Words from the (investment) wise for the week that was (October 20 – 26, 2008)
The past week witnessed mounting evidence that the world economy was facing a sharp downturn, causing unrest to engulf financial markets. Stocks and emerging-market currencies and bonds remained under heavy selling pressure as risk-averse investors rushed to liquidate positions, with the US dollar, Japanese yen and developed-market bonds providing perceived safe havens.
Improvements in the credit markets provided little encouragement to battle-weary investors in the face of weak US earnings reports and a poor outlook for at least the next few quarters. Forced selling by hedge funds needing to meet margin calls and redemption requests again featured prominently. The S&P 500 Index lost 6.8% on the week (YTD -40.3%), pulling the Index down to levels last seen in 2003.
With financial woes weighing on investor confidence, I couldn’t help thinking of what President Thomas Jefferson said in 1802: “I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.”
Fast forward to 2008, specifically to former Fed Chairman Alan Greenspan’s testimony to a House Oversight Committee hearing on the roles and responsibilities of federal regulators in the current financial crisis.
Greenspan described the financial crisis as a “once-in-a-century credit tsunami”. He acknowledged that the crisis exposed flaws in his thinking and to the working of the free market system, telling the Committee that his belief that the banks would be more prudent in their lending practices because of the need to protect their shareholders had been proven wrong by the crisis. He called this a “mistake” in his views and said he was “in a state of shocked disbelief”.
He furthermore said: “The housing bubble became clear to me sometime in early 2006, in retrospect. I did not forecast a significant decline because we have never had a significant decline in price.” Whew!
“Why did no one on Capitol Hill remind Easy Al that he mocked Americans for not taking adjustable-rate and other low-rate gimmick mortgages – only days before he hiked rates,” commented Bill King (The King Report).
And while we are on the topic of the credit debacle, allow me to share with you, courtesy of David Fuller, a little light relief on the bailout workings:
“Young Chuck moved to Texas and bought a donkey from a farmer for $100. The farmer agreed to deliver the donkey the next day. The next day the farmer drove up and said, ‘Sorry son, but I have some bad news, the donkey died.’ Chuck replied, ‘Well, then just give me my money back.’ The farmer said, ‘Can’t do that. I went and spent it already.’ Chuck said, ‘Ok, then, just bring me the dead donkey.’ The farmer asked, ‘What ya gonna do with him?’ Chuck said, ‘I’m going to raffle him off.’ The farmer said, ‘You can’t raffle off a dead donkey!’ Chuck said, ‘Sure I can, watch me. I just won’t tell anybody he’s dead.’ A month later, the farmer met up with Chuck and asked, ‘What happened with that dead donkey?’ Chuck said, ‘I raffled him off. I sold 500 tickets at two dollars a piece and made $998.’ The farmer said, ‘Didn’t anyone complain?’ Chuck said, ‘Just the guy who won. So I gave him his two dollars back.’ Chuck now leads the US bank bailout team.”
Next, a tag cloud of the text of the plethora of articles I have devoured during the past week. This is a way of visualizing word frequencies at a glance. Not too many surprises here with “banks” still dominating the words.
The list of well-known names identifying value on the US stock market at current levels is growing by the day and includes the likes of Jeremy Grantham (GMO – “Careful buying is justified”), Warren Buffett (“Buy America. I am“), John Hussman (Hussman Funds – “Why Warren Buffett is right”) and Barry Ritholtz (The Big Picture – “Another buy in”). Even perma-bears such as James Montier and Albert Edwards (Société Générale – “Turning more bullish”) are increasing their equity exposure, albeit only for the short term.
“… technical measures of momentum and breadth are at historical lows and valuations have been restored to the point where some notable long-term deep value investors are stepping up their purchases,” said BCA Research.
However, they advised investors to remain cautious. “The risk/reward trade-off does not yet warrant aggressive accumulation of risky assets, given that many investors are looking for a bounce to lighten positions, redemption orders continue to mount, and a prolonged recession lies ahead. Even if equities are nearing a bottom, there should be several good opportunities to add exposure in the months ahead. We recommend … only nibbling on stocks selectively.”
I am still of the viewpoint that stock markets are in a multi-month phase of bottoming out that will see relief, and potentially profitable, rallies from time to time. But stock market valuations, in general, are still stretched when considering an environment of economic and profit recession, arguing that a secular low may not necessarily have been reached.
I am about to hit the road again – traveling to neighboring country Mozambique for a few days – and am therefore only doing a shortened version of “Words from the Wise” this week. Although I am not doing my customary review of the financial markets’ movements and economic statistics, I am including a full section of interesting excerpts from news items and quotes from market commentators.
Economic data in the US and throughout the rest of the world showed an acceleration in the weakening of activity.
As far as the US interest rate outlook is concerned, Asha Bangalore (Northern Trust) said: “At its meeting of October 28 and 29, we expect the FOMC to reduce its target Federal funds rate by 25 basis points to a level of 1.25%. The Federal funds rate futures market is placing a higher probability on a 50 basis point reduction. The effective Federal funds rate has held below 1.00% every trading day since October 16.” (Also see my recent post “US rate cut imminent”.)
Source: Yahoo Finance, October 24, 2008.
In addition to the FOMC’s interest rate decision on Wednesday, October 29 and the Bank of Japan’s monetary policy announcement on Friday, October 31, next week’s US economic highlights, courtesy of Northern Trust, include the following:
1. New Home Sales (October 27): The consensus forecast is a drop in sales of new homes to an annual rate of 450,000 during September from 460,000 in August. In August, purchases of new homes dropped 66.9% from their peak in July 2005.
2. Durable Goods Orders (October 29): Durable goods orders (-1.0%) are expected to have fallen in September following a large decline in August. Consensus: -1.1% versus -4.5% in August.
3. Real GDP (October 30): Real GDP is predicted to have dropped 0.6% in the third quarter, which could possibly be the first of a string of declines. The largest negative contribution is most likely from consumer spending, followed be the housing sector and business equipment spending. Consensus: -0.5%.
4. Personal Income and Spending (October 31): The earnings and payroll numbers for September suggest a drop in personal income (-0.1%). Auto sales and non-auto retail sales have been significantly weak, implying a decline in consumer spending in September. Consensus: Personal Income +0.1%, Consumer Spending -0.3%.
5. Other reports: Consumer Confidence (October 28).
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 direction of the US dollar.
Source: Wall Street Journal Online, October 24, 2008.
Now for a few news items and some words and charts from the investment wise that will hopefully assist in keeping our investment portfolios on a profitable course. But be careful and remember the old Street adage: “In a bear market, money returns to its rightful owners.”
That’s the way it looks from Cape Town.
CNBC: The unfolding financial crisis, with Roubini and Rifkin
Source: CNBC, October 22, 2008.
Bloomberg: Volcker – rebuild US banks from “ground up”
Click here for article.
Source: Bloomberg, October 24, 2008.
Financial Times: World wakes from the wish-dream of decoupling
“Yet the news is not all bad: inflationary pressures are abating fast. Even so, this hides more bad news. The broken financial system will weaken the transmission from monetary easing to the economy. This will make the coming slowdown last a long time. Even though decisive action has saved the financial system from its recent heart attack, the patient remains enfeebled.
“In 2007, the world economy (measured at market exchange rates) grew by 3.7% in real terms. This year, according to the latest World Economic Outlook from the International Monetary Fund, growth is forecast to be 2.7%. Next year it is expected to be a mere 1.9%. The economies of high-income countries are forecast to stagnate next year.
“Meanwhile, emerging economies are forecast to grow at 6.1%. This seems fast. But it is 0.6 percentage points slower than was forecast in July and is well below the 8% achieved in 2007 and 6.9% still forecast for 2008.
“The pleasant surprise is the forecast growth of 6% in Africa next year. Developing Asia is forecast to remain the world’s leader, with growth of 7.7%: China is on 9.3%, while India is down to 6.9%. Meanwhile, central and eastern Europe is forecast to grow only 3.4% next year and the western hemisphere to grow even more slowly, at 3.2%.
“These forecasts were prepared before the worst of the financial shocks of September and October.”
Source: Martin Wolf, Financial Times, October 21, 2008.
Ambrose Evans-Pritchard (Telegraph): Crisis may make 1929 look a “walk in the park”
“Twenty billion dollars here, $20 billion there, and a lush half-trillion from the European Central Bank at give-away rates for Christmas. Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects.
“As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world’s central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.
“‘Liquidity doesn’t do anything in this situation,’ says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.
“‘It cannot deal with the underlying fear that lots of firms are going bankrupt. The banks and the hedge funds have not fully acknowledged who is in trouble. That is the critical issue,’ she adds.
“York professor Peter Spencer, chief economist for the ITEM Club, says the global authorities have just weeks to get this right, or trigger disaster.
“‘The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are allowing the money markets to dictate policy. We are long past worrying about moral hazard,’ he says.
“‘They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don’t think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park,’ he adds.”
Source: Ambrose Evans-Pritchard, Telegraph, September 22, 2008.
Financial Times: US to host G20 world summit over crisis
“The stock-market retreat came as prices for oil and gold fell sharply and European currencies slumped against the dollar and yen as traders bet on interest rates being slashed to offset a looming recession.
“Following calls from European leaders such as Gordon Brown, British prime minister, and Nicolas Sarkozy, France’s president, the White House said it was planning a meeting of the heads of state of the G20 group of countries in Washington on November 15.
“The G20 members include some of the countries most affected by the crisis in the developed world as well as emerging markets such as Brazil, China and India.
“‘The leaders will review progress being made to address the current financial crisis, advance a common understanding of its causes, and, in order to avoid a repetition, agree on a common set of principles for reform of the regulatory and institutional regimes for the world’s financial sectors,’ said the White House.
“It was not clear if the winner of the November 4 presidential election would attend but if either Barack Obama or John McCain were to participate, it would be a remarkably early first appearance on the world stage.”
Source: Chris Giles, George Parker, Ben Hall, James Politi and Daniel Dombey, Financial Times, October 22, 2008.
Charlie Rose: A conversation with Henry Paulson, United States Treasury Secretary
Source: Charlie Rose, October 21, 2008.
Bloomberg: Paulson says US has sufficient funds for bank plan
“‘Sufficient capital has been allocated so that all qualifying banks can participate,’ Paulson said in Washington, announcing details on how banks can sign up for the funds. ‘This program is designed to attract broad participation by healthy institutions and to do so in a way that attracts private capital to them as well.’
“Today’s announcement follows complaints from the banking industry that the rescue effort Paulson unveiled a week ago was short on specifics. Financial institutions such as PNC Financial Services Group and BB&T are considering signing up, and regulators today released details about how to do so.
“After an initial $125 billion was allocated to nine of the largest banks, including Citigroup and Morgan Stanley, the Treasury plans to inject another $125 billion into other lenders.”
Source: Rebecca Christie and Robert Schmidt, Bloomberg, October 20, 2008.
Bloomberg: Bernanke’s own words on economy, new fiscal stimulus
Source: Bloomberg, October 20, 2008.
Greg Ip (The Washington Post): Think the bailout is radical? Just wait.
“Could Bernanke go even further? He has promised to use ‘all of the powers at our disposal’ to stop the credit crunch. As of June 30, loans to US households, non-financial companies and state and local governments stood at $27 trillion. In theory, the Fed could supply all of this. But that doesn’t mean that it should. At some point, Fed loans would keep alive borrowers that simply ought to fail. And the more credit the Fed extends now, the longer it will take to withdraw once the crisis passes – a process that risks spurring inflation.
“But the Fed could go quite a ways yet: Its $1.8 trillion in assets is equal to just 12% of America’s gross domestic product. To battle deflation earlier this decade, the Bank of Japan stuffed Japanese banks with cash, hoping they’d lend it back out. At its peak, the Bank of Japan’s balance sheet amounted to 30% of GDP. All this government effort didn’t help much: Japan’s banks were still so undercapitalized that they were reluctant to lend. But the Bank of Japan’s exertions didn’t trigger inflation, either.
“Buy other assets. Ask the average congressman why he voted for the $700 billion bailout package, and he’ll probably point to the sickening plunge in the Dow Jones Industrial Average. So would it be better for the US government simply to buy stocks?
“The United States once routinely waded into foreign-exchange markets and is now intervening in the mortgage markets through its bailout of Fannie Mae and Freddie Mac. But buying stock is a bigger leap: There’s a greater chance of capital loss, and outright purchases enmesh the government in issues of ownership (one reason investing the Social Security Trust Fund in stocks remains controversial). Though US government purchases might drive up stock prices and help banks issue new shares to rebuild capital, they would not address the root of the credit crisis.
“A more elegant way to use Washington’s purchasing power would be to buy vacant homes and take them off the market to alleviate the downward pressure on housing prices. Of course, doing so without overpaying would be tricky indeed.
“A future US administration may use its new ownership stakes to press banks to relent on foreclosures or lend more to favored constituencies. But ownership will also make Washington the target of demanding interest groups and disgruntled customers and shareholders if the banks stumble.
“The odds are that once this crisis passes, the United States will return to its free-market roots, albeit with more regulations in place. But until then, things may get even wilder.”
Source: Greg Ip, The Washington Post, October 19, 2008.
Bloomberg: Fed to provide up to $540 billion to aid money funds
“‘Short-term debt markets have been under considerable strain in recent weeks’ as it got tougher for funds to meet withdrawal requests, the Fed said today in a statement in Washington. A Fed official said that about $500 billion has flowed since August out of prime money-market funds, which with other money-market mutual funds control $3.45 trillion.
“The initiative is the third government effort to aid the funds, which usually provide a key source of financing for banks and companies. The exodus of investors, sparked by losses following the bankruptcy of Lehman Brothers, contributed to the freezing of credit that threatens to tip the economy into a prolonged recession.
“‘The problem was much worse than we thought,’ Jim Bianco, president of Chicago-based Bianco Research LLC, said in a Bloomberg Television interview. Policy makers are trying to prevent ‘Great Depression II’ by stemming the financial industry’s contraction, he said.”
Source: Craig Torres and Christopher Condon, Bloomberg, October 21, 2008.
BBC News: France unveils bank rescue plan
“Among the beneficiaries, France’s largest bank, Credit Agricole, is to get 3 billion euros, while BNP Paribas will receive 2.55 billion euros.
“The move is aimed both at restoring confidence and liquidity to the banks.
“Ms Lagarde said the move was to ensure banks are ‘able to finance the economy correctly’. She added that the banks simply needed to increase their equity capital in order to give more loans to companies and individuals.
“President Nicolas Sarkozy has vowed that no French bank will be allowed to collapse and that savers will not lose ‘a single euro’.”
Source: BBC News, October 20, 2008.
Financial Times: Sarkozy plans new French wealth fund
“The new fund will be operated by Caisse des Dépôts et Consignations – the country’s existing sovereign wealth fund – but would be ‘more active, more offensive, more mobile’ in defence of French industrial assets, Mr Sarkozy said.
“‘I will not be the French president who wakes up in six months time to see that French industrial groups have passed into other hands,’ he said in a speech to business leaders near Annecy, eastern France.
“The president’s announcement came only two days after he urged other EU member states to set up their own sovereign wealth funds as a means of protecting European industry at a time when share prices of leading companies were heavily depressed. His proposal met a cool response from other governments.
“The new fund will focus on shoring up smaller French companies judged strategically important because of their technology or sector. It could take short-term equity stakes or provide reimbursable loans.”
Source: Ben Hall, Financial Times, October 23, 2008.
Bloomberg: South Korea backs $100 billion in debt to calm markets
“The government will provide tax benefits for long-term equity and bond investors, while the Bank of Korea will buy repurchasing agreements and government bonds to boost won liquidity, the heads of the finance ministry, central bank and financial regulator said in a statement from Seoul. Policy makers held an emergency meeting on October 17 to hammer out the plan.
“South Korea is struggling with Asia’s worst-performing currency, a shortage of US dollars and a stock market that has lost 38% this year. The guarantee on bank debts comes after Standard & Poor’s said last week it may cut the credit ratings of the nation’s largest lenders, which triggered the worst plunge in the won since the International Monetary Fund bailed the nation out in December 1997.”
Source: Kyung Bok Cho and William Sim, Bloomberg, October 19, 2008.
Council on Foreign Relations: Where is my swap line?
Click here for the full article.
Source: Council on Foreign Relations, October 18, 2008.
BBC News: Further banks may fail, says IMF
“The six-monthly study also warns that eurozone economic growth will almost grind to a halt next year. Growth in the 15 euro countries will fall to just 0.2% in 2009, it forecast. The report argued that disruptions in the US financial system have ‘heightened the risk of a systemic financial crisis in Europe further’. However, it maintained that a full-blown crisis ‘remains improbable’.
“The slowdown has resulted from high oil prices, rising inflation, a strong euro, falling export demand and the financial crisis, the Fund reported.”
Source: BBC News, October 21, 2008.
TimesOnline: Panic over hedge funds “could close markets”
“Nouriel Roubini, a professor at New York University, told a London conference that hundreds of hedge funds are poised to fail as frantic investors rush to redeem their assets and force managers into a fire sale of assets. He said: ‘We’ve reached a situation of sheer panic. Don’t be surprised if policymakers need to close down markets for a week or two in coming days.’
“Jon Moulton, the private equity investor behind Alchemy Partners, forecast a tidal wave of hedge fund collapses in the next three months. ‘We estimate 60% of the capacity of UK hedge funds will go this year, through bankruptcies and redemptions,’ Mr Moulton told The Times.
“There are widespread predictions of calamity in the hedge fund sector, which has been thrown into crisis by the collapse of Lehman Brothers and the ensuing turmoil in world markets.”
Source: Miles Costello and Helen Power, TimesOnline, October 24, 2008.
Current: Naked short selling destroying companies
Source: Current, October 23, 2008.
CNBC: Greenspan’s Testimony
Source: CNBC, October 23, 2008.
Financial Times: “I made a mistake,” admits Greenspan
“‘I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders,’ he said.
“In the second of two days of tense hearings on Capitol Hill, Henry Waxman, chairman of the House of Representatives, clashed with current and former regulators and with Republicans on his own committee over blame for the financial crisis.
“Mr Waxman said Mr Greenspan’s Federal Reserve – along with the Securities and Exchange Commission and the US Treasury – had propagated ‘the prevailing attitude in Washington … that the market always knows best.’
“Mr Waxman blamed the Fed for failing to curb aggressive lending practices, the SEC for allowing credit rating agencies to operate under lax standards and the Treasury for opposing ‘responsible oversight’ of financial derivatives.
“Mr Greenspan accepted that the crisis had ‘found a flaw’ in his thinking but said that the kind of heavy regulation that could have prevented the crisis would have damaged US economic growth. He described the past two decades as a ‘period of euphoria’ that encouraged participants in the financial markets to misprice securities.
“He had wrongly assumed that lending institutions would carry out proper surveillance of their counterparties, he said. ‘I had been going for 40 years with considerable evidence that it was working very well.’
“Mr Greenspan said that when, as Fed chairman, he declined to advocate regulating credit default swaps – derivatives that have been blamed for worsening the crisis – he had been following the will of Congress.”
Source: Financial Times, October 24, 2008.
YouTube: 40 Years is all it took to figure out the world ain’t flat
Source: YouTube, October 23, 2008.
Paul Kedrosky (Infectious Greed): The credit hearings political theatre
“One of the few interesting moments so far has been this one with Alan Greenspan:
“‘THE HOUSING BUBBLE BECAME CLEAR TO MEET SOMETIME IN EARLY 2006, IN RETROSPECT. I DID NOT FORECAST A SIGNIFICANT DECLINE BECAUSE WE HAVE NEVER HAD A SIGNIFICANT DECLINE IN PRICES.’
“Got that? Greenspan only noticed the housing bubble in 2006, as it was bursting, and his main reason for not thinking prices would not decline in the US is because the US has never had a significant decline. Sad stuff.”
Source: Paul Kedrosky, Infectious Greed, October 2008.
Asha Bangalore (Northern Trust): Bair notes more is necessary to stem foreclosures
“Today, Shiela Bair, the chairwoman of the FDIC, indicated that more was needed to stem the tide of home foreclosures. She was of the opinion that there has been a ‘failure to effectively deal with’ the mortgage foreclosure problem. Bair said ‘new efforts to stem foreclosure are needed, even if it means the Treasury offering to absorb losses on some soured mortgages’.
“She suggested the following: ‘Loan guarantees could be used as an incentive for servicers to modify loans.’ Furthermore, Bair noted that ‘the government could establish standards for loan modifications and provide guarantees for loans meeting those standards.’ Mortgage servicers are using ad hoc procedures to modify mortgages, implying that guidelines to modify mortgages are necessary.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, October 23, 2008.
Asha Bangalore (Northern Trust): Rebound of existing home sales suggests beginning of turnaround
“… the drop in inventories of unsold homes is another positive factor pointing to a small improvement in the housing market. There was 9.9-month supply of unsold existing homes in September, down from a 10.6-month supply in August. The inventory-sales ratio of single-family homes was 9.4 months in September versus 10 months in August and that of condos dropped to 14.3 months from 15.7 months in August. These numbers suggest that sales of both single-family homes and condos have improved.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, October 24, 2008.
Reuters: Home prices to fall another 10 percent: Fitch
“National home prices have declined a full 22% from the peak hit in 2006, the agency said in a note. Fitch has a peak to trough forecast for prices to decline 30%.
“The additional 8 percent decline is equal to another 10% decline from current levels, it said. Most of that correction will take place in the next several quarters before prices exhibit stability in 2010, said the agency.
“Fitch’s analysis indicates that expected drop will reverse the home price increases seen between 2004 and 2006.
“‘Should economic conditions become much worse than expected, home prices would decline more than Fitch’s projection and price stabilization would be delayed,’ said Huxley Somerville, group managing director and head of US residential mortgage backed securities.”
Source: Reuters, October 20, 2008.
Bill King (The King Report): Adjusted monetary base surging
Source: Bill King, The King Report, October 24, 2008.
Bespoke: Duration of US economic recessions
“As shown in the chart, there is a clear dichotomy in recessions prior to WWII (red) and after WWII (blue). Pre WWII, the average recession lasted 19.1 months. Since then, though, the average duration has been nearly cut in half to 10.2 months. While the reason for the shorter duration is up for debate, we would argue that faster information flow has allowed companies to quickly adjust activity in order to compensate for shocks to the upside or the downside.”
Source: Bespoke, October 23, 2008.
Bloomberg: Nobel economics Laureate Krugman sees “nasty” US recession
“‘That’s baked in,’ Princeton University professor and New York Times columnist Paul Krugman said in an interview on ‘Night Talk’ with Mike Schneider. ‘There is a lot of downward momentum.’
“He said a risein the unemployment rate to 7% ‘seems almost certain’ and he put the odds of an increase to 8% at ‘better than even’. The jobless rate in September stood at a five-year high of 6.1%.
“Krugman voiced some doubts that the steps Treasury Secretary Henry Paulson is taking to combat the credit crisis will succeed and suggested that more might be needed.
“‘It’s not clear there’s enough money,’ Krugman said.
“He added that Paulson may also have to insist that the banks use the money they’re receiving to make new loans if the plan is to work. ‘They may need to be much more interventionist than they have been thus far,’ the Princeton professor said.”
Source: Mike Schneider and Rich Miller, Bloomberg, October 17, 2008.
BCA Research: Will spreads finally narrow in the US?
“There was some good news last week with a sharp narrowing in CDS spreads of the major US counterparties. These debt instruments tend to lead the corporate bond market, and the narrowing raises hope that some normalization in inter-bank lending could develop. A stabilization in counterparty risk is only the first step forward, and it will be critical for bond spreads to narrow and for banks to stop hoarding cash.
“However, offsetting this positive has been an uptick in government bond yields. If credit spreads narrow due solely to rising Treasury yields, then no economic relief will occur. The Fed needs to make it clear that policy rates will stay low in order to anchor Treasury yields. Moreover, bailout efforts need to proceed to ensure the banking system starts functioning. Stay tuned.”
Source: BCA Research, October 21, 2008.
Bloomberg: Bernanke may seek new ways to ease credit as fed rate nears 1%
“The Fed’s Open Market Committee will probably reduce the benchmark federal funds rate by half a point next week to 1%, the lowest since May 2004, according to futures trading. The official rate has never been lower since the Fed made it an explicit target in the late 1980s.
“Further cuts below 1% could turn Fed Chairman Ben Bernanke’s focus away from the main rate and toward more use of alternative tools. Those might include increasing its holdings of mortgage bonds to lower costs for homebuyers and purchasing securities directly from the Treasury in order to pump more cash into the economy, Fed watchers said.
“‘If there is need for more stimulus, the Fed will buy up government debt’ to keep borrowing costs low, said Adam Posen, deputy director at the Peterson Institute for International Economics and a co-author with Bernanke. That’s tantamount to ‘turning government debt, as it is issued, into money.’
“Bernanke, 54, has already thrown the central bank’s balance sheet into action in unprecedented ways. Working with the New York Fed, the Board of Governors has rolled out 11 new programs aimed at absorbing risk or making dollars available when banks don’t want to loan.”
Source: Craig Torres, Bloomberg, October 23, 2008.
The New York Times: The guys from “Government Sachs”
“This summer, when the Treasury secretary, Henry M. Paulson, sought help navigating the Wall Street meltdown, he turned to his old firm, Goldman Sachs, snagging a handful of former bankers and other experts in corporate restructurings.”
Click here for the full article.
Source: Julie Creswell And Ben White,The New York Times, October 19, 2008.
Bespoke: The worst year ever – S&P 500’s worst declines
“Since its peak in October 2007, the S&P has now declined by 42.3%. On a historical basis, this is the sixth worst decline in the S&P 500 without a rally of 20% or more. As shown in the list below, outside of the Great Depression, the only period where the S&P 500 had a greater decline was during the bear market of 1973/1974. How much worse can it get?”
Source: Bespoke, October 22, 2008.
BCA Research: Risky assets still risky
“Market volatility remains a readings well above previous cyclical peaks and equity markets have failed to bounce sustainably after plunging to extremely oversold levels earlier this month. The problem is that while authorities may soon begin to turn the corner on stabilizing the financial system, the growth outlook is bleak. The G7 economy faces a prolonged recession and the full extent of the fallout and profit losses are still uncertain.
“In addition, policy rates remain too elevated in Europe, Australia and New Zealand, and the recent surge in the dollar and yen add a fresh drag for these economies. Correspondingly, we advise clients to remain defensively positioned. Even if the October 10 stock market lows hold, it is likely that investors will get several opportunities to add exposure aggressively in the months ahead.”
Source: BCA Research, October 24, 2008.
Richard Russell (Dow Theory Letters): All bull and bear markets end in exhaustion
“Right now, via the Lowry’s studies, I am watching to see if the Selling Pressure Index heads down on a trend basis. Its current height suggests that there’s still a huge amount of stock waiting to be sold, and this represents bearish pressure on the market. At some point, Lowry’s Selling Pressure Index will decline far enough so that we’ll figure that the inventory of stocks to be sold has been exhausted. At that point, we’ll look for a rush of buyers to enter the market.
“Right now, the Fed and the treasury are attempting to halt the primary bear trend of the stock market and the economy. I’m afraid they are fated to fail, and I don’t care how many trillions of dollars the government spends. As a matter of fact, the government going so heavily into debt will probably only extend the life of the primary bear trend – while possibly sending the market lower than it would normally have fallen.
“… this primary bear market, like all others before it, will fully express itself regardless of how anxious the US government is to reverse the primary bear trend. The bear will have his way, until the last group of bears has exhausted its desire to sell. That, in a nutshell, is the tragedy of a great bear market.”
Source: Richard Russell, Dow Theory Letters, October 22, 2008.
Richard Russell (Dow Theory Letters): Buffett – risky and dangerous act
Source: Richard Russell, Dow Theory Letters, October 20, 2008.
David Fuller (Fullermoney): Stock market opportunities beginning to outweigh risks
1. Better late than never, governments are increasingly moving to support their banking industries, while adjusting monetary policy to combat recession / deflation, rather than economic overheating (in some emerging markets) / inflation, as before.
2. The Ted spread has unequivocally peaked in my view. It is still 220 basis points above a healthy level but heading in the right direction.
3. Consequently, an ‘Armageddon’ collapse of the financial system will be avoided, albeit at a cost yet unknown, and recession is a reality.
4. Commodity inflation is much reduced.
“Therefore stock markets are left with the more familiar problem of corporate profit downgrades but equity prices have already gone a long way towards discounting this temporary problem. With monetary policy becoming more benign for shares, opportunities for investors in stock markets are now beginning to outweigh risks, but beware of further downgrades for corporate profits.”
Source: David Fuller, Fullermoney, October 20, 2008.
Bespoke: S&P sees dividends drying up
“According to S&P’s study, most of the decline is a result of dividend cuts in the financial sector where there have already been 35 cuts this year totalling $35 billion. This compares to only 12 cuts totalling $3.1 billion over the last five years.
“But not all the news is bad regarding dividend investing. The same S&P report also estimated that over half of all dividend paying companies in the S&P 500 plan on raising their payouts in 2009, and illustrates the importance of focusing on more than just yield when looking at companies that pay dividends.”
Source: Bespoke, October 21, 2008.
John Authers (Financial Times): Impact of sell-off on emerging markets
Click here for the full article.
Source: John Authers, Financial Times, October , 2008.
Bill King (The King Report): Dollar might be exhausted – significant pullback could appear
“Then there could be one last dollar surge in December as banks, brokers, operators, non-financial companies, and other dollar shorts cover their positions for yearend. But there could be an even larger dollar-buying force in December: foreign banks, especially the Japanese, which must procure term money for yearend. But after yearend obligations are met, the dollar could be very vulnerable.
“PIMCO’s Paul McCulley told investors to shun US Treasuries. If one should shun US Treasuries, one should also shun the dollar. If not for European financial chaos, the dollar would be in the toilet … ‘Deflation now, massive inflation later.’”
Source: Bill King, The King Report, October 24, 2008.
Richard Russell (Dow Theory Letters): No nation can run an empire on borrowed money
“Today, in The Wall Street Journal of all places, we see a featured piece on the op-ed page entitled, ‘The Dangers of a Diminished America’. A diminished America? How can that be? It be. The US has been getting away with it all by owning the unique advantage of printing the very money that its huge debt is denominated in. Yes, I’m talking about the reserve status of the US dollar. This is the Achilles Heel of the US. The US dollar will possess its reserve status as long as our creditors continue to accept Federal Reserve Notes, paper with nothing behind it accept the ‘full faith and credit’ of the United States.”
Source: Richard Russell, Dow Theory Letters, October 21, 2008.
Hans Redeker (BNP Paribas): Euro faces growing risks
“He points out that credit spreads in countries such as Russia and Turkey have widened in spite of capital injections into the banking industry by Western governments.
“‘The reason sovereign spreads are rising has its origin in private sector indebtedness and the structure of the liability side of balance sheets,’ Mr Redeker explains. ‘Banks and corporates in emerging markets have not only funded in local currencies, but an increasing share of liabilities are foreign currency-denominated.
“‘Local currency is now being changed into hard currency at any cost to cover hard currency funding needs. Local currency weakness is the result.”
“Meanwhile, the lack of adequate funding will leave CEE economies, including Russia and Turkey, exposed to a significant slowdown.
“‘Of concern from a European perspective is that this slowdown is taking place in the eurozone’s backyard, suggesting the region’s exporters face tough times. This will weaken the euro from a cyclical perspective.
“‘The more CEE currencies weaken and CDS spreads widen the more pressure the euro will face. The risks to the euro might be greater than thought and CEE CDS spreads must be on traders’ ‘to watch’ list.’”
Source: Hans Redeker, BNP Paribas (via Financial Times), October 21, 2008.
Commodity Online: Jim Rogers – commodity bull market will last longer
“Not really. Jim Rogers, one of the best known global commodities investors, says the commodity bull market will last longer thanks to the global economic meltdown.
“‘We have had 8 to 9 periods of forced liquidation over the past 100 to 150 years wherein everything was liquidated without regard to fundamentals. This is such a period,’ Rogers told Commodity Online in an exclusive e-mail interview.
“Rogers, the best known global guru on commodities, said the commodities market is these days hit by the prospects of growth slowdown in countries like China and the large-scale economic pessimism in the US and Europe.
“‘Historically the things which have come out best on the other side are things where the fundamental have been unimpaired. Commodities are the only thing I know with unimpaired fundamentals,’ he said.
“In fact, Rogers said, what is happening means there will be even less supply of everything in the future.
“‘The cyclical demand for commodities may slow, but the secular supply will be badly affected so the commodity bull market will last longer and go further in the end,’ he added.”
Source: Commodity Online, October 20, 2008.
MarketWatch: OPEC to cut production by 1.5 million barrels a day
“‘This slowdown in oil demand is serving to exacerbate the situation in a market which has been over-supplied with crude for some time, an observation which the Organization has been making since earlier this year. Moreover, forecasts indicate that the fall in demand will deepen, despite the approach of winter in the northern hemisphere,’ the cartel said.
“It also noted that ‘oil prices have witnessed a dramatic collapse – unprecedented in speed and magnitude – these falling to levels which may put at jeopardy many existing oil projects and lead to the cancellation or delay of others, possibly resulting in a medium-term supply shortage.”
“The biggest producer, Saudi Arabia, is cutting 466,000 barrels a day, with six-figure declines also coming from Iran, Kuwait, the United Arab Emirates and Venezuela.”
Source: Myra P. Saefong, Moming Zhou & Steve Goldstein, MarketWatch, October 24, 2008.
The Independent: Spending on gold nears $3bn as investors flee shares
“According to the World Gold Council (WGC), 145 tons of gold were bought on stock exchanges in the three months to September. This meant that gold held by investors on the exchanges hit 1,000 tons for the first time since the metal was introduced on the US bourse in 2004.
“Natalie Dempster, the WGC’s head of investment, said: ‘The question we get from high net worth individuals and funds is no longer ‘why should we invest in gold?’, but ‘where can we go to buy it?’’
“James Turk, founder of Gold Money, the Jersey-based company that stores precious metals for investors, said he had seen his customer base triple in September. He added that at the end of the third quarter, the company was looking after gold and silver deposits worth $400 million, more than double the value a year earlier.
“Mr Turk said: ‘Gold is seen as a natural safe haven given the uncertainty in the banking system and the volatility in the stock market.’”
Source: Mark Leftly, The Independent, October 19, 2008.
Richard Russell (Dow Theory Letters): Erratic action in gold
Source: Richard Russell, Dow Theory Letters, October 20, 2008.
Bespoke: Platinum almost the same price as gold
“Earlier in the year, there was a $1,300/ounce price difference between the two metals, but that difference is now just $83. The charts below highlight the historical premium between platinum and gold, and while it’s hard to believe the two could be trading at similar price levels now, it did occur quite often in the early 90s. What is shocking is how fast the premium has declined in recent months. Instead of buying gold coins, maybe now is the time to buy platinum ones.”
Source: Bespoke, October 23, 2008.
Financial Times: European weather map
“The FT’s latest European economic ‘weather map’ shows the extent of the deterioration since July. In July the continent’s economies had largely avoided a credit crunch but were being hit by sudden and steep rises in energy prices, compounded by the effects of a strong euro. In October, inflation is ebbing and the euro has softened.”
Click the image below for a larger picture.
Source: Financial Times, October 20, 2008.
Financial Times: ECB signals further interest rate reductions
“Little more than two weeks after it slashed its main policy rate by half a percentage point to 3.75% as part of co-ordinated global central bank action, policymakers at the notoriously inflation-sensitive ECB are making bolder signals that further reductions are possible.
“Evidence of slower growth and falling price pressures was ‘a new element of our analysis’, José Manuel González-Páramo, an ECB executive board member, told an Irish newspaper on Thursday. The ECB could ‘diminish rates without adding to inflationary risks in the medium term’, he said.”
Source: Financial Times, October 24, 2008.
Financial Times: European states struggle to raise money
“Spain failed to launch a bond last week, while Belgium and Finland were having difficulty attracting investors for debt offerings after governments set aside billions to recapitalise their banks and guarantee their debt.
“Governments face problems raising money, as investors demand higher yields because of the extra credit risk resulting from the bank guarantees and the huge pipeline of sovereign debt expected over the next year, which is hanging over the market.
“The eurozone countries will have to issue an extra $263.3 billion in debt in the next year to pay for bank recapitalisations and guarantees, according to Bank of America.”
Source: David Oakley, Financial Times, October 21, 2008.
Financial Times: Pound plunges as King warns on recession
“Mr King on Tuesday night gave his gloomiest assessment of Britain’s economic prospects since becoming Bank governor in 2003, saying that the country was now ‘entering a recession’.
“He compared the recent capital flight from British banks with a ‘mild form’ of a 1990s-style emerging market crisis, warning about the risk of another sharp decline in sterling and an even deeper recession.
“In one of only three big speeches Mr King gives a year, his views are bound to be taken by markets as a clear sign the Bank is gearing up for further significant cuts in UK interest rates.
“Until Tuesday night, Mr King and the Bank had refused to utter the word ‘recession’, insisting that the term should only be used to signify a deep contraction in output and not two successive quarters in which the economy might shrink a little.
“On Tuesday night he had no such qualms, saying a recession was likely because the recent financial crisis had come on top of the rise in oil prices, which had already squeezed incomes.”
Source: By Chris Giles and Neil Dennis, Financial Times, October 21, 2008.
Financial Times: China growth rate slides
“After five years of double-digit expansion, figures for the third quarter showed the annual growth rate falling to 9% – well below most pessimistic forecasts.
“The Chinese State Council, the country’s cabinet, also said it was planning increases in infrastructure spending after the economy’s growth rate fell for the fifth quarter in a row.
“For much of the past year, China had seemed immune to the problems in international credit markets. However, in recent weeks there have been growing signs that the economy might slow more sharply than expected, which has contributed to falling commodity prices.
“The 9% expansion in China’s gross domestic product in the third quarter was below the consensus forecast of 9.7% and down from the 10.1% annual growth in the second quarter.”
Source: Geoff Dyer, Financial Times, October 20, 2008.
David Fuller (Fullermoney): China slows down, but in good shape
“The Chinese banking system appears solid compared to those in the developed world. Loan to valuation ratios have been falling, there are limited linkages to global banks, there is no dependence on foreign capital, there is no confidence crisis and credit availability has only been an issue to the extent that the government has restricted it.
“The Chinese corporate sector is in good shape. Leverage has been falling and the level of retained earnings is high, as is the return on equity. The equity market only accounts for 15% of corporate financing.
“Consumer spending is likely to remain robust. Despite the 70% slump in Chinese shares and falling house prices, consumer spending has actually accelerated recently. Chinese consumers have very high saving rates, are not very geared and only 5% of Chinese households have a significant share exposure. On top of this, the authorities have been trying to boost consumer spending via a range of policies including social security reforms, labour reforms and assistance for rural workers.”
Source: David Fuller, Fullermoney, October 21, 2008.
BCA Research: Australia – accelerating inflation, slowing economy
“Yesterday’s release showed that consumer price inflation rose faster than expected in Q3, climbing to 4.6% YoY (from 4.3% in Q2). While this result will make policymakers nervous, it will not deter them from easing interest rates further next month. The rapid erosion in leading growth indicators, softening house prices, rising unemployment (albeit from historically low levels) and waning confidence warn that domestic activity is moderating. Furthermore, the Reserve Bank of Australia (RBA) predicted price pressures would remain elevated throughout the remainder of 2008, and possibly the early part of 2009.
“Despite this forecast, the RBA has moved to aggressively lower interest rates in the face of economic and financial market turmoil. Bottom line: Expect the RBA to cut significantly further. Our global fixed income team recommends an overweight allocation in government bonds within a globally hedged bond portfolio.”
Source: BCA Research, October 23, 2008.
New Zealand cuts key rate by 100 basis points to 6.5%
“‘Economic activity will be further constrained by these international developments,’ Reserve Bank Governor Alan Bollard said in a statement in Wellington today. ‘Should the outlook for inflation evolve as projected, we would expect to lower the rate further.’
“‘The domestic economy is likely to remain in recession through to the middle of next year at least,’ said Darren Gibbs, chief New Zealand economist at Deutsche Bank AG in Auckland. ‘The official cash rate will move to around 5%, if not below, by the middle of next year.’”
Source: Tracy Withers, Bloomberg, October 23, 2008.
BCA Research: Bank of Canada cuts another 25 bps
“Yesterday’s decision by the BoC provides needed relief to the Canadian economy. Domestic growth conditions will continue to slow in the coming months due to the rapid erosion of the terms-of-trade tailwind (i.e. the dramatic drop in crude oil prices) as well as weaker export demand resulting from the U.S. recession. Already business confidence and activity measures have eroded markedly. As for the consumer, a deteriorating employment outlook and mildly contracting house prices are weighing on sentiment and will likely undermine spending in the months ahead.
“That said, the currency is providing some relief, the Canadian economy did not experience the same housing bubble as many of its G7 counterparts, and the financial system remains well capitalized: according to the World Economic Forum, Canada’s has the world’s soundest financial system. Correspondingly, there is further scope to ease by the European, Australian and New Zealand central banks. Bottom line: We remain neutral on Canadian bonds within a global hedged fixed income portfolio.”
Source: BCA Research, October 22, 2008.
Bloomberg: Argentine bonds, stocks sink as takeover fuels default concerns
“The benchmark Merval stock index tumbled 15.8% on speculation President Cristina Fernandez de Kirchner plans to use the funds to meet financing needs that have swelled as prices on the country’s commodity exports tumbled. Argentina hasn’t had access to international debt markets since its 2001 default and demand for its local bonds has dried up in the past year on concern the government is underreporting inflation.
“‘It’s the final of many nails in the coffin from an institutional investor perspective,’ said Bill Rudman, who helps manage $3 billion of emerging-market equity at WestLB Mellon Asset Management in London. Argentina is ‘disappearing into irrelevance’, he said.
“The yield on the government’s 8.28% bonds due in 2033 surged 6.25 percentage points to 30.94%, according to JPMorgan Chase & Co. The bonds yielded 12.16% a month ago. The benchmark Merval stock index sank to a four-year low, extending its decline this week to 27%.
“Fernandez, 55, announced her plan to take over 10 private pension funds during a speech in Buenos Aires yesterday, saying the proposal would help protect retirees from the global financial crisis. The last time Argentina sought to tap workers’ savings was in 2001, just before it halted payments on $95 billion of bonds. Fernandez denied in the speech that her plan is a bid to ‘grab the cash’.”
Source: James Attwood and Drew Benson, Bloomberg, October 22, 2008.
Business Day: South African economic policy jerked left as SACP calls shots
“Changes to policy decided at the summit include the creation of a two-tier cabinet, a planning commission, and an industrial policy that focuses more sharply on job creation.
“The changes will surprise, if not shock, analysts who had been taken in by repeated assurances by the new ANC leadership that no policy changes were envisaged.
“Yet SACP deputy general secretary Jeremy Cronin signalled the overhaul yesterday: ‘Very important and fundamental paradigm shifts are occurring.’
“This is the first time the ANC has committed itself to these changes since its elective conference in Polokwane, which saw policy shift to the left.
“The theme of continuity and change, as well as ‘continuity in change’, permeated discussions at the summit.
“Cronin said ‘not everything is broken’, but there would be changes aimed at ‘fixing’ policy and government departments that had not yielded results.
“The planning commission, which Cronin said would come into effect soon after next year’s poll, would be headed by the Presidency and would have the power to align the work of departments and organs of state to support the state’s developmental agenda.
“‘The planning commission would … promote the alignment of government budgets with developmental planning, set broad targets through medium-term and long-term plans, conduct strategic risk assessment, and act as secretariat to the council of state,’ a statement released after the summit read.”
Source: Karima Brown and Amy Musgrave, Business Day, October 20, 2008.
1 comment to Words from the (investment) wise for the week that was (October 20 – 26, 2008)
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