Archive for August 28th, 2012
Tuesday, August 28th, 2012
What does Warren Buffett see that no one else does? He just made an outsize bid on ResCap loans, the latest example of his bet that the housing market represents a great investment opportunity. Joe Light has details on The News Hub. Photo: Bloomberg
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Tuesday, August 28th, 2012
by Don Vialoux, EquityClock.com
Upcoming US Events for Today:
- The Case-Shiller 20-city Index for June will be released at 9:00am. The market expects no change (0.0%) on a year-over-year basis versus a decline of 0.7% previous.
- Consumer Confidence for August will be released at 10:00am. The market expects 65.8 versus 65.9 previous.
- The Richmond Fed Manufacturing Index will be released at 10:00am. The market expects –10 versus –17 previous.
Upcoming International Events for Today:
- German Consumer Confidence for September will be released at 2:00am EST. The market expects 5.8 versus 5.9 previous.
Equity markets traded around the flatline on Monday, unable to maintain earlier gains as investors positioned themselves ahead of the much anticipated Jackson Hole speeches at the end of this week. Further monetary easing is the expectation; actual results could reveal a range of possibilities, making it almost pointless to dwell too much on economic fundamentals or equity market technicals as the next market move will likely be predicated on upcoming central bank announcements. Volume on Monday remained light as investors avoided making any significant moves. Volume of the S&P 500 ETF (SPY) once again charted the lowest levels in over a year as conviction continues to elude this market. Apirl 25 of 2011 was the last time the volume in this ETF was lower. The market peaked soon thereafter, falling into a summer swoon that lasted until October.
Looking at an hourly chart of the S&P 500 futures shows that a negative trend is becoming established. The characteristic profile of lower-highs and lower-lows is becoming obvious as buyers refrain from pushing the tape higher ahead of the central bank announcements. This trend is presently a short-term phenomena and has yet to make a considerable impact on the longer-term profile of the market.
So in yesterday’s report we started to provide some warning signals based on some technical indicators that suggest reason to be cautious. Further indications will be provided over the course of the week leading into this Friday’s Jackson Hole speech by Ben Bernanke and Mario Draghi’s speech to follow on Saturday. So here is today’s warning signal. Technology has been praised with adding considerable strength to equity markets over the past month as Apple charts new historical highs. Strength in this cyclical sector is a bullish sign for broad markets due to, among other things, the weighting and influence the companies in this space have on equity indices, such as the S&P 500. However, if the technology sector in general is indicative of the broad market due to the influence it has on it, then semiconductors are indicative of the conviction to the sector: conviction that has been falling off over the last couple of weeks. The Semiconductor ETF (SMH) is showing definitive signs of rolling over, breaking through its 20-day moving average and producing sell signals with respect to Stochastics, RSI, and MACD. Underperformance compared to the market is becoming obvious. Semiconductors are often looked to as the high beta (risk-on) component to the technology sector and as investors start shedding risk, it typically implies a negative event ahead as conviction to hold risk assets falls. On Monday, the recent divergence between the Technology sector and the Semiconductor industry continued as the sector charted gains while the industry charted declines. The Technology sector seasonally declines between now and the beginning of October before beginning a period of seasonal strength that runs through to January/February.
Sentiment on Monday, as gauged by the put-call ratio, ended bullish at 0.87.
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
- Closing Market Value: $12.43 (unchanged)
- Closing NAV/Unit: $12.45 (down 0.01%)
|2012 Year-to-Date||Since Inception (Nov 19, 2009)|
* performance calculated on Closing NAV/Unit as provided by custodian
Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.
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Tuesday, August 28th, 2012
The Transportation sector led U.S. equity markets on the downside yesterday. The Dow Jones Transportation Average fell below its 20, 50 and 200 day moving averages. Short term momentum indicators continue to trend down. Strength relative to the S&P 500 Index remains negative.
The Shanghai Composite Index continues to move lower on talk that inventory levels in China are high and rising. So far, the Index has yet to show signs of bottoming on a real or relative basis.
Don Vialoux on BNN Television
Don Vialoux substituted as host for Larry Berman who is on holidays in Asia. Following is a link to the presentation:
Following are notes used during the presentation:
BNN August 27th 2012
Possible Topics for Discussion in Block #1
U.S. equity markets in U.S. Presidential Election years
Equity markets in the month of September
· Weakest month of the year. Average loss per period for the Dow during the past 60 periods is 0.5%.
· Average loss per period during the past 10 Septembers:
Dow Jones Industrials: 1.44%
S&P 500: 0.95%
NASDAQ Composite: 1.25%
TSX Composite: 1.40%
U.S. equity markets currently are intermediate overbought and vulnerable to a correction. When Percent of S&P 500 stocks trading above their 50 day moving average rollovers from above the 80% level, at least a short term correction normally happens. Percent began to roll over from above the 80% level last week.
Important events to watch this week
· August U.S. Consumer Confidence on Tuesday: 65.5E versus 65.9A
· Merkel and Monti meeting on Wednesday
· August Chicago PMI on Friday: 53.5E versus 53.7A
· Bernanke’s Jackson Hole speech at noon on Friday
· ECB Chairman Draghi on Saturday
· August China PMI on Saturday:49.8E versus 50.1A
Last Tuesday, the S&P 500 Index and its related ETFs recorded a rare bearish key reversal on the charts implying that the Index has passed at least a short term peak. Requirements for a bearish key reversal are:
· An open higher than the previous day’s close
· A move above the previous day’s high
· A close below the previous close
· A move below the previous day’s low
Several sector SPDRs also recorded key reversals last week including Technology, Industrials and Consumer Staples.
FP Trading Desk Headline
FP Trading Desk headline reads, “Finding opportunities in Canadian oil patch” . Following is a link to the report:
Special Free Services available through www.equityclock.com
Equityclock.com is offering free access to a data base showing seasonal studies on individual stocks and sectors. The data base holds seasonality studies on over 1000 big and moderate cap securities and indices.
To login, simply go to http://www.equityclock.com/charts/
Following is an example:
Intel Corporation (NASDAQ:INTC) Seasonal Chart
Disclaimer: Comments and opinions offered in this report at www.timingthemarket.ca are for information only. They should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.
Don and Jon Vialoux are research analysts for Horizons Investment Management Inc. All of the views expressed herein are the personal views of the authors and are not necessarily the views of Horizons Investment Management Inc., although any of the recommendations found herein may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management Inc
Horizons Seasonal Rotation ETF HAC August 27th 2012
Tuesday, August 28th, 2012
August 24, 2012 (8 minutes)
Along with the European debt crisis, the U.S. housing sector was partly to blame for the current recession. However, is recent data suggesting a road to recovery? Bruce discusses the importance of the housing sector from an investment perspective and also shares the names of some international stocks that he likes.
During the interview, Bruce Cooper addresses the following questions:
- Why is the housing sector important from an investment perspective?
- What solutions do you see for the European crisis in the near term?
- What investment strategies have proven successful in these uncertain times?
- What sectors or countries do you favour?
- Can you share names of 3 international stocks that you like?
(click here or on image to view)
Copyright © TD Waterhouse
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Tuesday, August 28th, 2012
The impact of unsustainable production in Chinese Steel-making plants, to avoid the inevitable employment consequences, has created a ‘glut’. This excess inventory will need to be worked through before spot Iron Ore (and Coking Coal) prices can stabilize.
Morgan Stanley believes the sharp raw material price declines since mid-July followed a collapse in Chinese steel prices and aggressive margin compression. This was the result of continued weakness in demand and the over-production of crude steel, reflected in rising producer inventories. This is in turn has resulted in aggressive thrifting of raw material purchases. More recently, the price declines have accelerated with Chinese re-bar and HRC prices reaching 33-month lows.
In their view, prices of steel making raw materials can recover in 4Q 2012 and in 2013, but spot prices for both iron ore and coking coal first have to fall below the marginal cost of seaborne (not Chinese) production to drive out the short-term supply overhang. In addition, Chinese steel mills have to complete finished product and raw material de-stocking to stabilize both steel and raw material prices (if they are ever allowed to). Iron Ore prices could fall 17% further before this ‘stabilization’ and spot coking coal over 8% from current levels.
Spot Iron Ore and metallurgical coal prices…
Where will prices stabilize?
Our best estimate of where spot prices for iron ore and hard coking coal might bottom-out in this environment is one in which prices reflect levels that are below the marginal cash cost of the true seaborne market, not sellers of distressed or displaced cargoes in this environment, the price has to reflect a level that drives the seaborne sellers out of the market, albeit temporarily. At the same time, as the spreads between domestic and international prices widen (especially in the iron ore market), prices at levels below true seaborne marginal cost should also become sufficiently attractive to beleaguered Chinese mills to finally entice them back to the market, albeit on a small scale until steel prices stabilize. At the time of writing, with spot prices for 62% Fe fines CFR into North China at US$99.40/dmt, Australian net back prices on the IODEX platform for a capesize cargo, with an 8.03% moisture adjustment, are US$94.32/t, while Brazilian net backs are at US$82.60/t with a 9.0% moisture adjustment.
The global seaborne iron ore cost curve (ex-China), 2012
Worst case scenario – prices could overshoot below the seaborne marginal costs of around US$92/t DMT CFR. We think the true seaborne market (which excludes China domestic production) is driving current prices. Given that there could be as much 4Mt of displaced cargoes trying to find immediate buyers in this environment, we believe there is a possibility prices could overshoot on the downside.
Based on data from CRU Consultants, we estimate that on a business or cash equivalent basis, the 90th percentile of seaborne suppliers (ex-China) as a proxy for marginal cost is US$79/t on a FOB wet metric tonnes basis for two small Australian producers. At current spot freight rates and an average moisture content of 8%, this equates to an implied CFR price of US$92/t, some 7.7% below the current spot.
To highlight the very short-term risk of prices overshooting even below this level, we have assumed a potential further downside risk of 10% below this indicated price level, suggesting a possible floor in the price around US$82-83/t cfr North China for 62% Fe fines. At this level, prices would have fallen to the 86th percentile of current true seaborne costs, a level 16.9% below the current spot price.
Interestingly, at today’s spot price, the 4Q 2012 midpoint price is at US$93.25/dmt CFR DMT North China, slightly above the estimated level of the seaborne marginal cost. On the same basis of a potential overshoot 10% below estimated seaborne marginal cost, spot hard coking coal prices could fall as low as US$150-155/t fob North Queensland, indicating further potential downside of 5.2-8.3%.
Source: Morgan Stanley
Tuesday, August 28th, 2012
by Mark Hanna, Market Montage
It seems the only topic that currently matters to the market is central bank actions. The end of the week brings us the Jackson Hole, WY gathering of global financial policy makers at which Bernanke famously laid the groundwork for QE2 in 2010. Markets began one of their strongest runs since the March 2009 bottom, essentially running from September 2010 to February 2011 with only a break during November. However, as Bloomberg points out, the actual “easing” action didn’t come until after elections that year – in November. To further complicate things, we have Europe’s central bank in what seems to be a far more aggressive mode with Draghi at the helm versus Trichet. Both men have implicitly signaled something is coming with jawboning. The market has bought into it, and as I have stated in the past have almost backed the banks into a corner – i.e. “there is no turning back”. So it’s really about when, as much as what. And what is already “priced in”. Bloomberg has a bit of a less hopeful tone than Mr. Hilsenrath at the WSJ in terms of the potential for immediate gratification.
- Federal Reserve Chairman Ben S. Bernanke — returning this week to the scene of a 2010 speech that foreshadowed a second round of quantitative easing –probably will disappoint investors looking for him to signal new stimulus. Bernanke probably won’t use his Aug. 31 speech at the Fed’s annual symposium in Jackson Hole, Wyoming, to suggest a third round of bond buying is at hand, according to economists including Michael Feroli and James O’Sullivan.
- Two years ago, Bernanke said in his speech that the FOMC “is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.” The committee didn’t announce a second round of quantitative easing at its September meeting, though; it waited instead until November 3 of that year. Markets rallied in the weeks after Bernanke’s 2010 remarks; “on the day, however, the speech was generally read as inconclusive,” O’Sullivan said. “Nor do we expect Mr. Bernanke to send a definitive signal this year.”
- “The Fed chairman’s Jackson Hole address has traditionallybeen used more for laying out broad themes than for sending specific policy signals,” said O’Sullivan, chief U.S. economist for Valhalla, New York-based High Frequency Economics, in an Aug. 27 report.
- “You can’t find a trader who doesn’t think Ben Bernanke is going to signal QE3 at Jackson Hole,” said Dan Greenhaus, chief global strategist for broker dealer BTIG LLC in New York. “But to have traders so convinced that this is a sure thing kind of screams there’s room for a letdown here.”
- Policy makers at the central bank have said they are prepared to provide new stimulus “fairly soon” unless they’re convinced the economy is poised to rebound, according to the minutes of the FOMC’s July 31-Aug. 1 meeting released last week. Bernanke sees “scope for further action,” he wrote in an Aug. 22 letter to California Republican Darrell Issa, chairman of the House Oversight and Government Reform Committee.
- Given the division among policy makers and mixed economic data, Eric Green, a former economist at the New York Fed, said Bernanke will want to use the symposium to clarify his views. The minutes from the last FOMC meeting “make Jackson Hole even more relevant because it will help resolve the tension between the Aug. 1 period, which preceded firmer data, and how the Fed is looking at things now,” said Green, now global head of rates and foreign-exchange research at TD Securities Inc. in New York. “The burden of proof is to see a sustained pickup in growth, and I don’t think we’re going to get that,” he said, predicting expansion in the third quarter will come in below 2 percent again. “The world will be looking for something very clear, and the odds are that he will deliver.”
- Bernanke isn’t alone in considering fresh aid for his economy. Joachim Fels, Morgan Stanley’s London-based chief economist, predicts central banks in the U.K., euro area, Sweden and Australia will ease monetary policy further, as will those in about 10 emerging markets, including China and Brazil.
- Mario Draghi, in his first year as president of theEuropean Central Bank, will participate in a Jackson Hole panel on Sept. 1, five days before he chairs a meeting of his Governing Council at which investors seek details of a plan to defend the euro region from surging bond yields. Draghi’s Aug. 2 pledge to craft the plan and declaration that the euro is “irreversible” were enough to drive a rally in Spanish and Italian bonds as investors bet the central bank will be able to quell the region’s debt crisis, now in its third year. The yield on 10-year Spanish government bonds fell to 6.42 percent on August 24 from a peak of 7.62 percent on July 24. Ten-year Italian bond yields were 5.71 percent compared with 6.6 percent in July.
- While Der Spiegel magazine this month reported the ECB is considering yield caps, economists at Goldman Sachs Group Inc. predict it will eschew explicit goals and instead intervene to keep market rates within a wide range. Draghi might wait until Germany’s Constitutional Court rules on the legality of Europe’s permanent bailout fund on Sept. 12 before unveiling full details of his plan, two central bank officials said last week.
Copyright © Market Montage
Tuesday, August 28th, 2012
This weekend I read Elliott Management’s Quarterly Letter for the period ending June 30th, 2012. The letter was penned a few weeks ago, amd I think it has some pretty interesting takeaways on the market climate investors are dealing with on a day to day basis. Here’s an introductory paragraph:
“Global financial markets currently feel like they are in a period of calm before a storm, possibly centered on the European situation. The problem is that no one can foresee when the storm will make landfall, or how severe it will be. However, if history is any guide, serious economic and market disturbances are likely to provide us with a variety of complicated restructuring and other trading opportunities, so we are ready to don our foul weather gear. In the meantime, we are concentrating on adding some positions in real estate securities and structured products. In those markets, there still seems to be a sweet spot of labor intensive, complex, small- to medium-size situations which we are taking on at attractive prices, despite the general overpricing of mainstream or trophy properties.”
I wrote about this in the past, but is “hope” an investment strategy? I am not sure. I often hear strategists using the central bank “put” to get long the market as the tide of never-ending stimulus continues to roll on in prompting investors to bid up financial assets to levels where the risk / return spectrum doesn’t make sense. What is fascinating about this dynamic is that in the end, the pain is just going to be so much worth for the entire system. Except of course for distressed investors that know how to navigate through the choppy water of situations that other investors decry as too ugly or too complicated. The choice words: “complicated restructuring” always brings a smile to my face.
I try to distinguish distressed situations into a few buckets. Some are very valuation oriented in the sense that ultimate exit multiple will be the ultimate determinant of recovery. Some are very legal in nature where a few choice rulings by a judge can tilt recoveries dramatically. Some are a combination of both. And others are just simply situations where you have to be in the weeds, working diligently with all parties involved to even come close to having an idea of intrinsic value of securities. This year some of the best performing distressed assets are part of these last groups and specifically surplus notes and holdco notes of some of the financial guarantors. I would wager that if 50 funds were spending a significant amount of time on ATPG, 5 of those 50 had the capacity and capability to look at an Ambac or Syncora.
On government bonds:
“Safe haven” could be the two most expensive and painful words for investors in the financial lexicon this year. Indeed, long-term government debt of the U.S., U.K., Europe and Japan probably will be the worst-performing asset class over the next ten to twenty years. We make this recommendation to our friends: if you own such debt, sell it now. You’ve had a great ride, don’t press your luck. From here it is basically all risk, with very little reward.”
I wish there was a way to measure this but I generally believe that the market will hurt the most investors at any one time. It is the contrarian in me. If everyone is long tech in 99, the market will crush tech. If everyone is long real estate in 2005, the market will crush real estate. Ben Graham and Warren Buffett uses the analogy of Mr. Market, a manic depressant business department that will sell to you at high prices in times of glee and at low prices in times of gloom. I think of this manic depressant to also be a serial killer that enjoys pain and suffering of his counterparties.
Fixed income investors in long term government bonds have so many structural issues to contend with that pain is on the horizon. These investors are the opposite side of the same coin of the investors that get long the market due to hope of central bank actions. Both are relying on an third party to control their destiny, just in different fashions. I do understand the argument about being long treasuries as a disaster hedge, but a hedge is very different than an investment. I personally would never put money to work in SPY 100 puts as an investment, but I am long them as part of a holistic view on the portfolio (think portfolio insurance).
Final quote from Elliott’s letter:
“Of course Elliott’s goal at all times is to construct a portfolio which is protected against both the foreseeable and the unpredictable adverse forces and surprises that afflict long term trading strategies and firms. That is what we have tried to do for 35 years, and for the most part we have been reasonably successful and consistent. One of the ways we accomplish this is to pursue a mix of activities which have different drivers of risk and reward than just assessing future business values or interest rate and inflation trends. We also seek a staggered profile for exits and cash-out events. That is why we especially favor “uncorrelated” positions which require lots of manual effort, as well as situations in which we have substantial degrees of control over our destiny. For this reason, it is often the case that substantial portions of our portfolio generate some exits and inflection points at times when many firms’ books are stuck.”
I unfortunately have no idea how Elliott constructs their portfolio for the tail scenarios I spoke about above. In fact, I wish I knew more of their distressed analysts to be frank (contact if you ever want to chat ideas).
What I do like about this quote is the commentary on hard catalysts (exits and cash-out events). A friend once told me the difference between a value trap and a good investment is a catalyst. For distressed investors the number of catalysts are numerous. For example, entering bankruptcy itself could be a catalyst for either a long or short position. Let’s say a company with a senior bond and a sub bond files for bankruptcy. Those senior bonds may rally as left value is flowing to sub bond coupons. A judges ruling itself could be a catalyst where the market might be pricing in a ruling far different than you anticipate. Patriot Coal’s venue change ruling will be an interesting one in that sort of vein.
I talk to a lot of people on the buy side. Everyone is so blah now. Maybe its because its August and I don’t particularly spend a lot of time looking at European situations which has been the Garden of Eden for distressed fund raising in the past year. More maybe its because the markets a bit a head of itself. If I had to rate it on Oaktree’s risk scale I’d say we are approaching a 4. Not quite there yet, but very close.
One statistic thrown around often is how under invested funds are right now. And when funds are under invested, they under perform en masse. And that’s whats happening right now. Especially on the long / short side. And with high yield being up nearly 10% this year, many credit / distressed funds are under performing there as well. Does that mean market participants will bid up various risk assets throughout the 3rd and 4th quarter trying to chase performance? I’m note sure. I’ve always struggled with that argument because liquidity can turn on a dime and funds that were chasing can turn out to be the greater fool in hoping to sell to a greater fool.
This is a very very difficult market to be an active participant in. Every day you could wake up and Greece could have defaulted, or the Middle East could break out into a scuffle, or China’s economic data could be worse. And as the markets bid up risk assets and push credit spreads down, its just going to be more painful on the other-side. So like Elliott I am looking for off the radar, complicated distressed situations (I’ve spent a ton of time on PMI, and less off the radar, but fascinating: EIX/EME) and protecting the gains I’ve made using way out of the money puts as well as spending a whole lot of time on the short side selling call spreads and buying puts when volatility isn’t too high. And as usual, working on projects that I’ll announce to readers shortly.
Copyright © Distressed Debt Investing
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Tuesday, August 28th, 2012
Taking Stock of Corporate Earnings
by Neuberger Berman, Investment Strategy Group
The corporate earnings season for the second quarter of 2012 has just about ended. Investors entered this period with much apprehension as the global economic slowdown set expectations for disappointing earnings. However, U.S. numbers surprised on the upside, contributing to a rally in equity markets worldwide. Given the importance of the corporate sector to the current economic recovery, we take a deeper look at recent earnings data to highlight important trends.
An Engine of Growth
In the first half of 2012, global growth fell below expectations, which in turn led Wall Street analysts to revise earnings expectations lower. This shift is notable as the corporate sector has been viewed as a source of strength in the global economy. In the U.S., for example, employment has been driven by private payrolls as the government sector has continued to shed jobs. In our view, a sustained improvement in the U.S. economy is therefore contingent on the health and optimism of the corporate sector, as activities such as increased capital spending could improve employment and growth prospects.
United States — Still Holding Up
S&P 500 earnings for the second quarter were stronger than expected, with 70% of companies in the S&P 500 beating estimates. Earning growth was approximately 7% higher than the same period last year with financial names leading the way. However, this strong performance is not necessarily a cause for celebration as it largely reflects one large bank’s return to profitability after incurring sizeable write-downs during the second quarter last year. Excluding that influence, earnings growth was only 3%, with the cyclically sensitive sectors such as Materials and Energy reporting the lowest growth rates. For the full year, Wall Street analysts expect S&P 500 companies to generate earnings of $101 per share, an increase from $95 in 2011.
GDP AND EARNINGS GROWTH ACROSS REGIONS
Source: GDP growth data are IMF estimates as of April 2012. Earnings growth data are from FactSet as of
August 20, 2012 and are derived from bottom-up estimates.
Underlying the modest earnings numbers was a more ominous trend—less than half of companies exceeded sales estimates, the lowest level since the first quarter of 2009. In fact, there was virtually no growth in overall sales, indicating that the global slowdown had affected revenue growth for U.S. companies. Views from management during earnings calls confirmed as much. The S&P 500, which is estimated to derive around 40% of sales and earnings from outside of the U.S., has seen the impact of a contraction in Europe and a slowdown in emerging markets. Firms with high levels of foreign exposure reported more negative earnings surprises than domestically focused companies. The stronger U.S. dollar also came into play, impacting earnings through reduced sales and currency accounting effects.
While demand from U.S. investors held up reasonably well during the second quarter, companies noted that they continue to find it difficult to raise prices and are growing concerned that the uncertainty surrounding the U.S. “fiscal cliff’ will affect capital spending decisions and consumer confidence. Consequently, companies have been lowering guidance for the third quarter and analysts’ revenue estimates are indicating a slight contraction from the second quarter.
Europe, Asia Showing Weaknesss
Across the Atlantic, downward estimate revisions have plagued European stocks for months. Still, analysts expect companies in the MSCI Europe Index to achieve slightly positive earnings growth for in 2012 (see display). In the second quarter, more companies missed earnings expectations, with smaller-cap names suffering the most significant negative surprises.1 Earnings growth expectations are generally negative for cyclically sensitive sectors such as Technology, Materials and Energy, while the consumer sectors are expected to hold up best. Stocks in the UK, which represent the largest component of the MSCI Europe Index, are expected to see a 5% decline in earnings for 2012, compared with an 11% gain in 2011.
The negative outlook extends to Asia, where, as of mid-August, more than half of earnings reports came in below expectations. Contractions in export-related sectors (caused by weakening demand from Europe) and a slowdown in China have reverberated across the region. Sectors such as Materials, Telecommunications and Technology experienced the weakest earnings. Downgrades in earnings expectations were highest in global trade-focused countries such as Korea and China, but South East Asian countries with strong domestically driven economies were an area of strength.
A Mixed Picture for Stocks
While the recent earnings season paints a somewhat gloomy picture of growth prospects going forward, it is worth noting that U.S. corporate profits and margins are at near-record levels. U.S. corporations have continued to grow earnings through improved productivity despite flattening sales. Outside the U.S., uncertainties in the growth trajectory of Europe and Asia make investing a bit more challenging. For the year ahead, the consensus is for global earnings growth to be weaker this year before rising again in 2013 as the eurozone gradually heals.
In our view, currently depressed stock valuations are likely discounting a lower earnings growth rate than analysts anticipate, making us relatively positive on large-cap U.S. equities. However, we are more cautious about Europe, particularly on domestically focused companies, seeing the need for further clarity on economic developments. We continue to believe that Asia is in a secular growth trend with the caveat that investors should maintain a longer-term view as the shift to developed status may at times prove turbulent for some markets.
Copyright © Neuberger Berman
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Tuesday, August 28th, 2012
To print or not to print? Odds are that Fed Chairman Bernanke has been contemplating this question while drafting his upcoming Jackson Hole speech. The one good thing about policy makers worldwide is that they may be fairly predictable. As such, we present our crystal ball as to what the Fed might be up to next, and what the implications may be for the U.S. dollar and gold.
First off, we may be exaggerating: on process rather than substance, though. That is, Bernanke isn’t just thinking about whether to print or not to print as he is sitting down to draft his speech. Instead, he considers himself a student of the Great Depression and has been pondering policy responses to a credit bust for some time. Consider the following:
- Bernanke has argued that going off the gold standard during the Great Depression helped the U.S. recover faster from the Great Depression than countries that held on to the gold standard for longer.
- Bernanke is correct: subject to many risks, debasing a currency (which going off the gold standard was) can boost nominal growth. Think of it this way: if the government takes your purchasing power away, you have a greater incentive to work. Not exactly the mandate of a central bank, though.
- Note by the way that by implication, countries that hold on to the gold standard invite a lot of pain, but have stronger currencies. Fast forward to today and compare the U.S. to Europe. While neither country is on the gold standard, the Federal Reserve’s balance sheet has increased more in percentage terms than that of the European Central Bank since the onset of the financial crisis. Using a central bank’s balance sheet as a proxy for the amount of money that has been “printed”, it shouldn’t be all that surprising that the Eurozone experiences substantial pain, but the Euro has been comparatively resilient.
- Possibly the most important implication: Bernanke considers the value of the U.S. dollar a monetary policy tool. When we have argued in the past that Bernanke might be actively working to weaken the U.S. dollar, it is because of comments such as this one. This is obviously our interpretation of his comments; a central banker rarely says that their currency is too strong, although such comments have increasingly been made by central bankers around the world as those pursuing sounder monetary policy have their economies suffer from competitive devaluations elsewhere.
- Bernanke has argued that one of the biggest mistakes during the Great Depression was that monetary policy was tightened too early. Here’s the problem: in a credit bust, central banks try to stem against the flow. If market forces were to play out, the washout would be severe and swift. Those in favor of central bank intervention argue that it would be too painful and that more businesses than needed would fail, the hardship imposed on the people is too much. Those against central bank intervention point out that creative destruction is what makes capitalism work; the faster the adjustment is, even if extremely painful, the better, as the recovery is healthier and stronger.
- If the policy choice is to react to a credit bust with accommodative monetary policy, fighting market forces, and then such accommodation is removed too early, the “progress” achieved may be rapidly undone.
- We are faced with the same challenge today: if monetary accommodation were removed at this stage (interest rates raised, liquidity mopped up), there’s a risk that the economy plunges right back down into recession, if not a deflationary spiral. As such, when Bernanke claimed the Fed could raise rates in 15 minutes, we think it is a mere theoretical possibility. In fact, we believe that the framework in which the Fed is thinking, it must err on the side of inflation.
Of course no central banker in office would likely ever agree with the assessment that the Fed might want to err on the side of inflation. But consider the most recent FOMC minutes that read:
- An extension [of a commitment to keep interest rates low] might be particularly effective if done in conjunction with a statement indicating that a highly accommodative stance of monetary policy was likely to be maintained even as the recovery progressed
As the FOMC minutes were released three weeks after the FOMC meeting, many pundits dismissed them as “stale”; after all, the economy had somewhat improved since the meeting. Indeed, it wasn’t just pundits: some more hawkish Fed officials promoted that view as well. But to make clear who is calling the shots, Bernanke wrote in a letter dated August 22 (the same date the FOMC minutes were released) to California Republican Darrell Issa, the chairman of the House Oversight and Government Reform Committee: “There is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery.” Various news organizations credited the faltering of an incipient U.S. dollar rally on August 24 with the publication of this Bernanke letter.
For good order’s sake, we should clarify that the Fed doesn’t actually print money. Indeed, printing physical currency is not considered very effective; instead, liquidity is injected into the banking system: the Fed increases the credit balances of financial institutions in accounts held with the Fed in return for buying securities from them. Because of fractional reserve banking rules, the ‘liquidity’ provided through this action can lead to a high multiple in loans. In practice, one of the frustrations of the Fed has been that loan growth has not been boosted as much as the Fed would have hoped. When we, and Bernanke himself for that matter, have referred to the Fed’s “printing press” in this context, referring to money that has been “printed”, it’s the growth in the balance sheet at the Federal Reserve. That’s because the Fed’s resources are not constrained; it’s simply an accounting entry to pay for a security purchased; that security is now on the Fed’s balance sheet, hence the ‘growth’ in the Fed’s balance sheet.
Frankly, we are not too concerned about the environment we are in. At least not as concerned as we are about the environment we might be in down the road: that’s because we simply don’t see how all the liquidity can be mopped up in a timely manner when needed. At some point, some of this money is going to ‘stick’. Even if Bernanke wanted to, we very much doubt he could raise rates in 15 minutes. To us, it means the time for investors to act may be now. However, talking with both existing and former Fed officials, they don’t seem terribly concerned about this risk. Then again Fed officials have rarely been accused of being too far sighted. We are concerned because just a little bit of tightening has a much bigger effect in an economy that is highly leveraged. Importantly, we don’t need the Fed to tighten: as the sharp selloff in the bond market earlier this year (and the recent more benign selloff) have shown, as soon as the market prices in a recovery, headwinds to economic activity increase as bond yields are rising. That’s why Bernanke emphasizes “communication strategy”, amongst others, to tell investors not to worry, rates will stay low for an extended period. This dance might get ever more challenging.
In some ways, Bernanke is an open book. In his ‘helicopter Ben’ speech a decade ago, he laid out the tools he would employ when faced with a collapse in aggregate demand (the credit bust we have had). He has deployed just about all tools from his toolbox, except for the purchase of foreign government bonds; recently, he shed cold water on that politically dicey option. Then two years ago, in Jackson Hole, Bernanke provided an update, specifying three options:
- To expand the Fed’s holdings of longer-term securities
- To ease financial conditions through communications
- To lower the interest rate the Fed pays on bank reserves to possibly 10 basis points or zero.
We have not seen the third option implemented, but the Fed might be discouraged from the experience at the European Central Bank: cutting rates too close to zero might discourage intra-bank lending and cause havoc in the money markets.
As such, expect Bernanke to give an update on his toolbox in Jackson Hole. The stakes are high as even doves at the Fed believe further easing might not be all that effective and could possibly cause more side effects (read: inflation). As such, we expect him to provide a framework as to why and how the Fed might be acting, and why we should trust the Fed that it won’t allow inflation to become a problem. For investors that aren’t quite as confident that the Fed can pull things off without inducing inflation, they may want to consider adding gold or a managed basket of currencies to mitigate the risk to the purchasing power of the U.S. dollar.
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President and Chief Investment Officer, Merk Investments
Merk Investments, Manager of the Merk Funds
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