Words from the (investment) wise for the week that was (Oct 27 – Nov 2, 2008)
October lived up to its reputation as being a torrid month. The following extraordinary performances tell the story:
• MSCI Word Index: -19.1% (largest monthly decline since the Index started in 1969, beating October 1987’s -17.1%)
But the last week of the month witnessed a strong rebound in global stock markets as investors brushed aside discouraging economic reports and took heart from central banks cutting key lending rates and positive developments in the credit markets. This resulted in investors scooping up beaten-down stocks around the globe, and particularly emerging-market stocks, government bonds and currencies, mending some of the damage done earlier in October.
Further evidence of just how tough October has been was provided by Thursday and Friday’s stock market improvement producing the first back-to-back days of gains for the S&P 500 Index and the Dow Jones Industrial Index since September 25 and 26.
In the spirit of Halloween, one can rightfully ask: trick or treat? (By the way, the masks below, according to FT Alphaville, are not accompanied by suitcases of money.)
The FOMC lowered the Fed funds target rate from 1.5% to 1.0% on Wednesday. This action followed an emergency 50 basis point cut in the benchmark rate on October 8. The committee’s statement said economic activity has “slowed markedly” and cited weakness in consumer spending, business investment and exports. It also noted tight credit. The statement furthermore said that “downside risks to growth remain”, an indication that more rate cuts could follow. The target rate was last at 1.0% in 2004 and has not been below this level since 1958.
The Fed followed up its rate-cutting action with an announcement that it was setting up dollar swap lines with Brazil, Mexico, South Korea and Singapore, contributing to the sharp turnaround in emerging-market assets.
Next, a tag cloud of the text of the large number of articles I have devoured during the past week. This is a way of visualizing word frequencies at a glance. Unsurprisingly, the key words included the following: “market”, “bank”, financial”, “fund” and “credit”.
Where do we go from here? One bit of cheer is that the stock market is now entering what has historically been the strongest half of the year. “… investing in the S&P 500 Index from the last trading day in October (therefore referred to as the Halloween indicator) through the end of April accounted for the vast majority of S&P 500’s gains since 1950. While there are some noteworthy periods in which the Halloween indicator didn’t produce (i.e. 1973-74 and 2000-01), the overall outperformance is compelling,” reported Chart of the Day.
To which Jeffrey Hirsch (Stock Trader’s Almanac) added: “… November is much better in election years when the incumbent party is ousted – usually because of dissatisfaction with the status quo. Traders and investors often celebrate a change of the guard when the economy and stock market are on the ropes as they are now.”
Here is Richard Russell’s (Dow Theory Letters) take on matters: “Things are looking better. After a series of 90% down-days, we had a 90% up-day on Tuesday, October 28. Since then, the market action has been fairly good. With bonds appearing to have topped out, I’m beginning to think that there’s a fairly good chance the market has bottomed. On Thursday’s statistics, Lowry’s Selling Pressure Index (supply) finally dropped substantially, giving evidence of an important drop in supply. At the same time their Buying Power Index surged, finally showing an increased willingness to buy. So far, so good.”
I summarized my viewpoint in a post on Friday: “I give the current rally the benefit of the doubt provided the recent lows (8,176 on the Dow Jones Industrial Index and 849 on the S&P 500 Index) do not get taken out. However, it remains difficult to say whether a secular low has been reached in an environment of economic and profit recession. At least, the extent to which central banks, governments and the IMF are becoming involved to fend off a total economic meltdown is a sign that we could be in a bottoming-out phase of the bear market.”
The last word goes to Laszlo Birinyi (Birinyi Associates) who cautioned as follows: “We believe the markets are in uncharted territory with developments and characteristics that are unique in our experience and we can only guess at what might transpire over the next several months. Frankly we don’t know, history provides no clues and anyone who claims to have some insight or strategy cannot do so on the basis of fact and historical evidence.”
Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance round-up.
Economic reports released in the US during the past week were mostly negative. The most important of these was the announcement that real GDP fell by 0.3% in the third quarter. Weakness was driven by consumer spending, down 3.1% (i.e. subtracting 2.2 percentage points from the GDP calculation), as higher gas prices, housing weakness and job losses created huge headwinds for the consumer. Business equipment spending declined while strength was added by exports and government spending.
Summarizing the US economic situation, Asha Bangalore (Northern Trust) said: “The National Bureau of Economic Research (NBER) will eventually announce the onset of a recession. Based on the NBER’s methodology, the recession appears to have commenced in the fourth quarter of 2007/first quarter of 2008.
“The question now is about the depth and duration of the recession. In the post-war period, the median duration of a recession has been 10 months and median drop in real GDP from the peak to trough is a 1.9% annualized decline.
“How will the current recession compare with prior history? In our estimation, the depth and duration will err on the side of being slightly higher than the historical median given the nature of the credit crisis that is under way. Congress is supposedly working on a second stimulus package that could moderate the weakness in economic activity.”
Elsewhere in the world, the Bank of Japan cut interest rates on Friday for the first time in seven years, reducing the target overnight call rate by 20 basis points to 0.30%. Earlier last week, South Korea, Hong Kong, China, Taiwan and Norway also cut benchmark rates (in the case of China, the third cut in six weeks). It is expected that the European Central Bank, the Bank of England and the Reserve Bank of Australia will ease monetary policy during the coming week.
Source: Yahoo Finance, October 31, 2008.
In addition to interest rate announcements by the Bank of England and the European Central Bank on Thursday, November 6, next week’s US economic highlights, courtesy of Northern Trust, include the following:
1. ISM Manufacturing Survey (November 3): The consensus for the manufacturing ISM composite index is 41.5 versus 43.5 in September.
2. Employment Situation (November 7): Payroll employment in October is predicted to have dropped by 200,000 following a decline of 159,000 in the prior month. The jobless rate is predicted to have risen to 6.2% from 6.1% in September. Consensus: Payrolls: -200,000 versus -159,000 in September, unemployment rate: 6.3% versus 6.1% in September.
3. Other reports: Construction spending, auto sales (November 3), factory orders (November 4), ISM Non-manufacturing (November 5).
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 31, 2008.
A dramatic reversal of fortune hit emerging markets on the back of the Fed’s dollar swap lines for a number of key developing economies, resulting in the MSCI Emerging Markets Index surging by 20.4% (YTD -54.2%). The week’s largest increases were recorded by Russia (+40.8%), Mexico (+19.3%), Brazil (+17.4%), South Korea (+18.6%) and Turkey (+15.1%).
The performance of the Dow Jones World Index (green line) and the MSCI Emerging Markets Index (red line) during October is shown by the graph below.
The table below by Finviz summarizes the past week’s performances (in US dollar terms, whereas all the gains/losses referred to elsewhere in this post are in local currency terms) for various stock markets. Click here or on the thumbnail for a large table.
The US stock markets all improved strongly over the week as shown by the major index movements: Dow Jones Industrial Index +11.3% (YTD -29.7%), S&P 500 Index +10.5% (YTD -34.0%), Nasdaq Composite Index +10.9% (YTD -35.1%) and Russell 2000 Index +14.1% (YTD 29.8%).
The Dow needs to rise to 9,810 – 5.2% higher than its current level of 9,325 – in order to be “officially” classified as being in a bull market again. The Index will be required to increase by 10.2% to reach its 50-day moving average and 25.4% to get to the key 200-day line.
Click here or on the thumbnail below for a (delightfully green) market map, obtained from Finviz.com, providing a quick overview of the performance of the various segments of the S&P 500 Index over the week.
The bar chart below, also from Finviz, shows the US sector performance for last week, and specifically how defensive sectors such as utilities and healthcare underperformed on a relative basis.
Putting the stock market outlook in perspective, Eoin Treacy (Fullermoney) said: “… the current environment is extraordinary in terms of how overextended markets have become relative to their long-term averages. Statistically, a reversion to the mean (i.e. 200-day moving average) remains the most likely scenario in the short to medium term. Where markets consolidate subsequent to that move will be an important marker for the shape of any potential recovery.”
US mortgage rates increased, with the 30-year fixed rate jumping by 44 basis points to 6.56% (in line with the 30-year US Treasury Note rising by 29 basis points) and the 5-year ARM by 9 basis points to 5.99%.
The cost of buying credit insurance for US and European companies eased as shown by the narrower spreads for both the CDX (North American, investment grade) Index (down from 227 to 200) and the Markit iTraxx Europe Crossover Index (down from 920 to 765).
Money-market rates declined as a result of rate cuts by a number of central banks and the ongoing provision of liquidity. The three-month dollar Libor rate declined by 49 basis points to 3.03% during the week, but remained 203 basis points above the Fed’s target rate of 1.0%. The spread was 43 basis points at the start of the year.
Also on center stage was a strong turnaround in a number of emerging-market currencies as investors were comforted by (1) the Fed establishing dollar swap lines with Brazil, South Korea, Singapore and Mexico, and (2) aid programs from the IMF and other organizations reducing the risk of defaults.
Over the week the US dollar gained against the Japanese yen (+4.2%), but lost ground against the euro (-0.9%), the British pound (-0.9%), the Swiss franc (-0.9%), the Canadian dollar (-5.5%), the Australian dollar (-7.4%), the New Zealand dollar (-4.8%) and a host of emerging-market currencies.
Has the greenback made its high for the current cycle? Paul Kedrosky (Infectious Greed) argued in a recent guest post on my blog site that the US dollar’s surge won’t last. “Down is up, and up is down? How is it that a growing US economy was bad for the US dollar, but a potentially calamitous collapse in the same US economy has the US dollar up double-digit percentages?,” asked Kedrosky.
BCA Research outlined its currency strategy as follows: “First, the euro and pound will be ‘trading buys’ against the dollar and yen, but no more than that. The European economies and financial systems will be soggy for some time, and their central banks are still behind the curve. Second, the trade-weighted dollar is close to a three-year high, which will not make economic sense even after the US economy and banking system turn the corner. Most likely, the dollar will lose ground against emerging and commodity currencies with good fundamentals, but will hold its own against the euro. Finally, the yen is a tougher call and we recommend standing aside.”
However, commodities reversed course during the past week as dollar weakness resulted in an improvement for most commodities (with the exception of gold), as shown by the following chart:
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. Let’s hope that after the volatile trading that characterized most of October, conditions will calm down – as always happens after a storm. And if this is part of the change to be brought about by a new US president after Tuesday’s election, nobody will be complaining.
That’s the way it looks from Cape Town.
The American consumer – R.I.P.
“The great American consumer – much like the Norwegian Blue parrot of Monty Python fame – is dead. A stiff. Bereft of life. He rests in peace.”
Source: New York Post, October 26, 2008.
BBC News: Steve Forbes – Credit crisis: “The worst is over”
Source: BBC News, October 29, 2008.
CNBC: Recovery Could Take 20 Years – Hugh Hendry
Source: CNBC, October 22, 2008.
Sovereign Society: Felix Zulauf – world is entering a “soft depression”
“His prediction of a severe recession will take the S&P 500 Index down all the way to 550, possibly 500. Stocks have already plunged 40% from their October 2007 highs. Zulauf is adamant: ‘US stocks are still not cheap. The S&P 500 Index trades at 1.7 times book-value and the Dow more than 3.5 times book. This is still expensive.’
“The Swiss advisor now predicts a very different world will emerge as a result of widespread government nationalization of banking. These efforts – started in the West – will send the wrong message to emerging markets, also likely to follow the same course of full or partial nationalization.
“This will also mark the end (at least temporarily) of the globalization theme, as markets will gradually be closed to foreign competition amid a marked increase in government regulation of financial markets. He also expects foreign currency controls as economic distress accelerates.
“According to Zulauf, a ‘soft depression’ lies ahead. And Europe might be the focal point because the banking system there is worse than in the United States.
“‘There’s a disaster unfolding in Eastern and Central Europe. These countries are now unwinding leverage, namely Hungary, Romania and Bulgaria. They’ve borrowed heavily in foreign currencies and now have to pay those funds back as bank liquidity dries.’
“Zulauf also believes Italy, Greece and Spain will eventually exit the single European currency, or the euro.
“He seriously doubts the euro – in its current form – will survive beyond 10 years as government deficit ceilings are breached amid a bulging credit crisis. The 15 members comprising the Eurozone must keep budget deficits at 3% of GDP or lower in accordance with the Maastricht Treaty.
“Despite his bearish tone, Zulauf believes global equities will offer one of the best buying opportunities in a generation sometime over the next 24 months. This includes real estate. He’s expecting stocks to stage a powerful bear market rally off the October lows.
“But beyond a big move, he thinks the economic landscape is still deteriorating and earnings forecasts are too aggressive. Still, after the next big drop, he does believe stocks will be trading at incredibly low levels.”
Source: Sovereign Society, October 27, 2008.
BBC News: Financial crisis – world round-up
Click here for the full article.
Source: BBC News, October 29, 2008.
Financial Times: IMF to speed lending to select countries
“The new liquidity facility is the culmination of a decade of attempts at the IMF, after the Asian financial crisis of 1997-98, to come up with a way of protecting big emerging markets from financial contagion.
“The IMF’s executive board on Wednesday agreed to allow countries with sustainable debt and a good policy track record to borrow up to five times their ‘quota’, or financial contribution to the IMF, with almost no conditions.
“‘This fills a gap in the fund’s toolkit of financial support,’ said Dominique Strauss-Kahn, the IMF’s managing director. ‘It shows the fund can act quickly and decisively.’
“An IMF official said that a ‘discrete and not particularly large group” of nations would likely qualify. With the exception of Argentina, which Mr Strauss-Kahn ruled out as a participant, the fund declined to name them. But fund officials said it should be fairly easy for market participants to identify eligible countries from the IMF’s annual assessments of debt sustainability and fiscal and monetary policy.
“Independent economists said that the four emerging markets to which the US Federal Reserve offered currency swap lines on Wednesday – Brazil, South Korea, Mexico and Singapore – would certainly qualify, though they would probably choose Fed money first over IMF money. Other countries likely to meet the fund’s criteria included the Czech Republic, Chile and possibly Poland, while economies with large current account deficits such as South Africa and Turkey would probably not, they said.
“Lending will be for three months at the fund’s standard interest rates, renewable up to twice within a twelve-month period. IMF officials said that money could be available within 72 hours.”
Source: Alan Beattie, Financial Times, October 29, 2008.
Financial Times: IMF firepower could soon run short
“In spite of the period of relative peace in recent years among emerging markets, the private armies of global finance have grown much faster than the fund’s store of ammunition.
“The IMF, headed by Dominique Strauss-Kahn, has about $200 billion in easily reachable money and another $50 billion or so it can access rapidly. But Simon Johnson, a former IMF chief economist now at the Massachusetts Institute of Technology, says that is relatively small. ‘Maybe if the IMF had two trillion dollars it could be a serious global player,’ he says. ‘But $200 billion can go very quickly. There are a lot of countries in the same position as Ukraine, and you only need to add one or two of the really big countries to use it up.’ Mr Johnson reckons that with other countries also in trouble, the IMF has probably already had to pencil in committing about a quarter of its $200 billion over the next few months.”
Source: Alan Beattie, Financial Times, October 27, 2008.
Bloomberg: Ryan says treasury to need “unprecedented” financing
“‘This year’s financing needs will be unprecedented,’ said Anthony Ryan, the Treasury’s acting undersecretary for domestic finance, at a Securities Industry and Financial Markets Association conference in New York.
“Ryan’s borrowing outlook comes after Treasury officials spent much of the past month publicly praising the rescue plan’s virtues. The Treasury needs to sell debt to raise money for the new initiatives and also cope with a weaker economy, two factors analysts say may push the country’s budget deficit to more than $1 trillion for the current fiscal year.
“As part of the rescue effort, the Treasury aims to boost the economy by pushing $250 billion in new capital to US banks. Half of that money has been set aside for large banks, which hold about half of all US deposits, in hopes of stimulating more lending to businesses and consumers. The rest will go to regional banks and smaller institutions.
“Analysts say the 2009 budget deficit could be more than double the White House projections. In fiscal year 2008, which ended September 30, the deficit was a record $455 billion.”
Source: Rebecca Christie and Robert Schmidt, Bloomberg, October 28, 2008.
Bloomberg: Fed spurs record surge in longer-term commercial paper issuance
“Companies yesterday sold 1,511 issues totaling a record $67.1 billion of the debt due in more than 80 days, compared with a daily average of 340 issues valued at $6.7 billion last week, according to Fed data. The central bank probably absorbed about $60 billion of the total, said Adolfo Laurenti, a senior economist at Mesirow Financial.
“‘That’s the very first really good news in quite some time,’ said Laurenti. ‘It’s probably something the government can do and the normal investor would not otherwise do.’
“The Fed began buying commercial paper from companies yesterday to reduce rates, lure back investors and unlock the market, which seized up last month following the bankruptcy of Lehman Brothers.”
Source: Bryan Keogh, Bloomberg, October 28, 2008.
The Wall Street Journal: US mulls widening bailout to insurers
“The availability of US government cash in the middle of a global credit squeeze is drawing requests from insurance firms, auto makers, state governments and transit agencies. While Treasury intended for the program to apply broadly, the growing requests could put a strain on the $700 billion, a sum that only last month stunned lawmakers.
“Insurers are critical to market stability. Signs of eroding confidence at life insurers could further dent fragile business and consumer confidence. Insurers are among the biggest holders of the nation’s corporate debt, with $1.3 trillion on their books.”
Source: Deborah Solomon and Leslie Scism, The Wall Street Journal, October 25, 2008.
Associated Press: Treasury set to dish out financial rescue funds
“Assistant Treasury Secretary David Nason said the deals with the nine banks were signed Sunday, and the government will make the stock purchases this week. The deals are designed to bolster the banks’ balance sheets so they will begin more normal lending.
“The action will mark the first deployment of resources from the government’s $700 billion financial rescue package passed by Congress on October 3.
“The bailout package has undergone a major change in emphasis since it was passed by Congress. Treasury Secretary Henry Paulson decided to use $250 billion of the $700 billion to make direct purchases of bank stock, partially nationalizing the country’s banking system, as a way to get money into the financial system more quickly.
“The plan is also aimed at clearing banks’ balance sheets of bad assets. That effort has yet to begin although the administration expects to use $100 billion to purchase bad assets in coming months.
“Treasury is also starting to give approval to major regional banks with the goal of getting another $125 billion in stock purchases made by the end of this year.”
Source: Martin Crutsinger, Associated Press (via Breitbart), October 27, 2008.
CNNMoney.com: Bernanke discusses future of Fannie and Freddie
“In a speech broadcast to an economic symposium in Berkeley, Calif., Bernanke said there are many alternatives that need to be considered but that all will involve a role for the federal government and federal guarantees for securities backed by mortgage loans.
“‘Government likely has a role to play in supporting mortgage securitization, at least during periods of high financial stress,’ he said.
“The two government sponsored firms either owned or guaranteed about $5 trillion in mortgages between them and their problems could end up costing taxpayers hundreds of billions of dollars in future losses.
“But Bernanke said having them replaced by totally private firms could cause greater problems for the economy during a future financial crisis. Thus, he said that the federal government will likely have a role guaranteeing mortgages into the future.
“‘From a public policy perspective, a greater concern with fully privatized [firms] is whether mortgage securitization would continue under highly stressed financial conditions,’ he said. ‘As I have noted, almost no mortgage securitization is occurring today in the absence of a government guarantee.’
“Bernanke did not endorse any specific alternative for Fannie and Freddie and he stopped short of advocating for the government to completely nationalize the two firms. Instead, he gave a rundown of numerous proposals that have already been raised by Fed and Treasury officials as well as other experts.”
Source: Chris Isidore, CNNMoney.com, October 31, 2008.
Financial Times: Hungary gets $25.1 billion rescue package
“The IMF said it had reached an agreement with Hungary for a $15.7billion loan programme, while the European Union stood ready with an additional $8.1 billion in financing and the World Bank another $1.3 billion. The IMF loan will be disbursed over 17 months.
“It is the biggest international rescue package for an emerging market economy since the start of the current global crisis and is the first for an EU-member country. Last week the IMF approved a $2.1 billion deal for Iceland and a $16.5 billion programme for Ukraine.
“‘The Hungarian authorities have developed a comprehensive policy package that will bolster the economy’s near-term stability and improve its long-term growth potential,’ Dominique Strauss-Kahn, IMF managing director, said.
“‘At the same time it is designed to restore investor confidence and alleviate the stress experienced in recent weeks in the Hungarian financial markets,’ he added.”
Source: Financial Times, October 28, 2008.
Financial Times: Gulf Bank bailout
“The same aura of resilience extended to the Gulf’s banks – until Kuwait’s weekend rescue. Gulf Bank is the region’s first casualty – not because of subprime losses or overexposure to the heady Dubai property market, but after derivative counterparties defaulted, costing it an estimated $800 million. Seven days is a long time in a global financial crisis: a week after the Central Bank of Kuwait said deposit guarantees were not needed, Gulf Bank’s loss – which looks to be a one-off – forced it to guarantee all local bank deposits.”
Source: Financial Times, October 27, 2008.
Bloomberg: Shipping news suggests world economy is toast
“Here’s a clue. Picture a highway gridlocked by 41,815 abandoned trucks – because Volvo’s order book got destroyed to the tune of 99.63%, with customers signing up for just 155 vehicles in the three-month period, the Gothenburg, Sweden-based company said last week.
“The pathogen that has fatally infected swathes of the banking industry is now contaminating non-financial companies. ‘We’re heading toward the sharpest downturn I’ve ever seen in Europe,’ said Chief Executive Officer Leif Johansson.
“Volvo has company. Daimler AG, the world’s biggest truckmaker, said earlier this month that its US deliveries slumped by a third in the first half of the year.”
Source: Mark Gilbert, Bloomberg, October 30, 2008.
Bill Moyers Journal: Interview with James Galbraith
Source: Bill Moyers Journal, October 24, 2008.
Bespoke: Overnight Libor at lowest level in years
Source: Bespoke, October 30, 2008.
Asha Bangalore (Northern Trust): Fed takes aggressive action
“On October 8, the FOMC statement indicated that economic activity has weakened, while particular sectors were not mentioned. By comparison, the October 29 statement describes slowing conditions but also notes explicitly that the major culprit is consumer expenditure.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, October 29, 2008.
BCA Research: Fed moving closer to monetization
“As expected, the Fed eased policy again yesterday, returning the funds rate to 1%, the level reached in the wake of the burst technology bubble. The economy is in much worse shape today than it was back then, warning that policy may have to be eased even further.
“While the Fed’s program to purchase commercial paper appears to be off to a good start, the key issue is whether there is a more broad-based thaw in the credit freeze. The signs are still not encouraging on this front with many key credit spreads at or close to their peaks.
“The Fed’s balance sheet has exploded upwards, but the corresponding rise in bank reserves needs to spread out into the broader economy. In this respect, it will be important to monitor the ratio of M2 to the monetary base (the money multiplier). This has plunged recently, but that may simply be due to lags. If it fails to revive, the Fed will continue to expand its asset support programs but ultimately may have to resort to quantitative easing.”
Source: BCA Research, October 30, 2008.
The Wall Street Journal: Ex Fed governor makes case for zero Fed funds rate
“The FOMC is widely expected to reduce the rate to 1% from 1.5% at the conclusion of its two-day meeting Wednesday. Meyer and former Fed economist Brian Sack, who are both with Macroeconomic Advisers, said they expect another half-percentage-point rate cut in December, to 0.5%. Their baseline assumption is that the easing cycle will stop there.
“‘However, the expected rise in the unemployment rate, paired with the rising threat of deflation, presents a risk that the FOMC will have to ease even further, perhaps all the way to a zero federal funds rate,’ Meyer and Sack wrote in a research note.
“Meyer and Sack said they think the jobless rate will rise to as high as 7.5% from 6.1% now. They also expect a significant gross domestic product contraction of 2.8%, at an annual rate, in the fourth quarter, after a projected 0.7% decline in the third. They also expect GDP to fall in the first quarter of next year.”
“‘Plugging our interim forecast into our backward-looking policy rule suggests that the federal funds rate should be cut to zero by the middle of next year,’ Meyer and Sack wrote.
“‘Our forward-looking policy rule … gives similar results if we plug in our updated forecast, as it calls for a funds rate of about zero by early 2010,’ they wrote.”
Source: The Wall Street Journal, October 28, 2008.
Asha Bangalore (Northern Trust): Q3 GDP – details tell a grimmer story than headline
“Government spending contributed 1.15% to the headline GDP, with the defense component accounting for the lion share (+0.9%) of the increase. Going forward, state and local government spending is likely to be weaker than the already tepid growth seen in the past few quarters.
“The contribution of net exports to growth of real GDP in the third quarter (1.13%) was close to that of government spending. However, economic growth in foreign economies has slowed and projections show weaker world economic growth (even excluding the US) in the quarters ahead compared with forecasts prior to the intensification of the financial turmoil.
“Among the other major components of GDP, consumer spending fell at annual rate of 3.1% in the third quarter, the first quarterly decline since the fourth quarter of 1991 when consumer spending dropped at an annual rate of 0.3%. The magnitude of the decline in consumer spending is the largest since the second quarter of 1980, when some households literally were cutting up their credit cards.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, October 30, 2008.
John Williams (Shadow Government Statistics): US economy is in a severe recession
“With real retail sales, housing, nonfarm payrolls, new orders for durable goods and industrial production all showing quarterly and annual growth patterns never seen outside of a recession still in deterioration, GDP reporting eventually should show a string of quarterly contractions, with the recession dating back to fourth-quarter 2006, long before the exacerbation of the current systemic solvency crisis. … official GDP surrogates such as Gross National Product (GNP) and Gross Domestic Income (GDI) have shown varying patterns of quarterly contractions. GDP is the theoretical equivalent of GDI (consumption side versus income side) and is GNP net of the trade balance in interest and dividend payments.
“Based on existing GDP, GDI and GDP reporting, the following quarters have shown inflation adjusted quarterly contractions: 1Q07 (GNP), 4Q07 (GDP), 1Q08 (GDP/GDI), 3Q08 (GDP).”
Source: John Williams, Shadow Government Statistics (via The King Report), October 30, 2008.
Asha Bangalore: Consumer spending on watch list, no surprises here
“On a quarterly basis, the decline in the third quarter (-3.1%) is the first drop since the fourth quarter of 1991. In September, real consumer spending fell 0.4% on a year-to-year basis, which is the largest drop since January 1991. Why is this sharp decline important? Consumer spending is the largest component of GDP (a little over 70%) and it has been the engine of growth. At the cost of stating the obvious, a setback in consumer spending translates into overall weak economic conditions. Keeping up with the Halloween tradition, it is scary indeed!”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, October 31, 2008.
Asha Bangalore (Northern Trust): Falling prices lift sales of new homes
“The inventory of unsold new single-family homes dropped to a 10.4-month supply from an 11.4-month mark in August. The downward trend is a positive factor. But the elevated level continues to suggest that additional declines in home prices are nearly certain.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, October 27, 2008.
Standard & Poor’s: Case-Shiller – national trend of home price declines continues into the second half of 2008
“The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Home Price Indices. Once again, the indices have set new records, with annual declines of 17.7% and 16.6%, respectively. However, the acceleration in decline was only moderate in August. The July data reported annual declines of 17.5% and 16.3%, respectively.”
Source: Standard & Poor’s, October 29, 2008.
The New York Times: Consumers feel the next crisis: it’s credit cards
“The pullback is affecting even creditworthy consumers and threatens an already beleaguered banking industry with another wave of heavy losses after an era in which it reaped near record gains from the business of easy credit that it helped create.
“Lenders wrote off an estimated $21 billion in bad credit card loans in the first half of 2008 as more borrowers defaulted on their payments. With companies laying off tens of thousands of workers, the industry stands to lose at least another $55 billion over the next year and a half, analysts say. Currently, the total losses amount to 5.5% of credit card debt outstanding, and could surpass the 7.9% level reached after the technology bubble burst in 2001.”
Source: Eric Dash, The New York Times, October 28, 2008.
James Quinn (Telegraph): US faces deflation to compound its misery
“David Rosenberg, Merrill Lynch’s chief US economist, believes that deflation will occur, adding to the recessionary environment North America already finds itself in and potentially delaying the nation’s economic recovery.
“Mr Rosenberg was the first Wall Street economist to declare that the US had entered a recession back in January of this year, and had also long warned of systemic problems in the global credit markets.
“‘We believe the next major macro-economic theme is deflation,’ Mr Rosenberg writes in a research report. ‘Within a year, we see a very good chance that [inflation] will be running below 0% on a year-over-year basis.’
“He argues that just as the economy was showing signs of a recession nearly a year before economic growth turned negative, today’s current economic backdrop is deflationary.
“The respected economist goes on to explain that deflation can become self-perpetuating, as consumers begin to defer spending on hopes of further discounts as prices fall – so reinforcing the downward pressure on demand.
“‘Likewise, firms that are faced with deflation to their top lines are typically forced to cut costs to protect their profit margins and in so doing, trigger a second-round negative income effect on their workers and suppliers, which also ends up exacerbating the trend towards lower pricing.’”
Source: James Quinn, Telegraph, October 27, 2008.
Bloomberg: Mishkin sees “significant” odds inflation may go too low
Source: Bloomberg, October 28, 2008.
Guy Stear (Société Générale): US needs aggressive fiscal package
“‘Equity markets continue to slide, while credit derivatives have come under significant pressure in the past week, even though the outlook for the financial sector has become marginally better over the past fortnight,’ he points out. ‘The problem now lies with the non-financial sector.’
“The markets, Mr Stear says, are counting on interest rate cuts to turn the situation around – although these cuts are expected to be relatively short-lived. ‘US Fed funds futures are still pricing in hikes from the second half of next year,’ he notes.
“‘And while lower rates might help the banking system, they arguably might not do much for the non-financial sector, especially if the banks are still cagey about lending. Worries about defaults are mounting as liquidity is strained,’ Mr Stear says.
“‘So the real solution to this crisis is an aggressive expansionary fiscal package. This looks easier to achieve in the US than it does in Europe, although it will need to wait until after the Presidential elections.”
Source: Guy Stear, Société Générale (via Financial Times), October 28, 2008.
Financial Times: Pension fund gap hits $100 billion<
“The cash payment, estimated by several pension industry executives, would be spread over this financial year and next year.
“Companies’ pension fund losses – running at an estimated 20% in the year to date – also are expected to alter earnings this year, partly because of accounting changes.
“The 700 largest corporate plans were more than 100% funded at the end of last year, but as of last week that had fallen to about 83%, according to estimates by Mercer, a pension consultant.
“John Erhardt, a principal at Milliman, a consulting firm, said: ‘To bring company funds back to 100% funding, companies would need to put in about $50 billion this year and that again next year, for the top 100 funds. You could add another 30% to 40% to that for the rest of the funds.’
“‘Earnings will be impacted significantly. The 2008 year-end balance sheet will reflect that.’”
Source: Deborah Brewster, Financial Times, October 29, 2008.
Telegraph: Thousands of hedge funds on brink of failure
“‘This will go down in the history books as one of the greatest fiascos of banking in 100 years,’ said Mr Roman, who with Noam Gottesman, co-runs GLG, a former division of Lehman Brothers Holdings with assets of $24 billion. ‘There need to be some scapegoats, and the regulators are going to go hunt people. That will be good in the long run.’
“His views were echoed by Professor Nouriel Roubini, a former US Treasury and presidential adviser known for his accurate prediction of financial crises, who estimated that up to 500 hedge funds would fail within months.
“‘It’s the beginning of the decline of the US financial empire. The Great Depression ended in a massive war. I hope that’s not going to happen but it’s pretty ugly now,’ Prof Roubini said.”
Source: Rowena Mason, Telegraph, October 24, 2008.
Bloomberg: Levitt says derivatives necessary, should be regulated
Source: Bloomberg, October 29, 2008.
Bespoke: Another double digit move higher
“The fact that the Dow is still down 15% this month even with two 10% up days shows just how unhinged this market has become. Over the last fifty trading days, its average daily percentage move on an absolute basis has been 2.78%. The wild swings make the current period the most volatile in terms of one-day moves that we have seen since the early 1930s.”
Source: Bespoke, October 28, 2008.
Bespoke: The lost quarter century
Source: Bespoke, October 27, 2008.
CNBC: Is this the bottom and the turn?
Source: CNBC, October 28, 2008.
The New York Times: Forecasters race to call the bottom to the market
“‘To make a crazy forecast today is not crazy,’ said Owen Lamont, a former professor at Yale who has studied economic forecasting. ‘It’s not crazy to predict the Dow is going to 2,000. That’s in the realm of possibility.’
“Indeed, in an era of 1,000-point daily swings in the Dow and 30% losses in the stock market, prescience is at a premium – and the dividends of a high-profile correct call can be immense.
“In 1987, a little-known strategist named Elaine Garzarelli found herself a newly minted celebrity after predicting the market would crash just days before Black Monday. This time around, longtime doomsayers like Nouriel Roubini of New York University have become media staples since many of their most apocalyptic predictions started coming true.
“Even in normal times, forecasters have a strong incentive to make extreme predictions, which is why those ‘Dow 1,000!’ reports persist. ‘It’s eye-popping. It’s relevant. It seems exciting,’ Mr. Lamont said. Such predictions attract publicity, name recognition and a bigger client base in a business where investors pay thousands, if not millions, for stock advice and investment guidance.
“‘Anyone that invests 10 cents on the basis of someone’s forecast of the Dow is desirous of losing a good portion of their 10 cents,’ said William A. Fleckenstein, president of Fleckenstein Capital, a money management firm in Issaquah, Wash. ‘It is almost the height of arrogance to say this is where the Dow is going to trade.’
“‘These types of forecasts are wildly off-base,’ Mr. Fleckenstein said. ‘What they’re always about is extrapolation. People are always extrapolating recent trends. And you don’t know how far the trend is going to really run.’”
Source: Michael M. Grynbaum, The New York Times, October 26, 2008.
David Fuller (Fullermoney): How to identify a stock market low
“… for evidence of a stock market low, I would look for a loss of downside momentum by share indices, coinciding with a loss of upside momentum for the yen and US dollar. Meanwhile, the proximity of the 2002 bear market lows for the S&P, plus its current downside overextension relative to the moving average (MA), suggest that some mean reversion is overdue. If accompanied by weaker carry trade currencies, we should see a rally towards the declining MA. However if the yen and dollar remain firm, we may only see a ranging reversion towards the declining MA.
“Recently, the S&P paused in its decline following the October 10 low, but remains barely steady near that level. Moreover, stock market indices for most other countries have already broken downwards once again.
“… many people feel that the fundamentals are much worse today than in 2002. They certainly have a point. Therefore, a cautious investor may prefer to wait for evidence of new bull markets before significantly increasing equity exposure. The technical signals would be base formation development followed by breaks above the 200-day MAs, which also turn upwards. I do not know when that will occur but the charts will certainly show us.”
Source: David Fuller, Fullermoney, October 28, 2008.
Ian Scott (Nomura): Stocks to bottom soon
“He says with markets behaving as they are, rationalising such extreme movements with economic or corporate fundamentals is virtually impossible.
“‘While it is always theoretically possible to invent an economic scenario to justify current prices, the scenario that would now be required necessitates policy failure on a scale not seen since the 1930s.
“‘Yet it is hard to imagine a more committed policy response than the one we have had, and there are now some tentative signs that it is having an impact. Stocks should bottom soon.’
“Mr Scott argues that with inflation absent, interest rates are set to come down sharply. ‘Although we would bias away from leveraged companies, we would overweight rate-sensitive sectors.
“‘Indeed, there is a stark contrast between early-cycle cyclicals – where earnings estimates have been cut, valuations are low and rate cuts will be a benefit – and late-cycle industrials where earnings estimates have barely budged and valuations are high, and which tend to underperform when rates come down.
“‘We suggest biasing portfolios in favour of media, retail, real estate and technology and away from capital goods, construction and building materials, leisure, steel and consumer staples.’”
Source: Ian Scott, Nomura (via Financial Times), October 27, 2008.
Eoin Treacy (Fullermoney): Has dollar and yen turned into tailwind for equities
“The yen has gone from being one of the weakest currencies in the world to one of the strongest in a very short time. This has seen it advance considerably in a clearly accelerated move which is now under pressure. Although the Yen found a least short-term support today, it needs to sustain moves to significant new highs to question scope for a further retracement of recent gains.
“The dollar also rallied impressively over the last few months and encountered resistance this week. However, the commonality of this move is far less clear cut with the dollar than for the yen. The Dollar Index’s rally broke its almost three-year downtrend and forced investors to reassess the medium-term prospects for the currency. It encountered resistance this week near 88, but this is so far an equal sized reaction to that posted in September. It needs to now encounter resistance below 88 and sustain a move below 84 to confirm that it has hit a medium-term peak.”
Source: Eoin Treacy, Fullermoney, October 30, 2008.
The New York Times: Are stocks the bargain you think?
“They are usually careful to add that they don’t know what stocks will do in the short term. Yet their basic message is clear enough: stocks are now cheap, irrational fears have been driving the market down lately, and people who buy today will be glad that they did.
“After a day like Tuesday, when the market rose 11%, it’s easy to see the merits of the argument.
“ there is another argument that deserves more attention than it has gotten so far. It’s the bearish argument that is based neither on fears that the country may be sliding into another depression nor on gut-level worries about the unknown. It is based on numbers and history, and it has at least as much claim on reason as the bullish argument does.
“It goes something like this: Stocks are truly cheap only relative to their values over the last 20 years, a period that will go down as one of the great bubbles in history. If you take a longer view, you see that the ratio of stock prices to corporate earnings is only slightly below its long-term average. And in past economic crises – during the 1930s and 1970s – stocks fell well below their long-run average before they turned around.
“To make matters worse, corporate earnings have now started to plunge, too. Assuming that they keep dropping, stocks would also need to fall to keep the price-earnings ratio at its current level.
“The 10-year price-to-earnings ratio tells an incredibly consistent story over the last century. It has averaged about 16 over that time. There have been long periods when it stayed above 16 and even shot above 20, like the 1920s, 1960s and recent years. As recently as last October, when other measures suggested the market was reasonably valued, the Graham-Dodd version of the ratio was a disturbing 27. But periods in which the ratio has jumped above 20 have always been followed by steep declines and at least a decade of poor returns.
“By 1932, the ratio had fallen to 6. In 1982, it was only 7. Then, of course, the market began to self-correct in the other direction, and stocks took off.
“After Tuesday’s big rally, the ratio was just a shade below 16, or almost equal to its long-run average. This is a little difficult to swallow, I realize. Stocks are down 40 percent since last October, and every experience from the last 25 years suggests they now have to bounce back.
“But that’s precisely the problem. Since the 1980s, stocks have always bounced back from a loss, usually reaching a high in relatively short order. As a result, the market became enormously overvalued.
“As Robert Shiller, the economist who specializes in bubbles, points out, human beings tend to put too much weight on recent experiences. We think the market snapbacks of 1987 and the current decade are more meaningful and more predictive than the long slumps of the 1930s, 1940s and 1970s. Of course, anyone who made the same assumption in 1930 or 1975 – this just has to turn around soon – would have had to wait years and years until the investment paid off.”
Source: David Leonhardt, The New York Times, October 28, 2008.
Bespoke: S&P 500 earnings versus valuation matrix
“With that in mind, we created a matrix to show where the S&P 500 would trade based on different combinations of earnings and multiples. Boxes highlighted in red indicate levels within 5% of where the S&P 500 is currently trading. As shown, if (and we realize there is really no chance of this happening) the consensus for 2009 EPS forecasts proves to be accurate, the S&P would currently be trading at about 10 times next year’s earnings.
“So where are earnings likely to come in next year? One of the more bearish forecasts making the rounds is that earnings for the S&P 500 will come in at $60 per share next year. If that forecast proves to be accurate, that would bring the current multiple of the S&P 500 to about 15.5 times next year’s earnings. While a multiple of 15 is by no means extremely cheap on a historical basis, it is hardly expensive either.”
Source: Bespoke, October 29, 2008.
Bespoke: Percentage of stocks above 50-day moving averages
“On a sector basis, 15% of Consumer Staples stocks are trading above their 50-days. And that is the most positive sector. Financials and Utilities rank second at 10%, followed by Health Care at 8%. Materials and Telecom are still unfortunately stuck at zero.”
Source: Bespoke, October 30, 2008.
US Global Investors: Investors underweight Chinese equities
Source: US Global Investors – Weekly Investor Alert, October 31, 2008.
Ambrose Evans-Pritchard (Telegraph): Europe on the brink of currency crisis meltdown
“Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.
“‘This is the biggest currency crisis the world has ever seen,’ said Neil Mellor, a strategist at Bank of New York Mellon.
“Experts fear the mayhem may soon trigger a chain reaction within the eurozone itself. The risk is a surge in capital flight from Austria – the country, as it happens, that set off the global banking collapse of May 1931 when Credit-Anstalt went down – and from a string of Club Med countries that rely on foreign funding to cover huge current account deficits.
“The latest data from the Bank for International Settlements shows that Western European banks hold almost all the exposure to the emerging market bubble, now busting with spectacular effect.
“They account for three-quarters of the total $4.7 trillion in cross-border bank loans to Eastern Europe, Latin America and emerging Asia extended during the global credit boom – a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles.
“Austria’s bank exposure to emerging markets is equal to 85% of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia – all now queuing up (with Belarus) for rescue packages from the International Monetary Fund.
“Exposure is 50% of GDP for Switzerland, 25% for Sweden, 24% for the UK, and 23% for Spain. The US figure is just 4%. America is the staid old lady in this drama.”
Source: Ambrose Evans-Pritchard, Telegraph, October 26, 2008.
BCA Research: Currency strategy after panic subsides
“First, the euro and pound will be ‘trading buys’ against the dollar and yen, but no more than that. The European economies and financial systems will be soggy for some time, and their central banks are still behind the curve.
“Second, the trade-weighted dollar is close to a three-year high, which will not make economic sense even after the US economy and banking system turn the corner. Most likely, the dollar will lose ground against emerging and commodity currencies with good fundamentals, but will hold its own against the euro.
“Finally, the yen is a tougher call and we recommend standing aside. On economic grounds, the currency is a sell the minute that investor risk aversion peaks. However, the Japanese balance of payments warns that policymakers would have to knock down the yen. The private sector has been burned on foreign investments too often, and any renewed Japanese ‘stretch for yield’ will be moderated by interest rate cuts around the globe.”
Source: BCA Research, October 29, 2008.
BCA Research: Approval for yen intervention
“The G7 made a rare unscheduled statement on currency market movements earlier. The statement comes as the trade-weighted Japanese yen rallied to an 8-year high last week. It has recently become clear that many leveraged trades were financed with borrowed yen, and unwinding of these positions has sent the currency surging. The yen is up over 22% since August, which effectively destroys exporters’ profit forecasts and threatens to destabilize global markets.
“To that end, the G7 issued the following comments: “We reaffirm our shared interest in a strong and stable international financial system. We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability. We continue to monitor markets closely, and cooperate as appropriate.”
“Bottom line: If this ‘verbal intervention’ does not slow the accent of the yen in the coming days, expect the Bank of Japan (acting as an agent of the Ministry of Finance) to intervene in markets and purchase yen. Still, while the medium-term effect may be positive, the immediate impact will be limited unless there are coordinated efforts on behalf of all G7 nations. For now, this outcome seems highly unlikely.”
Source: BCA Research, October 28, 2008.
Bloomberg: Jim Rogers – commodities in a recession
Source: Bloomberg (via Clip Syndicate), October 24, 2008.
Richard Russell (Dow Theory Letters): Gold attempting to make a bottom
Source: Richard Russell, Dow Theory Letters, October 27, 2008.
Financial Times: Trichet says ECB may cut rates
“‘I consider possible that the governing council will decrease interest rates once again at its next meeting on November 6. It is not a certainty, it is a possibility,’ Trichet said in a speech at a banking conference in Madrid.
“‘New information is likely to indicate a further alleviation to upside risks to inflation in the medium term.’
“The ECB cut rates by 50 basis points in tandem with other central banks on October 8 and economists had already forecast further loosening by the end of the year as both growth and inflation cool.
“Mr Trichet said weakening economic growth was easing inflation fears but stressed that the ECB would only ease rates further from the current 3.75% if it felt the inflation outlook justified such a move.
“‘Any new monetary policy stance that we could decide on at our next regular monetary policy meeting must continue to allow us to tell our 320 million fellow citizens: You can be confident. We will deliver price stability in line with our definition of less than but close to 2% in the medium term,’ Mr Trichet said.”
Source: Financial Times, October 27, 2008.
Reuters: Germany to spend and fight recession
Source: Reuters, October 30, 2008.
Victoria Marklew: (Northern Trust): Deteriorating outlook in Germany and the Eurozone
Nationwide: Twelve months of house price falls
Click here for the full report.
Source: Nationwide, October 30, 2008.
Financial Times: Japan unveils economic stimulus package
“‘A storm that comes once in 100 years is raging,’ Mr Aso said of the global financial turmoil.
“While Japan’s financial system remained sound, he said, there was no doubt that the global crisis would affect Japan’s real economy. He promised to act quickly to implement bold measures to counter the downturn.
“The stimulus plan follows the passing of a supplementary budget earlier this month to fund Japan’s first stimulus package this year.”
Source: Michiyo Nakamoto, Financial Times, October 30, 2008.
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