Archive for April, 2009
Thursday, April 30th, 2009
This is a guest contribution by Bespoke Investment Group:
“For those interested, below we highlight the 25 largest companies in the world. For each company, we provide its country, sector, price (local currency), year to date change, and market cap in dollars. As shown, Exxon Mobil (XOM) is the biggest company in the world and the only one worth more than $300 billion. PetroChina ranks second and is the only other company worth more than $200 billion. The Industrial and Commercial Bank of China is the world’s third largest company, giving China two of the biggest three. Wal-Mart and Microsoft round out the top five. The United States still dominates the list with 12 of the 25 spots. China ranks second with four spots. General Electric used to be the biggest company in the world, but it has slipped all the way down to the 18th spot. Google (GOOG) is also on the list at number 22.”
Source: Bespoke Investment Group, April 27, 2009
Tags: Bank Of China, Biggest Company In The World, Commercial Bank Of China, Currency, Exxon, Exxon Mobil, General Electric, Goog, Google, Industrial And Commercial Bank, Industrial And Commercial Bank Of China, Investment Group, Largest Companies In The World, Market Cap, Microsoft, Number 22, United States, Wal Mart, Xom, Year To Date
Posted in Markets | Comments Off
Thursday, April 30th, 2009
This is a guest post from Bespoke Investment Group:
From our daily ETF Trends report at below we highlight various country ETFs and their current trading levels. An ETF becomes overbought when it trades more than one standard deviation above its 50-day moving average. The % overbought number is how far the ETF is currently above this initial overbought level. This is the first time in quite awhile that all country ETFs have been overbought at the same time, and it’s a sign that markets around the world are extended from their normal trading ranges. The Taiwan ETF is the most overbought at 13.32%, followed by Italy (8.34%), India (7.92%), Brazil (7.14%), Sweden (7.08%), and South Korea (7.08%). Japan is the least overbought at 1.4%.
Tags: Brazil, Current Trading, Emerging Markets, ETF, India, Investment Group, Italy, Japan, Moving Average, South Korea, Standard Deviation, Sweden, Taiwan
Posted in Emerging Markets, ETFs, India, Markets | Comments Off
Thursday, April 30th, 2009
By RGE Monitor
Today we present some of the main conclusions of the recently released update to the RGE 2009 Global Economic Outlook.
The global economy is in the middle of a synchronized contraction that will push global growth into negative territory in 2009 for the first time in decades. This will be the worst financial crisis since the Great Depression and the worst global economic downturn in decades. Global trade volumes face their sharpest contractions of the postwar era – trade is expected to contract 12% in 2009 due to the severe and prolonged global demand slump, excess capacity across supply chains and the continued crunch in trade finance.
Many analysts and commentators are pointing out that the second derivative of economic activity is turning positive (i.e. economies are still contracting but a slower rather than accelerated rate) and that green shoots of an economic recovery are blossoming. RGE Monitor’s analysis of the data suggests that the global economic contraction is still in full swing with a very severe, a deep and protracted U-shaped recession. Last year’s economic consensus forecast of a V-shaped short and shallow recession has vanished.
While the rate of economic contraction is slowing compared to the free fall rates of Q4 of 2008 and Q1 of 2009, we are still a long way away from the economic bottom and from a sustained recovery of growth. In particular, in Europe and Japan there is little evidence of a positive second derivative of economic activity.
However, by the end of Q1 2009, there were some signs that the pace of contraction had slowed in many economies especially in the US and China, where policy responses have been more significant and leading indicators in the manufacturing sector may have bottomed before they did in Europe and Japan. However, major economies including all of the G7 will continue to contract throughout 2009, albeit at a slower pace than at the beginning of the year.
Moreover the global recovery might be sluggish at best in 2010 given the overhang of credit losses of financial institutions, lingering credit crunch, need for retrenchment by overstretched and over-indebted households in current account deficit countries and a slow resumption of demand prompted by extensive government stimulus.
Some key elements of RGE Monitor’s outlook include:
- Global economic activity is expected to contract by 1.9% in 2009. Advanced economies are expected to contract 4% in 2009. Japan and the eurozone will suffer the sharpest downturns. US GDP will continue to contract, albeit at a slower pace throughout 2009, with negative growth in every quarter.
- Emerging markets will slow down sharply from the stellar growth rates of the past few years, with the BRIC economies growing at half their 2008 pace.
- Deteriorated terms of trade, slower capital flows and tighter credit will push Latin America into recession from the 4.1% growth of 2008. Argentina, Brazil, Chile, Colombia, Mexico, and Venezuela will all shift to negative territory on a year-over-year basis while smaller countries, like Peru, will experience a significant slowdown.
- Countries in Eastern Europe and the CIS will experience some of the sharpest contractions given the withdrawal of foreign credit and the risk of a severe financial crisis. The reduction in oil revenues and financial stress will contribute to a 5% yoy contraction in Russia and some countries – especially in the Baltics – are at risk of double-digit contractions.
- Export-dependent Asia’s growth will slow significantly to less than 3% in 2009. China will have a hard landing with GDP growth falling to 5.5% while India will slow sharply to 4.3%. All four Asian Tigers (Singapore, Taiwan, South Korea and Hong Kong) as well as Malaysia and Thailand will experience recessions.
- The Middle East and Africa will mark much slower growth, half of their 2008 pace, given the reduction in capital inflows, reduced demand from the US and EU and decline in commodity prices and output. Israel and South Africa will suffer slight contractions.
- The unprecedented fiscal and monetary stimulus may help alleviate the substantial contraction in private demand and reduce the risk of a global L-shaped near-depression. Debt financing may be a challenge for many countries though, especially emerging markets or the most vulnerable Western European economies.
- Job losses during the current global recession might exceed those in recent recession, contributing to increases in defaults and posing additional risks to banks. The unemployment rate in developed countries will reach double-digits by 2010 (as early as mid-2009 in the US) and push more people in developing countries into poverty. Moreover, despite new funding from multilateral institutions, severe contractions will raise the risk of social and political unrest.
- Commodities as a class are likely to come under renewed pressure in 2009 despite some support from production cuts. RGE expects the WTI oil price to average about $40 a barrel in 2009 as demand destruction continues to outweigh crude supply destruction.
Source: RGE Monitor, April 21, 2009.
Tags: Brazil, BRIC, BRICs, Economic Activity, Economic Consensus, Economic Contraction, Economic Downturn, Emerging Markets, Excess Capacity, Full Swing, Global Demand, Global Economic Outlook, Global Economy, Global Growth, Great Depression, India, Leading Indicators, Manufacturing Sector, Negative Territory, oil, Policy Responses, Roubini Global Economics, Supply Chains, Trade Finance, Trade Volumes, World Economic Outlook
Posted in Commodities, Credit Markets, Emerging Markets, India, Markets, Outlook | Comments Off
Thursday, April 30th, 2009
This post is a guest contribution by Paul Kasriel* of The Northern Trust Company.
Congress currently is in no mood to authorize more funds to help recapitalize the financial system. The Treasury says this will not be a problem. If financial institutions need additional capital from the taxpayers to remain solvent, the Treasury will simply shift the preferred shares it already owns in financial institutions to common equity shares. Voila - capital adequate financial institutions! Really?
Consider Balance Sheet One of hypothetical Gotham City Bank. Assets equal liabilities plus common equity. That is good for starters.
But suppose the Treasury believes that Gotham should have a ratio of common equity to total assets of 10% rather than the 5% it currently has. No problem. Treasury will just convert $5 of the preferred shares it owns in Gotham to $5 of common equity. This is shown in Balance Sheet Two.
Now Gotham is well capitalized, right? Wrong. The depositors and the bond holders always were in line in front of the preferred shareholders in case Gotham had to be liquidated. So, moving $5 from the preferred equity category to the common equity category does not make the depositors and bond holders any better off.
Are taxpayers any worse off? Not really. If Gotham’s original $5 of common equity was not going to be enough of a cushion to protect depositors and bondholders, then taxpayers were not going to get all of their preferred-share holdings back anyway.
Now suppose that $30 of Gotham’s loans and investments become uncollectible, as shown in Balance Sheet Three. This means that all of Gotham’s common equity has been wiped out. In fact, Gotham now has an equity “deficiency” of $20. No problem, according to Treasury. It will simply convert its remaining $10 of preferred equity to common equity. That won’t cut it in this case. As shown in Balance Sheet Four, Gotham still has a common equity deficiency of $10. In other words, if Gotham were to be liquidated, there are only $70 of assets to pay off $60 of deposits and $20 of bonds. Either the Treasury would have to come up with $10 of new funds or bondholders would have to take a 50% haircut. If the Treasury wanted to keep Gotham open and with a ratio of common equity to total assets of 10%, Treasury would have to inject $17 of new funds, all of which would be common equity. In other words, Treasury, meaning us taxpayers, would own 100% of Gotham.
In sum, Treasury’s plan to enhance the capitalization of some financial institutions by beating preferred equity shares into common equity shares is accounting alchemy.
Source: Paul Kasriel, Northern Trust – The Econtrarian, April 27, 2009.
*Paul Kasriel is Senior Vice President and Director of Economic Research at The Northern Trust Company. The accuracy of the Economic Research Department’s forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul’s 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst.
Tags: Accounting, Alchemy, Balance Sheet, Bank Assets, Bond Holders, Bondholders, Depositors, Financial Institutions, Investments, Liabilities, Northern Trust Company, Paul Kasriel, Preferred Equity, Preferred Share, Preferred Shareholders, Preferred Shares, Share Holdings, Starters, Taxpayers, Treasury
Posted in Bonds, Markets | Comments Off
Thursday, April 30th, 2009
By RGE Monitor
A few years back, before this crisis erupted, several economists were concerned about the sustainability of the large global imbalances fueled by the so-called Bretton Woods 2 (BW2) system. These economists recognized the tendency of emerging (export-led) economies to manage their exchange rate systems – the origin of large trade and current account surpluses that, via large foreign reserve accumulation, were financing the mirror of those surpluses, namely the large US trade and current account deficits.
These surpluses, primarily in several exports-led Asian economies, and also in oil producing countries, ballooned to extensive proportions in 2007 and 2008. The purchases of US government bonds by these investors helped keep long-term interest rates low and led many investors to seek out high-yielding investments especially in some emerging markets.
Although we are not (yet) witnessing a US dollar crisis, the Bretton Woods 2 system is still at the center of the debates on the origins of this crisis. Understanding the nature of this crisis is fundamental in order to understand what reforms need to be undertaken for this not to happen again, and to understand what the global economy will look like after this crisis. Although other factors played a part, it is hard to argue that the large global imbalances that arose a few years ago had no role whatsoever in the current global synchronized recession. However, so far, global imbalances do not seem to be on even the long-term agenda of most of those trying to remake the global financial system.
Global imbalances are now starting to narrow though – and the current crisis is likely playing a role – as saving rates rise in the US trade volumes fall on lower demand, expensive credit and weak commodity prices. The US current account deficit has fallen from 6.6% at the end of 2005 to 3.7% at the end of 2008 and the IMF estimates that it will fall further to 2.8% of GDP in 2009. Many of the emerging economies that easily financed wide deficits are now being forced into consuming less given the lack of credit and in some cases currency devaluation that boosts the costs of imports. Meanwhile the fall in the price of oil and other commodities is shifting many oil exporters, some of the larger surplus nations, into deficit territory.
Is this the death of BW2? Can export-led growth countries increase consumption? Or are we going to see large imbalances in the global economy come back when the recovery will be in full swing? And would a permanent correction of global imbalances be contractionary? If surplus economies continue along a business as usual path, trying to stoke export demand rather than increasing domestic spending to boost consumption, it could increase deflationary pressures.
Fiscal and current account surpluses and foreign exchange reserves can be used to increase government spending on infrastructure and public services and boost consumption and investment, which might help unwind the global imbalances. In fact, fiscal stimulus spending being undertaken during the current downturn by surplus countries like China and the Middle-East will help increase their own domestic demand and also boost the exports of deficit countries. Governments with comfortable fiscal/external surpluses, commodity revenues or foreign exchange reserves, such the Asia-Pacific, GCC and Latam economies, Canada, Norway, Germany and Russia, have rightly increased stimulus spending in spite of easing exports and commodity prices recently.
However, there are criticisms that such spending still fall short and are rather steered towards export firms than domestic demand which will only exacerbate global deflationary pressures. On the other hand, stimulus spending by deficit countries such as the US and UK will only accentuate pressure on global fiscal deficits and global imbalances.
Some are still concerned that the unwinding of imbalances might be disorderly leading to swift exchange rate moves. However, it is also possible that this might be a gradual process, aided by a beefed-up IMF and other multilateral institutions which will avert balance of payments crises if not sharp contractions in many emerging economies especially in Eastern Europe.
Some imbalances seem to be persistent though. China’s surplus does not seem to be shrinking very much, largely because the import contraction including goods for re-export and cheaper commodities is more severe than that of exports. And those of Germany and Japan are expected to continue to be quite large also.
The consumption share of China’s GDP has fallen since the year 2000 although Chinese government investment could provide a boost in 2009. The IMF suggests that China’s current account surplus will continue to rise- albeit at a slower pace – in 2009, nearing $500 billion from almost $430 billion in 2008. Such a large current account surplus implies still large reciprocal deficits in some of China’s trading partners, likely the US and several European countries.
As we noted in our recently released outlook, there is a risk that China’s fiscal stimulus might exacerbate production overcapacities, creating further deflationary pressures unless China is able to stimulate domestic demand, especially private consumption. Moreover, there is related risk that China’s extension of investment and credit expansion could defer China’s transition to a global economy in which the US consumer consumes less. As it currently stands, China’s almost $600 billion fiscal stimulus has less than 10% dedicated to social welfare programs. Expanding this expenditure through increasing government expenditure on health care, increasing pension payments and unemployment benefits, could have a significant effect on boosting consumption particularly as it could reduce some of the households’ structural pressures to save.
In the longer term, some tax policy changes, including the requirement of state owned enterprises to pay dividends and introduction of a value added tax, might also be supportive of consumption based growth. Chinese leaders are cognizant of the need to rebalance growth, meaning China may be better placed to do so than some of the export and investment-led advanced economies or the Asian tigers whose growth models are in question in the midst of the global export collapse.
So far, despite several months of hot money capital outflows, China seems to have increased its share of the safest US assets especially treasury bills. Given the global export weakness, China may be forced to maintain its quasi dollar peg, which will likely involve a resumption of US dollar asset purchases. Yet, Chinese concerns about the long-term value of its US assets have increased. China has been diversifying its assets on the margins, increasing the share of gold (from a very low share of total assets) and loaning its foreign exchange to resource exporters. The Chinese central bank governor has suggested that over time the IMF’s SDR has a certain attraction as a reserve currency given the instabilities that have stemmed from the US dollar’s reserve currency role.
The severe impact of the global recession and export contraction on Asia’s growth and manufacturing output and employment loss might pave way for Asia to re-think its export-led growth model and change its source of growth away from exports towards domestic consumption. However, this might require a lot more political will since this growth model has nevertheless helped Asia attain higher per capita income, stronger economic growth and significant poverty reduction.
Moreover, the structural changes required to change the growth model (move production from low-end manufacturing to high-end labor-intensive manufacturing and services to boost employment and incomes, improve social safety net, pension and health care systems, invest in skill training and R&D, and enhance intermediation of savings and credit access for firms by developing financial markets) all involve short-term costs with results only in the long-term, something that political leaders might be unwilling to trade.
On the other hand, it might be argued that Asia might continue to follow an export-led model even in the future to sustain growth and poverty reduction and at the same time use the presently available vast resources to boost safety net and cushion the economy and workers from any future global export downturn.
While policies to increase domestic demand might boost Asian imports and reduce current account surpluses, shrinking exports recently have in fact led imports to shrink at a faster pace than exports (given high import content of exports) thus keeping up the trade and current account surpluses in many Asian countries. Letting the exchange rate appreciate will also be challenging for Asia and will largely depend on China’s currency stance. In fact, many Asian countries started favoring an undervalued currency or at least stopped allowing appreciation recently as exports weakened and to maintain competitiveness vis-a-vis China.
Asia’ stance will also be governed by the losses that the central banks will have to realize on their US treasury holdings by letting their currencies appreciate. Moreover, any change in Asia’s growth model will be governed by the medium to long-term factors such as the pace of rise in the US savings rate and whether it’s structural or cyclical in nature, and also the trends in global commodity, shipping and Asian labor costs going forward.
It is a different story with commodity exporters who as a whole are set to shift from surplus to deficit territory in 2009 given robust spending and much lower revenues. Unlike China, oil exporters were already contributing more to rebalancing in the last few years, with much of the incremental increase in revenues being spent or rather absorbed at home by massive projects and increased consumption. In fact, rather than generating surpluses, the current risks are that the economies of many oil exporters in the CIS, Africa and even some in the GCC could contract in 2009 on given the weaker hydrocarbon and non-hydrocarbon sector outlook.
Facilitated by past savings, many of these countries including Saudi Arabia, the UAE and Russia are conducting expansionary fiscal policies this year and will run significant fiscal deficits at an oil price below $50 a barrel. Moreover countries like the UAE, Saudi Arabia and others are expected to run current account deficits, financed by the sale of past savings. Meanwhile with many sovereign wealth funds and other government capital been deployed at home, there may be fewer foreign purchases.
The eurozone’s largely balanced external position covers ample intra-EMU imbalances among eurozone countries. Current account dispersion reached from +8.4% in the Netherlands and 7% in Germany to -13.4% in Cyprus as of 2008. The European Commission notes that while large current account balances by themselves could merely be the expression of rational private sector choices, a comparison of real exchange rates with their benchmark “equilibrium” current accounts shows the existence of sizable real exchange rate misalignments.
Decompositions of this kind gave rise to claims that Germany, in particular in its role as EMU’s “center” economy, is engaging in beggar-thy-neighbor behavior by setting in motion a real competitive devaluation of its currency through falling unit labor costs. This makes a rebalancing of high deficit countries all the more challenging. Since a nominal devaluation is not an option within the EMU, high-deficit countries have no option but to deflate in real terms either through relatively higher productivity or consumption restraint against an already ambitious German benchmark.
Germany is not exposed to over-indebted households and non-financial corporates to the same extent as Spain, Ireland or even France. However, as the current downturn makes painfully clear, balanced financial accounts provide no shield against an over-reliance on external conditions or undiversified specialization patterns. Bundesbank president Axel Weber recently made clear that Germany should try to break its dependence on exports as the mainstay of its economic growth, whereas Chancellor Angela Merkel argues that a strong industrial base and external competitiveness are valuable assets, especially for an ageing and shrinking population. In fact, “[export-reliance] is not something we even want to change.”
Ultimately, the BW2 system of global imbalances has had far-reaching effects beyond the US and Asia. Like the US, emerging markets in Eastern Europe were able to fund large current-account deficits in the recent era of cheap financing. In May 2007, Nouriel Roubini wrote: “The currency and economic policies of China and East Asia have contributed – among many other factors – to unsustainable global current account imbalances whose rebalancing now risks becoming disorderly rather than orderly.” This is certainly the case in Central and Eastern Europe (CEE), where current account deficits have been the norm and where the unwinding of such imbalances is raising concern that it could contribute to a regional financial crisis along the lines of 1997 in Asia.
The drying-up of capital inflows, amid the global financial turmoil, is necessitating a sharp adjustment in Eastern Europe’s external imbalances. These imbalances rival, and in some cases exceed, those in pre-crisis Asia – i.e. current account deficits in Southeast Asia from 1995-97 fell within the 3.0-8.5% of GDP range, while those in CEE were well over 10% of GDP in Romania, Bulgaria and the Baltics in 2008. A correction in the region’s imbalances is already underway via currency depreciation (in countries with flexible exchange rates) and via a sharp drop in domestic demand. Thus far, the IMF has stepped in with financial assistance in three EU newcomers – Hungary, Latvia and Romania – to smooth out the sharp drop-off in capital inflows and to avert a disorderly unwinding of external imbalances. These countries are unlikely to be the last to knock on the IMF’s door.
Source: RGE Monitor, April 29, 2009.
Tags: Account Deficits, Asian Economies, Bretton Woods, Bw2, Canadian Market, Commodity Prices, Current Account Deficit, Dollar Crisis, Economists, Emerging Markets, Exchange Rate Systems, Global Economy, Global Financial System, Government Bonds, Oil Producing Countries, Recession, Roubini Global Economics, Surpluses, Term Agenda, Term Interest, Trade Volumes
Posted in Bonds, Commodities, Credit Markets, Emerging Markets, Gold, Infrastructure, Markets, Outlook | Comments Off
Wednesday, April 29th, 2009
Where is the stock market heading? Has the rally that started in early March been exhausted? These are the key questions on all investors’ minds as financial markets remain caught between the frantic actions of central banks to get the cogs of the credit system and economy turning again on the one hand, and a still shaky economic and corporate outlook on the other.
It is therefore no wonder that even so-called “pop analysis”, including some legendary axioms, is resorted to in a quest for direction. And besides “buy low and sell high” few other axioms are more widely propagated than “sell in May and go away”. A Google search revealed an astounding 127,000 items featuring this phrase.
As equities have seen a particularly strong six-week rally, followed by what looks like the start of a consolidation/retracement of some of the recent gains, investors are justifiably questioning the market’s next move. And they nervously wonder whether this May will not only herald longer days in the Northern Hemisphere, but also live up to its reputation as the advent of a corrective phase in the markets.
The important issue, however, is whether this axiom actually has any scientific basis at all. Analyzing historical returns, the figures vary from market to market, but long-term statistics seem to show that the best time to be invested in equities is the six months from early November through to the end of April of the next year (”good” periods), while the “bad” periods normally occur over the six months from May to October.
A study of the MSCI World Index, a commonly used benchmark for global equity markets, reveals that since 1969 “good” periods returned +6.5% per annum while investors were actually in the red by -1.0% per annum during the “bad” periods.
“Sell in May and go away” also holds true for the US stock markets. An updated study by Plexus Asset Management of the S&P 500 Index shows that the returns of the “good” six-month periods from January 1950 to March 2009 were 7.9% per annum whereas those of the “bad” periods were 2.5% per annum.
A study of the pattern in monthly returns reveals that the “bad” periods of the S&P 500 Index are quite distinct, with five of the six months from May to October having lower average monthly returns than the six months of the good periods. Interestingly, May – the first month of the bad patch – is the only exception.
But what exactly does this mean for the investor who contemplates timing the market by selling in May and reinvesting in November? Further analysis shows that had one kept the investment in the S&P 500 Index only during the “good” six-month periods, and reinvested the proceeds in the money market during the “bad” six-month periods, the total return would have been 10.5% per annum.
These calculations do not take tax into account. And, of course, every time one switches out of and back into the stock market there are costs involved, which would also reduce the returns for the market timer.
How did the good and bad periods stack up during the past two years? The results are as follows.
- May 2007 – October 2007: +4.52%
- November 2007 – April 2008: -9.62%
- May 2008 – October 2008: -30.1%
- November 2008 – April 2009: -5.1%
Some you win, some you don’t! It seems that the axiom “sell in May and go away” in itself is a rather doubtful basis for timing equity investments. However, it may serve a useful purpose as input, together with other factors, to otherwise rational decision making.
Tags: Annum, Axiom, Axioms, Central Banks, Cogs, Corporate Outlook, Corrective Phase, Early November, Fallacy, Financial Markets, Global Equity Markets, Google, Google Search, Historical Returns, Msci World Index, Northern Hemisphere, Retracement, Stock Market, Term Statistics, Us Stock Markets
Posted in Credit Markets, Markets, Outlook | Comments Off
Wednesday, April 29th, 2009
Hugh Hendry, the outspoken hedge fund manager and founder of Eclectica Asset Management, known for his remarkably accurate call on deflation, and long-duration government bond bets, appeared on CNBC last night to share his controversial outlook on markets. In his usual and cutting way, Hendry dismissed critics of his stance on long bonds, by pointing out that we are in the midst of “a rally of risk”.
The recent rise in stocks and talk about green shoots in the markets are optimistic assumptions, as the world downturn “still has a way to run,” said Hugh Hendry, CIO at Eclectica.
Here are the accompanying notes from CNBC.
The recent rise in stocks and talk about green shoots in the markets are optimistic assumptions, as the world downturn “still has a way to run,” Hugh Hendry, Chief Investment Officer at Eclectica, told CNBC Tuesday.
World gross domestic product looks overestimated, because global consumption has been based on debt, and this cannot continue, Hendry told “Squawk Box Europe.”
“In the last five weeks we had a rally in risk. Big deal,” he said.
“I am fearful of the surplus countries, like China and Germany. I think GDP has been overstated,” Hendry added.
“My notion was, you had Bernie Madoff doing US GDP accounting.” China “built capacity to serve a world that doesn’t exist. We’re drowning in capacity. The idea to propose we build more… that ain’t a remedy,” he explained.
Although companies’ results beat forecasts, this is mainly because they marked their expectations too low, but their outlook is grim, according to Hendry.
“I believe the downturn in the global economy still has a way to run. We’ve only been given evidence of further deterioration,” he said.
The rise in bond yields shows that the yield curve is flattening, pointing to more economic weakness ahead.
“What it reveals is that it’s terrifying. This rise in bond yields shows… the private sector is countering the Fed and is tightening policy,” Hendry said.
During the Great Depression, there had been rallies in the stock market, but stocks generally fell, Hendry reminded, explaining his bearish stance on stocks. He added that nobody can predict where the bottom was for the stock market.
“Monkeys spend all their time picking bottoms. I refuse to pick bottoms as I don’t live in trees,” he said.
Hendry also shared his thoughts on Tobacco stocks, commodities, bonds, and gold.
Tobacco stocks, especially in the US, are among the few assets that Hugh Hendry, chief investment officer at hedge fund Eclectica, said he likes Tuesday, but he added investors should be prudent as world economies are still in the middle of a deleveraging trend.
Altria and Philip Morris are interesting choices as they are “priced in dollars,” Hendry said, adding “I like dollars.”
“One of the things we know with certainty is that people smoke, they’re addicted to it,” Hendry added.
He said he was getting a 9 percent yield on the stock, but, because of the fragile economic situation, was thinking of buying senior debt, which would give the same yield but offers more security in case of bankruptcy.
“As a society, we have taken debt… to almost four times greater than the economy. That’s unprecedented. And it’s a turning point,” Hendry said. “Governments around the world want some inflation, and they are targeting inflation. It’s one thing to target it and another to achieve it. Who wants to take on debt today?”
Because of this, the economy will continue to contract and commodities such as oil are not a good bet either, according to Hendry.
Bonds are not a good buy for the summer, as they are usually an investment for the second half of the year, and investors should be “patient and scared” and, at the end of debt deflation, may get “fantastic values”.
Gold has behaved as a risk-free asset, but Hendry said he hopes for a correction in the price of gold to around $600 to $700 per ounce, from the current level of $898, to start buying.
“I’m not saying it will happen, but stranger things have happened,” he said. “Gold investors have had it easy. I expect gold to get a bit more uncomfortable for the people who hold it in the short term.”
“The intellectual case for gold is very strong. Governments are printing money, but only God prints gold and that takes billions of years.”
Tags: Accompanying Notes, Assumptions, Bernie Madoff, Bill Gross, Bond Yields, Chief Investment Officer, Cnbc, Deflation, Depressio, Deterioration, Duration Government, Economic Weakness, ETF, Global Consumption, Global Economy, Government Bond, Great Depression, Gross Domestic Product, Hedge Fund Manager, Hugh Hendry, Optimism, Rallies, Squawk Box, Stock Market, World Downturn, Yield Curve
Posted in Bonds, Commodities, Economy, Energy & Natural Resources, ETFs, Gold, Markets, Oil and Gas, Outlook | Comments Off
Tuesday, April 28th, 2009
A fascinating, enlightening conversation and debate about the economy with Bill Ackman, major investor and hedge fund manager of Pershing Square Capital Management LP, Kate Kelly of The Wall Street Journal, Andrew Ross Sorkin of The New York Times and Joseph Stiglitz, economist and a member of Columbia University faculty.
Here is the complete transcript:
CHARLIE ROSE: The Obama administration today took the latest step in
its efforts to repair the nation’s banking system. The Federal Reserve
began releasing information about its stress test on major banks. The Fed
reported that while reserves had substantially reduced in some banks, most
had capital well in excess of government standards. The 19 banks examined
hold two-thirds of the assets and more than half the loans in the U.S.
banking system. The government privately told bank executives their test
results this afternoon. The Fed also released its methodology ahead of an
announcement of the results in two weeks.
We want to talk about the financial sector, the stress test, all of
this, with a very interesting group of people. Bill Ackman of Pershing
Square Capital management, a hedge fund here in New York. Joseph Stiglitz
of Columbia University, co-winner of the 2001 Nobel Prize in economics.
Andrew Ross Sorkin of “The New York Times,” a reporter and columnist. And
Kate Kelly of “The Wall Street Journal.” I am pleased to have all of them
here at this table.
I will begin with you. Tell me where we are in terms of — what do we
know about the stress test? What do we know about the results? What are
they telling us and who cares?
KATE KELLY: Well, there are precious few details that have been
released so far. We’re going to know more I think on May 4th. But what
happened is, the banks underwent these stress tests. They had certain
parameters they were supposed to run their models against, run their
portfolios against — assumptions about unemployment and how severe it
would get this year, for example; assumptions about losses on the value of
certain holdings that were approximately close to what you saw last year
with the Lehman Brothers failure. And the Fed met individually with the
bank management today. I think it was CEO, CFO, other senior people, risk
officers, to discuss where they stood, how strong they were — I think they
had three buckets from strong to weak — and whether they would need to
So what’s interesting is, there has been much back and forth about how
much to disclose, and I don’t think we fully know what they are going to
disclose yet. But what they do will have a major impact on public
perception. And even if they don’t give us all the details, based on who’s
raising capital, we’re going to be able to make some assumptions.
CHARLIE ROSE: Yes.
KATE KELLY: So the government is in a bit of a box.
CHARLIE ROSE: All right, Andrew, add to that.
ANDREW ROSS SORKIN: Well, so the issue this afternoon — I talked to
a number of the executives who have been briefed on their status, if you
will — and the question right now is what assumption the government used
for their revenue, right? They did all these other assumptions which they
used for everybody across the aboard, but what they didn’t do — they
actually for each bank individually said what is their revenue going to be
for the next two years. And that’s the most fungible, if you will, of all
of these, because every bank thinks they’re going to have higher revenue
than the government seems to think. And so what we’re going to be seeing
over the next week is a debate privately, that hopefully will come out in
public at some level, over what those revenue judgments are, and — and
that’s– that’s what we’re going to find out. And that to me will tell us
in the end who’s strong and who’s not, and who we can actually believe.
CHARLIE ROSE: OK, but it will tell us that, and then what will
WILLIAM ACKMAN: It depends.
WILLIAM ACKMAN: The answer is, the banks that need more capital,
where does the money come from?
CHARLIE ROSE: Exactly.
WILLIAM ACKMAN: And the last six months, the money has come from the
taxpayer, and the question is if that is going to continue. And there are
some alternatives in the taxpayer.
And this past weekend, Larry Summers was on “Meet the Press,” and he
talked about asset liability swaps as alternative means to raise capital
for banks. I translate asset liability swap for debt-for-equity swap,
junior debt-for-equity swap, preferred stock for equity swap.
Basically, what’s interesting is that the banks in this country have
all the capital they need. The problem is too much of that capital is in
the form of debt, not enough is in the form of equity. The way we solve
that problem typically in America is through a reorganization process,
where a judge adjudicates a bankruptcy or some other form of
conservatorship or reorganization. They figure out the value of the firm.
They figure out how much equity needs to be raised, and they compromise
with the bond holders until the bond holders end up owning the firm.
And the benefit of this kind of approach is imagine a bank that needs
$100 billion of capital. You can put $100 billion in from the taxpayer –
in this case, Joe the plumber putting his money in. The money,
unfortunately, is going out the door to pay interest to call it Bill the
bond holder. And that doesn’t seem quite fair to me.
What you can do instead is Bill the bond holder has to convert $50
billion of his debt into equity, and that magically raises $100 billion of
capital, because for each dollar of debt that becomes equity, you’re
canceling a dollar of debt, you’re creating a dollar of equity. And the
system is really set up for this. This is a classic restructuring
CHARLIE ROSE: OK, why haven’t we tried this before? Is this — do
you think this idea has merit? This idea of Ackman and Larry Summers
talking about it publicly?
JOSEPH STIGLITZ: It’s what I said they should have been doing all
CHARLIE ROSE: Oh, this was your idea?
JOSEPH STIGLITZ: No, what I’m saying is, it is what we have done. We
did it in Continental Illinois, we’ve done it in — what they’ve confused
is the notion of too big to fail with the notion of too big to be
financially reorganized. And this is just a simple process of financial
reorganization. We do it all the time.
The bond holders don’t like it, because they would prefer the
taxpayers giving them money. It’s perfectly understandable. And the bond
holders have been — their voice has been heard very clearly, but it’s not
in our national interest. The banks would be stronger after they do this
kind of financial reorganization. They don’t have to pay out every month
all the interest payments that they had to pay before. They now have all
the capital that — you know, the leverage right now is huge. So small
change in the value of the assets means that the capital is all wiped out.
So now you have more capital, less debt. They’re in a better position to
go forward. It’s basically the notion that we call a fresh start.
CHARLIE ROSE: Right, so what does Mr. Geithner think of this?
JOSEPH STIGLITZ: Well, they’ve been resisting this.
CHARLIE ROSE: Because?
JOSEPH STIGLITZ: Well, the only reason I think is because the — a
lot of influence from the bond holders, financial sector bond holders don’t
like it. You don’t have to be a genius to figure out why they don’t like
CHARLIE ROSE: Exactly right. Andrew.
ANDREW ROSS SORKIN: Well, no, I mean, it’s funny, you said Bill the
bond holder. I should say Bill Gross the bond holder from Pimco, and he is
someone who has had a lot of influence, as have other bond holders, who
have suggested that the moment that you effectively force these bond
holders to take a haircut or to swap out into equity, you are going to
undermine the entire bond market and we’re going to see some kind of
Now, I’m not sure that’s the case, and as you’ve seen in other
bankruptcies, we’ve gotten through that. So at the end of the day, yes,
this would instill more confidence, but there is other people on the other
side saying that it would kill confidence.
WILLIAM ACKMAN: There is also a lot of misunderstandings. I mean, I
think that if the taxpayer really understood that their capital was going
in — if you think about a bank that took in $25 billion of TARP funds.
Let’s assume they have $400 billion of debt — that’s a round number for a
systemically important bank — $25 billion is enough to pay interest on
$400 billion of debt for a year. So banks won’t lend money because they
need that capital to pay interest on their debts.
I read a study by a guy by the name of Professor David Scharfstein of
Harvard Business School where he said of the $350 billion that was infused
into bank actually didn’t go into banks. Went into.
CHARLIE ROSE: This is the original TARP money?
WILLIAM ACKMAN: Right. It went into bank holding companies. Only
something like $17 billion went into the actual banks. And I know this is
a little technical perhaps for your audience, but I think it’s important.
The companies that trade on the stock exchange are called holding
companies, and they’re shells. They have debt. They have equity. And
they own the systemically important institutions. So the thing that we’re
worried about, that we want to protect, the deposit-taking institution, is
actually the subsidiary of the holding company. And that’s why these –
that’s why systemically important institutions are structured this way, so
that there’s the investor entity — I call it the holding company — can be
compromised. You know, the debt for equity then can be converted without
an impact at all on the subsidiaries. So the thing that guarantees
derivatives, the entity that lends money, you don’t want — when Lehman
failed, what happened was construction stopped, derivative counterparties
tore up contracts. If they had been a deposit-taking institution, there
would have been a risk.
The beauty here is you can simply just walk your way through the
capital structure of the holding company and create enormous amounts of
capital. Let me just follow it through for what it can do. Imagine if we
did this across the 19 — let’s not do it– you don’t convert all the debt
into equity. What you do is you set a standard. You say, look, we need
these banks to be extremely well capitalized, which means they need to have
a certain amount of capital. We now have all the data we collected from
the stress tests. So each bank needs to have — call it 10 percent common
equity to total assets, and we convert sufficient amount of debt — you
know, if JP Morgan has a better balance sheet, you convert some. Less for
JP Morgan, then you pick another institution and (INAUDIBLE) balance sheet.
It’s a very fair process.
Once you do that, if the banks are now overcapitalized and you
restrict dividends and you restrict stock buybacks, the only way the bank
can earn an adequate return on its capital is by increasing assets. And
what does that mean? It means making loans.
Now you’ve got 19 banks competing to make loans, and it has a huge
impact on the economy, because the average businessman says, I can’t spend
money today because I have a debt maturity and I can’t refinance. But if
he has three bankers knocking on the door, or 19 saying, “I’m going to lend
you money,” they can start spending again, and the economy can recover.
CHARLIE ROSE: Go ahead.
JOSEPH STIGLITZ: Exactly right. I mean, and in a way, it’s so
interesting, because we’ve been spending our money dealing with what
they’re now euphemistically call legacy assets. They used to first call
them toxic waste, toxic assets, then they called them troubled assets, and
now the official term is legacy assets. But that’s backward-looking. And
CHARLIE ROSE: Why is that backward-looking?
JOSEPH STIGLITZ: Because it’s looking at the loans that were made in
CHARLIE ROSE: As long as those loans are there, those assets are
there, those toxic assets are there, these banks have a very bad balance
JOSEPH STIGLITZ: Yes, but there’s another way of dealing with that
CHARLIE ROSE: Which you can’t — you don’t quite know how to
JOSEPH STIGLITZ: Which is to convert the debt — convert the debt
into equity. No one knows how to value those risky assets. And what
they’re doing is very simple. They want to take all that trash and dump it
on the U.S. taxpayer. And it doesn’t make it disappear.
CHARLIE ROSE: The original idea, we buy all the toxic assets.
JOSEPH STIGLITZ: That’s right.
CHARLIE ROSE: Under the Paulson plan, the first Paulson plan.
JOSEPH STIGLITZ: Exactly. And then they went into buying it in bulk,
and then they — the current program is to use the private sector as the
garbage collector and dump it on our backs, but it’s all basically the same
CHARLIE ROSE: From the beginning, the toxic assets have been a huge
problem. So what should we do about them now?
KATE KELLY: I just think there’s a fundamental debate going on here
about valuation, and I’m not sure what the answer is. But there is
certainly a countervailing view to what you were saying, that indeed these
toxic assets can be marked, and they should be marked lower than where the
banks think they should be, and that’s why the banks don’t want to sell
CHARLIE ROSE: But that raises the question, if they do that, what
will that mean to the balance sheets of the banks if they have to mark them
lower, and how many banks will we find are in fact at that evaluation
KATE KELLY: Probably quite a few, which is a scary prospect.
CHARLIE ROSE: And so what do you do then?
JOSEPH STIGLITZ: And that’s why you need to convert the debt into
equity. So that — it’s the only way you can do it. If it turns out then
that the banks are right and the toxic assets are worth a lot more, then
the equity of the banks will go up automatically, and they get fully
compensated. So the issue here is who’s going to bear the risk of the
uncertain valuation? And is it the people who gave the money to the bank
or is it the U.S. taxpayer? And it’s really simple as that.
CHARLIE ROSE: Andrew.
ANDREW ROSS SORKIN: This all points, though, to the issue of
confidence and what the goal of the stress test was supposed to do, which
was supposed to be to instill confidence. We were supposed to have this
stress test. We were supposed to get the results and we were supposed to
say, ah, this is all going to work out.
CHARLIE ROSE: Meaning they had enough capital to do what they need
(ph) to do.
ANDREW ROSS SORKIN: They had enough capital or we knew which ones
were in trouble and which ones weren’t, and we were all supposed to feel
very good about it. Instead, what I worry about now is that we’re going to
look at the results of the stress test, and it’s almost a lose-lose.
Either you are going to be very realistic, perhaps even too realistic for
many people, and you’re going to suggest that some of these banks really
are either insolvent or in so much trouble that they are going to need
either additional tax dollars, beyond by the way taking preferred shares
and swapping them for common, or you’re going to decide.
WILLIAM ACKMAN: How about bonds…
ANDREW ROSS SORKIN: Or bonds.
WILLIAM ACKMAN: … into equity.
ANDREW ROSS SORKIN: Or you’re going to decide that the entire process
is a whitewash and you’re going to have no confidence in the test to begin
KATE KELLY: I think you’re right about that quandary, because
initially, I think people were excited about getting real results. Then
the word leaked out that nobody was going to fail the stress test.
Everybody was more or less in good shape.
KATE KELLY: Right. And then the public reaction was, well, are these
stress tests worth the paper they’re written on?
CHARLIE ROSE: And what is their methodology is another question about
KATE KELLY: How can that be? How can — this is just going to hurt
JOSEPH STIGLITZ: And you look at the numbers when they come out, and
they certainly are not the worst numbers that one could imagine. I mean,
they’re sort of median. But stress is stress. It’s not where the average
is. It’s what happens if.
ANDREW ROSS SORKIN: I mean, they’re thinking worst case is
unemployment at 10.3 percent. Housing prices are down.
CHARLIE ROSE: You mean.
ANDREW ROSS SORKIN: The government.
CHARLIE ROSE: The assumption.
ANDREW ROSS SORKIN: The assumptions built into the stress test assume
three major things. One, that unemployment is at 10.3 percent.
KATE KELLY: In the worst-case scenario.
ANDREW ROSS SORKIN: In the worst-case scenario.
KATE KELLY: 8.8 is (INAUDIBLE).
ANDREW ROSS SORKIN: So this is median already in some cases.
Unemployment — unemployment is at 10.3. We go to.
WILLIAM ACKMAN: House prices.
ANDREW ROSS SORKIN: . house prices at 22 percent. Thank you, I
apologize. And finally, the economy contracts by 3.3 percent. All of
those are right down the middle. Nobody would argue, I think, that that is
true stress, worst-case scenario.
CHARLIE ROSE: Right. What would true stress be?
ANDREW ROSS SORKIN: Probably 11 or 12 percent unemployment.
WILLIAM ACKMAN: I think an analogy that I think will help understand
this. Think of a bridge that a truck had driven over. The bridge
collapses, the truck falls down, kills a thousand people who happen to be
walking under the bridge. When something like that happens, when they go
to rebuild the bridge, that bridge had a 10,000-pound capacity; the truck
weighed 9,800 pounds, but stress and otherwise, the bridge collapsed.
Before people are going to feel comfortable crossing that bridge
again, what you do is you make the bridge have a 40,000-pound capacity,
knowing that trucks of 10,000 pounds are only going to travel over it.
Just to create an enormous margin of safety.
What doesn’t work is to do a stress test which is not the extreme
stress and say that a bunch of banks passed.
What you need to do is — we don’t need well-capitalized banks under a
historic definition. What we need is extraordinarily well-capitalized
banks. And you have to ask yourself, what is the downside if the U.S.
banking system was the best capitalized banking system in the world? So
imagine a world — and using this debt for equity — the beauty of
converting debt for equity is it’s not a taking from taxpayer and it’s not
a taking from the bond holder. The bond holder is getting exactly what
they own. Right? A bond holder is an owner of a company in the same way
an equity investor. The equity investor.
ANDREW ROSS SORKIN: Except that most bond holders don’t want to do
ANDREW ROSS SORKIN: Most shareholders don’t want their stock to go
Tags: 2001 Nobel Prize In Economics, Andrew Ross Sorkin, Bank Executives, Banking System, Bill Ackman, Bill Gross, Charlie Rose, Columbia University Faculty, Financial Sector, Government Standards, Hedge Fund Manager, Joseph Stiglitz, Kate Kelly, Nobel Prize In Economics, Pershing Square, Pershing Square Capital, Pershing Square Capital Management, Pershing Square Capital Management Lp, Stress Test, Stress Tests, Wall Street Journal
Posted in Bonds, Markets | Comments Off
Tuesday, April 28th, 2009
Doug Short (dshort.com) provides useful analysis to make the point statistics however reliable or unreliable can cause us to change or modify our perspective. For example, Has the US Government been reporting reliable inflation data since the elimination of the Gold Standard in 1971? Or are the inflation stats according to economist John Williams of shadowstats.com more in keeping with reality.
After all, we’re aware that our cost of living has risen faster than our incomes, right? So what happens when we apply this standard of thought to the long term trend regression in the market? This is what Doug Short has done here. Take a look, you might be surprised:
About the only certainty in the stock market is that, over the long haul, overperformance turns into underperformance and vice versa. Is there a pattern to this movement? Let’s apply some simple regression analysis to the question.
Here’s a chart of the S&P Composite stretching back to 1871. The chart shows real (inflation-adjusted) monthly averages of daily closes. We’re using a semi-log scale to equalize vertical distances for the same percentage change regardless of the index price range. The regression trendline drawn through the data clarifies the secular pattern of variance from the trend — those multi-year periods when the market trades above and below trend.
The Bearish View
The peak in 2000 marked an unprecedented 154% overshooting of the trend – double the overshoot in 1929. The index had been above trend for 17 years, but it has now fallen 9% below trend. The major troughs brought declines in excess of 50% below the trend. If the S&P 500 were sitting squarely on the regression, it would be hovering around 830. If the index should decline over the next year or two to a level comparable to previous major bottoms, it would fall to the vicinity of 425-450.
The Bullish Alternative
A critical factor for the reliability of a regression analysis of stock prices over many decades is the accuracy of the inflation adjustment. The Bureau of Labor Statistics (BLS) has been actively tracking inflation since 1919 and has estimated inflation rates back to 1913 using data on food prices. In 1982, however, the BLS began incorporating changes to the Consumer Price Index (CPI), which is used to calculate inflation. These changes have resulted in much lower “official” inflation rates than would have been the case if the method of calculation had remained consistent.
At his www.shadowstats.com website, Economist John Williams publishes an “Alternate CPI” employing the earlier BLS method. Here is a chart that illustrates the significant difference between these two calculation methods.
Statistics and handicapping are funny that way. They can warp our perceptions in immeasurable ways. Which one do you agree with? Are you bullish or bearish?
We side with Doug Short, that the answer is somewhere in between.
Tags: According To John, Bls, Bottoms, Bureau Of Labor, Bureau Of Labor Statistics, Consumer Price Index, Critical Factor, Deca, Declines, Economist John, Food prices, Gold Standard, Incomes, Index Cpi, Index Price, Inflation Adjustment, Inflation Data, Inflation Rates, John Williams, Long Haul, Overshoot, Percentage Change, Regression Analysis, Simple Regression, Stock Market, Stock Prices, Term Trend, Troughs, Variance, Vertical Distances
Posted in Gold, Markets | 2 Comments »
Tuesday, April 28th, 2009
This week’s Economist cover story discusses the idea that it may be too early to assume that the global economy is in recovery. The illustration really captures this. Our vulnerability right now seems to be that we want the economy (and markets) to recover, so we are looking for the signs to validate our hopes are not just hopes.
“The worst thing for the world economy would be to assume the worst is over”
“THE rays are diffuse, but the specks of light are unmistakable. Share prices are up sharply. Even after slipping early this week, two-thirds of the 42 stockmarkets that The Economist tracks have risen in the past six weeks by more than 20%. Different economic indicators from different parts of the world have brightened. China’s economy is picking up. The slump in global manufacturing seems to be easing. Property markets in America and Britain are showing signs of life, as mortgage rates fall and homes become more affordable. Confidence is growing. A widely tracked index of investor sentiment in Germany has turned positive for the first time in almost two years.
All this is welcome—not least because the slump has been made so much worse by panic and despair. When the financial system was on the brink of collapse in September, investors shunned all but the safest assets, consumers stopped spending and firms shut down. That plunge into the depths could be succeeded by a virtuous cycle, where the wheels of finance turn again, cheerier consumers open their wallets and ambitious firms turn from hoarding cash to pursuing profits.
But, welcome as it is, optimism contains two traps, one obvious, the other …”
Read the complete story here.
Source: The Economist, April 23, 2009, A Glimmer of Hope?
Tags: Brink Of Collapse, Despair, Economic Indicators, Economist, Glimmer Of Hope, Global Economy, Investor Sentiment, Light At The End Of The Tunnel, Mortgage Rates, Optimism, Plunge, Property Markets, Share Prices, Signs Of Life, Six Weeks, Slump, Specks, Stockmarkets, Virtuous Cycle, Wallets, World Economy
Posted in Markets | Comments Off