Investment Postcards from Cape Town

A fascinating discussion a few weeks ago in welling@weeden with Albert Edwards and James Montier of Société Générale is republished below with the necessary permission.

“In the cacophony that is global investment strategy research, Albert Edwards (below left) and James Montier (right) stand out as clearly distinctive voices. And not merely because of their British accents or because they’ve tended to the decidedly bearish side of the scale over the last decade or so.

“Despite long tenure in the rarified top echelons of the investment banking world, for many years with Dresdner Kleinwort and more recently at Société Générale (where they are co-heads of global cross asset strategy) both have managed to retain a natural plain-spoken bluntness.

“Also large dollops of common sense and strong streaks of reflexive independence, which they employ in conveying their often invaluable insights on investment strategy. In Albert’s case, those spring mostly from his long experience in the dismal science of economics and in James’, from his explorations of the equally mysterious realms of behavioral neuroscience.

“They are, in a word, skeptics, and at this juncture most deeply skeptical of any and all notions that ‘the worst is over’. The recession, which has barely begun, is more likely to be deep than shallow, market valuations are hideously expensive and the flation policymakers should be worried about starts with de-, not in-.”

To find out their reasons, keep reading, if you dare.

Please click here for the full report.

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I find myself in the Swiss Alps this weekend, spending a few days with my family in the picturesque village of Veysonnaz. While tranquillity reigns and the family delights in having my attention for a change, the bad news for readers is that “Words from the Wise” is taking a break this Sunday.

As a substitute for the weekly review, I have obtained the necessary permission to republish a fascinating discussion of Kate Welling (Weeden & Co) with Albert Edwards and James Montier of Société Générale. They are, in a word, skeptics, and at this juncture most deeply skeptical of any and all notions that “the worst is over”. The article will be up on the site by the time you read this message and should give you plenty of food for thought.

The normal blogging service will be resumed later this week as I head back to Cape Town and my usual research resources.

For my American friends, I hope you have had a great fourth of July and enjoyed the fireworks. It would not surprise me if we also have some fireworks in the stock market this week.

Source: Chip Bok, Slate, July 3, 2008.

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With the outlook for the economy and financial markets rather gloomy, it is good sometimes to reflect on matters from a different perspective. In the article below Michael Lewis shares with us, in a humorous manner, his ideas on how we can survive the current mess. Lewis is the author of Liar’s Poker, The New New Thing, Moneyball: The Art of Winning an Unfair Game, and The Blind Side: Evolution of a Game.

The first thing you need to know about recessions is that they don’t signal the end of anything on Wall Street.

They’re more like a red flag during a Formula One race: The cars coast gently around the track until the wreckage is cleared whereupon they all roar off as if the accident never happened. The difference is that, on Wall Street, it’s possible to make the disaster work for you.

You can inch your car quietly forward so, when the race recommences, you’re its surprise leader.

To win any recession, however, you need to understand its rules. The good news is that there are only three really important ones. The bad news is that it’s not enough to commit them to memory. You must take them to heart, and allow them to guide your every step.

Rule No. 1: Betray your employer before your employer betrays you.

Chances are, if you work on Wall Street, you work for some giant corporation. Citigroup Inc., say, or Merrill Lynch & Co. The sheer size of these firms may convince you that they are, essentially, secure, that there is no better place to ride out a storm than among the tens of thousands of fellow employees.

This is a mistake.

No Safety in Numbers
There’s seldom any safety in numbers, and the more parlous the situation, the more dangerous it is to be in it with a lot of other people. London during an outbreak of the bubonic plague, the Superdome during Hurricane Katrina, the New Jersey suburbs. People are always clustering together precisely where and when they should not.

In World War I, hordes of men charged directly into machine-gun fire, no doubt reassured that they weren’t alone.

No, if you want to win the recession, you need to find a hole and crawl inside it, until the shooting stops. This hole is called a HEDGE FUND.

Look around. Note how many of the really shrewd people have recently decided to abandon the big firms for which they have happily worked for many years, and sneak off to some small corner of the financial universe.

Last week, the two guys who ran the distressed-debt desk at Citigroup just disappeared inside their own firm. The team doing the same thing at Bear Stearns Cos. vanished inside Tudor Investment Corp. Even the guy who kept Goldman Sachs Group Inc. out of the subprime mess fled, and raised money for his own fund.

I know what you’re thinking: What if no hedge fund wants me? What if I set up my own hedge fund and investors won’t give me their money? Which brings me to …

Rule No. 2: Remember what you are selling.

No matter what you’ve told yourself in good times, to justify the huge paychecks you have received, you aren’t selling actual money-making expertise. For decades, brokers and money managers as a group have underperformed the market. Yet ordinary investors continue to solicit their advice and pay them for their services. Why?

Greed, contrary to popular belief, isn’t what keeps this strange wheel spinning. Greed eventually gropes its way to self-interest. In good times, the dominant psychological impulse can be mistaken for greed but what’s really going on is that a lot of people are worried everyone else is getting rich and they aren’t.

At the bottom of the Wall Street money machine isn’t greed but anxiety.

Pure Gold
In bad times, this deep truth reveals itself more clearly, for the anxiety now gets expressed as fear. But there is as much money to be made from it as ever. The TV news projecting oil at $200 a barrel, the stock market collapsing, banks repossessing millions of houses, hedge-fund managers stealing their customers’ money and pretending to jump off bridges: This stuff is pure gold, if you know how to work the mine.

Sadly, most Wall Street people don’t. They instinctively avoid controversy. They dislike contemplating the events that inspire terror in potential investors. They think their job is to calm investors. To pretend everything is fine, even if it’s not.

This is the instinct you must fight: A calm investor is one who might think twice before investing in your hedge fund.

You need to learn to talk to investors in new ways. To frighten them so terribly that they feel compelled to pay someone to hold their sweaty hands. If you aren’t too obvious about your motives, that someone could very likely be you. Which brings us to …

Rule No. 3: Hide your motives. Or, specifically, minimize the appearance of financial interest.

Don’t tell anyone how well you’re doing for yourself, for example, not even women you have just met. Recessions blow in with them a general backlash against worldly pleasures and material obsessions.

You must reckon with this shift in public values, for it will occur even on Wall Street, and threaten to expose your ambition as freakish. A lot of people you thought you knew are about to rediscover what’s important in life: wife, kids, the love of one’s fellow man. But you are not.

Don’t worry: it’s temporary. This is still America.

But people are going to be watching you closely for any sign that you fail to grasp the relative unimportance of money. Mollify them. Acquire some painless habits, for instance, to suggest that you, too, have found meaning in something other than your success.

Sell the Maybach and buy a Prius. Have the gardener plant tomatoes in your yard  - but make sure he knows to put them in the front yard, where they can be seen.

The goal isn’t to get people to like you. That would be too much to ask. The position to which you aspire, recession champion, is inherently unsympathetic. You are the man on the lifeboat with his own private stash of food and water. The goal is merely to get people to tolerate you, and dissuade them from organizing themselves against you.

Do this well enough and by the time they realize what you’ve done the next boom will have begun, and they’ll treat you as their hero.

Source: Michael Lewis, Bloomberg, July 2, 2008.

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“The financial crisis has shown that markets are bubble-prone and that laissez-faire regulation doesn’t work. The authorities need to get a grip if we are to avoid a mega-bubble. But we may need an even deeper crisis for that to happen.” That is the conclusion of a fascinating round-table discussion just published by Prospect magazine.

The participants (from top left to bottom right) were: Mark Hannam who spent 12 years working in the City for the Bank of England, Citibank and Barclays; Jonathan Ford (chair), deputy editor of Prospect; John Gieve, deputy governor for financial stability of the Bank of England; Martin Wolf, chief economics commentator at the Financial Times; Anatole Kaletsky, an economic commentator and associate editor of the Times; and George Soros, chairman of Soros Fund Management.

Please click here or the thumbnail below to access the full text of the panel discussion.

Source: Prospect, July 2008.

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White knuckles and shaky knees abound as the bear’s growl grows louder.

While on the road in Switzerland (where even the gnomes are gloomy), I have put together a table of global stock markets’ performance – over various measurement periods and in both local currency and US dollar terms. The numbers speak for themselves and can best be summarized in a single sentence: “Nowhere to hide.” The Wall Street “leash effect” remained paramount, and decoupling nothing more than a theoretical myth.

The terrible performance during June, with especially the previously high-flying Chinese and Indian markets bearing the brunt of the selling pressure, was well-covered in the financial media.

Notwithstanding the poor showing in June, the second quarter was not all that bad as shown by the fairly flat performance of both the MSCI World Index ( 2.5%) and the MSCI Emerging Markets Index (-1.6%). Some indices such as the Nasdaq Composite Index (+0.6%) and the Russell 2000 Index (+2.2%) managed positive returns, but it was the Russian Trading System (+12.9%) the Brazilian Bovespa Index (+6.6%) and the Japanese Nikkei 225 Average (+7.6) that showed the rest a clean pair of heels.

The year-to-date performances (i.e. first six months of 2008) were all negative by double digits, with the exception of the Russell 2000 Index (-8.9%). But the really interesting figures were those since the respective bourses’ bull market highs. These numbers show the vast majority of stock markets to have entered bear markets, at least as far as the somewhat arbitrary “official” definition of a decline in excess of 20% is concerned.

As a result of the slide of the US dollar over the different measurement periods, the performance of those stock markets where the local currency strengthened against the greenback (pretty much all markets) obviously look better once expressed in US dollar terms (see second table).

A tradeable rally is probably not too far off, but the primary trend of most global stock markets remains down. Trying to squeeze out a few basis points from a bounce could turn out to be a high-risk strategy, particularly as long as the oil spike persists, causing sentiment and other overbought/oversold indicators to become even more oversold before a meaningful rally manifests itself.

“Stock market technicals are so horrid that one should not attempt to play for a rally even though stocks are extremely oversold. In a bear market an extremely oversold condition with horrid and degenerating fundamentals creates the conditions for an abnormal storm – hint, hint, hint,” said Bill King (The King Report). “Numerous pundits and analysts have been calling for a market bottom for weeks if not months due to sentiment readings. They don’t understand the environment now is far different than a couple years ago.”

In short, this is a DANGEROUS market in which to try to pre-empt short-term movements. In the words of Doris Day: “The future’s not ours, to see, Que Sera, Sera.”

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I have been bearish on government bonds since March this year and have repeatedly warned that they were an overpriced asset class, saying at the time: “… one should be cognizant of the fact that an investment in a 10-year Treasury Note will by definition lock in a total return of 3.5% over the next 10 years. This sounds unsustainable and I find it difficult to see the long-term investment merit of such an investment. Long-dated bond prices could be hit hard once yields adjust to more realistic levels.” (See “Long Bonds in Injury Time”, March 28, 2008.)

Although rising bond yields have been given a reprieve as a result of the deteriorating outlook for economic growth and commensurate safe-haven buying, I maintain that the medium-term outlook remains negative owing to valuation levels still being stretched, especially in the light of mounting inflationary pressures.

The chart below shows the long-term pattern of US ten-year Treasury bond yields and specifically the low of 3.14% reached on March 17 and the subsequent turnaround.

Source: StockCharts.com

A very apt and well-reasoned summary of the various factors impacting the outlook for government bonds appeared in The Economist a few weeks ago. This article is greatly complementary to my previous posts on bonds and is therefore republished in full in the paragraphs below.

“The yield of Treasury bonds is arguably the single most important indicator in financial markets. Since the American government is unlikely to default, the bond yield sets the risk-free rate against which other assets are measured. It also serves as a barometer of investors’ feelings about economic variables like inflation and recession.

“But precisely because it does so many things, the Treasury bond can send out conflicting signals. Consumers have been grumbling about the inflationary impact of higher oil and food prices for a while. But bond investors have only recently taken fright, pushing the yield on the 10-year Treasury bond above 4% on May 28, for the first time since the start of the year. Even now, however, the breakeven inflation rate (the difference between yields on conventional and inflation-linked bonds) on five-year Treasury issues is just 2.4%, within the range it has occupied for the past four years; compare that with the 7.7% inflation rate that American consumers expect over the next 12 months.

“One possibility is that the ‘bond-market vigilantes’ have been asleep. ‘We sometimes wonder if Treasury-bond investors enjoy losing money,’ muses Tim Bond, a strategist at Barclays Capital, as he ponders the logic of owning ten-year Treasuries yielding close to 4% when headline inflation is heading (on his view) for more than 5% by August.

“Bill Gross of Pimco, a bond-market investor, argues that inflation is understated in the official American figures because of statistical adjustments made over the past 25 years. The result may be that investors have been fooled into buying Treasury bonds on unrealistic expectations of real (after-inflation) yields.

“Another possibility is that breakeven rates are not an effective measure of investors’ inflation expectations. That is the view of Jack Malvey, a strategist at Lehman Brothers. He argues that yields on inflation-linked bonds have been distorted over the past decade by demand from pension funds, which see the bonds as an ideal way to match their liabilities.

“A third option is that bond investors think today’s inflation rates are a blip. ‘Inflation may be an issue now but it likely won’t be over the next ten years,’ says Pavan Wadhwa, head of European rates strategy at JPMorgan Chase. Optimists argue the anti-inflation credibility of central banks is stronger than in the 1970s. And they note that high oil prices, although they push up inflation in the short term, ultimately tend to act as a tax on growth.

“The credit crunch may also be having lingering effects. Bond yields reached their low in mid-March when the Bear Stearns crisis was in full swing. At that point, the ten-year Treasury bond yielded just 3.31%, the lowest level in five years. Investors were fleeing the riskier debt of bank and other corporate borrowers for the safety of government paper.

“Yields have moved up by more than half a percentage point since then, as investors have started to move money out of government bonds and back into the equity market. But recessionary fears still linger, especially when investors are bombarded with statistics such as the continued fall in American house prices and the decline in consumer confidence. It may still be worth holding Treasury bonds yielding around 4% as a hedge against a sharp economic downturn.

“In short, the bond market is caught in an awkward compromise, with worries about the financial and economic outlook balancing concern about inflation.

“In the medium term, however, it is hard to argue with Lehman’s Mr Malvey when he says that he expects yields in some government-bond markets to rise by two to three percentage points over the next two or three years. Although the world may not be about to return to the excesses of the 1970s, the Goldilocks era is tapering off: the trade-off between growth and inflation has deteriorated.

“Nor have Treasury-bond investors exactly been coining it in recent years. According to Barclays Capital, the annualised real return since the start of 2003 has been a meagre 1%. Will the Chinese, with a domestic inflation rate of 8.5%, really want to hold bonds yielding 4% in a currency they expect to depreciate against the yuan? Is the anti-inflationary credibility of the Federal Reserve really that convincing when it is clear that its rate decisions can be driven by concern for the health of the banking sector? Indeed does it make sense for German ten-year bonds to yield more than Treasuries when the inflationary rhetoric of the European Central Bank looks much more hawkish?

“Veteran investors may recall 1962, when the Treasury-bond yield was less than 4%. Those who bought bonds then earned negative real returns over the succeeding five-, ten- and 20-year periods. They should be very careful about making the same mistake again.”

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Investors are running for the hills today, but are they running in the right direction? In this very informative webcast, Marc Faber, author of the Gloom, Boom & Doom Report and Frank Holmes, CEO and chief investment officer of US Global Investors, discuss global investment opportunities and threats.

Please click here to listen to the webcast.

Source: US Global Investors, June 27, 2008.

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T.S. Eliot might have been out by a few months – it looks as though June might turn out to be the cruelest month of the year rather than April.

Renewed fears of inflation and slower growth caused by record energy costs played havoc with global stock markets last week, resulting in the Dow Jones Industrial Average being on track to record its worst June since the Great Depression. As stocks suffered, gold bullion surged and government bond yields dropped due to safe-haven buying.

Sentiment soured as investors became more concerned that the credit crisis still had a long way to run and that the fallout was increasingly contaminating the real economy.

Credit market stress deteriorated markedly as shown by the widening credit default spreads in both the US and Europe. The CDX (North American, investment grade) Index rose by 17 basis points to 143, and the Markit iTraxx Europe Crossover Index by 41 basis points to 541.

“When sorrows come, they come not single spies, but in battalions,” said Claudius in Shakespeare’s Hamlet. The pictures below, courtesy of Barry Ritholtz (The Big Picture), could have been taken from the play’s brochure.

Besides surging oil prices and financial sector woes, the focal point for the week was the FOMC’s interest rate announcement on Wednesday. As expected, the Fed left the Fed funds rate unchanged at 2.0%, and its wording in the accompanying statement largely reiterated the hawkish comments leading up to the meeting.
The Fed said overall economic activity continued to expand, partially due to “firming” in household spending, but it expected economic growth would face the burdens of tight credit conditions, housing contraction and the rise in energy prices.

The directive also said uncertainty over the inflation outlook remained high, although the Fed expected inflation to “moderate later this year and next year”, stating that downside economic risks had diminished somewhat, while inflation risks had increased.

“We’re in a nasty environment,” said Tim Bond, Barclays Capital’s chief equity strategist. “There is an inflation shock under way. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth. There is going to be a deep global recession over the next three years as policymakers try to get inflation back in the box.”

These sentiments were echoed by Jim Cramer (New York Magazine) who said: “In 25 years on Wall Street, I have never seen things this bad. We’ve had some tough times: the 1987 stock market crash, the collapse of the once-all-powerful Drexel Burnham Lambert, the immolation of Long Term Capital, the post-9/11 calamity, and the dot-com implosion. Every one of these events rocked the Street, causing pay cuts and layoffs and creating a sense of doom. But this time is different; it’s doom itself.

“Sell everything. Nothing’s working. Revisit when the prices are adjusted for a big recession, soaring inflation and a crushed consumer. Sell at 12,000 and come back at 10,000. Even better: short it,” said Cramer.

Difficult as it may be, you should guard against letting your emotions get the better of you. “Be prepared to hear a litany of dire predictions now as people jump on the ‘sell everything’ bandwagon by the very same people who were pounding on the table to buy stocks just a few short weeks ago. Ignore the noise and scare tactics and focus on what matters most – making good decisions and finding opportunities that do exist …,” remarked Charles Kirk (The Kirk Report).

Although I did not intend compiling a “Words from the Wise” report this week, I actually managed to do a shortened version in midair from Cape Town to Europe. As I could not access the Internet for some of the usual statistics and was constrained by the laptop’s limited battery capacity, the end result is significantly less comprehensive than usual. Blogging will remain slow for the next ten days as family time stakes its claim.

Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance round-up.

• The Conference Board Consumer Confidence Index fell further in June to 50.4 from May’s 58.1. This puts the Index at a 16-year low, and this is the fourth-lowest reading in the history of the survey, which dates back to 1969.

• New Home Sales declined in May as housing markets continued on a downward trend. Sales of new single-family homes came in at 512,000 after seasonal adjustment, a decrease of 2.5% below the revised April total of 525,000 sales, and 40.3% below the total of 857,000 for May 2007. The supply of new single-family homes remained high at 10.9 months.

• Personal Income soared 1.9% in May, following April’s 0.3% growth. Income growth was inflated by the effects of the tax rebates. Excluding those, personal income rose by 0.4% in May, up from 0.2% in April. Spending growth jumped to 0.8% from 0.4% the previous month. Real spending rose by half as much. The core PCE deflator rose by 0.1% again, while the top-line deflator rose by 0.4%.

Economy
“Global business sentiment softened last week and remains fragile, but it is well off its late April bottom,” reported the Survey of Business Confidence of the World conducted by Moody’s Economy.com. “There has been a worrisome increase in pricing pressures during the past month. Confidence remains weakest in the US where it suggests the economy is still contracting, and it is strongest in Asia where it is consistent with an economy growing near its potential.”

The past week’s economic reports in the US included the following notable releases:

The market is still pricing in two rate increases by year end. However, according to the Financial Times, Pimco’s Bill Gross said he thought the Fed was just “jawboning” to keep inflation expectations under control. “By this time in December the Federal funds level is still going to be 2.0%,” he said.”

“My bet is that the FOMC remains on hold for the rest of the year as consumer spending softens again and headline inflation moderates in the third quarter,” said Paul Kasriel, chief economist of Northern Trust.

Elsewhere in the world, Jean-Claude Trichet, the president of the European Central Bank, expressed fresh concern about inflation and wage growth, strengthening expectations that the ECB would raise its main rate by 0.25 percentage points next week to 4.25%.

WEEK’S ECONOMIC REPORTS

Source: Yahoo Finance, June 27, 2008.

In addition to the European Central Bank’s interest rate decision on Thursday, July 3, next week’s economic highlights include the following: Chicago PMI on Monday, Construction Spending and the ISM Index on Tuesday, ADP Employment and Factory Orders on Wednesday, and Initial Jobless Claims, ISM Services, and June’s jobs data on Thursday. Markets will be closed on Friday in observance of Independence Day.

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

Source: Wall Street Journal Online, June 29, 2008.

Equities

The MSCI World Index experienced four down-days and plunged by 2.3% (on top of the previous week’s -1.9%) during the past week as concerns about surging inflation, further credit-related trouble and deteriorating corporate earnings intensified. The MSCI has dropped by 11.7% since the beginning of 2008 – its worst first-half performance since a decline of 13.8% during the first six months of 1982.

The performance of emerging markets (-2.3%) varied from the Brazilian Bovespa Index (-0.5%) that fared relatively well, to the less fortunate Indian BSE 30 Sensex Index (-5.3%) and the Taiwan Taiex Index (-4.5%). The Chinese Shanghai Composite Index (-2.9%) is at risk of losing its entire gain of 141% recorded during last year’s eight-month rally.

The US stock markets got hammered on high volume and closed trading on Friday on a weak note. The index movements tell the story: Dow Jones Industrial Index -4.2% (YTD -14.5%), S&P 500 Index -3.0% (YTD -12.9%), Nasdaq Composite Index -3.8% (YTD 12.7%) and Russell 2000 Index -3.8% (YTD -8.9%).

Nine of the ten US stock market sectors recorded a decline for the week, with energy (+1.4%) the only one to end in positive territory. Of the subsectors, gold & silver stocks shone with a gain of 8.9%.

As far as specific companies were concerned, General Motors (GM) plummeted 16% after Goldman cut its earnings estimates and said the company may be forced to raise capital. Citigroup (C) and Merrill Lynch (MER) were both down about 10% on expectations that further write-downs were imminent.

The Dow Jones Industrial Index declined for eight of the last ten trading days, leaving it at its lowest level since September 2006 and down close on 20% (i.e. bear market definition) since its October 2007 high. Although the Dow has fallen below its March 2008 lows, all the other major US indices are still holding out above the year’s lows.

Fixed-interest instruments

Government bonds around the globe benefited from renewed concerns about the economic outlook and commensurate safe-haven buying.

The ten-year US Treasury Note dropped by 15 basis points during the week to close at 3.99%. Similarly, the UK ten-year Gilt yield declined by 11 basis points to 5.04% and the German ten-year Bund yield by 10 basis points to 4.53%.

Currencies

A realization that an imminent rise in US interest rates was not on the cards, resulted in dollar weakness, causing the greenback to decline by 0.9% over the week against the euro, 0.6% against the British pound and 0.7% against the Japanese yen.

Commodities

US dollar weakness and supply concerns pushed the Reuters/Jeffries CRB Index 2.0% higher for the week, on track for its largest gain in 35 years. The Index has risen by 30.1% since January, the largest increase since the 30.2% gain in the first half of 1973.

At centre stage during the past week, the price of West Texas Intermediate crude recorded an all-time high of $142.26 a barrel, before pulling back to close at $140.50 – a weekly gain of 3.8%. In addition to the lower dollar, supply concerns and unrest in Nigeria prompted the advance, as traders shrugged off an increase in inventory levels and word that Saudi Arabia was increasing output in July.

Crude oil prices could rise to as high as $170 per barrel in the coming months but are unlikely to hit $200 and should ease towards the end of the year, OPEC President Chakib Khelil said on Thursday, according to Reuters.

The declining dollar, together with rising price pressures and expectations that US interest rates might remain negative in real terms for quite a while, positively impacted on gold (+3.1%) and silver (+1.8%). Friday’s surge of $32 was the biggest one-day gain in gold in 27 years.

As far as agricultural commodities were concerned, corn (+6.1%) and soyabean (+3.9%) prices traded at record levels ahead of an update from the US Department of Agriculture on Monday.

Now for a few news items and some words and charts from the investment wise that will hopefully assist in keeping head above (the very murky) water. It’s best to remain cool and collected about these markets, and not take unnecessary risks.

Source: Unknown

CNBC: Analyzing inflation with Bill Gross
“The Fed is walking a tightrope between inflation and a recession, hoping to find its way to neutral. Bill Gross of Pimco shares his insight.”

Source: CNBC, June 25, 2008.

Telegraph: Barclays’s Tim Bond warns of a financial storm
“Barclays Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the US Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall ‘below zero’.

“‘We’re in a nasty environment,’ said Tim Bond, the bank’s chief equity strategist. ‘There is an inflation shock underway. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth.’

“Barclays Capital said in its closely-watched Global Outlook that US headline inflation would hit 5.5% by August and the Fed will have to raise interest rates six times by the end of next year to prevent a wage-spiral. If it hesitates, the bond markets will take matters into their own hands. ‘This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility, and the Fed is negative if that’s possible.’

“The Fed’s stimulus is being transmitted to the 45-odd countries linked to the dollar around world. The result is surging commodity prices. Global inflation has jumped from 3.2% to 5% over the last year.

“Mr Bond said the emerging world is now on the cusp of a serious crisis. ‘Inflation is out of control in Asia. Vietnam has already blown up. The policy response is to shoot the messenger, like the developed central banks in the late 1960s and 1970s,’ he said.

“‘They will have to slam on the brakes. There is going to be a deep global recession over the next three years as policy-makers try to get inflation back in the box.’

“Barclays Capital recommends outright ‘short’ positions on Asian bonds, warning that yields could jump 200 to 300 basis points. The currencies of trade-deficit states like India should be sold. The US yield curve is likely to ‘steepen’ with a vengeance, causing a bloodbath for bond holders.

“The bank said the full damage from the global banking crisis would take another year to unfold.”

Source: Telegraph, June 27, 2008.

(more…)

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