By Prieur du Plessis, on December 16th, 2007 posted in: Bonds, Business, Commodities, Currencies, Economy, Emerging markets, Equities, Finance, Gold, Housing, Investment, Markets, Money, Oil, Stocks, US dollar, Wall Street 3 people had their say - chime in!

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Phew – what a tumultuous week! MarketWatch very aptly described the events as “a central-banking version of the old playground poem ‘Solomon Grundy’.” “Ben Bernanke and company were speculated about on Monday, cut rates on Tuesday, took steps to inject credit-market liquidity on Wednesday, and were scrutinized and debated over on Thursday and Friday.”

Sub-prime issues, liquidity and credit crunch concerns continued to cause market jitters, especially as Morgan Stanley became the first major Wall Street investment house to warn that it may now be too late to stop a recession. And this report, entitled “Recession Coming”, came from Dick Berner, otherwise known at Morgan Stanley as the “resident bull”. Equally closely watched Nouriel Roubini went one step further stating that it was time to move away from the soft landing versus hard landing discussion and start concentrating on how deep the coming recession would be.

The past week was characterized by an avalanche of bearish reports and for the first time since the start of “Words from the Wise” three months ago not a single positive item regarding the US economy/markets made its way into the article. (This should normally start flashing a signal to contrarian investors.)

Before highlighting some of the thought-provoking quotes from market commentators, let’s briefly review the market’s actions on the basis of economic statistics and a performance chart.

Economy
The Fed cut the Fed funds and discount rates by a quarter-point to 4.25% and 4.75% respectively on Tuesday. Many investors were expecting a larger reduction and were even more perturbed by the Fed’s statement citing risks to inflation as well as economic growth rather than concerns about future economic growth. 

The Fed’s rate cuts were followed by an announcement on Wednesday that the Fed, the European Central Bank, the Bank of England, the Bank of Canada and the Swiss National Bank would make coordinated liquidity injections of as much as $64 billion in the coming weeks in an effort to alleviate the credit logjam. This represents the biggest act of international economic cooperation since the September 11 terrorist attacks, raising concerns that problems in the financial sector and the global economy could be wider than feared.

The latter part of the week witnessed a surge in US inflationary pressures with the PPI (+3.2%) showing the biggest gain in 34 years and the CPI (+4.3%) jumping to a two-year high.

The usual summary by Gold Seeker of the week’s economic reports was not available at the time of going to print, but Yahoo Finance came to the rescue with an excellent table of economic statistics.

WEEK’S ECONOMIC REPORTS  

Source: Yahoo Finance, December 14, 2007.

The coming week’s economic highlights, courtesy of Northern Trust, include the following:

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

Source: Wall Street Journal Online, December 16, 2007.

Global stock markets experienced a rollercoaster week, but closed in the red as investors became increasingly concerned about the snowballing of credit-related problems and central banks falling “behind curve”.

The Dow Jones World Index declined by 3.2% and emerging-market stocks by 3.0% (incorrectly reported on the chart above). Interest-rate-sensitive and smaller-cap stocks were big casualties of deteriorating investor sentiment. The Indian BSE 30 Sensex Index (+0.3%) was one of the few to escape the onslaught.

The US Dollar Index continued to strengthen during the week, spurred on by the Fed’s more-hawkish-than-expected statement. The surge in inflation data propelled the dollar to its biggest daily rise against the euro in almost three years on Friday. Higher-yielding currencies, in general, rose on the announcement of central banks’ plans to flood the system with cash.

Global bonds declined across the board as the spotlight fell on inflation, negating earlier safe-haven considerations. On the money-market side, one-month dollar and sterling Libor rates fell somewhat in response to the central banks’ announcement. Euro Libor rates, however, edged up as Eurozone inflation picked up the pace.  

The stronger dollar and mounting concerns about a US recession weighed on the prices of copper (-5.4%) and other base metals (-4.1%). The precious metals complex had a mixed week with only platinum (+1.0%) making some headway.

Crude oil (+3.4%) ended the week higher as continued harsh weather conditions impacted much of the US and a refinery fire also added to supply problems.

Now for some words (and graphs) from the investment wise that will hopefully assist to make sense of financial markets as Santa Claus approaches, but firstly a cartoon in lighter vein.

Source: Jim Sinclair’s MineSet, December 14, 2007.

Moody’s Economy.com: Survey of business confidence for world
“Businesses are very nervous.  Confidence edged a bit higher during the first week of December, but is consistent with an economy that is contracting. Expectations regarding the outlook over the next six months are eroding and have never been weaker in the five years of the survey. Confidence is stronger outside the US, but it has notably weakened most everywhere across the globe during the past month.”

Source: Moody’s Economy.com, December 10, 2007. 

Nouriel Roubini: US recession will be protracted and painful
“So it is time to move away from the soft landing versus hard landing discussion and start considering seriously how deep the coming recession will be. In the view of this author, the 2008 recession will be more deep, protracted and painful than the short recessions of 1990 to 1991 and 2001; this time around – unlike 2001 when only tech investment faltered – most components of aggregate demand are under threat: falling residential investment, falling CAPEX spending by the corporate sector and now evidence of a sharp slowdown and near stall of private consumption that accounts for 70% of GDP. With the US saving-less and debt-burdened US consumer now under threat the risk of a more protracted and severe recession than the mild one of 2001 are significant.”

Source: Nouriel Roubini, RGE Monitor, December 11, 2007.

Bill Gross: Beware the shadow banking system
“What we are witnessing is essentially the breakdown of our modern day banking system, a complex of levered lending so hard to understand that Fed Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.

“Forward-looking bond investors should understand that the shadow banking system has been built on leverage and cheap financing and that to keep it from imploding, a return to Fed Funds levels closer to those of 2003 may be required. While the Fed is not likely to repeat its 1% “deflation insurance” levels of that year, current Fed Funds futures which predict a 3¼% bottom are not likely to be correct either. Standby for a tumultuous 2008 as the market struggles to move from the shadows back into the sunlight of sounder banking and financial management, accompanied by Fed Funds levels at 3% or lower.”

Source: Bill Gross, Pimco’s Investment Outlook, December, 2007.

Ambrose Evans-Pritchard (Telegraph): Morgan Stanley issues US recession alert
“Morgan Stanley has issued a full recession alert for the US economy, warning of a sharp slowdown in business investment and a ‘perfect storm’ for consumers as the housing slump spreads. In a report ‘Recession Coming’ released today [December 11], the bank’s US team said the credit crunch had started to inflict serious damage on US companies.

“‘Slipping sales and tightening credit are pushing companies into liquidation mode, especially in motor vehicles,’ it said. “Three-month dollar Libor spreads have jumped by 60 to 80 basis points over the last month. High yield spreads have widened even more significantly. The absolute cost of borrowing is higher than in June.’

“‘As delinquencies and defaults soar, lenders are tightening credit for commercial, credit card and auto lending, as well as for all mortgage borrowers,’ said the report, written by the bank’s chief US economist Dick Berner. He said the foreclosure rate on residential mortgages had reached a 19-year high of 5.59% in the third quarter while the glut of unsold properties would lead to a 40% crash in housing construction.

“Like Goldman Sachs, and Lehman Brothers, the bank no longer believes Asia and Europe will come to the rescue as America slows. Mr Berner said US demand is likely to contract by 1% each quarter for the first nine months of 2008, but the picture could be far worse if the Federal Reserve fails to slash rates fast enough. It is betting on a quarter point cut this week, with three more cuts by the middle of next year. ‘We expect the Fed to insure against the worst outcome,’ he said.

“Morgan Stanley is the first major Wall Street bank to warn that it is may now be too late to stop a recession, though most have shifted to an ultra-cautious stance in recent weeks. Mr Berner – known at Morgan Stanley as the ‘resident bull’ – is one of the most closely watched analysts on Wall Street. While he began to turn bearish last April as the credit markets turned nasty, the latest report is written in tones that may is rattle the fast-diminishing band of optimists.”

Source: Ambrose Evans-Pritchard, Telegraph, December 11, 2007.

Continue reading Words from the wise for the week that was (Dec 10 – 16, 2007)

By Prieur du Plessis, on December 2nd, 2007 posted in: Bonds, Business, Commodities, Currencies, Economy, Emerging markets, Equities, Finance, Gold, Housing, Investment, Markets, Money, Oil, Stocks, US dollar, Wall Street 12 people had their say - chime in!

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Coming back on the 12-hour flight from London to Cape Town two days ago I did what I thought was undoable – I actually managed to catch eight hours’ sleep, blissfully unaware of the machinations of financial markets for the duration of the flight. The thought crossed my mind whether central bankers were sleeping as soundly in the midst of the liquidity and credit crunch in financial markets back at the summer peaks, “but much worse and more dangerous” in the words of highly-respected economist Nouriel Roubini.

My concerns were partly checked when upon arrival in South Africa I heard about Federal Reserve chairman Ben Bernanke’s remarks on Thursday that policymakers needed to be “exceptionally alert and flexible” to fight “headwinds for the consumer in the months ahead”. His comments comforted market participants as the words were viewed as a strong indication that another interest rate cut – the fourth since September – could be expected when the Fed’s Open Market Committee meets on December 11. Bernanke’s speech echoed earlier dovish comments by his number two man, Donald Kohn.

Markets were further calmed by a $7.5 billion capital injection from the Abu Dhabi Investment Authority (ADIA) for Citigroup, and by Citadel Investment Group marking distressed asset-backed securities to market.

Before highlighting some thought-provoking quotes from market commentators during the past week, let’s briefly review the markets’ actions on the basis of economic statistics and a performance chart.

Economy
The economic statistics for the week were characterized by a constant stream of gloomy releases. Against this backdrop, futures traders are now pricing in a 100% chance that the Fed will cut the Fed Funds rate next week by 0.25%, with a 50% probability that the reduction will be as large as 0.50%.

WEEK’S ECONOMIC REPORTS

Source: Gold Seeker Weekly Wrap-Up, December 1, 2007.

This week’s economic highlights include the ISM Index on Monday, Productivity, Factory orders, and ISM Services on Wednesday, Initial Jobless Claims on Thursday, and November’s jobs data, Michigan Sentiment, and Consumer Credit on Friday.

Markets
The performance charts usually obtained from StockCharts were unfortunately not up to date, but the Wall Street Journal Online again came to my rescue with the following chart indicating how different global markets fared during the past week.

Source: Wall Street Journal Online, December 2, 2007.

Global stock markets were propelled higher after Fed officials bolstered hopes for additional interest rate cuts. Emerging markets set the pace with impressive performances, but mature markets were no slouches either. Not to be outdone by the red-hot Asian emerging markets such as the Hong Kong Hang Seng Index (+7.9%), the Nikkei 225 Average gained a very respectable 5.3% for the week.

The Dow Jones Industrial Index recorded a second straight triple-digit points gain and the year’s biggest one-day percentage increase (+2.6%), notching up its third best week of 2007. The Nasdaq Index and S&P 500 Index were not far behind, with the latter experiencing its best four-day run since 2003.

The US dollar index continued to strengthen during the week as traders chose to focus on the positive implications of lower interest rates for the US economy rather than to worry about the negative consequences for the currency. The Japanese yen retreated as carry trades returned to favor on the back of an increasing appetite for risk.

US Treasuries hit three-year lows early in the week, but ended little changed. Continued credit fears kept conditions in the interbank markets extremely tight, with a scrambling for funds pushing Libor and Euribor rates to significant premiums over the official interest rates in the US, UK and Europe.

As far as commodities were concerned, the crude oil price fell sharply by 9.6% to register its biggest weekly decline in two years. Traders focused on a combination of an expected OPEC production increase this week, a stronger dollar and the weakening US economy. In turn, falling energy markets, together with end-of-month liquidation selling and sell recommendations from key New York investment firms, resulted in a sell-off in gold bullion of more than $40 for the week.

Now for some words (and graphs) from the investment wise that will hopefully assist to make sense of the shenanigans of the credit debacle and other pertinent issues, but firstly something in lighter vein.

Goldman Sachs traders: protesting bonus cuts

Hat tip: Paul Kedrosky’s Infectious Greed

Financial Times: Bill Gross – The debt markets “keep me up at night”
“Bill Gross, chief investment officer of Pimco, the world’s largest bond fund, has in recent years become famous for issuing downbeat warnings about the credit world. This month, however, his tone has turned positively apocalyptic.

“’We haven’t faced a downturn like this since the Depression,’ he observed to reporters when talking about the US housing sector and its impact. The debt market’s ‘effect on consumption, its effect on future lending attitudes, could bring [America] close to the zero line in terms of economic growth,’ he said. ‘It does keep me up at night.’”

Source: Gillian Tett, Financial Times, November 27, 2007.

Nouriel Roubini (RGE Monitor): Liquidity in financial markets back to summer peaks – only much worse and more dangerous
“There is now increasing evidence that the liquidity and credit crunch in international financial markets is back to its summer peaks of August and, in most dimensions, even worse than in the summer; financial markets are now in a ‘virtual panic mode’ according to a market participant (as reported by the FT).

“This worsening of the financial markets turmoil has occurred in spite of the hundreds of billions of dollars and euros that have been injected in the financial system by the Fed, the ECB and other central banks and in spite of the 75bps cut in the Fed Funds rate by the Fed. This massive easing of liquidity – both its quantity and price – has miserably failed to stem a severe liquidity crunch that is now back to the summer peaks, as evidenced for example in the interbank markets – both in US and Europe – by the sharp widening of Libor rates – at a variety of maturities – relative to equivalent maturity government yields and/or policy rate; such sharp rise of spreads to summer levels signals a worsening of the liquidity crunch.”

Source: Nouriel Roubini, RGE Monitor, November 25, 2007.

John Mauldin (Thoughts from the Frontline): The financial fire trucks are gathering
“So, even as the Fed cuts rate, the cost of financing and credit is going up. The odds for a 50-basis-point cut at the next meeting are rising with the arrival of each new fire truck.

“The Fed needs to act preemptively, and the sooner the better. Remember Greenspan’s speech a few years ago, in which he opined that the Fed needed to focus on avoiding the truly dangerous long-term situations rather than smaller near-term problems? The truly dangerous problem is a credit crunch. Lower rates in a credit crunch will be like pushing on a string. Think about Japan in the ’90s. Even zero rates did not help.

“This current credit crunch has the potential for growing into a full-blown credit crisis, the likes of which we have not seen in the modern world. It is not altogether clear that cutting rates at 25 basis points per meeting is going to do anything to help, if the cost of borrowing does not come down. We are in an entirely different type of crisis than we have ever seen. It is not for certain that the old tools, the fire sprinklers, if you will, will be enough. We may need to adapt to a new, interconnected world.”

Source: John Mauldin, Thoughts from the Frontline, November 30, 2007.

BCA Research: A wake up call for central bankers
“Central bankers shouldn’t be sleeping soundly. Last week’s financial market rioting sent a strong message to the Fed and other central banks that policymakers cannot wait to see spillover effects of tighter credit conditions on the economy. Quality spreads have soared and bid/ask spreads have blown out around the world. In Europe, it is alarming that interbank dealing in covered bonds came to a halt last week and planned high-quality debt issuance was cancelled.

“Measures of banking sector risk have exploded and liquidity in interbank money markets is deteriorating again. Interbank lending is the main channel through which central banks affect financial markets and the economy. Policymakers cannot allow these markets to stay moribund for long because it might mean that interest rate cuts become impotent. The Fed needs to cut interest rates promptly, and pressure is building on other central banks to follow suit.”

Source: BCA Research, November 27, 2007.

Continue reading Words from the wise for the week that was (Nov 26 – Dec 2, 2007)