nato’s expansion on its western and southern flanks.
“America and Britain are closely involved in providing military assistance to the Georgians in the form of arms and training. The support is aimed at encouraging the rise of Georgia as an independent, sovereign state.
“But the help is also partly a means of protecting the oil pipeline across Georgia that carries crude from the Caspian to the Black Sea, the only export route that bypasses Russia’s stranglehold on energy exports from the region.”
Source: Richard Beeston, Times Online, August 8, 2008.
John Authers (Financial Times): US dollar and commodities
Click here for the full article.
Source: John Authers, Financial Times, August 11, 2008.
Stephen Roach (Morgan Stanley): Pitfalls in a post-bubble world
“By perpetuating excess consumption, low saving, unrealistic goals of home ownership, and moral hazards in financial markets, this patchwork approach has the biggest flaw of all – it does little to change bad behavior. Far from heeding the tough lessons of an economy in crisis, Washington is doing little to break the daisy chain of excesses that got America into this mess in the first place.
“If this crisis is anything, it is a wake-up call. For all too long, the United States broke many of the most important rules of conduct for a leading economy. It failed to save. It levered asset bubbles in both equities and homes to sustain unparalleled excesses in current consumption. It went deeply into debt to sustain that course of action and borrowed heavily from the rest of the world to close the funding gap. The authorities were complicit in this binge – especially a central bank that condoned unbridled risk taking and excessive monetary accommodation.
“The longer the United States sustained the unsustainable, the more it believed in the perpetuity of its charmed existence. The real message of this crisis is that this game is now over. But steeped in denial and feeling the heat of voters in a politically charged presidential election year, Washington politicians insist that the game can go on.
“More than anything, America now needs ‘tough love’ – a new course that owns up to years of excess and the remedies those excesses now require. It is the broad outlines of what that new approach might entail – more saving, as well as more investment in both people and infrastructure. An energy policy might be nice as well – as would be more prudent stewardship of the financial system. This program won’t win any popularity contests. But in the end, it is America’s only hope for a sustainable post-bubble prosperity.”
Click here for the full report.
Source: Stephen Roach, Morgan Stanley, August 1, 2008.
Asha Bangalore (Northern Trust): Credit conditions remain unfavorable
“The details of the survey show that the housing market, which was the trigger for the current financial market crisis, is unlikely to stage a rebound in the near term. Almost 80% of respondents (78.7%) indicated that they have tightened mortgage underwriting standards, up from nearly 68.7% in the April 2008 survey.
“On the business side, the fraction of banks indicating they had tightened lending standards for small firms hit a new high (see chart 6) at 65.3%, while the percentage of banks reporting tighter conditions for large firms rose to 57.6% from 55.4% in the April survey.
“The survey also included questions about the outlook for credit standards in the second-half of 2008 and the first-half of 2009. The main message from answers to these questions is that a large percentage of banks would be tightening standards in the latter half of 2008 and the fraction of banks indicating they would tighten standards in the first two quarters of 2009 showed a small decline.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 11, 2008.
John Authers (Financial Times): Credit squeeze to get more painful
“The Federal Reserve’s survey of US banks’ senior lending officers came out with little fanfare this week. In the past it has proved to be an excellent leading indicator. When banks tighten the supply of credit, historically this has led to lower employment, lower investment and lower consumer demand, with a lag of between six months and a year.
“Lending officers said they were continuing to tighten standards, whether on credit cards, prime mortgages, consumer or business loans, even though a strong majority of banks had done this in the second quarter. That implies a squeeze on consumption, and lower investment, as the year goes on.
“A similar exercise by the European Central Bank, polling lenders in the eurozone, seemed a little less gloomy, but only on the surface. There were slight decreases in the proportion of banks planning to tighten standards for corporate and household loans, but the supply of consumer credit was still tightening. Furthermore, lending officers said demand for company loans was decreasing and economic risks were putting pressure on them to tighten.
“The implications are not lost on the credit market. The recovery for credit in the wake of the Bear Stearns crisis petered out in May. Since then, in Europe and the US, the cost of insuring against default for investment-grade companies has risen but stayed well below recent highs, while the default risk for high-yield or lower-quality credits has shot up, almost regaining its highs. Spreads payable on speculative-grade credits are at their highest in four months.
“With banks planning to lend less and charge more for loans, this makes sense; it will be harder for companies to avoid default.”
Source: John Authers, Financial Times, August 14, 2008.
BCA Research: US inflation – soon to erode
“We have highlighted several times before that core CPI is likely at a cyclical peak: inflation lags economic growth by several quarters and the economy continues to slow. We still assign a very low probability to rising inflation on a cyclical basis, because wage costs failed to rise during the economic boom and are already rolling over substantially. In addition, the gap between headline and core inflation is likely to close dramatically, via a sharp decline in the headline rate as both energy and food inflation cool.
“Bottom line: Hawkish Fed rhetoric is unlikely to translate into a change in policy rates for a long time because inflation fears should gradually recede. Further economic weakness remains the more immediate threat.”
Source: BCA Research, August 15, 2008.
GaveKal: US inflation implied by TIPS
Source: GaveKal – Checking the Boxes, August 15, 2008.
Asha Bangalore (Northern Trust): Despite soaring current inflation, the Fed remains on hold
“GDP in the Euro-area declined 0.2% in the second quarter, the first since record keeping for the Euro area commenced in 1995. Germany and France, the two largest economies of the group, recorded declines in real GDP of 0.5% and 0.3%, respectively, in the second quarter. Real GDP growth in Japan also fell 0.6% in the second quarter.
“Tax rebate dollars supported economic growth in the US in the second quarter. By the next FOMC meeting on September 16, the FOMC will have another month’s data for inflation, employment, and retail sales. Employment and retail sales should continue to show weakness and headline inflation will likely be considerably lower. Therefore, the Fed is firmly on hold.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 14, 2008.
John Williams (Shadow Government Statistics): Annual CPI growth at 8.6%
Source: John Williams’ Shadow Government Statistics, August 14, 2008.
Richard Russell (Dow Theory Letters): Danger of deflation
“The US and the economies of the free world run on credit. In the US it now takes six dollars in credit to produce one dollar in Gross National Product. Maybe the biggest problem today is that the banking system has become so traumatized that it is restricting credit. Today ‘nobody can get a loan’, the complete opposite of the situation which existed prior to the housing bust. The danger – constricting credit will impact heavily on the nation’s GDP. If that happens, say hello to a blistering recession.
“With credit being restricted, a second and very serious danger surfaces. That danger is asset deflation. The very thought of asset deflation sends chills of fear up Fed chief Ben Bernanke’s spine. Credit contraction, asset deflation – shades of the Great Depression.
“What’s the antidote for deflation? It’s print, print, print. What would gold’s reaction be to ‘print, print, print’? Gold’s reaction would be – rise, rise, rise.”
Source: Richard Russell, Dow Theory Letters, August 13, 2008.
Asha Bangalore (Northern Trust): Industrial production – details reveal significantly soft factory conditions
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 15, 2008.
BCA Research: US retail sales – slowing, and more weakness to come
“Retail sales growth slowed in July, led by dismal sales at auto dealers. The ongoing squeeze on discretionary spending continues, thanks to elevated essential spending costs like food, energy, interest payments and medical bills. The recent decline in oil prices is helpful, but will need to persist for much longer before consumers perceive energy as ‘affordable’.
“The main factor that will determine consumer spending behaviour will be employment growth and we expect hiring trends to continue to deteriorate until at least the end of the year. In addition, the other major headwinds (housing and the banking system) are still in place. Bottom line: Economic risks are high and we doubt there will be much improvement in the next few quarters.”
Source: BCA Research, August 14, 2008.
Asha Bangalore (Northern Trust): Narrowing of trade deficit is noteworthy, but future is less promising
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 12, 2008.
Mike Lenhoff (Brewin Dolphin): US exports to come under pressure
“US GDP grew by 1.8% year-on-year in the second quarter of 2008. Yet 1.5% of this growth came from net exports. Less than a third of a percent came from domestic demand. The domestic economy has lost pretty well all momentum. So imports have been curbed but US exports have been holding up well, thanks to a competitive exchange rate and the strength, at least until now, of the developing economies. The contribution from net exports is just about all that is holding up US growth, but this is now likely to give.”
Click here for the full report.
Source: Mike Lenhoff, Brewin Dolphin, August 12, 2008.
Bloomberg: Zillow’s Rascoff says housing market not at bottom yet
Source: Bloomberg, August 13, 2008.
Casey’s Research: Bankers’ headache getting worse
“These delinquency rates show that the financial system has not emerged from the credit crisis, but rather, entered a new stage where bad loaning schemes are blowing up in the face of the bankers who created them.”
Source: Casey’s Research, August 14, 2008.
CNN: The next wave of mortgage defaults
“The delinquency rate for prime mortgages worth less than $417,000 was 2.44% in May, compared with 1.38% a year earlier, according to LoanPerformance.
“Delinquencies jumped even more for prime loans of more than $417,000, so-called jumbo loans. They rose to 4.03% of outstanding loans in May, compared with 1.11% a year earlier.
“And prime loans issued in 2007 are performing the worst of all, failing at a rate nearly triple that of prime loans issued in 2006, according to LoanPerformance.
“‘The extent of how bad these loans are doing is very troubling,’ said Pat Newport, real estate economist with Global Insight, a forecasting firm.
“Prime loans are just the latest class of mortgages to suffer a spike in failure rates. The first lot to go bad was, of course, subprime mortgages, whose problems set the housing meltdown in motion. Next were the Alt-A loans, a class between prime and subprime loans that doesn’t require strict documentation of a borrower’s assets or income.
“Now, as prime loans are added to the mix, the resulting foreclosures could haunt the housing market for a long time, according to Global Insight’s Patrick Newport.”
Source: Les Christie, CNN Money, August 12, 2008.
Bloomberg: Banks’ subprime losses top $500 billion on writedowns
“The writedowns and credit losses at more than 100 of the world’s biggest banks and securities firms rose after UBS reported second-quarter earnings today, which included $6 billion of charges on subprime-related assets.
“The International Monetary Fund in an April report estimated banks’ losses at $510 billion, about half its forecast of $1 trillion for all companies. Predictions have crept up since then, with New York University economist Nouriel Roubini predicting losses to reach $2 trillion.
Bloomberg: S&P 500 pulls ahead of Brazil, India, Russia and China for first time in 2008
“The “Chart of the Day” shows the S&P 500’s 12% loss this year leaves it ahead of Brazil’s Bovespa Index, whose drop through last week had been the smallest of the five countries. The US equity benchmark claimed the lead after banks rallied 22% and the steepest monthly retreat in commodity prices sent the Bovespa into a bear market.
“The Bombay Stock Exchange’s Sensex Index dropped 25% in 2008 through yesterday, China’s CSI 300 Index decreased 54% and Russia’s benchmark RTS Index fell 21%. Brazil’s Bovespa has lost 15% this year.
“In the US, where economic growth this year is projected to be less than a third of Brazil’s 4.7%, the Federal Reserve reduced interest rates seven times to 2% in the past year. Brazil’s central bank has raised its benchmark 1.75% points to 13%, India’s climbed 1.25 points to 9% and Russia’s increased 1 point to 11%.”
Source: Eric Martin, Bloomberg, August 13, 2008.
Times Online: Swing back to bank stocks is overdone, says Merrill Lynch
“In mid-July, hedge funds, pension funds and other institutional investors dramatically reversed their enthusiasm for energy stocks and loathing for financials in an abrupt about-turn that sent bank shares soaring and oil and gas companies sinking.
“But Merrill said yesterday that the unwinding of the classic bet of the credit crunch may already have been overdone, giving warning that banks across Europe could still be forced to raise between $70 billion and $120 billion in new equity on top of the $120 billion already raised.
“Merrill said that the rush to buy back into banks may already have gone too far after it stress-tested their balance sheets. It also said that fears over the sliding energy price were being overplayed.”
Source: Patrick Hosking, Times Online, August 14, 2008.
Rovert Parkes (HSBC): Equity sector reversal taking place
“Robert Parkes, equity strategist at HSBC, says there has been a clear reversal in global sector performance between the first half of 2008 and the period from July 1 to date.
“‘The top five performers in the first half – oil services, industrial metals, mining, oil producers and chemicals – have been the five worst in the second half. Of the 38 sectors in our universe, 29 showed a reversal in performance in the second half versus the first half (four sectors outperformed in both periods and five underperformed in both).
“‘Away from the likely path of commodity prices, inflation, interest rates and the dollar, a theme likely to remain prominent … is concern about the global growth outlook,’ he says.
“‘It may be too early to get involved in cyclical sectors, particularly on the consumer side.
“‘For eurozone companies with dollar exposure, the negative impact from the exchange rate on earnings growth is likely to remain prominent in the third quarter before it fades in the fourth quarter and then turns positive as we move into 2009.
“‘For UK companies with dollar exposure, the currency is likely to boost earnings growth in each of the next four quarters.’”
Source: Robert Parkes, HSBC (via Financial Times), August 14, 2008.
Bespoke: Changes in P/E ratios during the current bear market
“During bear markets, P/E ratios typically contract as prices fall faster than earnings. During this bear market, the S&P’s P/E ratio has risen from 19.62 to 25.67. This P/E expansion can be attributed to the 3 worst performing sectors. Financial and Telecom P/Es have both gone negative, and Consumer Discretionary is pretty much negative at 1,402. On the other hand, five sectors have seen P/E contraction. Technology has seen the biggest P/E decline, going from 28.19 on 10/9/07 to 21 at current prices. Utilities, Industrials, Health Care and Energy are the other sectors that have seen P/Es contract. This is definitely a concentrated bear market, where a couple sectors have caused all the problems.”
Source: Bespoke (via Real Clear Markets, August 14, 2008.
GaveKal: Chinese equities looking increasingly attractive
“How do we explain this? After all, we have been arguing that the main reason the Chinese equity bubble burst so long before the Olympics (the previously anticipated catalyst) was that commodity prices soared, which in turn squeezed margins, hampered domestic demand, raised political uncertainty and risk premiums, etc…
“So today, with oil and other commodity prices in determined decline, shouldn’t Chinese equities be catching a break? We have come up with four potential explanations for the continued selloff: 1) foreign outflows; 2) continued inflation concerns; 3) excess inventories; and 4) disappointing government support.
“Needless to say, the continued selloff in Shanghai shares is concerning. However, since Chinese shares are now massively oversold and valuations are looking increasingly attractive , we are getting cautiously optimistic. And if commodities can continue to moderate, perhaps the most significant weight on Chinese equities will be lifted …”
Source: GaveKal – Checking the Boxes, August 12, 2008.
GaveKal: Asia – tremendous buying opportunity
Source: GaveKal – Checking the Boxes, August 13, 2008.
Vladimir Savov (Credit Suisse): Russian equities
“He notes the market has fallen to levels last seen in November 2006, but says there are material differences in the economy and valuations since then.
“‘Russian GDP in 2006 was $986 billion, compared to our expectation for 2008 of $1,644 billion,’ he says. ‘The average oil price in 2006 was $66 a barrel, compared with $116 so far in 2008. In 2006, earnings growth was 39%, against our forecast of 51% for this year. A price/earnings ratio of 12.1 times in November 2006 compares to our estimate of 9.2x times for 2008.’
“Mr Savov says investors have taken too conservative a view on Russian market risk. He adds that while recent government actions to address pricing issues at Mechel have impacted on the mining sector in general, these measures should be positive for inflation and growth in the longer term. On the South Ossetia conflict, he says that fundamentally Russia’s economy and infrastructure will not be affected.
“Mr Savov sees three catalysts for Russia to bounce. ‘First, a lasting ceasefire, and ultimately, some long-term resolution of the South Ossetia issue; Second, a rebound in oil prices. Third, an outcome of the Mechel situation in which the company remains a going concern.’”
Source: Vladimir Savov, Credit Suisse (via Financial Times), August 11, 2008.
Bloomberg: Goldman reverses course, says dollar has “bottomed”
“The US currency, after reaching a 5 1/2 month high of $1.48 per euro, will climb to $1.45 per euro in three months, analysts led by Thomas Stolper wrote in a research note. Goldman had forecast a decline to $1.56 for the same period. From today’s 109.8 yen, the dollar will strengthen to 110 yen in three months, up from a previous forecast of 106.
“The dollar has gained 7.6 percent versus the euro since touching a record low in July as traders reduced bets that the European Central Bank will raise interest rates and crude oil tumbled.
“‘The fundamental picture for the dollar has improved substantially in recent weeks,’ Stolper wrote in the note.”
Source: Ye Xie, Bloomberg, August 14, 2008.
Bill King (The King Report): US dollar an unattractive haven
“With international tensions reaching a new level of intensity and the global financial system still under historic duress, we’d guess that the dollar rally could continue but it is a temporary technical reaction.
“Soon the fundamentals, especially an already record US budget deficit that should greatly escalate, will re-emerge and instigate a very, very painful re-connection with economic and financial realities.”
Source: Bill King, The King Report, August 11, 2008.
John Authers (Financial Times): Sterling breaking down
Click here for the full article.
Source: John Authers, Financial Times, August 13, 2008.
Eoin Treacy (Fullermoney): Harrowing time for precious metals
“Platinum’s upside acceleration was a warning that we were on the cusp of a medium-term correction. However, the faster downward acceleration this week also indicates that we are swiftly approaching the lows for this reaction. At Fullermoney, we continue to believe that precious metals are in a long-term secular uptrend, but given the technical deterioration, investors will have to be patient before these metals can justify significantly higher levels. However, for investors unwilling to wait out the correction, this is probably a bad time to sell considering how overextended the market is right now. Patient, more risk tolerant investors may consider nibbling around current levels or more prudently wait for a clear upward dynamic which will signal that at least a short-term floor has been reached.”
Source: Eoin Treacy, Fullermoney, August 15, 2008.
Ambrose Evans-Pritchard (Telegraph): Stage two of the gold bull market is just beginning
“Yet gold crashes. It has failed to deliver on its core promises as a safe-haven and inflation hedge, at least for now. Why?
“Four possible answers:
1) Nobody seriously believes that Russia will over-play its hand. The world could not care less about Georgia anyway. Ergo, this is a bogus geopolitical crisis.
2) The inflation story is vastly exaggerated in the OECD core of countries that still make up 60% of the global economy. The price of gold is already looking beyond the oil and food spike of early to mid 2008 (a lagging indicator of loose money two to three years ago) to the much more serious matter of debt-deflation that lies ahead.
3) The seven-year slide of the dollar is over as investors at last wake up to the reality that the global economy is falling off a cliff. Indeed, the US is the only G7 country that is not yet in or on the cusp recession. (It soon will be, but by then others will be prostrate). As an anti-dollar play, gold is finished for this cycle.
4) The entire commodity boom has hit the buffers. Looming world recession (growth below 3% on the IMF definition) trumps the supercycle for the time being.
“Gold has fallen from $1030 an ounce in February to $807 today in London trading. It has collapsed through key layers of technical support, triggering automatic stop-loss sales. The Goldman Sachs short-position that I have been observing with some curiosity has paid off.
“For gold bugs, the unthinkable has now happened. The metal has fallen through its 50-week moving average, the key support line that has held solid through the seven-year bull market. This week is not over yet, of course. If gold recovers enough in coming days, it could still close above the line.
“Well, my own view is that gold bugs should start looking very closely at something else: the implosion of Europe. (Japan is in recession too.)
“My guess is that political protest will mark the next phase of this drama. Almost half a million people have lost their jobs in Spain alone over the last year. At some point, the feeling of national impotence in the face of monetary rule from Frankfurt will erupt into popular fury. The ECB will swallow its pride and opt for a weak euro policy, or face its own destruction.
“What we are about to see is a race to the bottom by the world’s major currencies as each tries to devalue against others in a beggar-thy-neighbour policy to shore up exports, or indeed simply because they have to cut rates frantically to stave off the consequences of debt-deleveraging and the risk of an outright slump.
“When that happens – if it is not already happening – it will become clear that the pillars of the global monetary system are unstable, infested with the dry rot of excess debt.
“Gold bugs, you ain’t seen nothing yet. Gold at $800 looks like a bargain in the new world currency disorder.”
Source: Ambrose Evans-Pritchard, Telegraph, August 12, 2008.
BCA Research: Gold – soon to find a floor
“Historically, precious metals are highly correlated with the dollar (negatively) and oil prices (positively). As the oil strength and dollar weakness of the past year unwind, gold has faced downward pressure.
“However, several factors suggest that gold should soon find support and begin to edge higher in both absolute terms and relative to oil. Specifically, the setback in crude prices will help to alleviate inflation angst at the major central banks. This, coupled with rising economic pressure on the ECB and BoE to abandon their hawkish stance may bring lower European real interest rates, which is bullish for gold by increasing the supply of fiat money.
“In addition, gold ETF demand is recovering after a brief pullback and our model indicates that the ‘fair value’ of gold is in the low $900/ounce zone and rising.
“Finally, gold tends to be less sensitive to a global economic slowdown than industrial metals or energy.
“Bottom line: Gold is likely to find support around $850/ounce and then edge higher. The gold/oil ratio should continue its oversold bounce over the next few months.”
Source: BCA Research, August 12, 2008.
Frank Holmes (US Global Investors): Commodities are oversold
“The unwinding of the long energy/short financials trade also has been a big driver of recent share price performance. The combination of rules to eliminate naked short selling on financial stocks, a backlash against higher commodity prices and potential government intervention aimed at speculators in the futures market, along with calls for pension funds to divest their commodity holdings, all converged in mid-July.
“We remain optimistic about the long-term picture for natural resources. However, the short term will remain volatile due to uncertainties in global currency exchange rates and future derivatives write-downs by investment banks and other financial institutions. We’ve seen that when the banks and brokerages have to raise capital to address their derivatives problems, it triggers abrupt liquidity squeezes that increase short-term volatility, especially in emerging markets and small-cap equities. The recent confrontation between Russia and Georgia has brought about heightened geopolitical tensions, which have contributed to volatility in currency markets and introduced significant uncertainty over the current world order.
“On a positive note, China announced last week that it was changing policy to increase loan quotas. This is a significant shift in policy; in effect, China is refocusing on economic growth now that inflation there has trended lower. This type of policy action will continue to drive infrastructure spending, which in turn will drive demand for commodities. Another positive is the clear election-year signal by the U.S. government that it will do what is necessary to protect the financial sector and avoid a major recession, including an additional fiscal stimulus package in early 2009.
“We believe this correction, while painful, is healthy and constructive for natural resource markets over the long term. Commodity supplies remain extremely tight, and as global population and emerging economies continue to grow, these trends will be supportive of commodity prices. The risk to this scenario would be major policy changes by the world’s most populous countries that would slow infrastructure spending, which we continue to view as unlikely.”
Source: Frank Holmes, US Global Investors – Weekly Investor Alert, August 15, 2008.
Ifo: Eurozone economic climate indicator falls further
“The economic climate has further clouded over in nearly all countries of the euro area in the third quarter of 2008. Particularly negative assessments of the current economic situation have come from Italy, Spain, Portugal, Ireland and Belgium. Favourable assessments of the current situation continue to come from Finland, Austria, Germany and the Netherlands, however. In the opinion of the World Economic Survey (WES) experts, the slowing in economic activity will continue in all countries of the euro area in the coming six months.
“At 3.6%, the inflation expectations exceed the ECB target even more so than at the beginning of the year (2.5%). In contrast to the previous survey, the WES experts anticipate an increase in key lending rates in the course of the come six months.
“The US dollar is assessed as undervalued vis-à-vis the euro. In the coming six months, a slight strengthening of the US dollar is expected. Also the Japanese yen and the British pound are seen as undervalued vis-à-vis the euro.”
Click here for the full report.
Source: Ifo, August 13, 2008.
James Pressler (Northern Trust): Eurozone economy contracted in Q2
Source: James Pressler, Northern Trust – Daily Global Commentary, August 14, 2008.
James Pressler (Northern Trust): Eurozone economies seeing price acceleration
“Today’s Eurostat report offers the ECB a chance to hold monetary policy for the near-term – recognizing that growth has slowed considerably but the slowdown appears contained given current interest rates. If the recent fall in oil prices translates into less-threatening CPI figures in the coming months, the ECB will have every justification in focusing its attention on the weak economy with an eye toward easing if necessary.”
Source: James Pressler, Northern Trust – Daily Global Commentary, August 14, 2008.
Edmund Conway (Telegraph): Mervyn King issues warning on UK economy
“He warned that households face an ‘extremely difficult’ year ahead as Britain is hit by rising energy and oil prices and the worst financial crisis ‘since the Second World War’.
“Setting out a gloomy diagnosis of the problems facing families, Mr King also warned that:
• Inflation will rise to 5% or above – the highest level in 16 years – ruling out an immediate cut in interest rates.
• House prices will continue to fall in the coming months, despite already suffering the biggest drops in recorded history.
• Thousands more workers will lose their jobs as struggling firms cut back on staff.
“Mr King slashed his forecast for the UK’s growth, acknowledging that by the end of this year the economy will be shrinking rather than expanding.
“This last happened in 1992, when Britain was in the midst of a major recession. The Governor added that a technical recession – defined as the economy shrinking for two successive quarters – was more than possible.
“‘It is bound to be the case there will be a quarter or two of negative growth,’ he said. ‘Oil prices are at the highest level in real terms at any point in the post-war period apart from the late 1970s, and we’ve also seen the biggest financial dislocation since the Second World War.
“‘What is unique about the present set of circumstances is that both shocks have happened at the same time, and the combination has meant that life is extremely difficult, and will be for the UK economy over the next year.’”
Source: Edmund Conway, Telegraph, August 13, 2008.
Financial Times: Alert as Japanese economy contracts
“In Japan, new data showed the world’s second largest economy contracted by 0.6% in the second quarter, its worst quarterly performance for seven years.
“The quarterly decline makes Japan the biggest economy yet to experience economic contraction this year.”
Source: Chris Giles, Financial Times, August 13, 2008.
Bloomberg: Nomura’s Koo says Japan may already be in recession
Source: Bloomberg, August 11, 2008.
Financial Times: China to overtake US as largest manufacturer
“The great leap is revealed in forecasts for the Financial Times by Global Insight, a US economics consultancy. According to the estimates, next year China will account for 17% of manufacturing value-added output of $11,783 billion and the US will make 16%.
“Last year the US was still easily in the top slot and accounted for a fifth of the total. China was second with 13.2%.
“John Engler, president of the National Association of Manufacturers, a Washington-based trade group, played down the effect of the projections. It was ‘inevitable’ that China would take over on account of its size, he said. ‘This should be a wholesome development for the US, for it promises both political stability for the world’s largest country and continuing opportunities for the US to export to, and invest in, the world’s fastest-growing economy.’”
“The expected change will end more than a 100 years of US dominance. It returns China to a position it occupied, according to economic historians, for some 1,800 years up to about 1840, when Britain became the world’s biggest manufacturer after its Industrial Revolution.”
Source: Peter Marsh, Financial Times, August 10, 2008.
Forbes: China’s July wholesale prices up 10%
“The producer price index was up 10% in July over the same month last year, the highest rate since 1996, the Xinhua News Agency said, citing the government’s statistics bureau. The index measures the price of goods as they leave the factory.
“Analysts have warned that rising costs for energy and raw materials would push up Chinese wholesale prices, squeezing thin profit margins for companies and adding to pressure for retailers to raise consumer prices.
“The July rise in the producer price index, or PPI, exceeded analysts’ expectations and was a sharp jump over June’s 8.8% rate.”
Source; Joe McDonald, Forbes, August 11, 2008.
Bloomberg: India inflation accelerates to 16-year high of 12.44%
“Wholesale prices rose 12.44% in the week to August 2, after increasing 12.01% in the previous week, the commerce ministry said in New Delhi today. Economists were expecting a 12.2% gain.
“Prime Minister Manmohan Singh’s cabinet today approved an average 21% salary increase for about 5 million government employees. That may give the central bank little choice other than to raise interest rates again after three increases since June, economists said.
“‘We expect inflation to remain elevated and reach 13.5% by December,’ said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd. in Mumbai. ‘We are looking at a 50 basis point increase for both the repurchase rate and the cash- reserve ratio by year-end.’
“The Reserve Bank of India last month raised its benchmark rate by a half point to a seven-year high of 9%.”
Source: Kartik Goyal, Bloomberg, August 14, 2008.
Bloomberg: Argentina’s debt rating cut by Standard & Poor’s
“S&P lowered Argentina’s rating to B, five levels below investment grade and in line with countries including Jamaica and Paraguay, from B+.
“Argentina faces ‘increasing economic challenges,’ S&P analyst Sebastian Briozzo wrote in a statement. ‘Inflation and fiscal and financial strain have increased while the likelihood of the government taking prompt corrective measures to staunch the loss of creditworthiness remains low.’
“Argentine bonds tumbled last week after President Cristina Fernandez de Kirchner defended the government’s inflation data. While government data puts annual inflation at 9.1%, S&P said ‘private estimates suggest that it might actually be about 24% to 28%’.”
Source: Drew Benson, Bloomberg, August 11, 2008.
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