Words from the (investment) wise for the week that was (March 15–21, 2010)

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The major stock market indices added to their gains this week – obtaining comfort from the Fed’s policy statement that the “juice” was not about to be removed anytime soon – and hit 18-month highs before closing down on Friday as “quadruple witching day” in the US weighed on sentiment. A day earlier on Thursday, the S&P 500 tracking ETF (SPY) broke a 14-day winning streak – its longest since the launch of the ETF in 1993.

The Federal Open Market Committee (FOMC) on Tuesday once again announced that the fed funds rate target was likely to remain “exceptionally low” for “an extended period”. The communiqué was slightly more upbeat on the outlook for the economy, saying the labor market was “stabilizing” (last statement: “the deterioration in the labor market is abating”), although a number of constraints on growth remained.

The FOMC’s statement “met market expectations on the three key aspects of leaving interest rates unchanged, maintaining dovish language about future policy moves and allowing the special programs to lapse,” Mohamed El-Erian, chief executive and co-chief investment officer of Pimco told Reuters (via MoneyNews). He added that the end of the Fed’s program of purchasing $1.25 trillion of mortgage-backed securities at the end of March signaled a form of credit tightening. Traders are also expecting an increase in the Fed’s discount rate from 50 basis points above the fed funds rate to the pre-crisis margin of 100 basis points.

Meanwhile, US Senate Banking Committee chairman Christopher Dodd introduced a revised version of a financial regulatory reform bill on Monday. “The Act’s reduced risk retention requirements and its recognition of its potentially negative impact on access to credit by consumers and businesses are encouraging, but the amount of discretion left with the regulators would be troubling to securitizers and originators. However, the delay in the effectiveness of final implementing regulations until, at the earliest, 2012, would give the industry an opportunity to adjust to the new requirements or to petition Congress for relief,” reported lawyers Edward De Sear and Charles Sweet (Bingham).

21-03-10-01

Source: Tom Toles, GoComics.com, March 18, 2010.

The past week’s performance of the major asset classes is summarized in the chart below – a somewhat mixed picture with equities, high-grade corporate bonds, gold, government bonds and the US dollar all higher as pundits waxed and waned between risky assets and safe havens. However, oil and commodities were pushed lower on the back of the stronger greenback. It should be interesting to see how the bond vigilantes handle this week’s auction of $118 billion worth of Treasuries, in the joint-largest auction on record. (For some perspective regarding the short-term outlook for the various asset classes, click the following links for Adam Hewison’s (INO.com) latest technical analyses: S&P 500, US dollar, gold bullion and crude oil.)

21-03-10-02

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The cyclical bull market that commenced on March 9, 2009 marched higher during the past week, albeit with some hesitancy and a weak finish by the close. The MSCI World Index and the MSCI Emerging Markets Index gained 0.8% and 0.9% respectively.

As one would expect during a bull market, small caps have been a leading performer since the low of March 9 last year, with the Russell 2000 Index gaining 96.3% compared to a rise of 71.4% in the S&P 500 Index. Considering the last few days, however, small caps seem to have been tiring. As a result, the Russell 2000 Index has been the only major US stock market index to register a loss for the past week. As mentioned in a post yesterday, I will be keeping a close watch on this possible canary in the coalmine in order to gauge the most likely short-term direction for small caps and stocks in general.

Click here or on the table below for a larger image.

21-03-10-03

Top performers among the entire spectrum of stock markets this week were Ukraine (+8.1%), Qatar (+7.3%), Thailand (+6.7%), Uganda (+4.8%) and Greece (+3.7%). At the bottom end of the performance rankings, countries included Cyprus (-6.7%), Costa Rica (-3.5%), Malawi (-3.4%), Nepal (-2.8%) and Macedonia (-2.7%).

Of the 96 stock markets I keep on my radar screen, 64 (last week 74%) recorded gains, 33% (21%) showed losses and 3% (5%) remained unchanged. The performance map below tells the past week’s mostly bullish story.

Emerginvest world markets heat map

21-03-10-04

Source: Emerginvest (Click here to access a complete list of global stock market movements.)

Nine of the ten economic sectors of the S&P 500 closed higher for the week, with Telecoms (+2.4%) and Industrials (+2.2%) leading the pack and Energy (-1.1%), Materials (+0.2%) and Technology (+0.2%) forming the rear guard.

21-03-10-05

Source: US Global Investors – Weekly Investor Alert, March 19, 2010.

John Nyaradi (Wall Street Sector Selector) reports that as far as ETFs are concerned, the winners for the week included iShares MSCI Thailand (THD) (+6.2%), iShares Dow Jones US Health Providers (IHF) (+4.2%) and iShares MSCI South Africa (EZA) (+3.7%).

At the bottom end of the performance rankings, ETFs included First Trust ISE-Revere Natural Gas (FCG) (-5.7%), United States Natural Gas (UNG) (-5.5%) and Claymore/MAC Global Solar Energy (TAN) (-5.4%).

Criticizing Paul Krugman’s comments that the US should consider a 25% surcharge on Chinese goods, the quote du jour this week comes from Stephen Roach, chairman of Morgan Stanley Asia. He said in a Bloomberg interview: “We should take out the baseball bat on Krugman. … They don’t want to look in the mirror. America doesn’t have a China problem. It really has a savings problem. America has the biggest shortfall of national savings of any leading country in modern history. And when you don’t have savings you have to run current account deficits to import surplus savings from abroad and run massive trade deficits to attract the capital. Last year America ran trade deficits with over 90 – that’s right nine zero – countries. … Isn’t it the height of hypocrisy that America can articulate a particular position in its currency but the Chinese are not allowed to do that.” (Hat tip for transcript: Credit Writedowns.)

Elsewhere, the Financial Times reported that President Barack Obama appeared to be nearing victory in his epic struggle to push healthcare reform through a reluctant US Congress in a vote today (Sunday).

Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. The usual suspects such as “bank”, “debt”, “government”, “market” and “rate” featured prominently, with “China” also again in the limelight as China’s Premier Wen Jiabao rebuffed calls from the US for the renminbi to appreciate.

21-03-10-06

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town when not traveling) are given in the table below. With the exception of the Shanghai Composite Index that is flirting with its 50- and 200-day lines, the indices in the table are all trading above their key moving averages.

The table also provides the February lows for the various indices as these must hold in order for the cyclical bull market to remain intact.

Click here or on the table below for a larger image.

21-03-10-07

I am repeating the following paragraph from last week’s review as it is worth revisiting: “Using Fibonacci retracement lines, the S&P 500 is now testing the 62% retracement line drawn from the May 2008 peak to the March 2009 bottom (see purple lines). According to John Murphy (StockCharts.com), a break of this key upside target raises the possibility that the Index could retrace 62% of the entire bear market that started in the fourth quarter of 2007, in which case the potential upside target is 1,232 (see green lines).”

21-03-10-08

Source: StockCharts.com

Also commenting on the technical picture of the S&P 500, Kevin Lane (Fusion IQ) said: “We remain cautiously optimistic with the trend up, internals strong, the Russell 2000, the NASDAQ and now the S&P 500 at new recovery highs. Skeptics remain the loudest people in the room and while their concerns may be valid we have learned that the market rewards the minority and confounds the majority. The S&P 500 cleared its previous resistance peak near 1,150 and now looks to challenge the 1,200 level. Although there may be some back and filling along the way, we have long argued that there would be one last move up driven by investors who skeptically avoided the market.”

A week ago, Jeffrey Saut (Raymond James) said: “Nassim Taleb (trader extraordinaire) has 10 rules. Rule number 8 reads: ‘No matter how confident, always protect the downside.’ We agree and therefore always try to ‘look’ down before looking up in an attempt to manage the risk. As for the ‘here and now’, the broadest index of them all, the Wilshire 5000, has strung together 11 consecutive higher sessions, a feat not seen since the mid-1990s. Accordingly, it is pretty overbought on a short-term basis. That upside skein can be seen in the candlestick charts, which have not experienced a downside ‘red candlestick’ session since the upside reversal of February 25, 2010. [PduP: Last week saw three declines.]

“We are therefore turning cautious, but not bearish, on a trading basis. That strategy suggests a short-term correction is potentially due, but NOT an intermediate-term bearish decline. Indeed, since the end of the envisioned January/February ‘selling stampede’, we have been constructive on stocks. However, we currently think pairing some trading positions, and/or raising stop-loss points, is warranted.

“Meanwhile, the Reuters/Jefferies CRB Index (commodities) broke below its rising trendline, the 10-Year Treasury Yield Index (TNX/3.71) broke above its 50-day moving average (read: higher rates), the Volatility Index (VIX/17.58) continued to trade below 18 (read: too much complacency), mutual fund cash positions are at historic lows of 3.6%, and the NYSE overbought/oversold indicator tagged a rare overbought reading above 90 last week. Ergo, color us cautious in the very short-term.”

“Where breadth goes, the market usually follows,” goes an old market saw. Analyzing market internals, the number of S&P 500 stocks trading above their respective 50-day moving averages has increased to 87% from 21% in early February (see chart below). “At these levels, there really hasn’t been much more room to run on the upside before a short-term pullback (or at least sideways trading) has been seen,” said Bespoke. For a primary uptrend to be in place, the bulk of the index constituents also need to trade above their 200-day averages. The number at the moment is 90% – somewhat down from its September peak of 95%, but nevertheless firmly in bullish terrain.

21-03-10-09

Source: StockCharts.com

In addition to being overbought, the S&P 500 is also now expensively valued on a long-term cyclically adjusted PE (CAPE) basis, according to Robert Shiller, economics professor at Yale and author of, among others, Animal Spirits, Subprime Solution and Irrational Exuberance.

In order not to work with notoriously unreliable forward-looking earnings estimates, I have always preferred using Shiller’s CAPE methodology, or normalised earnings, as they average ten years of earnings. This measure provides a good picture of the market’s value regardless of where we are in the business cycle. I have therefore been updating a CAPE chart for a number of years. On this basis, the multiple has increased to 20.5 since the March low of 13.3, representing an overvaluation of 25.0% when compared to a long-term average of 16.4.

21-03-10-10

For more discussion on the economy and financial markets, see my recent posts “Picture du Jour: Keep an eye on small caps“, “Government bonds – what’s up?“, “Is real estate rolling over?“, “Technical Talk: One last move up“, “Chinese stocks – finely balanced“, “Stock market valuation is stretched on long-term basis“, “Author Michael Lewis on Wall Street’s delusion” and “Barron’s Confidence Index – more work to do“. (And do make a point of listening to Donald Coxe’s webcast of March 19, which can be accessed from the sidebar of the Investment Postcards site.)

Twitter and Facebook
I regularly post short comments (maximum 140 characters) on topical economic and market issues, web links and graphs on Twitter. For those readers not doing so already, you can follow my “tweets” by clicking here. You may also consider joining me as a friend on Facebook.

Economy
The Recession Status Map below, courtesy of Dismal Scientist Economy.com, aggregates growth statistics from around the world and allows one to see at a glance which economies are in recession, at risk, recovering or expanding. Click here to link to the interactive version.

21-03-10-11

Source: Dismal Scientist

“Global businesses remain cautious. They are no longer panicked as they were a year ago, but they still have yet to regain the confidence that prevailed prior to the financial crisis and Great Recession. Businesses are upbeat when broadly assessing current conditions and the outlook through this summer. They are much less sanguine when responding to specific questions regarding the strength of sales, hiring and inventories,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. As has been the case since the beginning of the global economic recovery in the middle of 2009, South Americans are the most upbeat and North Americans the most nervous. Confidence is strongest among financial firms and weakest among those that work in real estate and government.

21-03-10-12

Source: Moody’s Economy.com

Meanwhile, German investor confidence fell in March for the sixth consecutive month. The ZEW indicator of economic sentiment dropped to 44.5, its lowest level since July 2009, from 45.1 in February. Investor confidence has been weighed down by concerns about large budget deficits in other eurozone member countries such as Greece.

The Bank of Japan (BoJ) last week adopted further monetary easing by doubling the size of a liquidity program for banks, whereas Brazil kept its monetary policy unchanged. However, as inflationary pressures start to build, the Reserve Bank of India increased interest rates for the first time since July 2008.

A snapshot of the week’s US economic reports is provided below. (Click the links to see Northern Trust‘s assessment of the various data releases.)

Friday, March 19
• US debt holdings of foreign central banks continue to grow

Thursday, March 18
• Contained consumer prices supportive of easy monetary policy
• Index of Leading Indicators – projection of economic growth remains intact
• Total continuing claims persist at high level

Wednesday, March 17
• Effective federal funds rate is moving closer to target federal funds rate
• Lower energy prices account for dip in Wholesale Price Index
• Housing market update – Mortgage Purchase Index

Tuesday, March 16
• FOMC policy statement – Fed is optimistic about labor market compared with view in January
• Construction of new homes standing still – will activity pick up soon?

Monday, March 15
• Factory production declined, weather may have played a role
• Decline of Housing Market Index is Troubling

Commenting on the growth outlook for the US economy, Asha Bangalore (Northern Trust) said: “The Conference Board’s Index of Leading Economic Indicators (LEI) increased 0.1% in February after a 0.3% increase in the prior month. On a year-to-year basis, the January-February average shot up 9.6%, which exceeds the high recorded in the 2001-2007 expansion. The main takeaway is that projections of economic growth remain in place.”

21-03-10-13

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 18, 2010.

Week’s economic reports

Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Date

Time (ET)

StatisticFor

Actual

Briefing Forecast

Market Expects

Prior

Mar 15

08:30 AM

Empire Manufacturing SurveyMar

22.86

22.0

22.0

24.91

Mar 15

09:00 AM

Net Long-Term TIC FlowsDec

$19.1B

$42.50B

$47.5B

$63.3B

Mar 15

09:15 AM

Capacity UtilizationFeb

72.7%

72.5%

72.5%

72.5%

Mar 15

09:15 AM

Industrial ProductionFeb

0.1%

-0.2%

0.0%

0.9%

Mar 16

08:30 AM

Building PermitsFeb

612K

610K

601K

622K

Mar 16

08:30 AM

Export Prices ex agriculture.Feb

-

NA

NA

0.7%

Mar 16

08:30 AM

Housing StartsFeb

575K

550K

570K

611K

Mar 16

08:30 AM

Import Prices ex oilFeb

0.2%

NA

NA

0.4%

Mar 16

08:30 AM

Export Prices ex agricultureFeb

-0.2%

NA

NA

0.7%

Mar 17

08:30 AM

Core PPIFeb

0.1%

0.1%

0.1%

0.3%

Mar 17

08:30 AM

PPIFeb

-0.6%

-0.3%

-0.2%

1.4%

Mar 17

10:30 AM

Crude Inventories03/13

1.01M

NA

NA

1.43M

Mar 18

08:30 AM

Core CPIFeb

0.1%

0.0%

0.1%

-0.1%

Mar 18

08:30 AM

CPIFeb

0.0%

-0.1%

0.1%

0.2%

Mar 18

08:30 AM

Initial Claims03/13

457K

460K

455K

462K

Mar 18

08:30 AM

Continuing Claims03/6

4579K

4500K

4522K

4567K

Mar 18

08:30 AM

Current Account BalanceQ4

-$115.60

-$117.5B

-$119.0B

-$102.3B

Mar 18

10:00 AM

Leading IndicatorsFeb

0.1%

0.0%

0.1%

0.3%

Mar 18

10:00 AM

Philadelphia FedMar

18.9

17.8

18.0

17.6

Source: Yahoo Finance, March 19, 2010.

Click here for a summary of Wells Fargo Securities’ weekly economic and financial commentary.

Next week sees Fed chairman Ben Bernanke testifying in Washington on exit strategy (Thursday, March 25). In addition, US economic data reports for the week include the following:

Monday, March 23
• Existing home sales
• FHFA Home Price Index

Tuesday, March 24
• Durable orders
• New home sales

Wednesday, March 25
• Jobless claims

Thursday, March 26
• GDP
• Michigan sentiment

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global financial markets performed during the past week.

21-03-10-14

Source: Wall Street Journal Online, February 26, 2010.

Final words
Marilyn vos Savant, American author, said: “To acquire knowledge, one must study. To acquire wisdom, one must observe.” (Hat tip: Charles Kirk.) Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist readers of Investment Postcards to observe in order to take wise investment decisions.

That’s the way it looks from Cape Town (where I am slowly starting to pack my bags for a visit to the Americas – Montevideo, Santo Domingo and San Diego – in a week’s time).

21-03-10-15

Source: Jim Morin, GoComics.com, March 18, 2010.

MoneyNews: Moody’s warns of risk to US, UK top debt ratings
“The United States and Britain are more likely than Germany and France to witness an embarrassing downgrade of their top debt rating, agency Moody’s Investors Service said Monday.

“In a quarterly report assessing the prospects of the triple A-rated countries, including Spain and the ‘less fiscally challenged’ Denmark, Finland, Norway and Sweden, Moody’s warned that the economic recovery remained fragile in many advanced economies.

“‘This exposes governments to substantial execution risk in the implementation of their exit strategies, which could yet make their credit more vulnerable,’ says Arnaud Mares, senior vice president in Moody’s sovereign risk group and the main author of the report.

“Governments and central banks are looking at when and how to unwind their massive stimulus measures, which include historically-low interest rates, liquidity provisions, industry incentives and increased spending. Although some experts warn that exiting these policies too early risks creating a new economic downturn, they are also straining government finances.

“For now though, Moody’s said the triple A governments don’t face an immediate threat to their top ratings as the servicing of the debt remains manageable – the top credit rating reduces the interest payments countries have to pay on their debt when going to the bond markets to raise capital.

“However, debt affordability is ‘most stretched’ in Britain and the US, Moody’s said.

“In light of the muted recovery from recession in many countries, Moody’s said government action on spending and taxes is the main way of ‘repairing the damage’ that the global crisis inflicted on government finances.

“Moody’s said triple A governments also face a ‘delicate balancing act’ with respect to the timing of these adjustment and that tightening fiscal policy before the recovery has become self-sustainable could risk undermining the recovery, thereby damaging governments’ power to tax. However, it warned that postponing fiscal consolidation much longer is ‘no less risky as it would test the patience of the market’ and could force central banks to take the initiative.

“‘At the current elevated levels of debt, rising interest rates could quickly compound an already complicated debt equation, with more abrupt rating consequences a possibility,’ said Pierre Cailleteau, managing director of Moody’s sovereign risk group.”

Source: MoneyNews, March 15, 2010.

The Wall Street Journal: Rewriting Wall Street’s rules
“Senator Chris Dodd is trying to push through financial regulation with an eye on consumer protection. Unlike the health-care bill, there is expected to be less partisanship, the News Hub panel reports.”

Source: The Wall Street Journal, March 15, 2010.

Financial Times: Fed chief defends role as watchdog
“Ben Bernanke, chairman of the Federal Reserve, appealed to Congress to preserve the central bank’s supervision of the financial system as lawmakers consider removing some of the Fed’s powers.

“The Fed would lose oversight of banks with less than $50bn in assets in a bill by Chris Dodd, chairman of the Senate banking committee, which was introduced this week and will go to a mark-up next week.

“‘It makes us essentially the ‘too-big-to-fail’ regulator,’ Mr Bernanke told a congressional hearing. ‘We don’t want that responsibility. We want to have a connection to Main Street, as well as to Wall Street.’

“The $50bn threshold is a compromise from Mr Dodd, offered after his earlier proposal to remove all of the Fed’s bank supervision was roundly rejected by the Treasury, the Fed and some senators.

“Paul Volcker, the former Fed chairman, appeared alongside Mr Bernanke to describe the idea of hiving off all of the bank’s oversight as a ‘grievous mistake’ that would harm the conduct of monetary policy and financial stability by limiting the Fed’s understanding of the financial system.

“The hearing in the House financial services committee was set up to provide a counterblast to Mr Dodd’s original, more far-reaching proposal that would have moved the Fed’s responsibility for 5,000 bank holding companies and 850 state-chartered banks to a single regulator. Barney Frank, chairman of the House committee, does not favour the shift in duties.

“But the Fed faces a harder challenge in preserving the entirety of its supervision, with Mr Dodd and allies on the Senate banking committee determined to hold the line, arguing that the Fed gains nothing from regulating small banks and the job would be better performed by other regulators.”

Source: Tom Braithwaite, Financial Times, March 17, 2010.

The Wall Street Journal: Bernanke makes the case for Fed powers
“Fed Chairman Ben Bernanke tries to defend the central bank’s role in supervising smaller banks. WSJ’s David Wessel joins The News Hub to discuss.”

Source: The Wall Street Journal, March 17, 2010.

MoneyNews: Stiglitz – Federal Reserve framework is corrupt
“The US Federal Reserve’s framework is a corrupt one in that its regional banks are managed by board members who are officers from the very private institutions they are designed to govern, says Nobel economist Joseph Stiglitz.

“Stiglitz, also a former chief economist at the World Bank, says if a country had come to him looking for aid while running a central bank in such a manner, alarm bells would have gone off.

“‘If we had seen a governance structure that corresponds to our Federal Reserve system, we would have been yelling and screaming and saying that country does not deserve any assistance, this is a corrupt governing structure,’ says Stiglitz according to the Huffington Post.

“‘It’s time for us to reflect on our own structure today, and to say there are parts that can be improved.’

“The New York Fed presently has on its board of directors Jamie Dimon, the head of JPMorgan Chase, according to the Huffington Post.

“Lawmakers are currently negotiating a bill that would overhaul parts of the country’s financial regulation.”

Source: Forrest Jones, MoneyNews, March 15, 2010.

Financial Times: Fed signals optimism over US economy
“The US Federal Reserve gave a slightly more upbeat outlook for the country’s economy on Tuesday, but said interest rates would remain close to zero for an ‘extended period’.

“The central bank said the labour market was ‘stabilising’ and business spending on equipment and software has ‘risen significantly’. Both descriptions marked improvements in tone compared with the previous meeting in late January.

“Despite the progress, however, Fed policymakers signalled no change in the central bank’s monetary policy stance, with interest rates set to remain at their current 0-0.25 per cent range for the time being.

“Economists said this suggested there was still nervousness within the Fed about the strength of the recovery – and confidence that inflation would not pose a threat soon.

“‘The data flow has been on the positive side,’ said Ethan Harris, an economist at BofA Merrill Lynch. ‘But the Fed needs to see something more fundamental in the economy to start hiking rates. The current path is not enough.’

“Ben Bernanke, Fed chairman, has been treading a careful line between signalling the central bank’s readiness to tighten monetary policy as the economy recovers and insisting that conditions are not yet ripe for such a move.

“‘The actions of the Fed leadership signal a strong aversion to repeating the premature tightening mistakes of US central bankers in the 1930s or Japanese central bankers earlier this decade,’ said Michael Feroli, economist at JPMorgan.

“In a recent speech, Charles Evans, Chicago Fed president, indicated that the reference to low rates for an ‘extended period’ meant keeping them at the current level for the next three to four meetings – or until at least August or September.

“Thomas Hoenig, the Kansas City Fed president, dissented from the majority for a second consecutive Federal Open Market Committee meeting.”

Source: James Politi, Alan Rappeport and Michael Mackenzie, Financial Times, March 16, 2010.

MoneyNews: Pimco – end of Fed mortgage program is credit tightening
“The end of the Federal Reserve’s program of purchasing $1.25 trillion of mortgage-backed securities at the end of March is a form of tightening monetary policy, the chief of the largest US bond fund manager said on Tuesday.

“Mohamed El-Erian, chief executive and co-chief investment officer of Pacific Investment Management Co., or Pimco, said the end of the Fed’s mortgage program, one of the US central bank’s major support programs, signals a form of credit tightening.

“The Federal Reserve Open Market Committee’s statement on Tuesday ‘met market expectations on the three key aspects of leaving interest rates unchanged, maintaining dovish language about future policy moves and allowing the special programs to lapse,’ El-Erian told Reuters.

“By the end of March, the Fed plans to have bought $1.25 trillion worth of mortgage-backed securities and about $175 billion worth of agency debt – a process economists and investors have called ‘quantitative easing’.

“The unwind of the program weans the US economy from government support at a time when the Fed believes the recovery is gathering some strength.”

Source: MoneyNews, March 17, 2010.

Asha Bangalore (Northern Trust): Effective federal funds rate is moving closer to target federal funds rate
“The effective federal funds rate as of March 16 was 0.20%, matching the reading of the previous day. The spread between the upper limit of the target federal funds rate and the effective federal funds rate has been a subsidy that the Fed enabled to allow banks to earn a few basis points to strengthen their balance sheets. This opportunity to borrow in the federal funds market at the effective rate and earn the target rate by depositing at the Fed is gradually vanishing.

“The effective federal funds rate has hovered around 11 and 13 basis points in the October 2009-February2010 period. In the first two weeks of March it moved up to 15 basis points. It appears that the effective federal funds rate is heading toward the upper limit of the target rate in the next few weeks. The main implication is that the Fed is removing another accommodative emergency measure.”

20-03-10-01

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 17, 2010.

Bloomberg: Money rates rising hint Treasury losses amid Fed exit
“Money market interest rates at five-month highs show the Federal Reserve is laying the groundwork to siphon a record $1 trillion in excess cash from the banking system and sending a bearish signal on Treasuries.

“Overnight federal funds rates rose to the highest since September and the cost to dealers to borrow and lend US securities for one day more than doubled in the past month. Three-month Treasury bill rates rose last week to the highest since August.

“The rise is a sign traders are preparing for tighter monetary policy as stimulus measures end. In the three months before the Fed started raising borrowing costs in June 2004, 10-year Treasury yields rose about 0.75 percentage point as bond prices fell. While higher rates mean increased borrowing costs for President Barack Obama, they also show growing confidence that the economic recovery is gaining traction.

“‘The Fed is definitely getting its ducks in a row,’ said Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services Ltd., which oversees $7.5 billion. ‘There is no doubt that in the early phases of the Fed’s plan, the Treasury market could suffer.'”

Source: Liz Capo McCormick and Daniel Kruger, Bloomberg, March 15, 2010.

MoneyNews: Roubini – US in danger of double dip recession
“The US economy is in danger of falling back into recession, as illustrated by recent weak statistics and thanks to Europe’s debt crisis, says economist Nouriel Roubini.

“In the executive summary of a report for clients of his firm Roubini Global Economics (RGE), Roubini writes, ‘A slew of poor economic data over the past two weeks suggests that the US economy in 2010 is headed for – at best – a U-shaped recovery.’

“The figures for consumer confidence, home sales, construction and employment suggest gross domestic product, or GDP, growth could fall well short of RGE’s already anemic forecast of 2.7 percent for the first half of the year.

“‘With the positive effects of the historic levels of fiscal stimulus due to fade this year, the US faces at best a 1.5 percent growth rate in H2 (the second half), which looks too close for comfort to a tipping point of a double-dip,’ Roubini writes.

“Europe’s debt crisis puts the euro zone at risk of re-entering recession too, he says.

“And even if that doesn’t occur, Europe’s slumping demand will hurt US exports.”

Source: Dan Weil, MoneyNews, March 16, 2010.

Asha Bangalore (Northern Trust): Index of Leading Indicators – projection of economic growth remains in intact
“The Conference Board’s Index of Leading Economic Indicators (LEI) increased 0.1% in February after a 0.3% increase in the prior month. On a year-to-year basis, the January-February average shot up 9.6%, which exceeds the high recorded in the 2001-2007 expansion. The main takeaway is that projections of economic growth remain in place. At the same time, the six-month annualized change shows a moderating trend (8.9% increase in February vs. 12.8% gain during six months ended September 2009).

“In February, real money supply (forecast) and interest rate spread made the largest positive contributions in addition to smaller growth recorded for supplier deliveries and new orders for consumer durables. The remaining six components were decliners – consumer expectations, initial jobless claims, factory workweek, building permits, orders of non-defense capital goods, and stock prices.”

20-03-10-02

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 18, 2010.

Asha Bangalore (Northern Trust): Factory production declined, weather may have played a role
“Industrial production moved up only 0.1% in February following a string of strong gains since July 2009. The February gain is, in fact, the smallest increase in the last eight months. The Fed indicated that bad weather in February could have trimmed the pace of production. Excluding the increase in the mining and utilities components, factory production slipped 0.1% in February.

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“The operating rate of the nation’s industries moved up slightly in February to 72.7% from 72.5% in January. The noticeably low operating rate of the factory sector suggests that investment in new projects is unlikely in the near term, with replacement demand accounting for the increase in capital spending.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 15, 2010.

Asha Bangalore (Northern Trust): Total continuing claims persist at high level
“Initial jobless claims declined 5,000 to 457,000 during the week ended March 13. Continuing claims, which lag initial jobless claims by one week, move up 12,000 to 4.579 million and the insured unemployment rate held steady at 3.5%. Total continuing claims inclusive of unemployment insurance claims under special programs are a better measure to get a sense of softness in the labor market. Total continuing claims were reported as 10.6110 million for the week ended February 27, marking the twelfth consecutive weekly reading in excess of 10 million. This persistence of total continuing claims at an elevated level is of significant concern for policy makers.”

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Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 18, 2010.

Asha Bangalore (Northern Trust): Housing market update – Mortgage Purchase Index
“Housing market news has been grim in the past two months, despite attractive mortgage rates and the $8,000 first-time home buyer tax credit program. The Mortgage Purchase Index of the Mortgage Bankers Association fell slightly to 221.5 during the week ended March 12 from 226.8 in the prior week. The Mortgage Refinance Index declined to 2,649.1 from 2,669.0 during the same period. The Mortgage Purchase Index has failed to move up meaningfully in the first three months of 2010.”

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Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 17, 2010.

Asha Bangalore (Northern Trust): Decline of Housing Market Index is troubling
“The Housing Market Index (HMI) of the National Association of Home Builders slipped to 15 in March from 17 in the prior month. On a quarterly basis, the HMI has dropped for two consecutive quarters. Indexes measuring home sales during the next six months (24 vs. 27 in February) and traffic of prospective buyers (10 vs. 12 in February) fell, casting a shadow on the housing market.”

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Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 15, 2010.

Bespoke: US housing starts remain near record low levels
“No matter how you look at it, housing starts in the US remain stuck near record low levels. This morning’s release of the monthly number showed that there were 575K starts during the month of February on a seasonally adjusted annualized rate (SAAR). While this figure is up 20% from the lows in April of 2009, it is still down 75% from the recent peak we saw in January 2006.

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“After adjusting the data for population growth, the housing starts data shows an even more significant decline. Based on this metric, there was one housing start per 537 Americans during the month of February (0.186%). During the boom years earlier this decade, there was one housing start for every 130 Americans (0.764%). Going farther back to 1972 when housing starts as a percentage of population peaked, there was one start for every 83 Americans (1.193%). Just as the nearly uninterrupted growth in housing starts during the 1990s and early 2000s was unsustainable, the current near continuous decline is unlikely to remain in place.”

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Source: Bespoke, March 16, 2010.

Asha Bangalore (Northern Trust): Contained consumer prices supportive of easy monetary policy
“The Consumer Price Index (CPI) held steady in February, after four consecutive monthly gains of 0.2%. The 0.5% decline of the energy price index just offset gains in food prices and core items. Declines in prices of gasoline, electricity and heating oil more than offset the hike in natural gas prices. On a year-to-year basis, the CPI has risen 2.1% in February, after posting larger gains in each of the three prior months. In February, the food price index moved up only 0.1%.

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“Excluding food and energy, the core CPI edged up 0.1% in February vs. a 0.1% drop in January. The mild increase of the core CPI in February puts the year-to-year increase at 1.3%, the lowest since February 2004.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 18, 2010.

Asha Bangalore (Northern Trust): Lower energy prices account for dip in Producer Price Index
“The Producer Price Index (PPI) of Finished Goods fell 0.6% in February, following a 1.4% increase in the prior month. The headlines of the past two months reflect the swings of the energy price indexes, which is a 2.9% drop in February and a 5.1% increase in January. In February, lower gasoline prices (-7.4%) were responsible for 90% of the decline of the energy prices according to the Labor Department. Food prices increased 0.4%, marking the fifth consecutive monthly gain. Excluding food and energy, core PPI edged up 0.1% in February. On a year-to-year basis, the PPI of finished goods has moved up 4.4% in February, while the core PPI, which excludes food and energy, rose 1.0%.”

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Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 17, 2010.

MoneyNews: Roubini – we’re headed for world of inflation
“One way or another, RGE Monitor senior analyst Arun Motianey says we’re headed for an inflationary world.

“The three most likely investing scenarios now are inflation without indexation, inflation with indexation and deflation, says Motianey, who recently joined investment guru Nouriel Roubini’s Roubini Global Economics.

“‘Deflation is a very serious risk [but] inflation is a greater likelihood.”

“With debt swamping governments from here to Europe to Japan, Motianey recently told Tech Ticker he thinks the central banks will probably choose to monetize public sector deficits.

“‘I’m expecting the central banks of the world to see the light,’ he says. ‘This would be a period of voluntary inflation, instead of involuntary inflation (like the 1970s)’, he said.

“In other words, the Fed will print money to buy Treasuries.”

Source: Julie Crawshaw, MoneyNews, March 17, 2010.

BusinessWeek: China, Japan reduced holdings of US Treasury debt in January
“China and Japan, the two biggest foreign holders of Treasuries, reduced their positions of US government debt in January as a measure of demand for American financial assets fell to a six-month low.

“China remained the biggest owner abroad of Treasuries, even as its holdings dropped by a net $5.8 billion to $889 billion, according to Treasury Department data released yesterday in Washington. Japan cut its holdings in January by $300 million to $765.4 billion, the report showed.

“China has been a net seller of Treasuries for three straight months, the longest such stretch since the end of 2007. Chinese officials have questioned the dollar’s role as a reserve currency and recently sought assurances about the safety of US government debt as the budget deficit widens to a projected record $1.6 trillion this year.

“‘Foreign central banks stopped buying Treasuries in January,’ said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ‘If this were to continue, if China were to stop recycling its dollars into US Treasuries, it could have dire implications for Main Street America in that mortgage rates could move higher.’

“International buying of long-term equities, notes and bonds totaled a net $19.1 billion, compared with net purchases of $63.3 billion in December, the report showed. That was the smallest net gain in purchases since July.”

Source: Vincent Del Giudice, BusinessWeek, March 15, 2010.

The New York Times: Corporate debt coming due may squeeze credit
“When the Mayans envisioned the world coming to an end in 2012 – at least in the Hollywood telling – they didn’t count junk bonds among the perils that would lead to worldwide disaster.

“Maybe they should have, because 2012 also is the beginning of a three-year period in which more than $700 billion in risky, high-yield corporate debt begins to come due, an extraordinary surge that some analysts fear could overload the debt markets.

“With huge bills about to hit corporations and the federal government around the same time, the worry is that some companies will have trouble getting new loans, spurring defaults and a wave of bankruptcies.

“The United States government alone will need to borrow nearly $2 trillion in 2012, to bridge the projected budget deficit for that year and to refinance existing debt.

“Indeed, worries about the growth of national, or sovereign, debt prompted Moody’s Investors Service to warn on Monday that the United States and other Western nations were moving ‘substantially’ closer to losing their top-notch Aaa credit ratings.

“Sovereign debt aside, the approaching scramble for corporate financing could strain the broader economy as jobs are cut, consumer spending is scaled back and credit is tightened for both consumers and businesses.

“The apocalyptic talk is not limited to perpetual bears and the rest of the doom-and-gloom crowd.

“Even Moody’s, which is known for its sober public statements, is sounding the alarm.

“‘An avalanche is brewing in 2012 and beyond if companies don’t get out in front of this,’ said Kevin Cassidy, a senior credit officer at Moody’s.”

Source: Nelson Schwartz, The New York Times, March 15, 2010.

Financial Times: Inflation-linked issuance to hit record $200bn
“A record $200bn issuance of new inflation-linked bonds from the US, Europe and the UK is forecast this year as governments seek to finance ballooning budget deficits.

“The global market for inflation-protected debt will hit $2,000bn (€1,455bn) as governments, such as Germany and Ireland, consider launching such bonds for the first time to help pay for the large build up of debt, Barclays Capital said.

“Investors have become increasingly worried about the dangers of rising prices in the longer term, boosting demand for inflation-linked bonds. This follows the actions of central banks, which have pumped vast amounts of money into the financial system in the past year.

“Investor appetite has also been boosted because so-called linkers are seen as a safe and stable asset class, attractive to investors who remain worried about the economic outlook.

“In Europe and the UK, demand for long-dated index-linked bonds will be underpinned by long-term investors, notably pension funds.

“Alan James, head of inflation-linked bond research at Barclays Capital, said: ‘The stability of inflation-linked bonds as an asset class is attractive. Demand is most likely to be seen in the 10-year sector and longer. And that’s where issuers are focusing.’

“Markets are still pricing in modest levels of inflation, allowing issuers to take advantage of cheaper borrowing costs. UK 10-year breakeven rates, which measure the annual expectation of inflation over 10 years, are only 2.25 per cent. In France, 10-year inflation expectations are 2.038 per cent, while in the US, they are 2.25 per cent.”

Source: David Oakley, Financial Times, March 17, 2010.

Bespoke: 52-week highs explode
“A total of 130 S&P 500 companies hit 52-week highs today, or 26% of the index. No companies hit 52-week lows. Below is a chart of net 52-week highs (% 52-wk highs minus % 52-wk lows) for the S&P 500 since 2008. While net new highs had been struggling to expand in recent months, today’s reading marks a new bull market high. Investors want to see this reading hit new highs as the market hits new highs to confirm long-term rallies, and today the current bull market rally was once again confirmed. This doesn’t mean we can’t see pullbacks from overbought levels in the short term, however.”

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Source: Bespoke, March 17, 2010.

Bespoke: S&P 500 financial sector new highs at 40%
“More than a quarter of S&P 500 stocks made new 52-week highs yesterday, but the percentage was even higher in the S&P 500 Financial sector. Below is a chart of net new 52-week highs (% 52-wk highs minus % 52-wk lows) for the Financial sector since the start of 2008. Yesterday’s reading was by far the highest seen over this period. Forty percent of the sector made new 52-week highs yesterday, while no stocks in the sector made a new low. This is representative of very strong breadth for the Financials.”

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Source: Bespoke, March 18, 2010.

Bespoke: Sector trading range charts
“Below we highlight 6-month trading range charts for the S&P 500 and its ten sectors. For each chart, the light blue shading represents between one standard deviation above and below the 50-day moving average. The red zone is between one and two standard deviations above the 50-DMA, and vice versa for the green zone. Moves into or above the red zone are considered overbought. In each chart, we’ve also included a line to show if the sector has broken out to new bull market highs yet on this most recent rally.

“As shown, the S&P 500 has indeed taken out its prior highs, but it is now near the top of the red zone, which has typically been met with pullbacks (or at least sideways trading) over the last six months. Of the ten sectors, only Industrials, Consumer Discretionary, and Consumer Staples have blown through their prior highs. The Financial sector just made a new high yesterday, but it hasn’t yet broken out convincingly. The Technology sector is the next closest to its prior highs. Energy, Materials, Health Care, Utilities, and Telecom still remain below their prior bull market highs.”

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Source: Bespoke, March 18, 2010.

Richard Russell (Dow Theory Letters): What to make of “triple bull signal”?
“Turning to the nearer term, the stock market issued a ‘triple bull signal’ yesterday. And I’ll be really fascinated to see how the year 2010 turns out. I have the feeling that there are going to be a lot of major surprises this year. I’m guessing that the year 2010 is going to be a very tricky and difficult year. The reason I say that is that so much of the bullishness of 2010 was manufactured by the Fed and the Treasury and with the help of the greatest addition of debt in the history of the US or any other nation. Everything in life and in finance is a trade-off. And I wonder what the trade-off will be from the US taking on trillions in debt to defeat the Great Recession.

“For the time being, the market is saying that ‘everything’s OK’. For the time being, that is. The three bullish signals are:

“First, the Dow finally closed above 10,725, moving the market into the bullish zone – this based on my interpretation of the 50% Principle.

“Second, in closing at a new high for the advance since March, the Dow confirmed the previous string of new highs set by the Transportation Average. This was a Dow Theory bull signal.

“Third, new 52-week highs on the NYSE rose to 601, thus bullishly surpassing the count of 523 on January 11.

“The question for me and my subscribers is, ‘Should we do anything about it?’ My considered answer is to tell subscribers what I am personally going to do. The answer is, ‘Not very much’. I could take a belated position in DIA, but I don’t think it’s worth the risk, after taking in tax considerations and commissions. I’m content to stay with my gold and cash position. All things considered, I’ll sit tight with them.”

Source: Richard Russell, Dow Theory Letters, March 18, 2010.

MoneyNews: Biggs – US stocks poised to surge 15 percent
“Contrarian investor Barton Biggs, managing partner at Traxis Partners LLC, expects stocks to soon jump.

“‘I think we’ve got a move of 10 to 15 percent in the next couple of months here in the US and 15 to 20 percent n the emerging markets,’ Biggs says.

“‘Earnings are coming in very strong and I think the US and global economy are gaining momentum as we come into spring this year,’ he recently told Bloomberg.

“‘I think there’s too much bearishness … everybody’s seeing bubbles everywhere. Maybe they’re going to be right (but) I think in the shorter run, things are going up,’ Biggs says.

“Biggs likes emerging market stocks now, especially China and India.

“In the United States, he says that big-cap quality stocks are the cheapest part of the market.

“He also thinks the ‘new normal’ envisioned by Pimco co-chair Mohammed El Erian has been erroneously accepted as conventional wisdom, which he says is usually wrong.

“‘I don’t know what the environment’s going to be, but it’s not going to be the ‘new normal’,’ he says.

“The ‘new mix’ is out to topple the ‘new normal’ as the paradigm for US’s economic future, Business Week reports.

“The 5.9 percent annualized surge in fourth-quarter growth – the fastest since 2003 – was powered more by exports and business investment than the traditional drivers of consumption and housing.

“This new mix of demand will boost the economy by 3.7 percent in 2010 and pave the way for 3.5 percent annual average increases thereafter, says Joseph Carson, an economist at AllianceBernstein.”

Source: Julie Crawshaw, MoneyNews, March 16, 2010.

MoneyNews: Goldman’s Cohen – stocks can still climb 14 percent this year
“The economy and stock market will likely experience good times ahead, says Abby Joseph Cohen, global market strategist for Goldman Sachs.

“While many experts say the 71 percent rally in the Standard & Poor’s 500 Index during the past year indicates stocks are overvalued, Cohen disagrees.

“‘The stock market is almost always a discounting mechanism,’ she said.

“‘It almost always moves in advance of the economy, but we don’t think it has moved too far at this point,’ she told CNBC.

“Cohen, who made her name with bullish market calls in the 1990s, expects the S&P 500 to trade around 1,250 to 1,300 at year-end. That would be a 9 percent to 14 percent increase from the current level of 1,150.

“Lower volatility and less correlation between different financial markets are making investors more comfortable about investing in stocks, she says.

“Another way to look at it: ‘Since the end of 2003, the GDP has expanded dramatically more than stock prices,’ Cohen said. That gives stocks more room to rise.

“As for the economy, rising corporate cash flow; improved, albeit still weak, employment data; and increasing durable goods orders represent positive signs, Cohen says.”

Source: Dan Weil, MoneyNews, March 16, 2010.

Bespoke: China zigs while US zags
“The S&P 500 is up 2.70% year to date, but China’s Shanghai Composite is down 9.16%. As shown in the chart below, the Shanghai Composite made its bull market high back in August 2009. The index is currently 14% below that level, while the S&P 500 just made a new bull market closing high last week. The two indices have really diverged in recent weeks. US stocks have come roaring back from their lows on February 8, but China has pretty much been dead money.”

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Source: Bespoke, March 15, 2010.

David Fuller (Fullermoney): Chinese stocks – any need to worry?
“My distinctly unscientific perception, based on what I have seen and heard recently, is that negative sentiment towards China outweighs positive short to medium-term views by at least 10 to 1. Some of us might consider that to be a contrary indicator.

“However, the heavy weight and long-term reports crossing my inbox are mostly bullish. This sampling is too small and the sources too authoritative for me to consider long-term bullishness to be a contrary indicator. My guess is that China is the big story for at least the first half of the 21st century.

“But what about the technical outlook? It is delicately poised and relative underperformance is a concern. However, that upside key day reversal on February 3 remains the most significant technical development for nearly two months and today’s smaller upward dynamic is encouraging. What I would like to see next, from a bullish perspective, is a break above that downside dynamic on March 4. What I hope not to see is a decline beneath February’s key.

“People fear that China’s credit tightening might trigger another significant sell-off in world markets. China’s monetary policy authorities need to get the balance right if they are to stem property speculation without overkill. This can be a fine balance but they have every incentive to succeed and their gradualist (baby-steps) approach to monetary policy tightening seems prudent. They will make some mistakes, like everyone else, but this is a medium-term risk and should have little effect on China’s long-term potential.

“Meanwhile, global stock markets have recently shown more evidence of a melt-up than a meltdown. Investors are climbing the ‘wall of worry’. I will worry more when they sound euphoric.”

Source: David Fuller, Fullermoney, March 17, 2010.

Bespoke: Chinese ADRs still hanging in there
“While the Shanghai Composite index has been struggling relative to the S&P 500, ADRs of Chinese companies listed in the US have been performing much better. In the chart below, we compared the performance of the Shanghai Composite and a basket of US listed Chinese ADRs with market caps of $250 million or more. Since the start of 2009, the Shanghai Composite index is up 64.4%. Our basket of Chinese ADRs, however, is up 106%.

“Last August, both the Shanghai Composite and our basket of ADRs reached a short term peak and then corrected. In the ensuing rebound, ADRs powered ahead to new highs, while the Shanghai Composite saw an anemic rally and has been unable to eclipse its August peak.

“Investors have long looked for ways to gain direct exposure to the Chinese domestic stock market since domestically listed shares have been closed to outside investors. Judging by the recent returns of Chinese ADRs, however, investors may have a much simpler and more attractive alternative.”

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Source: Bespoke, March 16, 2010.

Bespoke: Rotating back into the US
“One of the easy ways to see how a country is performing relative to other countries is to look at its market cap as a percentage of world market cap. In the early stages of the global rebound off the March lows, the US rose significantly, but other countries were gaining even more. In recent months, however, the tide has turned, and the US is now outperforming the rest of the world.

“As shown below, US stock market cap as a percentage of world market cap has been steadily rising since last November. During the 2003-2007 bull market, emerging markets and other countries really outperformed the US. If this bull market continues and the US continues to gain share, it will represent a very big trend change that will make a huge impact on portfolio performance depending on an investor’s domestic versus international equity allocation.

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“While the US is gaining share, China is losing share. Aside from an uptick in the summer months of 2009, China’s stock market cap as a % of world market cap has been trending downward throughout the entire rebound.”

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Source: Bespoke, March 16, 2010.

John Authers (Financial Times): Renminbi revaluation
“The FT’s investment editor, John Authers, dissects the Chinese economy and assesses what chance there will be for a renminbi revaluation.”

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Source: John Authers, Financial Times, March 16, 2010.

John Authers (Financial Times): Politics of renminbi
“Will they or won’t they? On both sides of the Pacific, debate over the Chinese currency is burning. Will the Chinese government allow the renminbi to appreciate against the dollar once more and, if so, will they make a one-off revaluation or allow a creeping, managed appreciation along the lines seen between 2005 and 2008?

“Judged in economic terms, the question seems straightforward, if finely poised. Chinese producer price inflation is rising sharply, in part as a result of the higher import prices that an unnecessarily weak currency entails. Consumer price inflation is also rising, thanks to higher food prices, and so a stronger currency might be a good way to stop overheating.

“It would make a sensible addition to the other measures that China has taken to try to cool the effects of the drastic stimulus it started in late 2008.

“The problem is that the issue is not viewed in economic terms, in Beijing or in Washington. Instead, it is a political dispute. Any decision on the renminbi will ultimately be a political one. The US Congress is trying to step up the pressure, arguing that China is giving itself an unfair advantage of siphoning away US jobs by keeping its currency cheap.

“The pressure is on the US administration to take a similarly aggressive stance. Economically, this position is questionable. A stronger Chinese currency would mean more expensive imports for the US. If that means higher costs for US companies, the response might be to cut costs at home.

“But politically such an approach is even more questionable. Judging by the words of the Chinese leadership during the past week, the renminbi will not be allowed to appreciate if that means yielding to foreign pressure. If the US rhetoric remains restrained, we should expect a stronger Chinese currency within months. If the US gets more aggressive, then probably not.”

Source: John Authers, Financial Times, March 16, 2010.

Bloomberg: China’s Wen rebuffs US calls for stronger currency
“China’s Premier Wen Jiabao rebuffed calls for the yuan to appreciate, risking a further deterioration in relations with the US where lawmakers and economists say his stance is hampering a global recovery.

“‘I don’t think the renminbi is undervalued,’ Wen said yesterday at a press conference in Beijing marking the end of China’s annual parliamentary meetings, using another term for the yuan. ‘We oppose countries pointing fingers at each other and even forcing a country to appreciate its currency.’

“Non-deliverable yuan forwards fell the most in more than a month as Wen’s remarks prompted traders to reduce their expectations for appreciation in the coming year.

“US lawmakers, including Senator Charles Schumer, are proposing that China be hit with stiffer tariffs to compensate for the unfair export advantage they say comes from an undervalued currency. Economist Paul Krugman estimates that global growth would be about 1.5 percentage points higher if China stopped restraining the value of the yuan, and after Wen’s comments said the US should consider putting a 25 percent surcharge on Chinese goods.

“‘Chinese officials are alone in their refusal to acknowledge that the yuan is undervalued,’ Senator Charles Grassley of Iowa, the ranking Republican on the Senate Finance Committee, said in a statement responding to Wen’s remarks. ‘If they choose to stick their heads in the sand, we’ll have to find another way to address this problem because it’s been going on for far too long.'”

Source: Bloomberg, March 15, 2010.

Financial Times: Japanese yen could prove surprisingly resilient
“Although the Bank of Japan’s decision to ease monetary policy further may weigh on the yen, at least a portion of its multi-year rally is irreversible says Stephen Gallo, head of market analysis at Schneider FX.

“He says yen weakness was a significant force within the currency markets during the past 15 years because Japan’s trade surplus and its citizens’ propensity to save allowed the nation to export capital that was well above what was necessary to keep trade and financial flows in balance.

“Between 1995 and 2007 as Japanese exports boomed and the carry trade, in which the low-yielding Japanese currency is sold to fund the purchase of riskier, higher-yielding assets, took off, the yen fell more than 45 per cent.

“Mr Gallo says it is naive to believe that simple carry trade unwinds and a flight to safety are the only forces that have lifted the yen during the past two years, however.

“‘A massive decline in Japanese exports and an ageing population has seriously eroded the level of yen outflows, and this has buoyed the yen tremendously,’ he adds.

“Mr Gallo says as a consequence of the 2008 financial crisis, demographic shifts, weaker trade flows and a declining savings rate in Japan, yen outflows are unlikely to resume in a big way any time soon. He adds: ‘We believe that the yen’s multi-year rally is more structural than cyclical.'”

Source: Stephen Gallo, Financial Times, March 17, 2010.

Japan Economics Analyst: The yen should weaken and will weaken
“The yen is gradually starting to weaken. This is easing financial conditions in Japan after severe tightening. The effective yen rate is down about 10% from its most recent peak and our Financial Conditions Index is subsiding from a sharp spike.

“We are expecting the effective yen rate to fall around 10% during the next 12 months as the result of a correction against Asian currencies as well as the US$. In particular, Asian EM monetary policy is moving in a different direction to Japan’s, and we expect their currencies to appreciate by double digits against the yen. Such movement should gain impetus from the renminbi appreciation we envisage.

“Yen/US$ remains the most significant cross for the Japanese economy due to US$ dominance in trade settlement. However, the Japanese economy and Japanese share prices are now much more sensitive to Asian currencies due to changes in the trade structure. Export market competition with Asian companies is a growing factor. Asian currency appreciation against the yen is both a booster for Japanese competitiveness and a source of growth for exports of Japanese goods and services through the transfer of purchasing power to Asia.

“The BOJ remains reactive in policy conduct and cautious on additional QE, but even limited measures (such as an increase in fund supplies) should spur yen depreciation given that other major central banks look like they are considering QE exits. In that sense we see a golden opportunity to combat deflation using a weaker yen.”

Source: Japan Economics Analyst (via Fullermoney), March 15, 2010.

Bloomberg: Feldstein sees Greek euro-exit pressure as plan fails
“Harvard University Professor Martin Feldstein, who warned almost two decades ago that the euro would prove an ‘economic liability’, said Greece’s austerity plan will fail and the country may quit the single currency to fix its fiscal crisis.

“Under pressure from investors and fellow policy makers, Prime Minister George Papandreou’s government is striving to knock four percentage points off its budget gap this year from 12.7 percent of gross domestic product and has vowed to meet the EU’s 3 percent limit in 2012 for the first time since 2006.

“‘The idea that Greece can go from a 12 percent deficit now to a 3 percent deficit two years from now seems fantasy,’ Feldstein, an adviser to US presidents since Ronald Reagan, said in a March 13 interview in Geneva. ‘The alternatives are to default in some way or to leave, or both.’

“His diagnosis clashes with that of European Central Bank President Jean-Claude Trichet, who calls Greece’s strategy ‘convincing’ and rejects as ‘absurd’ any speculation it might leave the euro zone. Investors nevertheless aren’t ruling out Feldstein’s analysis. Billionaire George Soros said last month that the euro ‘may not survive’, and credit default swaps indicate a 22 percent chance Greece will default within five years, up from 16 percent a year ago.”

Source: Simon Kennedy, Bloomberg, March 17, 2010.

TheStreet.com: Gold will soar on euro crisis
“James Turk, founder of GoldMoney, says eurozone sovereign debt issues will be one of the factors pushing gold to $1,800 by the end of the year.”

Source: TheStreet.com, March 16, 2010.

Reuters: Gold’s cross-currency strength signals its evolution
“Gold’s rally to record highs in euro and sterling terms and the resilience of spot prices in the face of a rising dollar is sign-posting the metal’s broadening insurance appeal, as sovereign debt fears shift to the fore.

“Worries over Greece’s fiscal outlook created a perfect storm for euro-priced gold this month, as some investors selling the single currency chose bullion as an alternative.

“News that the next UK general election could result in a hung parliament, making it harder for an incoming government to tackle Britain’s debt, sparked a similar rally in sterling gold, taking it to a record 759.86 pounds an ounce.

“Investors’ growing sensitivity toward sovereign risk is starting to suggest dollar-denominated gold can maintain strength even as the dollar rises – usually a prime factor pushing the precious metal down.

“‘Gold is holding up very well given the foreign exchange market movements, and you have to ask why that is,’ said GFMS Chairman Philip Klapwijk. ‘Sovereign debt is very high up the agenda at the moment.'”

Source: Veronica Brown, Reuters, March 12, 2010.

Financial Times: Four banks face trial over derivatives deals
“Four banks were charged with fraud on Wednesday for their roles in a €1.7bn ($2.3bn) financing package for the Italian city of Milan in a case that will fuel the global debate about the use of complex derivatives.

“UBS, JPMorgan Chase, Deutsche Bank and Germany’s Depfa will face trial in Milan after a judge ruled there was sufficient evidence for them to face criminal charges of aggravated fraud for their role in devising a swaps package for the city’s 2005 bond issue.

“The case comes amid claims that investment banks helped Greece to fudge its national debt figures through the use of derivatives in order to qualify for membership of the euro.

“That has sparked fears that other states and local authorities could face huge losses from financial transactions they entered into during the credit boom. Italian local governments borrowed some €35bn in swap-related transactions between 2001 and 2008. The Bank of Italy estimates they could now be facing losses of €1bn.

“Dario Loiacono, a Milan lawyer, said on Wednesday: ‘It is clear that the municipalities did not understand the risks and costs they were taking on. This case will clarify who has responsibility for that.'”

Source: Vincent Boland, Financial Times, March 17, 2010.

Financial Times: Brown delays EU hedge fund reforms
“London’s hedge fund and private equity industry won a last-minute reprieve from contentious new European regulations on Tuesday, after Gordon Brown pleaded that the issue be shelved until after the general election.

“The personal intervention by the prime minister staved off certain defeat for Britain at a finance ministers’ meeting in Brussels, where France leads a powerful coalition that is calling for tough regulation of the sector.

“But the confrontation has only been deferred. Spain, holder of the rotating European Union presidency, signalled that it intended to secure a deal on proposed legislation on the ‘alternative investments’ sector before its term ends in June.

“That could create a bruising early test of relations between an incoming Conservative government – if the opposition party wins the election expected on May 6 – and the rest of Europe on an issue of vital economic interest for Britain.

“France and Germany have led calls for regulation of hedge funds and private equity, arguing for more disclosure of trading information to supervisors as they pose a systemic risk. Britain accepts the need for regulation but argues that draft rules would be too onerous.

“The proposed EU directive mainly affects Britain: an estimated 80 per cent of Europe’s hedge funds and 60 per cent of private equity firms are based in the UK.”

Source: George Parker and Nikki Tait, Financial Times, March 16, 2010.

The Economist: Changing shape of the German economy

Source: The Economist, March 16, 2010.

The Wall Street Journal: IMF a better solution for Greece
“The IMF is a better body than the proposed European Monetary Fund for helping Greece overcome its fiscal problems, Dow Jones fixed income reporter Nick Andrews reports.”

Source: The Wall Street Journal, March 18, 2010.

Financial Times: Berlin shifts stance on IMF role in Greece
“Germany is leaning towards involving the International Monetary Fund should Greece call for help to stem its budget crisis, a move Berlin hopes would help avoid potential constitutional court objections to a German bail-out.

“With the euro under pressure on the currency markets, and fresh concerns about delays in agreeing on any purely European rescue package, Germany’s shift makes an IMF-led programme far more likely. Hitherto, Berlin has shared widespread EU hostility towards any involvement of the fund, fearing that such a move would demonstrate Europe’s inability to regulate its own economic and monetary union.

“In talks between eurozone members, the German government has been hamstrung by its concern that signing up to official plans to help Greece would violate a ‘no bail-out’ clause in EU rules on the euro and expose it to legal challenges before Germany’s highest court, officials said.

“A senior official on Thursday told the Financial Times that Berlin was no longer excluding a role for the IMF – a move that would allow Athens to call for help from the institution with most experience of such crises, though possibly still with eurozone funding.

“Michael Meister, a senior member of parliament for chancellor Angela Merkel’s Christian Democratic Union, also told the FT on Thursday that, ‘should our expectations [that Athens does not need a bail-out] be disappointed, Greece would have to accept measures imposed by the IMF’. The financing of such measures ‘would then have to be negotiated between the IMF and the eurozone member states’.”

Source: Gerrit Wiesmann and Quentin Peel, Financial Times, March 18, 2010.

Bloomberg: BOJ’s loan program stymied as credit demand wanes
“The Bank of Japan’s decision to double the size of a liquidity program for banks may prove more effective in placating the government than stemming deflation.

“The bank yesterday increased its three-month lending facility for banks to 20 trillion yen ($221 billion) in a 5-2 vote, a ‘monetary easing’ that may help reduce borrowing costs and bolster corporate sentiment, Governor Masaaki Shirakawa said at a Tokyo press briefing.

“There’s little sign that the initial effort helped the economy: bank lending has fallen for three straight months, prices tumbled by a record and wages dropped. Where the initiative did win plaudits is among politicians – Prime Minister Yukio Hatoyama, facing a July parliamentary upper house election as his poll numbers subside, welcomed the move.

“‘You can provide liquidity to banks but they don’t have to lend,’ Joseph Stiglitz, the Columbia University economist and Nobel laureate, said in an interview when asked whether the BOJ is doing enough to defeat deflation. Central banks in Japan and the US ‘have to rethink the fundamentals’ and work with governments to force banks to extend more credit, he said.

“‘Japan is in a type of ‘liquidity trap’ where extra cash injections may not have much impact, according to Stiglitz, a former White House Council of Economic Advisers chairman.”

Source: Mayumi Otsuma and Aki Ito, Bloomberg, March 18, 2010.

Reuters: Russia corruption “may force Western firms to quit”
“Extortion by corrupt officials in Russia has got so bad that some Western multinationals are considering pulling out altogether, the head of a US anti-bribery group said in an interview.

“Alexandra Wrage, whose non-profit organization TRACE International advises firms on how to avoid bribery, told Reuters the ‘rampant endemic’ corruption in Russia was much worse than in other big emerging economies.

“‘My recommendation is: ‘Maybe you should reconsider doing business in Russia,” she said. ‘I am considerably more optimistic about Nigeria than I am about Russia on this issue.’

“Berlin-based NGO Transparency International rates Russia joint 146th out of 180 nations in its Corruption Perception Index, saying bribe-taking is worth about $300 billion a year.

“‘A lot of the conversations (with businesses) around Russia are: ‘Can we stay there?”,Wrage said during a visit to Moscow last week to run a workshop for over 100 mainly Western firms.

“‘Companies are fearful of the US Department of Justice or the UK SFO (Serious Fraud Office) … they are really scrambling to get it right, and really struggling and, in the case of more than one company, talking about pulling out.'”

Source: Michael Stott, Reuters, March 15, 2010.

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