Words from the (investment) wise for the week that was (Feb 25 – Mar 2, 2008)

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Reviewing the past week’s market action I couldn’t help but recall the words of Claudius in Shakespeare’s Hamlet: “When sorrows come, they come not single spies, but in battalions.” A laundry list of ominous economic reports, continuing worries about the credit insurers, more news of mortgage-related write-downs and talk of hedge funds facing margin calls served up the perfect storm of investor anxiety.


Fed Chairman Ben Bernanke was in the spotlight on Wednesday and Thursday when he delivered his semi-annual testimony on the economy and monetary policy to the House and Senate banking committees. Testifying after inflation readings for January showed strongly rising prices, he admitted that inflation risks have increased, but emphasized the Fed’s view that growth risks remained the greater threat to the economy right now.

Bernanke acknowledged that tumbling house prices could set off a second phase of the credit crisis. He said: “Financial markets continue to be under considerable stress,” and also warned of possible small bank failures in the US.

The take-away from Bernanke’s testimony was that the Fed will be cutting rates again at the March 18 FOMC meeting, with the Fed funds futures now seeing a 100% chance of a 50 basis point cut and a 62% chance of a 75 basis point cut.

John Mauldin, author of the Thoughts from the Frontline newsletter, said: “Bernanke practically promised more rate cuts … The Fed is going to cut and cut again … I think it likely they will go below 2%. They may stay there longer than we now think if I am right about a protracted and slow Muddle-through recovery.”

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.

A number of important US economic reports were released last week, causing considerable angst among investors that a combination of slowing growth and increasing inflation could result in 1970s-style stagflation.

In addition to Bernanke’s downbeat Congressional testimony, several economic numbers came in worse than expected, namely tumbling house prices, falling consumer confidence, consumer spending close to zero, falling orders for durable goods, a recession-like manufacturing survey, flat GDP growth and signs of a weakening labor market.

Importantly, producer prices rose by 7.4% in January from a year ago, coming on the heels of the news last week that the CPI rate jumped to the highest year-on-year rate in decades.

Research from UBS suggested that total losses for financial firms related to the sub-prime meltdown would reach at least $600 billion against the $160 billion of write-downs so far disclosed.

On the positive side, the Office of Federal Housing Enterprise Oversight announced that it would be removing the portfolio caps on Fannie Mae and Freddie Mac, thereby hoping to improve liquidity in the secondary mortgage market to promote increased lending. Also, Standard & Poor’s affirmed the triple-A ratings for MBIA and Ambac, but this was negated by news that the bailout of the latter had hit a problem.



Time (ET)




Briefing Forecast

Market Expects


Feb 25

10:00 AM

Existing Home Sales






Feb 26

8:30 AM







Feb 26

8:30 AM

Core PPI






Feb 26

10:00 AM

Consumer Confidence






Feb 27

8:30 AM

Durable Orders






Feb 27

10:00 AM

New Home Sales






Feb 27

10:30 AM

Crude Inventories






Feb 28

8:30 AM







Feb 28

8:30 AM

Chain Deflator-Prel.






Feb 28

8:30 AM

Initial Claims






Feb 29

8:30 AM

Personal Income






Feb 29

8:30 AM

Personal Spending






Feb 29

8:30 AM

Core PCE Inflation






Feb 29

8:30 AM

Core PCE Prices





Feb 29

9:45 AM

Chicago PMI






Feb 29

10:00 AM

Mich Sentiment-Rev.






Source: Yahoo Finance, February 29, 2008.

In addition to the Fed releasing its Beige Book on Wednesday, the next week’s economic highlights, courtesy of Northern Trust, include the following:

1. ISM Manufacturing Survey (Mar 3): The consensus for the manufacturing ISM composite index is 48.1, after a 50.7 reading in December. Several reports of the factory sector have sent a message of a contracting manufacturing sector. Consensus: 48.1 from 50.7 in January

2. Employment Situation (Mar 7): Payroll employment in February is predicted to have barely risen (+10 000). Payroll employment dropped by 17 000 in January. The jobless rate is predicted to have risen to 5.0% from 4.9% in January. Consensus: Payrolls – +25 000 versus -17 000 in December, unemployment rate -5.0%

3. Other reports: Construction spending, auto sales (Mar 3), Pending Home Sales (Mar 6), Productivity and Costs, ISM Non-manufacturing Survey, Factory Orders (Mar 6).

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


Source: Wall Street Journal Online, March 3, 2008.

Global stock markets closed the week higher, with the MSCI World Index gaining 0.6%. If not for emerging markets (+1.5%) and the Japanese Nikkei 225 Average (+0.8%) the global index would have been underwater.

A sharp sell-off on Friday (driven by a host of negative news regarding financial stocks) resulted in declines for the US indexes for the week, as follows: S&P 500 Index (-1.7%), Nasdaq Composite Index (-1.4%) and Dow Jones Industrial Index (-0.9%). Gold and silver stocks (+3.5%) were the strongest performers for the week, whereas banks (-6.4%) and brokers ( 5.5%) were on the receiving end of the selling orders.

The major US indexes all recorded declines (ranging from 3% to 5%) for February, resulting in a fourth consecutive month in the red – the biggest losing streak since 2002.

Mounting economic concerns caused government bond yields across the globe to decline sharply as nervous investors piled into government debt as a perceived safe-haven asset class.

The entire maturity spectrum recorded double-digit yield declines in the US, with the yield on the two-year Treasury note falling by 34 basis points to 1.64% and the 10-year yield dropping by 27 basis points to 3.52%. Capital markets in the rest of the world behaved similarly.

The past week saw the US dollar plunging to lifetime lows on a trade-weighted basis and against the euro as market participants focused on weaker US economic growth leading to further rate cuts by the Fed. “The last time the dollar was this low, Jimi Hendrix was on tour,” said Barry Ritholtz (Big Picture).

The US dollar dropped by 2.3% against the euro based on the view that the European Central Bank would keep interest rates on hold for a while longer. Losses against other major currencies were: Swiss franc (-3.7%), Japanese yen (-2.3%) and British pound (-0.9%). Concerns about the UK economy and slowing house prices impacted negatively on sterling.

The Reuters/Jeffries CRB Index (+3.8%) continued its record-breaking ride during the past week on the back of a slumping dollar and increased investor inflows (as also evidenced in an announcement by Calpers to commit large additional assets to commodities). Crude oil (+3.1%), gold (+2.9%), platinum (+1.2%), industrial metals (+4.7%) and agricultural commodities (+4.0 %) all reached record levels.

Inflation concerns and negative real short-term interest rates pushed gold bullion to a record $975.90 en route to the $1 000 level. Silver continues to play catch-up within the precious metal complex, surging by 10.4% to breach $20 before minor profit-taking set in. A trader remarked: “Silver is in huge short supply, and the shortage is getting worse by the day; the silver inventories which depressed the price for more than 60 years are gone.”

West Texas Intermediate oil hit an all-time high of $103.50 as a result of supply disruptions, but eased by the end of the weak as economic worries got the better of supply concerns.

Agricultural commodities and base metals again experienced a strong week.

With the ISM Manufacturing Survey out on Monday and February’s payroll numbers on Friday, another key week for financial markets lies ahead. Hopefully the words and graphs from the investment wise will assist in guiding us through the murky waters and keeping our investment portfolios afloat.

US economy – that recessionary feeling

Source: Tom Toles, Yahoo News (via Barry Ritholtz’s Big Picture).

Moody’s Economy.com: World business confidence stable but weak
“Business confidence is stable but weak; consistent with a US economy that is contracting, expanding only marginally in Canada and Europe, and growing no better than potential in Asia and South America. Businesses’ assessments of current economic conditions dropped to a new low on a 4-week moving average basis. Real estate firms and financial institutions are the most worried, but business service firms and even manufacturers and high-tech firms are measurably more nervous.”


Source: Moody’s Economy.com, February 26, 2008.

Bloomberg: Roubini – Recession may last up to six quarters

Source: Bloomberg, February 26, 2008.

Asha Bangalore (Northern Trust): Predicting a contraction of real GDP
“Real gross domestic product (GDP) grew at an annual rate of 0.6% in the fourth quarter of 2007. The headline was let unchanged after revisions. But, with the exception of exports, all major components of GDP show slower growth compared with the advance estimate.


“Going forward, we are predicting a contraction of real GDP in the first quarter, marking the onset of a recession. The downturn in business activity should prevail until the third quarter of 2008. A revival of business momentum is likely by the end of the year, assuming the Fed eases monetary policy by about 100 bps and financial market impairment ends.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, February 28, 2008.

Asha Bangalore (Northern Trust): Bernanke’s testimony: easing is on the table, but inflation remains a concern
“Bernanke’s testimony addressed expected issues, the only surprise was that his remarks about inflation were quite extensive. A lower federal funds rate is nearly certain on March 18, with the February employment report, auto sales, auto retail sales, and financial market conditions determining the magnitude of the rate cut. Following a repetition of the FOMC’s forecasts, previously published, Bernanke noted that ‘the risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further,’ which ensures additional easing.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, February 27, 2008.

Bill King (The King Report): Fed must inflate or the system dies
“Bernanke essentially reiterated the dovish braying that Fed VCEO Don Kohn expressed on Tuesday. Ben also sees the financial system and economy as a bigger threat than inflation.

“Ben has to pretend that inflation expectations remain well anchored because he knows the Fed must inflate or the system dies. So Ben once again regurgitated the Fed mantra ‘yes we see inflation but slowing economic growth will arrest it’, which has been chanted for over a year. The second mantra verse is ‘okay we see food and energy inflation but core inflation remains well anchored.’

“This bone-headed Keynesian (slowing economy will offset inflation) delusion was totally debunked in the ‘70s but the Fed believes it has no choice and must lie about inflation on almost a daily basis.”

Source: Bill King, The King Report, February 28, 2008.

Richard Russell (Dow Theory Letters): What else can Bernanke do?
“Kohn is saying that the Fed is far more worried about the US economy than it is about potential inflation. Translation – the Fed will ACT to stimulate the economy but when it comes to fighting inflation – the Fed will resort to TALK.

“Put yourself in Bernanke’s place. What else can he do? Really nothing. He will do as much as possible to reliquefy the banks. He will do what he can to save as many homes as he can. He can hope that a rising stock market will work its magic on the psyches of America’s consumers. And he will shower the US with money in the hopes that this added ocean of currency will somehow float the US out of trouble.”

Source: Richard Russell, Dow Theory Letters February 27, 2008.

GaveKal: Signs of a secular uptrend in inflation
“… as things starting to marginally improve on the growth front, attention is now being directed to the risk of rising inflation.

“Indeed, recent inflation-related data points have not been encouraging. And this is especially true in Asia, where many countries are now experiencing the fastest pace of inflation since before the Asian Crisis. Most recently, Singapore has reported that its CPI has reached +6.6% YoY in January, the highest level since 1982. While, Asian inflation remains centered on food (e.g., wheat prices are up a whopping +19.6% MTD) and energy, we are nevertheless starting to see some concerning signs of a secular uptrend toward higher inflation.

“And even in the US, TIPS are now starting to reflect rising inflationary concerns, as the TIPS spread has widened to the highest level since August 2006 … And looking ahead, there is little evidence that commodity prices are going to offer any relief on inflation. Last week, for example, China’s largest steelmaker, Baosteel, agreed to a +65% input price increase from the world’s largest iron-ore supplier, Brazil’s Vale. In turn, Baosteel announced yesterday that it was increasing its steel prices by +20% (far higher than the +12% to +17% increase expected by analysts).”


Source: GaveKal – Checking the Boxes, February 26, 2008.

The Wall Street Journal: Inflation may be worse than we think
“Amid Wall Street’s recession panic, the latest official inflation news has received less attention than usual. The ‘headline’ consumer price index (CPI) for the year ending in January was up 4.3%, the third consecutive monthly reading above 4%. This has been easy to attribute to rising energy costs, for which the blame is often misplaced on foreigners and oil companies. But as I’ve argued on this page in the past, the real problem is the sick dollar.

“While the practice of excluding energy and food costs to glimpse the ‘underlying’ rate of inflation meets a lot of skepticism, the official consumer-price picture still keeps everyone guessing. The root of the confusion is the fact that the prices consumers actually pay change far more quickly than the CPI.

“The most timely figures come from the commodity markets, where prices are transparent and reflect conditions in the immediate present. Yet commentators tend to discount volatile data like energy and food prices when they assess the ‘underlying’ rate of inflation. This is a big mistake.

“Markets look forward, while government surveys of the cost of living are a rearview mirror. A little ‘indicator analysis’ shows that commodity prices, far from reverting quickly back to the mean, are early-warning indicators of the future CPI. Last year’s large increases in energy and food imply that consumer-price inflation is going to be much closer to today’s ‘headline’ rate of 4.3% than the ‘core’ rate of 2.5%.”

Source: David Ranson, The Wall Street Journal, February 27, 2008.

Times Online: Fed struggles to halt march of stagflation
“The ailing US economy is confronted not by a single threat but by a whole battalion of sorrows on the march that comprises deepening recession and accelerating inflation.

“Last week the Government reported that in the year to January consumer prices rose by 4.3%. This is so far above the top end of anybody’s definition of price stability as to be more than slightly alarming. The detail of the data showed just how pervasive inflation has become. It goes well beyond the usual suspects of oil and energy-related products and even food.

“Last month the prices of three quarters of the goods measured in the official figures rose by more than 2%. This suggests that inflation is more than just spiking in reaction to some short-term cost pressures but is becoming embedded in ways dangerously reminiscent of the late 1960s. That was when the global economy last began a long cycle of high inflation that proved stubbornly hard to conquer, even when demand slumped in the 1970s.

“This is why people in the United States are worrying openly about stagflation. The rising inflation trend seems, at least so far, to be impervious to the weakening economy. Even as price pressures have picked up, the signs of recession have proliferated.

“How much of a constraint will inflation be on the Fed’s room to cut rates further? The view at the central bank seems to be divided between economic pessimists who are optimistic about inflation and economic optimists who are pessimistic about inflation.

“We won’t have to wait long to find out which side is correct.”

Source: Gerard Baker, Times Online, Febuary 26, 2008.

Standard & Poor’s: Case-Shiller – year-end home prices mark widespread declines
“Data through December 2007, released today by Standard & Poor’s for its S&P/Case-Shiller® Home Price Indices, the leading measure of US home prices, show broad based declines in the prices of existing single family homes across the United States, marking 2007 as a full year of declining home prices.


“The chart above depicts the annual returns of the US National Home Price, the 10-City Composite and the 20-City Composite Indices. The decline in the S&P/Case-Shiller® US National Home Price Index – which covers all nine US census divisions – neared double digits, posting -8.9% versus the 4th quarter of 2006, the largest decline in the series 20-year history. During the 1990-91 housing recession the annual rate bottomed at -2.8%.

“‘We reached a somber year-end for the housing market in 2007,’ says Robert Shiller, Professor at Yale University and Chief Economist at MacroMarkets LLC. ‘Home prices across the nation and in most metro areas are significantly lower than where they were a year ago. Wherever you look things look bleak, with 17 of the 20 metro areas reporting annual declines and the remaining three reporting flat or moderate growth rates.’”

Source: Standard & Poor’s, February 26, 2008.

Asha Bangalore (Northern Trust): US homes – inventories keep climbing
“… it appears that additional price declines are likely given the inventory situation of existing homes. There was a 10.3-month supply of all existing homes in the market and a 10.1-month supply of existing single-family homes in January. A year ago, these readings were 6.7-month supply and 6.5-month supply, respectively. All said, adjustments in the housing market will continue in the months ahead until the inventory situation improves significantly.”


Source: Asha Bangalore, Northern Trust – Daily Global Commentary, February 25, 2008.

MarketWatch: US mortgage rates rise on inflation concerns
“Mortgage rates rose again this week, bringing the 30-year and 15-year fixed-rate mortgages to levels last seen in November, Freddie Mac’s chief economist said on Thursday. The upward rate movements are a reversal of what was seen in January, when rates had dropped significantly enough to inspire a surge in refinancing.

“According to Freddie Mac, the 30-year fixed-rate mortgage averaged 6.24% for the week ending Feb. 28, up from 6.04% last week. The mortgage is now higher than it was a year ago; the 30-year averaged 6.18% at this time last year. Just three weeks ago the benchmark loan averaged 5.67%, meaning it has jumped more than half a percentage point since then, a significant move given that mortgage rates have not been volatile in the last few years and that the Federal Reserve has been cutting interest rates aggressively.

“‘When mortgage rates move down very sharply, they tend to rebound equally sharply,’ said Greg McBride, senior financial analyst with Bankrate.com. ‘However, there’s usually one catalyst that sparks that rebound, and this time around there wasn’t one single precursor.’

“For one, concern about inflation is putting upward pressure on long-term rates, he said. That’s because inflation erodes the buying power of future payments that a bond holder receives, he added. Rates rise to compensate. Inflation worries will continue to influence rates over the next several months, and continued Fed rate cuts could stoke those worries even more, McBride said.”

Source: Amy Hoak, MarketWatch, February 28, 2008.

Bespoke Investment Group: Greenspan’s irresponsible advice
“Below we highlight a chart of the Fed Funds rate over the last eight years. Almost right after Greenspan suggested homeowners switch to adjustable rate mortgages, the Fed then went on to raise the rates that these adjustable rate mortgages were tied to! While his ill-timed calls regarding the stock market are understandable, Greenspan’s comments regarding short-term rates are especially puzzling. Unlike the stock market where he had no direct control, Fed Chairman Greenspan had ultimate control of where the Fed Funds rate was headed. Suggesting that homeowners migrate out of fixed rate and into adjustable mortgages right before a three-year 5.25% increase in the key short-term rate was not only a bad call, but also irresponsible.”


Source: Bespoke Investment Group, February 25, 2008.

MoneyNews: What crash? Home prices rising in half of US
“If you live in Florida, Las Vegas or California, you probably see a meltdown in your local real estate market. But in nearly half of the country’s 150 metropolitan markets, the median home price rose in the fourth quarter last year, the National Association of Realtors reports.

“The biggest gains came in small cities. The Cumberland area of Maryland and West Virginia topped the list with a 19% jump from a year ago, to a median price of $116,600. Next was Yakima, Wash., up 18% to $170,600, followed by the Binghamton, N.Y. area, up 14.8% to $110,000.

“‘I would call them back-country cities,’ Robert Shiller, the Yale University professor who made himself famous predicting the bursting of the 1990s stock bubble and the 2002 to 2005 real estate bubble, tells The New York Times. ‘They are just going through normal growth, and they are out of the bubble picture.’

“Some big cities have been able to withstand the real estate crunch as well: Manhattan, San Francisco and San Jose, for example.

“‘This proves what my friend Alan Greenspan always said: real estate is a regional, not a national business,’ David Jones, a veteran Wall Street economist tells MoneyNews.com. ‘You see so often the S&P/Case-Shiller Index, which measures the 20 biggest markets, and you think that home prices are falling everywhere in the country,’ Jones says. ‘This National Association of Realtors report proves otherwise.’”

Source: MoneyNews, February 22, 2008.

Richard Russell (Dow Theory Letters): Bill Gross – Housing is key to US economy
“The key to the US economy is housing. America’s consumers are not going to buy while the price of their homes are sinking month after month. Instead, they’re going to ‘pull in their horns’.

“Bill Gross of PIMCO says that to get housing moving again, the US will have to subsidize housing. Gross notes that despite the decline of short rates engineered by the Fed, the all-important 30-year bond yield has not come down.

“Gross states that the government will have to offer a 30-year mortgage at 4% or 4.5% yield with no money down. They can offer this subsidized mortgage to sincere, stable people who are good credit risks. This is the only way that the public will be ready to come in and buy houses en masse in the current situation.

“I believe Bill Gross is absolutely right, and instead of giving money away in small, meaningless quantities as they are going to do, the government should adopt Gross’s plan. To move off the current stagflation situation, the government has got to get people buying houses again. It’s going to take government help and subsidization to get housing and the economy moving. That or a long wait while housing finally hits bottom, and then turns up again.”

Source: Richard Russell, Dow Theory Letters, February 25, 2008.

BCA Research: Monoline ratings – a marginal improvement
“Investors celebrated the S&P ratings announcements earlier this week, sending risky assets markedly higher on the news. However, the skies are far from clear.

“Although S&P lowered the financial strength rating on two monoline insurance companies yesterday, it affirmed the AAA rating on the two with the largest exposure to subprime: Ambac and MBIA. Ratings agency credibility has dwindled, and their models are suspect, but as long as they give their AAA blessing, the monolines will remain in business and ride out the storm. In turn, the dreaded domino effect of ratings downgrades and forced selling can be avoided.

“While the financial sector still needs another quarter or two to fully recognize the losses incurred in the subprime meltdown, a stabilization of the financial guaranty industry will go a long way to help alleviate investor concerns, unfreeze the credit markets and support risky assets. Still, headwinds for both the economy and financial markets will persist until the source of the underlying problem (i.e. the US housing market) stabilizes.”


Source: BCA Research, February 26, 2008.

Mish Shedlock (Global Economic Trend Analysis): Ratings point to incompetance
“Let’s compare the financials of two stocks: MBIA which has Moody’s top rating of Aaa and Pfizer recently downgraded by Moody’s to Aa1 and by Fitch to AA-Plus from AAA.

Comparing financials (MBIA versus Pfizer)
• Profit margin: -61.76% vs. +17.07%
• Return on equity: -35.54% vs. +12.13%
• Revenue: $3.12 billion vs. $48.61 billion
• Earnings per share: -$15.22 vs. +$1.20
• Total cash: $5.73 billion vs. $20.30 billion
• Total debt: $17.44 billion vs. $8.69 billion

“Do the finacials of MBIA look ‘gilt edged’?

“Is there any other way to interpret the above ratings other than incompetence or corruption? If there is, can someone please tell me what it is?

Source: Mish Shedlock, Mish’s Global Economic Trend Analysis, February 26, 2008.

Bloomberg: Alt-A mortgage securities tumble, signaling losses
“Securities backed by Alt-A mortgages and other home loans to borrowers with better-than-subprime credit tumbled this month, causing investment funds to unwind or meet margin calls and signaling larger losses for Wall Street.

“Valuations for AAA rated securities backed by Alt-A loans, deemed between prime and subprime in terms of expected defaults, slumped 10% to 15% this month, partly because it’s so difficult to trade or find prices for them, Thornburg Mortgage, the Santa Fe, New Mexico-based lender and investor, said in a securities filing today.

“‘There really hasn’t been an orderly two-sided market in 2008,’ Arthur Frank, a mortgage-bond analyst in New York at Deutsche Bank AG, said today in a telephone interview.

“Lenders made Alt-A home loans to borrowers who wanted atypical terms such as proof-of-income waivers, delayed principal repayment or investment-property collateral, without having to offer sufficient compensating attributes including larger down payments. Subprime loans were made to borrowers with poor or limited credit records or high levels of debt.

“About $950 billion of Alt-A mortgage securities are outstanding, compared with about $650 billion of subprime securities and $500 billion of prime-jumbo securities, according to Frank. Potential losses stemming from subprime-backed bonds are larger because of two-sided derivative contracts linked to the debt, many of which have been packaged into collateralized debt obligations and turned into securities.”

Source: Jody Shenn, Bloomberg, February 28, 2008.

Paul Kedrosky (Infectious Greed): Bad day? Be glad you’re not selling muni bonds
“Here’s a fun market inefficiency for you: Despite missing payments at vanishingly low numbers, muni bond rate-auctions failed more in February than at any time in the last 23 years.


“Of course, that means much higher rates on muni bonds, as high as 20%, which, in turn, means more municipalities will miss out on future rate payments, thus neatly making the whole thing, at least temporarily, deliriously circular.”

Source: Paul Kedrosky’s Infectious Greed, February 25, 2008.

Times Online: Germans accuse UBS of sub-prime ‘mis-selling’
“One of Germany’s biggest financial institutions is to sue UBS, the Swiss banking giant, claiming it was mis-sold hundreds of millions of pounds worth of sub-prime securities.

“The action is expected to trigger a wave of similar lawsuits across world financial centres as institutions seek recompense for losses incurred from buying complex financial instruments that are now worth a fraction of their original price. It will also heap further pressure on Marcel Ospel, UBS’s embattled chairman, to resign.

“Sources familiar with the situation say HSH Nordbank, which has assets of €207 billion and is the world’s largest provider of shipping finance, is to take legal action against UBS to recover up to €500 million that was lost in a vehicle, set up six years ago, called North Street 4. At the time, this contained a basket of synthetic collateralised debt obligations, otherwise known as CDOs. Around 70% of the debt was corporate and the rest was exposed to the US sub-prime mortgage market.

“UBS has also been one of the hardest hit from the fall-out from sub-prime. It has since been forced to write down $18.4 billion from its own exposure to these mortgages. Now it faces action from banks it sold them to. UBS arranged at least nine North Street transactions with a combined value in excess of $15.6 billion.”

Source: John Waples, Times Online, February 24, 2008.

Jeffrey Saut (Raymond James): Give the bull the benefit of the doubt
“… if we see a further decline in interest rates it is likely attributable to a worsening of the financial crisis. If we don’t get lower rates it should be because the economy begins to reaccelerate. In either case it isn’t particularly good for financials. Meanwhile, the cover of Business Week says ‘Meltdown’, Newsweek’s cover reads ‘Road to Recession’, a Wall Street Journal article suggests ‘Good News: Fund Managers Are Miserable’, and NYSE short interest has hit a record high!

“Yet, ‘The Check’s in the mail’ is the operative phrase as tax refund checks are flowing, while the economic-stimulus rebate check will be flowing over the next few weeks, not to mention the raising of mortgage ‘caps’! Since ALL government-sponsored economic stimulus packages since 1948 have worked, we are inclined to give this one the benefit of the doubt! We continue to invest accordingly.”

Source: Jeffrey Saut, Raymond James, February 25, 2008.

John Hussman (Hussman Funds): Secular bear market – expect disappointing returns
“The total return of the S&P 500 is now a few weeks shy of having lagged riskless Treasury bills for a decade. Against this backdrop, I was asked by a journalist last week whether I believed that stocks were in a ‘secular bear market’. Though I tend not to think in terms of ‘bull’ or ‘bear’ markets (being more concerned with conditions that can be identified using fully observable data rather than hindsight), my immediate response was that a secular bear is self-evident. It’s difficult to imagine how the market could be characterized any other way when, despite recent bull market highs, the S&P 500 has lagged Treasury bills for a decade.

“Thinking about it more carefully, my impression is that investors are averse to the idea of a ‘secular bear market’ because it implies something about the future. For stocks to be priced to deliver disappointing future returns, after already suffering a decade of disappointing returns, seems too extraordinary to consider. But that’s exactly what we should expect.”

Source: John Hussman, Hussman Funds, February 25, 2008.

Barry Ritholtz (Big Picture): S&P 500 earnings down by 4.2% for 2007
“At the beginning of 2007, the S&P500 was over 1 400, the Dow was just under 12 500, and the Nasdaq was about 2 500. Stocks, according to consensus estimates, were ‘cheap’, and profit growth expected to be 10%+.

“With 90% of earnings reported by the S&P500 firms, we now have enough data to see how the full calendar year was for profits. Here’s the overview from S&P’s Sam Stovall:

“At the end of 2006, S&P equity analysts expected operating earnings per share (EPS) for the S&P Composite 1500 (comprised of the S&P 500, MidCap 400 and SmallCap 600 indexes) to advance 10% in 2007, a healthy follow-up to the 15% gain seen in 2006. Yet with 2007’s results nearly final, we now find that EPS for the S&P 1500 actually sank by almost 4% on a worse-than-expected fallout from the housing, subprime, and credit crises.

“Within the S&P 1500, the S&P 500 index, which represents 88.5% of the market value of the 1500, likely registered a 4.2% year-over-year decline, while the S&P MidCap 400 (7.8% of the 1500) eked out a 0.1% gain, and the S&P SmallCap 600 (3.7% of the 1500) fell 5.6%.

“The 1500’s negative earnings results for the year were the result of deteriorating profit growth for the Consumer Discretionary and Financials sectors in particular, as these sectors posted declines of 17.8% and 33.3%, respectively, as of Feb. 19, 2008. The second half of last year was the toughest for the overall market, as it suffered through EPS declines of 9% in the third quarter and 22% in the fourth, a quarter that many dubbed the ‘kitchen-sink quarter’ as companies wrote down everything – including the proverbial fixture.

“The relative performance of the mid-caps was likely due to the presence of many energy, commodity and agricultural stocks. Indeed, a few sectors have done rather well: The exporting industrials, anything Ag or energy related, consumer staples, utilities have all thrived. Financials, anything house related, many retailers, consumer discretionary all performed poorly. I was a little surprised by the full year number, thinking the good sectors and the first half numbers might partially offset the second half.”

Source: Barry Ritholtz’s Big Picture, February 29, 2008.

BCA Research: EUR/USD breaches 1.50 – what next?
“The euro has been grinding higher against the US dollar for the past two years and now appears to be undergoing a final spike. An extended consolidation should soon unfold.

“Interest rate differentials have been the primary driver of the euro in recent weeks. In contrast to aggressive Fed easing, the ECB is in no rush to cut interest rates even though President Jean-Claude Trichet has opened the door a crack. Sticky headline inflation and last week’s ‘high’ IG Metall wage settlement will only encourage ECB hawks. In turn, the spread between EMU and US short rates has surged to 125 basis points.

“However, we suspect the ECB will shift its tone and start cutting by mid-year. The euro area is hardly a model of economic vitality, with business activity downshifting materially and retail sales falling sharply. Any capitulation by policymakers should trigger the beginning of a topping out process. Bottom line: We advise against chasing the euro higher. Still, we await signs that US monetary stimulus is paying dividends and/or the euro spike reaches technical extremes before expecting an extended consolidation.”


Source: BCA Research, February 28, 2008.

David Gaffen (WSJ MarketBeat): It gets worse for the US dollar
“In a press conference today, President Bush reiterated that ‘we believe in a strong dollar policy,’ but he could have fooled us, considering what’s happened to the greenback. The dollar’s ravaging continues today, and the news only seems to get worse.

“Fed Chairman Ben Bernanke has clearly sparked more selling with his comments about potential bank failures and judgment that current challenges exceed that of the 2001 to 2002 slowdown period. Standard & Poor’s earlier today said the US’s credit profile could come under threat if consumers and businesses continue to pull back on spending, and analysts say certain central banks around the world are welcoming dollar weakness as a way to offset higher commodity costs.

“Let’s say it this way – it was a big deal a while back when the Canadian dollar reached parity with the US dollar. But if the current trend continues, pretty soon the Australian dollar will buy $1 as well. The euro, meanwhile, was closing in on $1.52, and the dollar is in danger of falling below 105 yen.

“Interestingly enough, this is happening without the participation of speculators. Bank of America analysts, in commentary today, point out that speculative positioning in most major currencies had ‘fallen to less than 40% of its average over the last year, particularly among major European currencies.’ It is possible that ‘speculative investors could clearly expand positions, acting as a catalyst to bring the USD lower in the weeks ahead,’ they write.

“They do, however, believe that a “serious overshoot” in dollar selling is possible – a with the euro rising to $1.55 to $1.57, at which time a marked turnaround could take place.”

Source: David Gaffen, WSJ MarketBeat, February 28, 2008.

US dollar submerged
Hat tip:
Barry Ritholtz’s Big Picture, February 28, 2008.

John Authers (Financial Times): Rising oil price negatively impacts US dollar
Source: John Authers,
Financial Times, February 27, 2008.

GaveKal: Dollar losing reserve status
“For three straight days, the US$ has posted new all-time lows against the Euro – and now it stands at US$1.52/€. Not surprisingly, this has raised concern that the US$ could be losing its status as the dominant reserve currency of the world. And indeed, since its inception, the euro has gained ‘market share’ – rising from 18% of global reserves in 1999 to 26.4% in 3Q07. Meanwhile, the US$ share of reserves has dropped from its peak of 72% in early 2002 to 63.8% in 3Q07. Clearly, the US$ remains the dominant currency, but the Euro is undoubtedly gaining ground.

“How do we explain this? (1) The Middle East’s growing distaste for US$’s. (2) Central Europe and Russia’s move towards the euro. (3) More euro’s fit in a briefcase. We should not dismiss the fact that the euro has gained market share in the world of drugs and organized crime.

“However, the more structural issue is that of current account (CA) deficits. Since the end of 2001, the Eurozone’s current account balance has, unlike the US’s, either been near-balanced or even positive. As such, there has been excess demand for euros worldwide. But is this really a sustainable trend?

“Today we note that, while the US CA deficit is now improving (and is actually positive when excluding oil imports), the Eurozone’s CA balance dropped, in dramatic fashion, into deficit last December. Moreover, we have reason to fear a collapse of confidence in the ECB, the European economy, and the EU political system. As such, it is likely that the euro will become less attractive as a reserve currency in the near future. The trouble is that this is a reflexive process: The rise of the euro will, in and of itself, give it credibility over the dollar. Thus, until one of the aforementioned catalysts sparks a reverse of trend, the euro could reach even higher. In the meantime, we recommend cash positions in Asian currencies.”


Source: GaveKal – Checking the Boxes, February 29, 2008.

BCA Research: Chinese renminbi – more upside ahead?
“Chinese authorities have allowed the renminbi (RMB) to accelerate in recent weeks, despite the worsening global economic outlook. Interestingly, RMB appreciation against the dollar in the past two years has always slowed when financial market turmoil erupted. As a result, the divergence this time around suggests Chinese authorities are still in tightening mode and growth remains well above their comfort level. Indeed, the latest round of economic data suggests that the economy continues to expand at a rapid pace and shows very little sign of slowing.

“We expect additional tightening measures heading forward (including further appreciation in the RMB). However, the lack of widespread inflationary pressures provides ample room for authorities to change course if the economy begins to slow significantly. As such, the odds of a hard economic landing are low, despite widespread fears.”


Source: BCA Research, February 26, 2008.

David Fuller (Fullermoney): Currency pegs putting pressure on Gulf economies
“The weakness of the US dollar puts pressure on economies which are growing strongly because USA’s current interest rate policy doesn’t provide the ideal fit for a rapidly expanding economy. While the dollar peg provides stability, it also applies an expansionary monetary policy to countries which might be thinking of tightening as the threat of economic overheating increases. Inflationary problems also become more pressing. However, the fact remains that oil is priced in dollars and having a dollar peg is convenient when oil is a state’s number one asset.

“A weakening dollar is already pressuring the profit margins of oil producing states, but if their currencies were allowed to appreciate significantly they would be getting much less of their domestic currency per barrel of oil, and other exports would lose competitiveness. I agree that pressure has been mounting on the currencies of the Gulf states to appreciate, but I have not seen any commentary originating with the leaders of these countries, indicating that they are about to change policy.

“As we have seen in Asia, countries can successfully hold down the value of their currencies for long periods of time and grudgingly give up this competitive advantage for their exporters. I see no reason why the Gulf countries would be any different.”

Source: David Fuller, Fullermoney, February 27, 2008.

Eoin Treacy (Fullermoney): Australian dollar on a tear
“Interest rates in Australia are on an upward trajectory in an environment where the economy is running surpluses and where the stance on inflation is cautionary. Given the interest rate differentials with the USA and other countries, the Australian dollar is becoming increasingly strong and has broken upwards from its long base against the greenback. Parity is a natural area of psychological resistance and I would expect the Australian dollar to test this level in the medium-term.”

Source: Eoin Treacy, Fullermoney, February 28, 2008.

Financial Post: Global shortage of metals looming
“Our peak oil thesis gained some new respect last week as oil prices hit yet another record, the first close over US$100 per barrel. Demand fluctuates, but it is all about supply, and supply concerns this week showed how tight the market really is.

“Peak oil has lots of press, but what about peak copper? Peak zinc? Peak gold? Sounds preposterous, but maybe it’s not so far-fetched. Nearly every commodity is experiencing some supply issues, for a host of reasons. Add it all up, and it means potential supply shortages in the future. Demand may slacken this year, but in the next 10 years today’s high commodity prices may actually look like a bargain.

“All being said, it seems like there is a potential perfect storm brewing on the commodity front over the next five to 10 years. If the world keeps up its insatiable demand for commodities, watch out – there won’t be much left of anything.”

Source: Peter Hodson, Financial Post, February 25, 2008.

Bloomberg: Calpers to boost commodity exposure
“The California Public Employees’ Retirement System, the largest US pension fund, may increase its commodities investments 16-fold to $7.2 billion through 2010 as raw materials prices surge to records.

“Calpers, which has about $240 billion in assets, agreed at a Feb. 19 board meeting to hold between 0.5% and 3% of its assets in commodities, spokesman Clark McKinley said. The Sacramento, California-based fund last year put $450 million into commodities, its first such investment.

“The agreement is the fruit of Chief Investment Officer Russell Read’s efforts since joining in 2006 to boost returns by shifting funds into raw materials and markets such as China and India. Oil has soared above $100 a barrel, wheat breached $13 a bushel for the first time, and gold and platinum climbed to the highest ever since Calpers began investing in commodities.

“‘We plan on ramping up the program by hiring additional staff,’ McKinley said by phone yesterday. ‘We are excited about commodities, which have performed exceptionally well for us.’”

Source: Saijel Kishan, Bloomberg, February 28, 2008.

David Fuller (Fullermoney): Industrial metals – where to invest
“… aluminium and tin are my least favourites, in that order. I’m rating lead somewhat higher because of its backwardation. I rate copper higher still because of its falling inventories, clear backwardation and broad platform of trading. A sustained break above this level would look very bullish. However, zinc and nickel have catch-up potential because they are barely out of the starting blocks for this current upside move. Inevitably there are reasons for this recent underperformance, to cast doubts on my preference for these two.

“Nickel is my favourite despite the risk of a delay before it really performs. However as nickel inventories start to trend down, and they have lost upside momentum, the rally should be explosive.”

Source: David Fuller, Fullermoney, February 27 & 28, 2008.

Bloomberg: US backs plan for IMF to sell some gold reserves
“The US Treasury, in a policy reversal, backed an International Monetary Fund plan to sell some of the lender’s $98 billion in gold reserves to help make up for a decline in revenue.

“‘The United States will help ensure that the IMF has adequate resources to fulfill its vital global mission by seeking authority from Congress for a limited sale of IMF gold,’ David McCormick, the Treasury’s undersecretary for international affairs, said in a speech in Washington.

“The Bush administration supports sales of as much as 12.9 million ounces recommended by an advisory group headed by Andrew Crockett, former head of the Bank of International Settlements, to set up a fund to cover anticipated losses at the IMF, McCormick told reporters. Such an endowment ‘will provide a basis for sound and sustainable IMF finances,’ McCormick said.

“The IMF’s finances have come under pressure as economic growth and government revenue accelerated in emerging markets, reducing their need for emergency loans.”

Source: John Brinsley, Bloomberg, February 25, 2008.

Richard Russell (Dow Theory Letters): Unusual time for US Treasury to reverse gold policy
“It strikes me that this is a rather unusual time for the US to reverse policy. Could it be that the US doesn’t want gold to advance above $1 000? It’s hard to believe, but I think that’s about right.”

Source: Richard Russell, Dow Theory Letters, February 26, 2008.

David Fuller (Fullermoney): IMF gold sales only a psychological headwind
“An increase in supply can only be a psychological headwind for the gold price, albeit much less so in an uptrend. In contrast, we saw the headwind’s impact during central bank sales from the 1980s until early this century. Thereafter European central bank sales were limited to fixed amounts, currently 500 tonnes a year. As I understand it, IMF gold would not be sold in the spot market, judging from their last divestiture of bullion in 1999 and 2000. I believe this was done via a transfer to another central bank.

“The key variable for gold is investment demand, which has been strong in recent years. This is unlikely to change while bullion’s price remains in a long-term upward trend.

“For those of us who invest in gold, the best case outcome following the IMF’s announcement of sales would be if the bullion was snapped up by a central bank or sovereign wealth fund in a country with a strong current account surplus, such as China or Russia. A more problematic environment for gold would occur if another major and needy source decided to sell some of its gold. For instance, the USA to fund public sector programmes in the next few years.”

Source: David Fuller, Fullermoney, February 26, 2008.

Bill King (The King Report): OPEC countries looking at alternative energy sources
“Hype and flamboyance increasingly overshadow substance on The Street. This maxim was evinced last week when the flamboyant Boone Pickens announced on CNBC that he was short oil because he expected the price to decline to the low to mid-80s in Q2.

“On the same day, world-renown oil analyst Tom Petrie concurred with Pickens’ view on oil but Mr. Petrie shared profound information that was glossed over and ignored by CNBC ‘experts’, talking heads and dopey producers. And we saw no financial media or Street coverage of Petrie’s trenchant news.

“Mr. Petrie told CNBC that he had just returned from extensive Middle East travel and had learned that the Saudis and other Arab OPEC countries were pouring billions of dollars into alternative energy sources. Petrie proclaimed ‘Arab oil producers, including the Saudis, believe more in Peak Oil than Americans do.’ What else does one need to know about the future supply of oil?”

Source: Bill King, The King Report, February 27, 2008.

Financial Times: Water fears lead Saudis to end grain output
“Saudi Arabia plans to halt wheat production by 2016 because of concerns about the desert kingdom’s scarce water resources, according to a US government agency. The Saudi Arabian government has not publicly given details of the move, which comes as global cereal prices surge, driven by strong demand and lagging supply.

“Saudi Arabia will begin reducing production annually by 12.5% from next year and will use imports to bridge the domestic consumption gap, the US Department of Agriculture – which collects information on global supply and demand for agricultural commodities – said in a report about the Saudi plan. It estimates that Saudi Arabia’s wheat imports will reach 3.4m tons by 2016, which could place the Gulf state in the top 15 largest importers of the cereal. The country at present imports a negligible amount of wheat, while producing about 2.5m tons annually.

“The forecasted increase in demand from Saudi Arabia, in addition to already high consumption in the region – Egypt is the world’s second largest wheat importer – would tighten global wheat supplies even further, analysts said.

“The US report said that ‘the main reason for change in the local wheat production policy was concern over the depletion of fossil water since the crop is grown on 100 per cent central pivot irrigation’.”

Source: Andrew England and Javier Blas, Financial Times, February 27, 2008.

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5 comments to Words from the (investment) wise for the week that was (Feb 25 – Mar 2, 2008)

  • Is stock market at a tipping point?…

    A laundry list of ominous economic reports, continuing worries about the credit insurers, more news of mortgage-related write-downs and talk of hedge funds facing margin calls served up the perfect storm of investor anxiety last week.

    Read all about …

  • H H Herrendorf

    The governing body of the commodity world will soon impose higher margin calls and all the high priced commodities will lose 10 to 25% of their values, mostly due to speculators exits of these futures contracts. Dow will rally 10% … we will then see if there are shortages or just speculators.

  • Ian Nunn

    It has been wisely reported in the past that official oil reserves in the Mid-East are inflated. By how much is anybody’s guess – except for the respective oil ministries. The Saudi’s especially, would be in the best position to assess where Hubbert’s Peak lies on the time-line. Are they showing their hand?

  • Fullcarry

    Everybody is so convinced of their opinions. How do people respond when events prove them wrong?

  • Wow, there is so much information on this site! It’s loaded with great articles, keep up the great work 🙂

    If you get a chance, feel free to take a look at my blog:


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