Words from the (investment) wise for the week that was (August 25 – 31, 2008)
The gyrations of financial markets ahead of the Labor Day weekend tested the patience of bulls and bears alike. As big swings took place in thinly-traded markets, I was reminded of Albert Schweitzer’s words: “As we acquire more knowledge, things do not become more comprehensible but more mysterious.”
None the wiser, I also did not succeed in capturing a leprechaun and finding the gold during my visit last week to the Emerald Isle. However, the beautiful Irish scenery, hospitality and “open for business” attitude resulted in a very successful trip and will keep me going back in search of the “buried treasure”.
Nervousness about the financial system was still paramount as investors realized that none of the problems were likely to be fixed anytime soon. The upshot of the week’s trading was a further weakening in credit markets, judging by the elevated credit spreads. Global stock and bond markets ended another volatile week on a mixed note, whereas crude prices gained surprisingly little on the impending arrival of Hurricane Gustav and a festering geopolitical situation with Russia.
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, words such as “banks”, “prices”, “credit” and “financial” featured prominently in my reading matter.
I do believe we are still in a primary bear market where stock markets are, at best, faced with a prolonged convalescence period characterized by sub-optimal returns. Whether significant further declines will take place from these levels and valuations overshoot to bargain levels is anybody’s guess.
However, in the short term I give the nascent stock market rallies the benefit of the doubt provided the mid-July lows are sustained. For any rally to become more enduring will require further base building and an eventual shift in central bank policy to targeting GDP growth rather than inflation.
The rally’s lack of breadth, however, is worrying, causing Richard Russell (Dow Theory Letters) to warn: “If July 15 was a true bottom, the market should be roaring up today, and that’s not what’s been happening. Caution is warranted!”
But we should also take note of the fact that 64% of stocks in the S&P 500 are currently trading above their 50-day moving averages, as pointed out by Bespoke. “As shown in the chart below, the reading has been creeping higher and higher since mid-July, and looks to be on its way to the 80% to 85% levels seen twice over the last year. Readings above 50% are signs of a healthy market, and it hasn’t been above 50% for much of 2008.”
Seasonality indicates that “September has firmly secured the rank as the worst month of the year” (Stock Trader’s Almanac), but that a year-end rally typically starts in late September / early October.
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.
The minutes from the FOMC meeting of August 5, released on Tuesday, indicate that committee members were concerned about the near-term risks to growth. Most participants expected inflation to fall, although they remained wary about upside risks to inflation. Given the problems in financial markets, members did not view current monetary policy as overly stimulative.
Other economic reports released in the US during the past week included the following:
• The GDP growth rate in the second quarter was revised upward to 3.3% from 1.9%, exceeding expectations. In the first quarter, real GDP increased by 0.9%. The better-than-expected outcome did not change most economists’ view that the economy was weakening, with the beneficial effects of rebate checks and foreign demand fading fast. Corporate profits edged down for the fourth straight quarter, falling twice as fast as in the first three months of the year.
• New orders for durable goods rose by 1.3% in July, surpassing expectations for only a slight increase. Core capital goods orders also surprised on the upside, increasing by 2.6% over the month.
• Existing home sales increased by 3.1% over the month in July, according to the National Association of Realtors. This increase put the annualized pace of sales up to 5 million units. However, substantial slack persisted, with inventories hitting a record high of 11.2 months. Furthermore, the median price of an existing house declined by 7.1% in year-ago terms, slightly worse than in June.
• Personal income tumbled by 0.7% in July after rising by 0.1% in June. Excluding the tax rebate effect, disposable personal income rose by 0.5% in July, up from 0.3% in June. Spending growth slipped to 0.2% from 0.6% the previous month. Real spending fell by 0.4% as price growth remained high. The core PCE deflator rose by 0.3%, matching the fastest rate since September, while the top-line deflator rose by 0.6%. The saving rate fell back to 1.2% from 2.5% in June but remained inflated by rebates.
Summarizing the US economic situation, John Mauldin (Thoughts from the Frontline) said: “Even many mainstream economists are now suggesting we will be in a recession by the fourth quarter, if we are not in one now. The recovery, when it comes, will be tepid until credit spreads signal an end to the credit crisis. It is going to be Muddle Through for 2009. This is NOT going to be good for the stock market. When will it be safe to get back into the water? Pay attention to credit spreads.”
Data releases from Europe and Japan underlined rapidly deteriorating economies flirting with recession. The Japanese government announced a $107 billion set of fiscal measures, including tax cuts and larger government-guaranteed loans, in response to the weakening economy.
Week’s economic reports
Source: Yahoo Finance, August 29, 2008.
In addition to the Fed releasing its beige book on September 3 and interest rate announcements by the Bank of England and the European Central Bank on September 4, next week’s US economic highlights, courtesy of Northern Trust, include the following:
1. ISM Manufacturing Survey (September 1): The consensus for the manufacturing ISM composite index is 49.5 vs. 50.0 in July. If the consensus forecast is accurate, it would be consistent with weakness in other parts of the economy. Consensus: 49.5 versus 50.0 in July.
2. Employment Situation (September 5): Payroll employment in August is expected to have dropped by 85,000, taking the tally of consecutive monthly declines to eight. The jobless rate is predicted to have held steady at 5.7%. Consensus: Payrolls: -75,000 versus -51,000 in July, unemployment rate: 5.8% vs. 5.7% in July.
3. Other reports: Construction spending, auto sales (September 2), factory orders (September 3), ISM non-manufacturing (September 4).
Click here for a summary of Wachovia’s weekly economic and financial commentary.
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, the trend of the US dollar.
Source: Wall Street Journal Online, August 31, 2008.
Among mature markets, the US stock indices were mostly lower, but European stocks turned in good performances, for example Italian Comit 30 Index (+2.6%), French CAC 40 Index (+1.9%) and German XETRA Dax Index (+1.3%). Australia (+4.1%), Japan (+3.2%) and Canada (+2.4%) also shrugged off the gloomy economic outlook and moved higher.
The emerging markets category saw solid gains in Hong Kong (+4.3%) and Taiwan (+2.0%), whereas large declines were registered by Pakistan (-7.9%), Russia (-3.3%) and Turkey (-2.6%). The Russian Trading System Index ( 16.3%) and the Chinese Shanghai Composite Index (-13.6%) were the worst performers for the month of August.
With the exception of the Russell 2000 Index (+0.3%; YTD -3.5%), the US stock markets closed lower as shown by the major index movements: Dow Jones -0.7% (YTD -13.0%), S&P 500 Index +0.7% (YTD -12.6%) and Nasdaq Composite Index -2.0% (YTD 10.7%).
Particularly noteworthy, the MSCI World Index has outperformed the MSCI Emerging Markets Index over the past month (-1.6% vs -8.2%), past three months (-11.9% vs -21.0%), YTD (-15.4% vs -23.2%), and also since the stock market peaks of October 2007 (-20.7% versus -28.6%).
The Russell 2000 Index is trading above both its 50- and 200-day moving averages, whereas the Dow Jones Industrial Index, S&P 500 Index and Nasdaq Composite Index are above their 50-day averages but still below the important 200-day line – often used as an indicator of the primary trend.
The thrifts and mortgage finance group (+16%) was the best-performing group for the week, led by Freddie Mac (FRE) and Fannie Mae (FNM), up 61% and 37% respectively. This is a strong reversal from being the worst-performing group during the previous week with a decline of 23%. The stocks were driven down recently by speculation on whether a government bailout was imminent, a prospect that would probably wipe out the equity holders. Those concerns seemed to diminish last week after some analysts estimated that the firms had enough capital to last at least until next year.
The homebuilding group was the second-best performing group, gaining 9% on housing reports being interpreted as showing signs of a stabilizing market.
The trucking group (-7%) was the worst performer, led by its single member, Ryder System (R). A brokerage analyst downgraded the trucking sector, predicting that freight volumes in the peak shipping season through November might be weaker than expected because of the soft US economy.
The Internet retail group (-6%) was the second-worst performer, led by its largest member, Amazon (AMZN). A blog posting by a newspaper reporter raised the topic again of how well Amazon’s Kindle electronic book reader was actually selling.
The ten-year US Treasury Note declined by 4 basis points to 3.83%, the UK ten-year Gilt yield by 13 basis points to 4.48%, the German ten-year Bund yield by 5 basis points to 4.17% and the Japanese ten-year bond yield by 5 basis points to 1.42%.
The past week saw the greenback rising against the euro (+0.7% – a six-month high), the British pound (+1.6%), the Swiss franc (+0.2%), the Australian dollar (+1.2%) and the Canadian dollar (+1.6%).
Sterling has come under further selling pressure as pessimism about the UK economic outlook intensified, dropping to a 12-year low on a trade-weighted basis ahead of the Bank of England’s interest rate announcement next week.
The Japanese yen was the only currency to gain against the US dollar during the past week, closing 1.1% higher on the back of better-than-expected economic data and the announcement of a $107 billion fiscal stimulus package.
West Texas Intermediate crude traded between $115.0 and $118.76 a barrel last week before closing 0.8% up at $115.46 on Friday. The gain was relatively small given the impending arrival of Hurricane Gustav and concerns about the geopolitical situation with Russia, but word from the Department of Energy that it would release strategic oil stocks to combat any disruption kept oil prices in check. (The Gulf of Mexico is responsible for 25% of US crude oil production and 15% of US natural gas production.)
The chart below shows the past week’s movements for the various commodities:
Now for a few news items and some words and charts from the investment wise that should be of help with keeping our investment portfolios on a winning path. As the Irish say: “Go n-eírí an bóthar leat. May the road rise with you.” And also wishing you a fabulous Labor Day weekend.
Hat tip: Barry Ritholtz’s Big Picture
YouTube: Take a load off Fannie
Financial Times: Fannie and Freddie doubts grow
“Bank of China this week revealed it had cut its portfolio of securities issued or guaranteed by the two government-sponsored enterprises by a quarter, or $4.6 billion, since the end of June. The sale underscored signs of nervousness among foreign buyers of Fannie and Freddie’s debt.
“Federal Reserve custody data on Thursday showed foreign official and private investors reduced their holdings of agency debt for the sixth consecutive week.
“Bill O’Donnell, analyst at UBS said: ‘If this recent theme of cooling passions for GSE’s debt becomes a longer-term trend, then it could be problematic for the GSEs given that the central banks have taken … roughly 30% to 60% of new GSE issuance in recent months and years.’
“The US Treasury was granted powers last month to extend its credit lines to Fannie and Freddie and to invest in their debt and equity.”
Source: Saskia Scholtes, Financial Times, August 29, 2008.
Times Online: Buffett predicts game over for Fannie and Freddie
“Warren Buffett, the world’s richest man, said it was no longer feasible for America’s two biggest mortgage finance companies to exist independently. He went on to forecast that the US economy would remain in the doldrums for at least five months.
“Fannie and Freddie, which underpin America’s mortgage market by buying home loans and packaging them into bonds, did not have any net worth, Mr Buffett told CNBC. Both face losses of tens of billions of dollars on the bonds. Analysts said they look increasingly likely to need a cash injection from the Government and Mr Buffett said they were too big to fail, predicting: ‘You will see some action fairly soon.’
“Mr Buffett was also downbeat about the housing market and, in turn, the broader economy. ‘What we’re seeing in business, in our retail business, or anything having to do with housing, is a further slowing down in June and July, both in terms of credit experience where people first got into trouble with house payments, and now credit card payments,’ he said. ‘In my judgment, it [the economy] won’t be any better five months from now.’
“Mr Buffett, who runs the Berkshire Hathaway investment group from its headquarters in Omaha, Nebraska, added: ‘You always find out who’s been swimming naked when the tide goes out. We found out that Wall Street has been kind of a nudist beach.’
“Mr Buffett said he expected more banks to fail, especially in areas where there was a housing bubble. ‘We will see failures where the bankers were dumb in what they did,’ he said.”
Source: Tom Bawden, Times Online, August 23, 2008.
John Authers (Financial Times): Credit crunch winners and losers
Click here for the full article.
Source: John Authers, Financial Times, August 29, 2008.
Financial Times: Bankers caught between hope and despair
“By the same token they are unsure to what extent weakening growth will help to ease high inflation.
“‘There is enormous uncertainty about where we stand at the moment,’ Stanley Fischer, governor of the Bank of Israel, said at the close of the Federal Reserve’s annual retreat in Jackson Hole, Wyoming.
“His comments came as US Treasury officials worked through the weekend on options for Fannie Mae and Freddie Mac, the troubled mortgage groups, amid expectations an announcement could come this week.
“Mr Fischer told central bankers from 43 nations ‘we are in the midst of the worst financial crisis since World War II’. But it was still not clear how big an event it would turn out to be.
“So far, he said, ‘in real economy terms we are not looking at anything exceptional’. But the crisis was entering a ‘second round’ in which economic and financial weakness could feed on each other.
“Other current and former central bankers shared this view. Alan Blinder, a former Fed vice-chairman, said: ‘It is amazing a year later how much is still unresolved.’
“Monetary policymakers appear torn between hope that the global economy is turning out to be resilient – in part thanks to policy interventions – and fear that the worst could lie ahead.
“They think the economy will muddle through and recover next year. But they cannot rule out the possibility that the financial crisis – in conjunction with the oil shock – could deliver a bad economic outcome.”
Source: Krishna Guha, Financial Times, August 24, 2008.
Barron’s: Is the global liquidity tide turning?
“Too bad they are little more than corks tossed on violent seas of global forces totally beyond their control.
“The inflationary tide in global liquidity could be turning … The sharp break in gold suggests that could be happening, and that’s being transmitted through the commodities markets. The dollar has stopped going down, and even has flattened out against the renminbi. The bear market in risk assets, such as stocks and particularly the Chinese market, also is symptomatic of a liquidity squeeze. As for the US housing market, it is at the nexus, resulting in wealth losses for borrowers and a reduction in lenders’ ability and willingness to extend credit.
“That’s something that the crowd in Jackson Hole can scarcely control. So they might as well enjoy themselves on their junket.”
Source: Randall W. Forsyth, Barron’s, August 21, 2008.
The Wall Street Journal: New credit hurdle looms for banks
“At issue are so-called floating-rate notes – securities used heavily by banks in 2006 to borrow money. A big chunk of those notes, which typically mature in two years, will come due over the next year or so, at a time when banks are struggling to raise fresh funds. That’s forcing banks to sell assets, compete heavily for deposits and issue expensive new debt.
“The crunch will begin next month, when some $95 billion in floating-rate notes mature. JPMorgan analyst Alex Roever estimates that financial institutions will have to pay off at least $787 billion in floating-rate notes and other medium-term obligations before the end of 2009. That’s about 43% more than they had to redeem in the previous 16 months.
“The problem highlights how the pain of the credit crunch, now entering its second year, won’t end soon for banks or the broader economy. The Federal Deposit Insurance Corp. said on Tuesday that its list of ‘problem’ banks at risk of failure had grown to 117 at the end of June, up from 90 at the end of March. FDIC Chairman Sheila Bair said her agency might have to borrow money from the Treasury Department to see it through an expected wave of bank failures. She said the borrowing could be needed to handle short-term cash-flow pressure brought on by reimbursements to depositors after bank failures.
“As banks scramble to pay the floating-rate notes, they could see profit margins shrink as wary investors demand higher interest rates for new borrowings. They’re also likely to become less willing to make new loans to consumers and companies, aggravating economic downturns in both the US and Europe.”
Source: Carrick Mollenkamp, The Wall Street Journal, August 27, 2008.
Scott Bugie (Standard & Poor’s): Second phase of credit crunch could be severe
“‘Loan book deterioration is starting to hit a wider array of financial institutions, as credit losses migrate from subprime into other sectors of household finance, such as credit cards, Alt-A and prime mortgages, and auto loans well into 2009,’ he says.
“Mr Bugie believes losses on the loan books of US banks could reach $265 billion a year for the next two to three years. In Europe, he says, the focus of concern is shifting to commercial loans as European economies enter a downturn.
“While capital-raising has largely offset losses that financial institutions have incurred from writedowns, much of the capital raised has been in the form of hybrid securities with both debt and equity characteristics, he says.
“‘Consequently, the quality of the banks’ capital has eroded somewhat.’
“And he warns that in the US and Europe, a major concern is regional banks’ ability to raise capital.”
Source: Scott Bugie, Standard & Poor’s (via Financial Times), August 26, 2008.M
GaveKal: The Libor spread points to financial stress
Source: GaveKal – Checking the Boxes, August 26, 2008.
Asha Bangalore (Northern Trust): Fed on hold, arguments in favor of supporting growth outweigh inflation concerns
It is also interesting to note the following quote:
“‘Most members did not see the current stance of policy as particularly accommodative, given that many households and businesses were facing elevated borrowing costs and reduced credit availability due to the effects of financial market strains as well as macroeconomic risks. Although members generally anticipated that the next policy move would likely be a tightening, the timing and extent of any change in policy stance would depend on evolving economic and financial developments and the implications for the outlook for economic growth and inflation.’”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 26, 2008.
Richard Russell (Dow Theory Letters): We’re heading for de-leveraging and deflation
“What’s going on? ‘One school holds that bonds are mispriced. Buyers are either complacent or smoking something stronger than tobacco. Even if they are in full command of their faculties, they are choosing liquidity over yield.’
“Russell Comment – Bond people tend to be very sophisticated. I think they are thinking in terms of the great international de-leveraging that may be coming up. Or why would the 10-year T-notes be selling at a lousy 3.8% yield which is actually below the rate of inflation? Obviously, the bond crowd sees deflation ahead. And nobody else does. Maybe the stock market is just getting wind of it now!
“Remember, years ago I said that the big problem coming up would be INCOME. Everybody’s going to need income, and income will be hard to come by. I’m still of that same opinion. My dear subscribers – hunker down – there’s a hard rain a’comin’. We’re heading into de-leveraging and deflation, and nobody’s positioned for it.”
Source: Richard Russell, Dow Theory Letters, August 25, 2008.
Bloomberg: Feldstein says low Fed rates may not stimulate growth
“‘Lower interest rates are not going to get us anything more,’ said Feldstein, who retired in June as president of the National Bureau of Economic Research. ‘The economy has really shown one sign after another of weakening.’”
Source: Bloomberg, August 21, 2008.
Sheryl King (Merrill Lynch): Economic domino effect
Click here for the full report.
Source: Sheryl King, Merrill Lynch, August 27, 2008.
Asha Bangalore (Northern Trust): Q2 GDP is history, focus should be on the future
“The upward revision of government expenditures (3.9% vs. 3.4%) was another category accounting for the upward revision of GDP growth in second quarter. Other minor upward revisions included a 1.7% gain in consumer spending vs. a 1.5% increase and a 3.2% drop in capital spending vs. a 3.4% drop in the advance estimate. Offsetting these upward revisions were downward revisions of expenditures on structures and residential investment expenditures.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 28, 2008.
BCA Research: US leading economic indicator – still no recovery in sight
“The Conference Board’s US leading economic indicator (LEI) fell again in July, providing a fresh reminder that the slowdown is far from over. A domestic recession is underway and policy efforts to stimulate growth have been short-circuited by a collapse of risk-taking in the financial markets.
“Mortgage rates rose as policy rates declined, underscoring that the housing slump will persist. Rumors that the Treasury Department may have to absorb the two large GSEs are proliferating, underscoring the seriousness of the banking and financial crisis (please see the next Insight).
“Bottom line: The economy will remain weak for the foreseeable future, implying persistently low Treasury yields and further struggles for the equity market.”
Source: BCA Research, August 25, 2008.
Asha Bangalore (Northern Trust): Consumer spending – strong likelihood of decline in Q3
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 29, 2008.
BCA Research: US durable goods orders – expanding, but …
“Investment spending has been a relative ‘bright light’ for the US economy, mainly because a weak dollar has allowed US companies to gain global market share, and overseas demand has been resilient. Indeed, core capital goods orders bottomed in 2007 and have been slowly trending higher, in contrast with domestic consumption, which peaked in 2004 and continues to decelerate.
“Nevertheless, our investment spending model forecasts that capex growth will drop to zero by the end of the year. Sticky corporate bond yields, and a further slowing in final demand at home and abroad, will cause companies to defer expansion plans: expect more weakness ahead.”
Source: BCA Research, August 28, 2008.
Bill King (The King Report): Goldman’s Jan Hatzius – don’t be fooled by durable goods numbers
Source: Bill King, The King Report, August 28, 2008.
Asha Bangalore (Northern Trust): A perspective on home prices
“The price-to-rent ratio (used here) is computed from the national Case-Shiller Home Price Index and Owners’ Equivalent Rent of the Consumer Price Index. The Case-Shiller Price Index goes back to 1987:Q1. (For the convenience of reading a chart, I set the 1987:Q1 price-to-rent ratio = 100.) Excluding the go-go years when home prices climbed rapidly, the median price-to-rent ratio and mean price-to-rent ratio during 1987:Q1 – 2001:Q4 were 94.31 and 96.38, respectively.
“Compared with these numbers, the 125.4 price-to-rent ratio in the second quarter of 2008 is still at an elevated level. It appears that home prices have a long march ahead when compared with the mean (109.6) and median (102.5) price-to-rent ratio for the period 1987-2008:Q2 also.
“If history is any guide, the price-to-rent ratio suggest that the bottom of home prices is not here yet.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, August 27, 2008.
BCA Research: US house prices – no bottom in sight
“The outlook for US housing is still bleak. Mortgage rates remain elevated, inventories of existing homes are stuck at record highs and prices continue to fall. The only silver lining in this dark cloud is that a nationalization of the GSEs is becoming increasingly likely, which could provide much needed capital to finance housing transactions. However, even such an unprecedented step would not sound the ‘all clear’.
“A domestic recession is underway and a rising unemployment rate means that the uptrend in foreclosure rates will spread beyond the sub-prime market.
“Bottom line: Even if the GSEs are nationalized, there will be no quick fix for the housing market, and it appears that the slump has at least another year to run.”
Source: BCA Research, August 27, 2008.
Financial Times: Merrill losses wipe away long-term profits
“Since the onset of the credit crunch last year, Merrill has suffered after-tax losses of more than $14 billion as its balance sheet has been savaged by almost $52 billion in writedowns and credit-related losses.
“Merrill’s total inflation-adjusted profits between its 1971 listing and 2006 were about $56 billion, according to figures from Thomson Reuters Fundamentals and an FT analysis of reported earnings.
“The $14 billion in losses for 2007 and the first two quarters of 2008 equal half of Merrill’s profits since the beginning of the decade.
“Merrill had the highest ratio of credit crunch losses to historical profits among 10 US and European financial groups analysed by the FT, which included Citigroup, JPMorgan Chase, Bank of America, Morgan Stanley, Goldman Sachs, Lehman Brothers, Bank of America, Credit Suisse and UBS.
“UBS, which has lost more than $15 billion during the crisis, had the second-highest ratio.”
Source: Francesco Guerrera, Financial Times, August 28, 2008.
Financial Times: SEC plans for global accounting standards
“The US Securities and Exchange Commission on Wednesday proposed a ‘roadmap’ to manage the migration of US companies from its rules to the international ones. The plans are open to comment for 60 days.
“More than 100 countries use, or are adopting, International Financial Reporting Standards (IFRS), including all 27 European Union members as well as China, Japan, Canada and India. US GAAP, the accounting lingua franca until the sudden rise of IFRS, is the last significant standard to be switched.
“Under the SEC’s plans, US groups are likely to adopt IFRS in 2014 providing certain conditions are met, a decision that will be taken in 2011. Some companies may be allowed to adopt IFRS sooner.
“Christopher Cox, SEC chairman, said more groups were reporting under IFRS than US GAAP and the number would rise as other large economies made the switch. He said US GAAP would be marginalised if the US did nothing, making it harder for international investors to consider US companies.
“A single set of globally understood accounting rules is expected to help cut companies’ cost of capital and better enable cross-border investment. In countries without strong accounting traditions, the rules are expected to raise the quality of reporting, helping inward investment.”
Source: Jennifer Hughes, Financial Times, August 27, 2008.
Bespoke: Credit spreads continue to get worse
Source: Bespoke, August 26, 2008.
Financial Times: Government bonds reflect bad tidings
“In the past month, US, German, UK and Japanese bond yields have been falling as investors have dismissed the threat of inflation and priced in a higher risk of global recession led by the big economies.
“The expectation of rate cuts in the UK and eurozone should be vindicated by weaker growth and lower inflation in the coming months. In the US, the sharp cuts earlier this year should suffice unless the economy hits a wall in 2009.
“At the centre of the big freeze, US policymakers still face challenges as home prices keep falling while inventories of unsold properties rise.
“With economic gloom deepening, falling US Treasury yields have been accompanied by rising yields for corporate and mortgage bonds. Until house prices stabilise, banking writedowns will sustain a bid for government debt at the relative expense of other riskier fixed-income securities.
“At some point, however, selling long-dated Treasuries and buying risky mortgage and corporate bonds will become the dominant trade for investors. One barometer to watch will be a sharply steeper yield curve, whereby long-term yields rise much more than those of the two-year note.
“Once banks have plugged all their balance sheet holes, a steeper Treasury curve will facilitate borrowing at low rates and the buying of longer-dated, higher-yielding mortgages and other debt. Call it a carry trade on steroids that slowly helps banks nurse their balance sheets back to health.
“Unfortunately for the Fed, the stars are not yet aligned for banks and investors to play the game of ultimate carry, which suggests that further selling of risky assets beckons.”
Source: Michael Mackenzie, Financial Times, August 25, 2008.
Richard Russell (Dow Theory Letters): Lowry’s Index shows worst lies ahead
“I just talked to Paul Desmond, who runs Lowry’s. I asked him why he was so sure that we were heading for 90% down-days. His answer was that this rally is so weak. Overall volume was only 3.7 billion today and today upside volume was only 62.8% of up + down volume. Furthermore, Paul noted that breadth is very weak – breadth should be exploding on the upside here, but that’s not happening. In all, this is a weak rally, suggesting that worse action lies ahead!”
Source: Richard Russell, Dow Theory Letters, August 28, 2008.
Bespoke: NYSE short interest declines again
“So what has the SEC done to continue enforcement of short selling rules? They let the temporary order expire, and said a new set of rules would be coming in the ‘next few weeks’.”
Source: Bespoke, August 27, 2008.
David Fuller (Fullermoney): The upside is for the bulls to prove
“Sustained breaks above the August rally highs to date for major indices, preferably with financials participating.
“This is a big ask without a catalyst such as a change in the emphasis of monetary policy from fighting inflation to boosting economic growth. Whether this Rubicon is crossed in the next few weeks or sometime next year remains to be seen and probably depends on events.
“Meanwhile, valuations are much improved, albeit still well above record attractive levels. The west’s credit crisis has not gone away but some other concerns have diminished. For instance, most people no longer expect another spike in the price of crude oil anytime soon, and rightly so give demand destruction. A commodity related spike in long-dated government bond yields has not only been avoided for the time being, but yields are actually falling in line with recession fears. Concern over an additional collapse of the US dollar has been replaced by a reassuring rebound.
“In other words, some of the year-long concerns are either abating or at least priced into markets to a not insignificant degree. As practically every financial journalist has talked about the worst financial crisis since the USA’s Great Depression, this is not a new story, right or wrong. The only new worry of consequence is some unnecessary and hopefully temporary Cold War style provocation between the Russian Federation and the USA. Potentially more significant for stock markets is the mountain of cash sitting in money market mutual funds.
“Nevertheless investors are understandably cautious given all the financial concerns, whether largely discounted or not, and everyone knows that most stock markets are still in overall downtrends. Therefore the upside is, as we say, for the bulls to prove. Judging from the sluggish chart action, the fear of further losses is still greater than the fear of being of being left behind in the next good rally.”
Source: David Fuller, Fullermoney, August 27, 2008.
Bespoke: Stock market seasonality – September could present rough sledding
“In the chart below, we show the average historical trading pattern of the S&P 500 during the last four months of the year. The blue line shows the S&P 500’s trading pattern from 1960 – 2007, while the red line shows the average of the last ten years. As shown, over both time frames, the S&P 500 typically declines during most of September before staging a year-end rally beginning in late September/early October.”
Source: Bespoke, August 26, 2008.
Bespoke: High earnings growth expectations?
Source: Bespoke, August 26, 2008.
Bespoke: Strategist price targets down the home stretch
Source: Bespoke, August 26, 2008.
Charles Kirk (The Kirk Report): ETF leaders and laggards
Source: Charles Kirk, The Kirk Report, August 26, 2008.
Bespoke: Energy’s loss is the financials’ gain
“As shown in the shaded areas, estimate revisions for both the energy and financial sectors have had sharp reversals. In mid-July, nearly 55% of stocks in the financial sector had seen their numbers cut in the prior month. Today, the percentage has decreased to only 25%. In the energy sector, in mid-July analysts had raised estimates on nearly 75% of the stocks in the index over the prior four weeks. Currently, nearly 25% of the stocks in the sector have seen their numbers cut over the last four weeks.”
Source: Bespoke, August 29, 2008.
GaveKal: Japanese stocks set to outperform bonds
Source: GaveKal – Checking the Boxes, August 29, 2008.
US Global Investors: Plenty of sidelined liquidity in China
Source: US Global Investors – Weekly Investor Alert, August 29, 2008.
David Fuller (Fullermoney): Russia offers medium-term value
“Most of this break occurred as capitulation selling hit resources stocks everywhere, making it the last sector to fall. The invasion of Georgia just gave the Index an extra push on the downside. Even after allowing for global tensions, the decline is becoming quite overextended. However this pattern cannot support more than a technical rally at present and the May high is very unlikely to be retested anytime soon.
“Taking a longer-term view, Fullermoney continues to favour a policy of acquiring resources shares with substantial assets in the ground, in politically stable regions. I would describe Russia as a politically stable region, albeit authoritarian. There are also governance issues, not least concerning the rights of minority shareholders. Nevertheless, resources-rich Russia is also likely to remain one of the world’s faster growing economies.
“Could Russia’s stock market index fall further before it next experiences a sustained advance? Easily, not least as there is no conclusive evidence that any stock market has bottomed. Is Russia’s market likely to be higher in a year or two? I think so.”
Source: David Fuller, Fullermoney, August 26, 2008.
Bloomberg: Vietnam’s stock market attractive for investors, says Mobius
“‘Vietnam’s stock market now is down, so there are more opportunities,’ Mobius said in an interview in Ho Chi Minh City, where Templeton opened its Vietnam representative office today. ‘The market will go up and will be much more valuable in about three years.’
“Mobius, who oversees about $40 billion in emerging-market equities, is increasing Templeton’s investments in Vietnam after it bought a 49% stake in the fund management unit of Joint-Stock Commercial Bank for Foreign Trade of Vietnam, known as Vietcombank Fund Management, earlier this year.
“Templeton is turning to emerging markets as it said earlier this month stocks tumbled more than justified because demand for raw materials continues to boost economic growth in those nations. The MSCI Emerging Markets Index has plunged 29% since reaching a record in October.
“Vietnam’s central bank has raised interest rates three times this year to ease inflation.
“‘Inflation is high, but we are happy to see the government is acting rapidly and very strongly to beat inflation,’ Mobius said. ‘But that’s also why the stock market looks attractive.’”
Source: Van Nguyen, Bloomberg, August 22, 2008.
David Fuller (Fullermoney): US dollar – waiting for clearer evidence
“However, that is what most people are predicting and hoping for, because they are long. Sentiment is so often a contrary indicator, as you know. For this reason, I maintain that the USD has to sustain its breakout from prior trading ranges, during this pause, if we are to see renewed strength in the weeks and months ahead. Meanwhile, if the USD continues to move sideways, interest rate differentials will erode more of leveraged traders’ recent gains, increasing the possibility of declines back into the prior ranges.
“I remain sceptical of the USD’s alleged medium to longer-term recovery scope, for reasons previously discussed at length. However, psychology and technical action are the key short-term drivers, so I am waiting for clearer evidence of the next significant move, either way.”
Source: David Fuller, Fullermoney, August 29, 2008.
Richard Russell (Dow Theory Letters): Dash for cash is good for gold
“The first – there’s a dash for cash throughout the world. Big, sophisticated money sees what’s going on, and they want cash, all the cash they can accumulate.
“Second – Today, all cash is fiat junk currency. When this realization hits, the next big move will be into the only reliable cash outside the central bank system. That move will be to – gold. There will be a rush for gold somewhere ahead. Even now, I suspect gold is in a bottoming process (but not the gold shares).”
Source: Richard Russell, Dow Theory Letters, August 26, 2008.
Guardian: Gold reserves more important than before, says Bundesbank
“‘Gold sales are not a suitable way to sustainably consolidate the public accounts,’ the Bundesbank said after a query about trade union proposals that it sell gold to fund some of a $37 billion economic stimulus package.
“‘National gold reserves have a confidence and stability-building function for the single currency in a monetary union. This function has become even more important given the geopolitical situation and the risks present in financial market developments.’
“The Bundesbank is the world’s second-largest holder of gold after the US Federal Reserve, and has sold just 20 tonnes out of total reserves of over 3,000 tonnes in the past five years.
“These sales were to allow the German finance ministry to mint gold coins, unlike the much more active sales programmes of other central banks which wanted to shift their portfolios from gold to a more diverse array of assets.”
Source: Guardian, August 22, 2008.
Victoria Marklew (Northern Trust): German data suggest Euro-zone is headed for recession
“So, the bad news is that the Euro-zone will almost certainly see a second quarter of contraction in Q3, with Germany, France, and Italy headed that way and Spain almost certain to drop into negative territory too. The good news is that, for now at least, it looks as if the ‘zone will stall rather than fall right off a cliff, implying signs of recovery could crop up by the end of this year. But watch those leading indicators.”
Source: Victoria Marklew, Northern Trust – Daily Global Commentaryy, August 26, 2008.
Financial Times: Moscow’s plan is to redraw the map of Europe
“This war was never about South Ossetia or Georgia. Moscow is using its invasion, prepared over years, to rebuild its empire, seize greater control of Europe’s energy supplies and punish those who believed democracy could flourish on its borders. Europe has reason to worry. Thankfully, most of the international community has condemned the invasion and confirmed their unwavering support for Georgia’s territorial integrity and sovereignty.
“I believe the most potent western response to Russia is to stay united and firm by providing immediate material and political support. If Moscow is trying to overthrow our government using its lethal tools, let us resist with democratic tools that have sustained more than 60 years of Euro-Atlantic peace. Backing Georgia with Europe’s political and financial institutions is a powerful response. Regrettably, this story is no longer about my small country, but the west’s ability to stand its ground to defend a principled approach to international security and keep the map of Europe intact.”
Source: Henny Sender, Financial Times, August 27, 2008.
Bloomberg: Gazprom leads surge in Russian debt risk
“Credit-default swaps on the world’s largest natural-gas producer increased 36 basis points to 260 this month, and Moscow-based oil-pipeline operator OAO Transneft rose 33.5 to 265, according to at CMA Datavision. Contracts on Russia’s government debt climbed 32 to 134, the highest since April 2.
“The credit crisis has already prompted a jump in Russian corporate funding costs, with the nation’s largest lender, OAO Sberbank, increasing rates on outstanding loans by an average of 2 percentage points last month. International investor concern over the Georgia military action may add at least a further 0.5 percentage points to annual interest payments, according to Mikhail Galkin, a fixed-income analyst at MDM Bank in Moscow.
“‘Access to capital for Russian corporations, already severely damaged by the global credit crunch, has further deteriorated on the back of increased political risks,’ Galkin said in an interview today.”
Source: Abigail Moses and Denis Maternovsky, Bloomberg, August 27, 2008.
BCA Research: UK economy – look out below!
“Our UK housing model has been predicting double-digit price declines for some time. Alarmingly, the housing market appears to be slipping even faster than the model predicted. Yesterday’s release showed that nationwide house prices plunged in August to -10.5% YoY (from -8.1% in July). Still, UK housing remains extremely overvalued and none of the leading real estate indicators suggest that the market is likely to find support in the coming months.
“In turn, the negative wealth effects will continue to mount, keeping the consumer depressed and hesitant to spend. The poor consumer outlook is highlighted by the dismal CBI retail survey for September. The financial sector will also remain under pressure as banks face a second bust in the commercial real estate market.
“Bottom line: The BoE will need to respond by aggressively lowering interest rates (beginning before yearend) in order to limit the fallout in the overall economy. Stay bearish the pound and overweight gilts within a global hedged fixed income portfolio.”
Source: BCA Research, August 29, 2008.
Bloomberg: UK economic growth stagnated in second quarter
“Gross domestic product was unchanged from the previous quarter, the Office for National Statistics said, compared with a previous estimate for growth of 0.2%. Economists had expected a 0.1% expansion, according to the median estimate of 34 economists. Growth was 1.4% from a year earlier, the weakest since 1992.
“The report, which showed the biggest drop in investment in 23 years, adds pressure on the Bank of England to set aside inflation concerns and cut interest rates. It also worsens Prime Minister Gordon Brown’s struggle to salvage his reputation for economic competence.
“‘There is still worse to come,’ Ross Walker, an economist at Royal Bank of Scotland, said in a Bloomberg Television interview. ‘We may have to wait until early 2009 before we get the first rate cut because the inflation situation still looks pretty forbidding.’
“Industrial production, which includes manufacturing as well as utilities and oil and gas extraction, has now contracted for two consecutive quarters. Construction also shrank. Service industries, which range from banks to airlines, grew at the slowest rate since 1995.”
Source: Jennifer Ryan, Bloomberg, August 22, 2008.
James Pressler (Northern Trust): Japan – response to upcoming recession
“Even though GDP has not contracted for the two consecutive quarters required, the world’s second-largest economy is showing every sign of recession. A prolonged contraction in industrial production has been the main sign of recent recessions, and that seems to be the case as of today’s release. The monthly figure for July production was surprisingly up on the month, but it is very likely that it will show another contraction for Q3 as a whole, and GDP will follow suit. Given this grim scenario, it is no surprise that the government took action. However, it would be hasty to call Tokyo’s announced measures a ‘stimulus’ package.
After years of stable or declining prices, July inflation rose to a decade-high 2.3% according to today’s release. Real interest rates are now decidedly negative, and consumer sentiment has taken a significant hit.”
Source: James Pressler, Northern Trust – Daily Global Commentary, August 29, 2008.
Financial Times: Jing Ulrich and Qing Wang on Chinese reforms
Source: Financial Times, August 26, 2008.
MarketWatch: Saudi Arabia takes big step toward opening market
“The Capital Market Authority (CMA), the Saudi market regulator, announced last Wednesday that it will let foreigners gain exposure to the local market through so-called swap agreements.
“The CMA will allow authorized persons to enter into swap agreements with non-resident foreign investors, whether institutions or individuals, to transfer profits from shares listed on the Saudi Stock Exchange, the Tadawul. The so-called authorized persons will retain legal ownership of the shares.
“‘Up until now, Tadawul has been the least open to foreign investment among the GCC bourses,’ said analysts at Kuwait-based Global Investment House in a recent report.
“‘This step is considered a leap in the regulators efforts to diversify the market’s investor base and develop the kingdom’s financial market,’ the analysts said.
“In the past, foreign investors didn’t have access to the Saudi stock market, except through mutual funds. Only residents of the GCC countries have been allowed to invest directly in Saudi companies.”
Source: Polya Lesova, MarketWatch, August 28, 2008.
5 comments to Words from the (investment) wise for the week that was (August 25 – 31, 2008)
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