Words from the (investment) wise for the week that was (Jan 26 – Feb 1, 2009)

Sunday, February 1st, 2009

“Words from the Wise” this week comes to you in a shortened format as pressure from my “day job” precludes me from doing my customary commentary. However, a full dose of excerpts from interesting news items and quotes from market commentators is provided. (For more discussion about economies and financial markets, also see my post “Video-o-rama: Global economy – banked into submission“.)

Just a side note: As President Obama’s economic stimulus package makes its way to the US Senate and the government crafts plans to create a “bad bank”, the Chinese celebrated the Lunar New Year to usher in the Year of the Ox. According to Jim Trippon (China Stock Digest), the Chinese believe good and bad follow each other closely.

After a year of financial meltdowns in 2008, it is comforting to learn that the Year of the Ox is a sign of prosperity and has been very rewarding in the history of China. Are we unnecessarily concerned about the economic slowdown in China, and will the country’s vast foreign reserves come to the Western world’s rescue? If only hope were an investment strategy!

Why does the cartoon below remind me of Margaret Thatcher’s poignant observation: “The problem with socialism is that you eventually run out of other people’s money”?

Bill King (The King Report) said: “The Paradox of Thrift (or saving) is a reductio ad absurdum by John Maynard Keynes that avers that if everyone saves, aggregate demand will decline, and this will imperil the economy. We’d like to contribute the ‘Paradox of Spending’ to Econ 101. This maxim holds that if everyone spends, there are no savings; debt surges and the implosion of that debt collapses an economy.”

Next, a tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. As the saying goes: A picture paints a thousand words …

The US stock markets experienced their worst January in history, as seen from the movements of the major indices: Dow Jones Industrial Index -8.8%, S&P 500 Index -8.6%, Nasdaq Composite Index -6.4% and Russell 2000 Index -11.2%. This brings into question the January Barometer, stating “As January goes, so goes the year”.

Key resistance and support levels for the US indices are shown in the table below. The immediate upside target is the 50-day moving average, followed by the early-January highs. On the downside, the December 1 and all-important November 20 lows must hold in order to prevent considerable technical damage. As seen from the table, the Dow has already breached its January 2 low and closed the week only marginally above the roundophobia number of 8,000.

As far as the outlook for the stock market is concerned, I will suffice with a comment from Richard Russell (Dow Theory Letters): “The stock market often tries to confuse us by coming up with something new. Assuming that the Averages do better than their preceding January peaks, it would have occurred without the usual heavy buying on rising volume. It may be that the January peaks will have to be bettered before the ‘real’ volume comes in. … we will have to monitor the stock market action carefully, to make sure we are not being sucked in to a fake rally as was the case following the 1929 crash.”

Also make sure to read my recent posts “Albert Edwards: Back in the bear camp” and “Jeremy Grantham – The bear buys stocks“.

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, January 30, 2009.

In addition to interest rate announcements by the Bank of England and the European Central Bank (Thursday, February 5), the US economic highlights for the week include the following:

Source: Northern Trust.

Click here for a summary of Wachovia’s weekly economic and financial commentary.

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

Source: Wall Street Journal Online, January 30, 2009.

Caution should be exercised, since the economic and earnings background remains precarious. And do remember Charles Darwin’s words: “It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change.”

That’s the way it looks from Cape Town.

NBR: Warren Buffett one on one
SUSIE GHARIB, ANCHOR, NIGHTLY BUSINESS REPORT: Are we overly optimistic about what President Obama can do?

WARREN BUFFETT, CHAIRMAN, BERKSHIRE HATHAWAY: Well I think if you think that he can turn things around in a month or three months or six months and there’s going to be some magical transformation since he took office on the 20th that can’t happen and wouldn’t happen. So you don’t want to get into Superman-type expectations. On the other hand, I don’t think there’s anybody better than you could have had; have in the presidency than Barack Obama at this time. He understands economics. He’s a very smart guy. He’s a cool rational-type thinker. He will work with the right kind of people. So you’ve got the right person in the operating room, but it doesn’t mean the patient is going to leave the hospital tomorrow.

SG: Mr. Buffett, I know that you’re close to President Obama, what are you advising him?

WB: Well I’m not advising him really, but if I were I wouldn’t be able to talk about it. I am available any time. But he’s got all kinds of talent right back there with him in Washington. Plus he’s a talent himself so if I never contributed anything for him, fine.

SG: But I know that during the election that you were one of his economic advisors, what were you telling him?

WB: I was telling him business was going to be awful during the election period and that we were coming up in November to a terrible economic scene which would be even worse probably when he got inaugurated. So far I’ve been either lucky or right on that. But he’s got the right ideas. He believes in the same things I believe in. America’s best days are ahead and that we’ve got a great economic machine, its sputtering now. And he believes there could be a more equitable job done in distributing the rewards of this great machine. But he doesn’t need my advice on anything.

Click here for the full article.

Source: Susie Gharib, NBR, January 22, 2009.

CNN Money: House passes $819 billion stimulus bill
“The House on Wednesday evening passed an $819 billion economic stimulus package on a party-line vote, despite President Obama’s efforts to achieve bipartisan support for the bill.

“The final vote was 244 to 188. No Republicans voted for the bill, while 11 Democrats voted against it.

“The Senate is likely to take up the bill next week.

“‘I hope that we can continue to strengthen this plan before it gets to my desk,’ Obama said in a statement after the vote. ‘We must move swiftly and boldly to put Americans back to work, and that is exactly what this plan begins to do.’

“‘One week and one day ago, our new President delivered a great inaugural address … which I believe is a great blueprint for the future,’ said House Speaker Nancy Pelosi. ‘With swift and bold action today, we are doing just that – with this vote today, we are taking America in a new direction.’

“Next week, the full Senate will vote on its version, which differs in some significant ways from the House bill. The two chambers will then need to reconcile their differences before each vote on the final version. To pass the package in the Senate, Democrats will need 60 votes – meaning at least two Republicans.

“Congress has put the legislation on a fast track, as many lawmakers on both sides of the aisle agree that swift action is needed to help pull the economy out of a deep recession. Both Democratic and Republican leaders have said they aim to get the bill to Obama’s desk for him to sign before lawmakers’ Presidents Day recess in mid-February.”

Source: David Goldman, CNN Money, January 28, 2009.

CEP News: US Government plans to set up “bad bank” to buy toxic assets
“The US government is crafting plans to create a “bad bank” to purchase toxic assets from financial institutions and strengthen the balance sheets of financial institutions, according to a report from CNBC on Tuesday evening.

“The concept of a ‘bad bank’ is one which has been floated around by many countries across the globe as a means to add further stimulus to financial institutions and speed up market recovery. Nevertheless, the details of the plan have not been released.

“At the very least, CNBC quoted an unnamed Treasury official as saying that the government was planning a ‘major’ announcement next week.

“In the aftermath of the announcement, Bloomberg News cited ‘sources familiar with the matter’ that the Federal Deposit Insurance Corporation (FDIC) would be the likely candidate to run such an institution, arguing that Chairperson Sheila Bair has proposed issuing FDIC-backed debt to finance the project.

“Also on Tuesday, US Senator Chris Dodd, an active member in the crafting of recent financial legislation in the United States, said the creation of a ‘bad bank’ sounded like a good idea and confirmed that he is aware that the Obama administration is looking into such a matter.”

Source: CEP News, January 28, 2009.

CNBC: Plan for banks’ toxic debt may be unveiled next week

Click here for the article.

Source: CNBC, January 27, 2009.

Yahoo Finance: Good bank, bad bank or banana
“While the idea of the government becoming the de facto bad bank in a system-wide good bank-bad bank solution has some merit, there’s a big problem with the ‘aggregator bank’ idea that’s gaining momentum in Washington DC, says Lawrence J. White Professor of Economics at New York University’s Stern School of Business.

“‘Whether you call it a bad bank an aggregator bank or a banana doesn’t change the basic problem: You’ve got to figure out what price is going to get paid for the assets that leave the financial system and end up in this government entity,’ White says. ‘That’s the hard part.’”

Click here for the article.

Source: Yahoo Finance, January 27, 2009.

CNBC: Barry Ritholtz – suggestions on how to restructure banks

“1. Stop interfering with the markets!: Nationalizing banks isn’t market interference, keeping these mortally wounded banks alive is! Stop pussyfooting around and admit the truth. The market knows it, investors know it.

Let the FDIC do its job. That is:

2. Temporarily nationalize the banks: We know they are insolvent, and cannot survive without taxpayer money. Spending 150% of their market cap for an 8% share is absurd.

Wipe out the debt, liquidate bad common holders, fire the board and management, appoint new competent, risk sensitive management. They have six months to spin out a 10% stake in each of their holdings, followed by the rest within 5 years (10 at most).

3. Taxpayer owned: Once nationalized, that 10% spin out of the component parts would be in the form of preferred to taxpayers! For BAC, you would spin out Bank of America, Merrill Lynch, Countrywide, plus the ‘B/A Toxic Holdings I & II’. For Citi, it would be Travelers, Citi, Smith Barney, ‘Citi Toxic Holdings I & II’, etc.

4. Now recapitalize: With the toxic waste off of the books, you can easily recapitalize the banks. Give the old creditors a ‘sweetheart’ deal – they get a 10% stake also, but only if they buy a matching amount in the new bank.

5. Align compensation with long-term profitability: Stop rewarding traders for short term gains despite long term losses. Stop paying taxpayer monies out as dividends. Bonuses must be a function of the long term health of the company – not monthly volatility.”

Sources: CNBC and The Big Picture, January 29, 2009.

David Fuller (Fullermoney): What to do with bad assets
“The question of what to do about the bad assets on bank balance sheets has been circulating for some time. No one has yet come up with a sound method of valuing these assets and until they do, the uncertainty surrounding the situation will remain acute.

“US Aggregate Reserves for Depository Institutions in Excess of Required Reserves continue to climb to levels massively in excess of what is needed. Banks are doing everything they can to shore up their balance sheets because they do not know how they will be called upon to meet their outstanding obligations. The inability to value their assets is at the root of this problem.

“The de facto guarantees that have been put behind the major players in the banking system have helped to bring the TED spread down to much more reasonable levels. However, the difference between AA Bank spreads and BBB Bank spreads imply that investors continue to bet that high numbers of lower rated banks will default at some stage. This would seem to be common sense. A less leveraged, slimmed down banking sector will have less members and those either ‘too big to fail’ or with the healthiest balance sheets are most likely to survive.

“Personally, I am in favour of a form of the ‘bad bank’ solution. However, I see recapitalisation and the valuing of suspect assets as separate issues. If a ‘bad bank’ takes possession of illiquid, hard-to-value assets, it should do so at prices well below what banks would deem as breakeven. This is the only fair way to make sure that the taxpayer is not paying up for duff assets. Recapitalisation should subsequently be considered only where any opacity in a firm’s balance sheet has been cleared out; so that taxpayers know exactly what they are putting their money into.

“We know that a large number of hard-to-value assets have deep intrinsic value, which is not readily available to assess in today’s conditions. Price discovery will only become apparent when an active secondary market for such assets is created. The ‘bad bank’ will be key to creating and managing such a pool of liquidity. If the value of the bad assets turns out to be more than a bank received in bailout funds, they would have a justifiable cause to seek redress but that would be an issue for the courts subsequent to the financial crisis and not for now.”

Source: David Fuller, Fullermoney, January 29, 2009.

The New York Times: Sweden’s fix for banks – nationalize them
“The Swedes have a simple message to the Americans: Bite the bullet and nationalize.

“With Sweden’s banks effectively bankrupt in the early 1990s, a center-right government pulled off a rapid recovery that led to taxpayers making money in the long run.

“Former government officials in Sweden, many of whom come from the market-oriented end of the political spectrum, say the only way to solve the crisis in the United States is for the government to be prepared to temporarily take full ownership of the banks.

“Sweden placed its banks with troubled assets into a so-called bad bank, where they could be held and then sold over time when market and economic conditions improved. In the meantime, it used taxpayer money to provide enough capital to allow banks to resume normal lending.

“In the process, Sweden wiped out existing shareholders.”

Source: Carter Dougherty, The New York Times, January 22, 2009.

Bloomberg: Fannie to tap US for as much as $16 billion in aid
“Fannie Mae, the largest source of home-loan money in the US, said it will need to tap as much as $16 billion in emergency funds from the US Treasury Department to stay afloat as deterioration in the housing market persists.

“Fannie’s planned request, announced today, follows Freddie Mac, which said on January 23 that it will need as much as $35 billion more in federal aid. Unprecedented mortgage losses drove the net worth of both companies below zero last quarter, they said in separate securities filings.

“This will be Washington-based Fannie’s first draw on a $200 billion emergency fund set up by Treasury in September to keep the government-sponsored enterprises solvent. Fannie said losses on mortgage loans and a decline in the market value of its assets accounted for the shortfall in the fourth quarter.

“Fannie’s Treasury request was “much worse” than expected, said Rajiv Setia, a fixed-income strategist at Barclays Capital in New York. Setia estimates taxpayers will have to shell out at least $50 billion for Fannie and $70 billion for Freddie this year. One or both, especially Freddie, may exceed the Treasury’s backstop this year, he said.”

Source: Dawn Kopecki, Bloomberg, January 26, 2009.

Daily Mail: Revealed – day the banks were just three hours from collapse
“Britain was just three hours away from going bust last year after a secret run on the banks, one of Gordon Brown’s Ministers has revealed.

“City Minister Paul Myners disclosed that on Friday, October 10, the country was ‘very close’ to a complete banking collapse after ‘major depositors’ attempted to withdraw their money en masse.

“The Mail on Sunday has been told that the Treasury was preparing for the banks to shut their doors to all customers, terminate electronic transfers and even block hole-in-the-wall cash withdrawals. Only frantic behind-the-scenes efforts averted financial meltdown.”

Source: Glen Owen, Daily Mail, January 24, 2009.

CEP News: IMF slashes global growth forecasts
“On the back of a $2.2 trillion loss on toxic US assets worldwide, the global economy is expected to contract in 2009 before recovering the following year, according to a report from the International Monetary Fund (IMF) on Wednesday.

“‘Unless stronger financial stains and uncertainties are forcefully addressed, the pernicious feedback loop between real activity and financial markets will intensify, leading to even more toxic effects on global growth,’ read the report, which urged governments to continue taking action to rescue the financial system.

“‘We now expect the global economy to come to a virtual halt,’ said IMF chief economist Olivier Blanchard at a press conference.

“As a consequence, the global economy is expected to grow 0.5% in 2009 rather than by 2.2% as previously estimated, and expand by 3.0% in 2010.

“To address the situation, the IMF report voiced support for the so-called ‘bad bank’ approach where governments could set up a financial institution to purchase toxic assets, removing them from the balance sheets of banks.

“‘We think that more decisive action is needed now by both policy-makers and market participants, and with greater emphasis on balance sheet cleansing,’ said Jaime Caruana, financial counsellor of the IMF.”

Source: CEP News, January 28, 2009.

Bloomberg: Gloom deepens among world’s chief executives
“Gloom is deepening among business leaders, casting a pall over this year’s World Economic Forum in Davos, Switzerland.

“Just one in five of 1,124 chief executives in 50 nations said they were very confident about prospects for revenue growth in 2009, down from half last year, and more than a quarter said they were pessimistic, a survey by PricewaterhouseCoopers showed. The sentiment was the worst since the accounting and consulting firm began tracking the CEO outlook in 2003.

“‘The speed and intensity of the recession has rocked the psyches of CEOs and created a global crisis of confidence,” Samuel DiPiazza, PWC’s New York-based CEO, said in a statement.

“Such concerns are virulent as executives from JPMorgan Chase’s Jamie Dimon to Stephen Green of HSBC Holdings join more than 2,500 counterparts, academics and policy makers in the ski resort for five days of soul-searching and deal-making. They meet as the world economy hurtles deeper into recession, banks add to more than a $1 trillion in writedowns and governments tighten their grip over the financial system.

“‘The outlook is pretty grim,’ said Howard Davies, director of the London School of Economics and a former Bank of England policy maker who will be in Davos. ‘Things are not good and business surveys are coming out showing they’re getting even worse.’”

Source: Matthew Benjamin and Simon Kennedy, Bloomberg, January 28, 2009.

The Wall Street Journal: YouTubing in Davos with Huffington and Forbes
“YouTube’s Chad Hurley, Arianna Huffington and Steve Forbes share their views on Davos and the global economic crisis with WSJ’s Andy Jordan.”

Source: The Wall Street Journal, January 28, 2009.

Bloomberg: Roubini – “nowhere to hide” from global slowdown
“‘There is nowhere to hide,’ Nouriel Roubini, an economics professor at NYU’s Stern School of Business who predicted the financial crisis, said from Zurich in an interview with Bloomberg Television. ‘We have for the first time in decades a global synchronized recession. Markets have become perfectly correlated and economies are also becoming perfectly correlated. This is not your kind of traditional minor recession.’”

Click here for the article.

Source: Bloomberg, January 27, 2009.

Financial Times: Nations turn to barter deals to secure food
“Countries struggling to secure credit have resorted to barter and secretive government-to-government deals to buy food, with some contracts worth hundreds of millions of dollars.

“In a striking example of how the global financial crisis and high food prices have strained the finances of poor and middle-income nations, countries including Russia, Malaysia, Vietnam and Morocco say they have signed or are discussing inter-government and barter deals to import commodities from rice to vegetable oil.

“The revival of these trade practices, used rarely in the last 20 years and usually by nations subject to international embargoes and the old communist bloc, is a result of the countries’ failure to secure trade financing as bank lending has dried up.

“The countries have not disclosed the value of any deals, and some have refused even to confirm their existence. Officials estimated that they ranged from $5 million for smaller contracts to more than $500 million for the biggest.”

Source: Javier Blas, Financial Times, January 26, 2009.

Financial Times: Capital flows to developing world at risk
“Capital flows to emerging markets are in danger of collapsing this year as the financial crisis in advanced economies risks choking off the supply of credit to the developing world, an association of large banks warned on Tuesday.

“The Institute for International Finance forecasts net private sector capital flows to emerging markets will be no more than $165 billion this year, less than half the $466 billion inflow in 2008 and only one fifth of the amount sent in the peak year of 2007.

“The figures underscore the impact the banking crisis and risk-averse investors are having on emerging market economies, one of the central issues at this year’s World Economic Forum in Davos.

“Bill Rhodes, a senior Citigroup executive who is vice-chairman of the IIF, urged leading economies to co-operate with each other and the private sector to address the problem. ‘This is a worldwide recession the like of which we have not seen since World War II,’ he said. ‘There is no one country or group of countries that can do this on its own. The only way to solve it is co-ordination across the board.’

“Mr Rhodes also called on the International Monetary Fund to intensify its efforts to supply liquidity to emerging markets by extending the duration of the current facility from three months to more than a year. ‘The IMF’s resources need to be expanded and its approaches modified to provide financing to emerging markets that have been caught in a crisis not of their making.’”

Source: Peter Thal Larsen, Financial Times, January 27, 2009.

Paul Kedrosky (Infectious Greed): Fun with Fitch – sovereign hotspots
“Some slides from a useful new Fitch presentation on one of my favorite subjects: sovereign hotspots around the world.”

Source: Paul Kedrosky, Infectious Greed, January 29, 2009.

Asha Bangalore (Northern Trust): Fed reiterates support for credit markets
“The Federal Open Market Committee (FOMC) left the target federal funds rate unchanged at 0%-0.25%. Richmond Fed President Lacker cast the only dissenting vote as he would have preferred increasing the monetary base through purchases of Treasury securities rather than through the credit programs.

“The FOMC policy statement noted that the ‘Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time’. This part of the message is identical to the December 2008 statement.

“Overall, today’s [Wednesday] statement presented a broader picture of the economic situation and included some bullish expectations about the economy. By contrast, the December 16 policy statement focused largely on features of the Fed’s new regime. In particular, six aspects of the policy statement were different from the December 2008 announcement.

“First, significantly slowing global demand was mentioned versus the December statement that did not mention the global economy.

“Second, today’s statement noted that ‘conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions.’

“Third, the FOMC predicts that ‘a gradual recovery in economic activity will begin later this year’, and the statement indicated that ‘the downside risks to that outlook are significant’.

“Fourth, in December, inflation was expected to ‘moderate in coming quarters’. There is notable departure from this view because the Fed now ‘expects that inflation pressures will remain subdued in coming quarters’.

“Fifth, the FOMC indicated that it ‘is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets’.

“Sixth, today’s statement has an explicit discussion about the Fed’s balance sheet. As expected the Fed reiterated support of credit markets.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 28, 2009.

BCA Research: US LEI – uptick unsustainable
“The Conference Board’s leading economic indicator (LEI) ticked up in December, but we do not view this as the beginning of a sustained economic recovery.

“The tick up in the LEI was mainly due to the large positive contribution from real money supply and the yield curve. Meanwhile, measures of the real economy continue to weaken: large declines occurred in building permits, employee hours worked, supplier deliveries, while initial unemployment claims are skyrocketing.

“It is still unclear that monetary and fiscal policy are effective (private sector borrowing rates have only marginally fallen) and the housing market is still very weak.

“True, existing home inventories fell in December, but seasonal factors played a large role (inventories always fall during the autumn and winter). Improved activity levels during the spring selling season, should they occur, would be a more accurate signal that the housing market is stabilizing.

“However, the unemployment rate is set to still rise sharply, which will further undermine consumer confidence and spending, particularly on big ticket items. Bottom line: Economic data will continue to be weak and the LEI will likely slide further before a sustainable bottom is made.”

Source: BCA Research, January 29, 2009.

Asha Bangalore (Northern Trust): Q4 GDP Report – gain in inventories masks true weakness
“Real gross domestic product (GDP) declined 3.8% in the fourth quarter of 2008, the minus sign for GDP growth was not a surprise but a larger decline was widely expected. The increase in inventories (+$6.2 billion versus -$29.6 billion in Q3), which was largely unexpected, offset the weakness in demand and trimmed down the headline reading.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 30, 2009.

Bespoke: GDP price index enters the deflation zone
“While the markets have been focused on the better than expected GDP report for the fourth quarter, the GDP price index was potentially even more notable. While economists were looking for a quarter/quarter annualized increase of 0.4%, the actual level was a decline of 0.1%. This negative print is only the seventh time since the end of WWII (and the first time since 1954) that prices decrease based on this measure. For now at least, the Fed’s view that ‘inflation pressures will remain subdued in coming quarters’ appears to be right on target.

Source: Bespoke, January 30, 2009.

Richard Russell (Dow Theory Letters): Is inflation creeping back?
“Below is my inflation/deflation chart. This is simply the long T-bond divided by gold. When the ratio rise in favor of bonds, it’s saying that the bonds are stronger than gold, which is deflationary. When the ratio declines in favor of gold, it tells us that gold is gaining in relative strength, and that’s inflationary. Note the head-and-shoulders pattern just before the plunge – the plunge took the ratio below the rising trendline. This is the chart Bernanke has been waiting for.”

Source: Richard Russell, Dow Theory Letters, January 27, 2009.

Standard & Poor’s: S&P/Case-Shiller – home price declines continue
“Data through November 2008, released today by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, shows continued broad based declines in the prices of existing single family homes across the United States, with 11 of the 20 metro areas showing record rates of annual decline, and 14 reporting declines in excess of 10% versus November 2007.

“‘The freefall in residential real estate continued through November 2008,’ says David Blitzer, Chairman of the Index Committee at Standard & Poor’s. ‘Since August 2006, the 10-City and 20-City Composites have declined every month – a total of 28 consecutive months.’”

Source: Standard & Poor’s, January 27, 2009.

Asha Bangalore (Northern Trust): Existing home sales – inventories remain at elevated levels
“Sales of existing homes rose 4.7% in December after two monthly declines, inventories remain at elevated levels, and the median price of an existing single-family home fell in December. The gain in home sales is noteworthy while other aspects of today’s report are much the same as we have seen for several months. The important take-away in this report is that inventories of unsold existing homes remain at elevated levels. Although mortgage rates have moved up slightly, they remain at significantly favorable levels.

“The seasonally adjusted inventory-sales ratio of existing single-family homes fell to a 9.6-month supply from an 11.4-month supply in November. This appears impressive at the outset, but digging deeper it appears that the November reading was probably an aberration because the quarterly averages for 2008 range between a 9.8-month supply and a 10.26-month mark. Inventories of unsold homes need to shrink considerably more for home prices to stabilize.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 26, 2009.

Asha Bangalore (Northern Trust): New home sales plunge
“In December, sales of new homes declined, prices fell, and inventories were the highest on record. The main message from the December report is that homebuilders will continue to reduce production of new homes.

“The inventory of unsold new homes rose to a 12.9-month supply in December, the largest on record.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 29, 2009.

The Wall Street Journal: An upside to plunging home prices
“John Lonski, CEO of Moody’s Capital Markets Research Group, discusses the latest decline in home prices. He tells WSJ’s Kelly Evans that although it highlights plunging home prices and the deterioration of mortgage-backed securities, it’s promoting the stabilization of home sales.”

Source: The Wall Street Journal, January 27, 2009.

Asha Bangalore (Northern Trust): Durable goods orders post sharp drop
“Orders and shipments of durable goods fell in 2.6% in December, after a downwardly revised 3.7% drop in November. The declines in orders of durable goods were widespread.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 29, 2009.

Asha Bangalore (Northern Trust): Consumer confidence posts new low
The Conference Board’s Consumer Confidence Index fell to 37.7 in January from 38.6 in December. This is a new record low for the series which dates back to February 1967. The grim headlines and media coverage of the financial and economic turmoil and staggering layoff announcements justify the sober consumer outlook.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 27, 2009.

The Wall Street Journal: Lending drops at big US banks
“Lending at many of the nation’s largest banks fell in recent months, even after they received $148 billion in taxpayer capital that was intended to help the economy by making loans more readily available.

“Ten of the 13 big beneficiaries of the Treasury Department’s Troubled Asset Relief Program, or TARP, saw their outstanding loan balances decline by a total of about $46 billion, or 1.4%, between the third and fourth quarters of 2008, according to a Wall Street Journal analysis of banks that recently announced their quarterly results.

“Those 13 banks have collected the lion’s share of the roughly $200 billion the government has doled out since TARP was launched last October to stabilize financial institutions. Banks reporting declines in outstanding loans range from giants Bank of America and Citigroup, each of which got $45 billion from the government; to smaller, regional institutions. Just three of the banks reported growth in their loan portfolios: US Bancorp, SunTrust Banks Inc. and BB&T Corp.

“The overall decline in loans on the 13 banks’ books – from about $3.36 trillion as of September 30 to $3.31 trillion at year’s end – raises fresh questions about TARP’s effectiveness at coaxing banks to reopen their lending spigots.

Source: The Wall Street Journal, January 26, 2009.

Richard Russell (Dow Theory Letters): Will new primary bull market be signalled?
“The Dow Theory to the fore. On January 20, the DJ Transportation Average broke below its November 20 bear market low of 2,988.99. The new low was not confirmed by the Industrial Average, which held above its own November 20 bear market low of 7,552.29. This non-confirmation set up the potential for a Dow Theory bull signal. If the Industrials and Transports can now muster the strength to rally above their preceding January peaks, (Industrials on January 6 at 9,015.10 and Transports at 3,717.26), a new primary bull market will be signaled.

“There are two concepts about this that bother me.

(1) If a new bull market is signaled, it would mean that the bear market of November 2007 to November 2008 ended in only one year. Since the preceding bull market (1982 to 2007) lasted 25 years, a one-year bear market (no matter how severe) seems too short in time to correct one of the greatest bull markets in history.

(2) Based on the Lowry’s figures, it appears that most of the upside progress since the November 20 bear market lows has been the result of a decline in selling pressure. Historically, the beginning of a new bull market has been characterized by not only a drastic drop in Lowry’s Selling Pressure Index, but also by heavy buying and strong upside volume (neither of which has been present).

“The stock market often tries to confuse us by coming up with something new. Assuming that the Averages do better their preceding January peaks, it would have occurred without the usual heavy buying on rising volume. It may be that the January 6 peaks will have to be bettered before the ‘real’ volume comes in. In other words, even if a new bull market is signaled in the weeks ahead, we will have to monitor the stock market action carefully, to make sure we are not being sucked in to a fake rally as was the case following the 1929 crash.”

Source: Richard Russell, Dow Theory Letters, January 29, 2009.

Bespoke: Fourth quarter earnings “beat rate” below 50%
“There’s still a long way to go before the fourth quarter earnings season comes to an end, but the first batch of reports indicate just how bad of a quarter it was. Since Alcoa kicked off earnings season earlier this month, only 45% of US companies have beaten analyst EPS estimates. As shown in the chart below, this would be the lowest reading since at least 1998. Even though analysts have been cutting estimates sharply over the past few months, companies still haven’t been able to beat at a better than 50% clip. Hopefully this ‘beat rate’ gets better as earnings season chugs along, but we wouldn’t count on it.”

Source: Bespoke, January 26, 2009.

Bloomberg: Earnings may slump 45%, Socgen says
“Analysts have cut their estimates for company earnings worldwide by $1 trillion since October, suggesting profits may tumble as much as 45% this year amid the global recession, according to Societe Generale SA.

“A profit slump of that magnitude would mean stocks are trading at 20 times future 12-month earnings, according to calculations by the quantitative analysis team at France’s third- largest bank, led by Andrew Lapthorne in London. The MSCI World Index currently trades at 10.7 times its members’ estimated earnings after plummeting 42% in 2008 and 11% so far this year, according to Bloomberg data.

“‘Global earnings forecasts are disintegrating as companies and analysts struggle to adjust to rapidly declining commodity prices, continuing financial sector losses and, of course, a crumbling global economy,’ wrote Lapthorne’s team in a report today. ‘There is little sign of this pace of downgrading abating. Equities will struggle.’”

“Analysts estimate companies on the Standard & Poor’s 500 Index will report a 28% drop in fourth-quarter profits, according to data compiled by Bloomberg. That compares with a 55% increase forecast in March 2008. Analysts currently predict earnings will decline 2.3% in 2009, the data show.

“SocGen’s strategy team estimated the 45% profit decline by extrapolating the pace of downgrades to earnings predictions since October. The team was ranked first by investors in Europe this year, according to Thomson Reuters Plc’s Extel survey.”

Source: Alexis Xydias, Bloomberg, January 23, 2009.

Bespoke: Sector relative strength – financials still lagging
“In our relative strength charts, we highlight how each sector has performed versus the S&P 500 over the last year. For each sector, rising lines indicate the sector is outperforming the S&P 500, while falling lines indicate underperformance. In each chart, we also note each Fed meeting over the last year. Red dots indicate meetings where the Fed lowered rates, while black dots indicate meetings where the Fed left rates unchanged.

“While the Financial sector has led the recent rally, a look at the sector’s long-term relative strength shows that they are nowhere near breaking the downtrend they have been in for at least a year now.

“While everyone is focused on the Financials, the Energy sector has been enjoying its position out of the spotlight. While the sector was killed in the summer and fall when the decline in oil kicked into high gear, since then, energy stocks have been steadily outperforming even as oil remains near its lows. Just imagine what could happen if oil actually started to rally.”

Source: Bespoke, January 29, 2009.

Bespoke: 10-year Treasury yield reaches key juncture
“Even with the Fed’s reiteration that they were considering outright purchases of US Treasuries, the yield on the 10-year has been climbing steadily higher from its lows in December. At 2.77%, the 10-Year is approaching yields that it traded at before the bottom dropped out in early December. How we trade in the next few days will go a long way in determining whether the current sell-off is simply profit-taking after a massive rally, or the beginning of the end of the latest bubble in asset classes (stocks, real estate, commodities, etc.).”

Source: Bespoke, January 29, 2008.

David Fuller (Fullermoney): Treasuries – a dangerous game
“The promise (threat?) by the Fed to purchase US long-dated securities has deterred me from shorting them to date, despite some very good sell signals …

“However I have also described the Fed’s frequent hints of its apparent willingness to buy US debt as akin to a con artist’s shell game. However in the Fed’s version, instead of trying to guess under which of three rapidly moving cups the pea lurks, we are guessing how and when we might see their bond purchases.

“I do not question the Fed’s word that it would be prepared to buy Treasuries to keep long-term rates low, if necessary. Instead, my point is that they may hope to avoid purchases if they persuade the market to do their work for them. In other words, I wonder how many people, from hedge fund managers to foreign governments, have bought or at least retained their Treasuries, despite historically low yields and rapidly increasing supply.

“This is a dangerous game. Financial history is full of instances where investors have been persuaded to pay record high valuations for assets, usually because: ‘It is different this time.’ Perhaps … for a while, but the bubble always bursts in a mean reversion process which usually ends in an overshoot of its own.

“The only way I can envisage significantly lower long-term yields for US Treasury bonds, would be if the economy slid into a lengthy deflation, as we saw with Japan in the late 1990s and earlier this decade, causing real interest rates to rise. This is a risk, but one that the Bernanke Fed has vowed to avoid. It has the means to do so.

“At Fullermoney, we think gold is replacing US Treasuries as the safe haven investment.”

Source: David Fuller, Fullermoney, January 30, 2009.

Bespoke: Credit default risk down but still high
“Below we highlight a chart of an index that measures the default risk of investment grade credit in the US. Throughout the credit crisis, default risk has risen sharply, although it has ticked lower since peaking in December. Any decline in default risk is a good sign, but it needs to fall much more before anyone can make the claim that things are ‘settling down’. As shown, the index has still not broken below the bottom of its uptrend line that formed back in April 2008.”

Source: Bespoke, January 27, 2009.

Bloomberg: Soros stopped betting against pound
“Billionaire investor George Soros, who made $1 billion selling the pound in 1992, said he is no longer betting against the UK currency after it reached $1.40.

“‘I did actually foresee the fall in sterling and that was one of the positions we carried,’ he told reporters at the World Economic Forum in Davos, Switzerland. Below $1.40 ‘it seemed to me the risk-reward was no longer clear’.

“Soros said today that he has made money from the financial crisis. The British government’s efforts to protect the banking system from the turmoil last week led to a drop in the pound to the lowest level against the dollar since 1985.

“‘We did have a short position in sterling, but it doesn’t mean I’m bearish on sterling today or bullish,’ Soros said. ‘It will continue to fluctuate.’

“Soros’s comments contrast with those of Jim Rogers, who co-founded the Quantum Fund with him and is now chairman of Singapore-based Rogers Holdings. Rogers said on January 20 that the pound was ‘finished’ because of turmoil in the banking system and a decline in North Sea oil output.”

Source: Simon Kennedy, Bloomberg, January 28, 2009.

Bespoke: Russian troubles
“Russia’s currency made news today for having its biggest two-day decline versus the dollar in a decade. For those interested, below we provide a long-term chart of the Russian ruble versus the US dollar. As shown, the amount of rubles that one dollar will get you has spiked significantly in recent months, going from about 23 rubles per dollar last May to its current level of 34.84 rubles per dollar.”

Source: Bespoke, January 29, 2009.

BBC News: Zimbabwe abandons its currency
“Zimbabweans will be allowed to conduct business in other currencies, alongside the Zimbabwe dollar, in an effort to stem the country’s runaway inflation.”

Source: BBC News, January 29, 2009.

Financial Times: Gold pushes above $900 in buying spree
“Strong investor buying on Monday pushed the price of gold above $900 a troy ounce, hitting a 3½-month high in dollar terms and posting all-time highs in euro and sterling, in a stark sign of money seeking refuge from equities and bond markets.

“Traders said that investors, particularly in continental Europe and the UK, were pouring money into gold exchange-traded funds – a popular way to gain access to the metal – and also noted strong buying of physical gold, from coins to bars.

“Edel Tully at Mitsui & Co Precious Metals in London said gold was the ‘obvious shelter’ for safe-haven investors.

“The total amount of gold held by the world’s gold ETFs last week rose for the first time above the 40 million ounce level. Together, such investment vehicles are now the largest holders of physical gold after the official reserves of the US, Germany, the International Monetary Fund, France and Italy.

“In the short term, traders said gold was likely to consolidate above $900 an ounce this week and could test the $930 an ounce level previously touched in October.”

Source: Javier Blas, Financial Times, January 26, 2009.

Bespoke: Will gold break its downtrend?
“After briefly piercing the $1,000 level in March of last year, the price of gold went into a long-term downtrend with a series of lower highs and lower lows. However, since bottoming out at $681 in October, gold has rallied to over $900 per ounce. This has brought the commodity right to the top of its downtrend line from the March 2008 high. While the current rally in gold has been attributed to fears over competitive currency devaluations across the globe, how the commodity acts in the coming days will go a long way in determining how valid those fears are.”

Source: Bespoke, January 26, 2009.

Richard Russell (Dow Theory Letters): Gold benefits from devaluations
“The world battle for exports, with the help of cheap currencies is on. They call it competitive devaluations, and the whole picture is not lost on gold. The move is starting – to move to hard assets. The hardest of all assets is gold. Gold, in case you forget, is pure wealth, it’s the only money with no debt against it or without a counter-partner. Gold needs no nation or central bank to attest, by fiat – that it’s money.”

Source: Richard Russell, Dow Theory Letters, January 26, 2009.

Bloomberg: StockCharts’s Murphy sees gold at $1,000 by year end
“John Murphy, chief technical analyst at StockCharts.com, talks with Bloomberg’s Brennan Lothery about the outlook for the gold price in 2009. Murphy also discusses commodity prices, the US equity market and investment strategy.”

Source: Bloomberg, January 27, 2009.

Bespoke: Baltic Dry Index up seven days in a row
“The Baltic Dry Index gained another 1% today, which makes seven up days in a row. Since bottoming in December, the Index has formed a nice uptrend, gaining over 50%. Longer term, however, the Index’s highs from last Spring are still a long way off. While the Index bottomed on December 5 with a 94.4% decline from its all-time high of 11,793, at its current level of 1,014, it is still down 91.4% from its May 20 high. In order to get back to those highs, the index would have to rally an additional 1,063%. Hey, you have to start somewhere.”

Source: Bespoke, January 28, 2009.

CNBC: Oil move to $20?
“Crude oil may fall to $20 this year, says Joe Petrowksi, Gulf Oil and Cumberland Farms CEO.”

Source: CNBC, January 27, 2009.

Victoria Marklew (Northern Trust): Eurozone – is that light at the end of the tunnel?
“Today’s [Tuesday] Ifo and last week’s Belgian leading indicator offer the tantalizing hope that the economic downturn across the Eurozone is starting to bottom out – but one month is not enough to call a trend, and the ‘zone’ in general, and Germany in particular, are still likely in for a rough first quarter of 2009.

“First, the Ifo index in Germany. The headline business climate index edged upward from 82.7 in December to 83.0 in January, the first improvement in eight months. Nevertheless, the difference between the current conditions and expectations indices remains wide, suggesting that the economy will contract again in Q1 2009 and that the government’s latest forecast of -2.25% real GDP growth this year is about right.

“Which takes us to our favorite Eurozone leading indicator, the Belgian National Bank’s (BNB) business confidence indicator. As we’ve noted before, thanks to Belgium’s strong trade ties with its neighbors (about 80% of Belgium’s manufacturing output is sold abroad, mostly to fellow EU members), the BNB’s business confidence index is a reliable leading indicator – about six months out – for GDP growth in the Eurozone as a whole.

“The Belgian and German data imply that the Eurozone as a whole will see a marked contraction in Q4 2008 and Q1 2009, flat-to-negative growth in the middle of the year, and a sustained improvement finally underway by Q4.”

Source: Victoria Marklew, Northern Trust – Daily Global Commentary, January 27, 2009.

CEP News: Spain is officially in a recession, says Central Bank
“With GDP contracting for two quarters in a row, the Spanish economy has officially entered into a technical recession, the Bank of Spain said in its quarterly GDP report released on Wednesday.

“According to the central bank, the Spanish economy contracted by 1.1% to Q4 from Q3, when output had fallen 0.2%. On an annualized basis, the economy declined 0.8% in Q4, down from Q3’s 0.9% increase. The Bank of Spain also reported that for 2008 as a whole, the economy grew at 1.1%, down from 2007’s 3.7% print.

“With the economy expected to decline 1.6% in 2009, the government is looking to spend upwards of €90 billion in stimulus measures. As a result of the pressures on public finances, Standard & Poor’s had reduced Spain’s sovereign credit rating from AAA to AA+ earlier in the month.”

Source: CEP News, January 28, 2009.

BCA Research: UK economy – in a deep recession
“The UK economy is the epicenter of the global housing/credit crisis and will need substantially more support from policymakers.

“Last week’s release highlighted that the UK economy contracted again in Q4 by more than expected to -1.8% YoY. More importantly, the outlook is grim given that the collapse in both commercial and residential real estate prices is still gaining momentum, banks have shut off the credit taps, and business sentiment surveys indicate that activity has ground to a halt.

“UK households face dramatic headwinds from plunging home prices and rapidly rising unemployment. Correspondingly, our models warn that retail sales growth will contract later this year, causing deflationary pressure to build further.

“Bottom line: In order to prevent debt-deflation from gaining further momentum, UK policymakers will need to continue stimulating aggressively (using both conventional and unconventional measures). While the collapse in the pound is helping ease overall monetary conditions, the lack of global trade limits the positive impact for the economy.”

Source: BCA Research, January 26, 2009.

US Global Investors: China – threat of capital flight
“While China’s capital outflow during the fourth quarter is only 2% of the country’s formidable foreign exchange reserve, the specter of liquidity fleeing China may continue to haunt investors as the worst-case scenario if the government’s policy efforts fail to revive the economy.”

Source: US Global Investors – Weekly Investor Alert, January 30, 2009.

Financial Times: Japan’s production falls record 9.6%

“Japanese industrial production fell a record 9.6% in December, while core annual inflation almost evaporated, reinforcing expectations of a record economic contraction as the global financial crisis worsens.

“Unemployment hit a three-year high, household spending dipped, and manufacturers saw no quick turnaround in the outlook for industry – the main driver of the world’s second-biggest economy – as inventories hit record highs despite factory closures and lay-offs.

“Subsiding inflation and worsening economic conditions are also stoking deflation worries, as in other major economies, which may prompt more central bank steps to support the staggering economy and free up frozen credit markets that are starving key companies of cash.

“Economists said fourth-quarter GDP figures, due out in February, would show Japan’s economy shrinking at a double-digit annual rate, and Tatsushi Shikano, senior economist at Mitsubishi UFJ Securities, said early 2009 also looked bleak.”

Source: Reuters, Financial Times, January 30, 2009.

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Words from the (investment) wise for the week that was (January 12 – 18, 2009)

Sunday, January 18th, 2009

Investor sentiment around the globe was negatively impacted during 2009’s second full week of trading as a barrage of bleak economic and corporate news offered more confirmation of a deepening recession, bringing risk aversion to center stage.

The US dollar and government bonds (excluding emerging markets and countries on the periphery of the Eurozone) gained, but global equities and commodities were on the defensive as nervous investors tried to gauge the likely damage of the economic malaise.

Global bourses concluded a whipsaw week with hefty losses, but stemmed some of the downside as a relief rally came to the rescue towards the end of the week. The MSCI World Index and the MSCI Emerging Markets Index declined by 6.2% and 5.8% respectively.

The US indices all dropped over the week as shown by the major index movements: Dow Jones Industrial Index -3.7% (YTD -5.6%), S&P 500 Index -4.5% (YTD -5.9%), Nasdaq Composite Index -2.7% (YTD -3.0%) and Russell 2000 Index -3.1% (YTD -6.6%). As a matter of interest, the year-to-date returns at the same point last year (i.e. after 11 trading days) were -6.0% for the Dow and -6.5% for the S&P 500.

Adding a spark of hope on Thursday, the US Senate voted to release the second and final $350 billion tranche of the TARP funds, whereas the House Democrats unveiled a much-awaited $825 billion stimulus package aimed at halting the economic rot. Meanwhile, in a speech at the London School of Economics, Fed Chairman Ben Bernanke said Barack Obama’s economic package could provide a “significant boost” to the US economy.

Source: Daryl Cagle

But back to the stock market. The bar chart below shows the US sector performance for the past week, and specifically how defensive sectors such as consumer staples, healthcare and utilities outperformed other sectors on a relative basis.

The financial sector plummeted by 16.3% as several US banking shares fell to multi-year lows amid growing concerns that they will battle to cope with increasing credit losses as the global recession intensifies.

Source: StockCharts.com

The nascent earnings season saw a glut of fourth-quarter losses. These included larger-than-expected losses from Bank of America (BAC) and Citigroup (C), resulting in their respective share prices plunging by 44.7% and 48.2% over the week.

Citi announced plans to break up the bank into two businesses, following the decision to sell a controlling interest in the valuable Smith Barney brokerage to Morgan Stanley (MS). On the other hand, Bank of America will receive an additional $20 billion of TARP funds to bed down its troublesome acquisition of Merrill Lynch, as well as a guarantee on $118 billion of potential losses on distressed assets. Elsewhere, the Irish government nationalized Anglo Irish Bank, and HSBC was rumored to be seeking fresh capital of $30 billion.

As far as the US housing situation is concerned, I am keeping a close eye on the mortgage situation. According to Freddie Mac’s Primary Mortgage Market Survey, the national average rates for a US 30-year fixed mortgage last week declined to 4.96% from 5.33% two weeks ago and 6.46% in October last year. However, the rate is still 378 basis points higher than the three-month dollar LIBOR rate. This spread averaged 97 basis points during the 12 months preceding the crisis, indicating that lower rates are not being passed on to consumers.

Despite the interbank lending rates having declined from their peaks, banks have significantly curtailed the amount of money they are actually lending. The US Depository Institutions Aggregate Excess Reserves continue their ascent at levels far in excess of the amount that banks need to keep on deposit to meet their reserve requirements (see chart below). This measure indicates that the balance sheets of banks remain under pressure, especially in view of the fact that the value of some assets is not known. A peak in the Excess Reserves graph should coincide with a turning point in the recovery of banks. (Also see my post “Credit Market Watch“.)

Source: Fullermoney

Next, a quick textual analysis of my week’s reading. No surprises here with keywords such as “economy”, “market”, “bank”, “China”, financial” and “prices” featuring prominently.

On the issue of corporate bonds, I received a number of questions after referring to the iBoxx Investment Grade Corporate Bond Fund (LQD) and High Yield Corporate Bond Fund (HYG) in last week’s “Words from the Wise” review. In the short term, a further correction of both investment-grade and high-yield corporate bonds looks likely, but the sector is worth watching for opportunities arising at lower levels. Also, the high-yield instruments – under intense pressure because of an avalanche of defaults predicted by the ultra-wide spreads – could see spreads contracting markedly if the defaults are not as bad as priced in.

Turning to the outlook for the stock market, Bennet Sedacca (Atlantic Advisors Asset Management) issued a short-term buy signal on Thursday: “We are once again increasing exposure to equities from 0% to a near fully invested posture. I fully recognize the bad news that is out in the marketplace, but given Treasuries at 0-2.25% and Mortgage Backed Securities at 3-4%, high quality large cap growth stocks (self-financing companies purchased via IVW – the S&P large cap growth ETF) look attractive to me.

“We also like healthcare via PPH (pharma holders ETF), USO (oil ETF), XLV (broader healthcare ETF), but have a negative bias towards bonds and have taken substantial profits in recent days in the Mortgage Backed Securities space, where government intervention has led to artificially high bids. We also added a smallish position in XLF (financials). We believe quality is king and that ‘a’ low , but not THE low has been reached in stocks.”

Key resistance and support levels for the major US indices are shown in the table below. The immediate upside target is the 50-day moving average, followed by the November 4 highs about 16% to 18% from current levels (not shown on table). On the downside, the December 1 and all-important November 20 lows must hold in order to prevent considerable technical damage.

An analysis of the number of stocks trading above their 50-day moving averages makes for interesting reading. “With the S&P 500 back into oversold territory and even approaching its November lows, it’s actually surprising to see this breadth measure at 40%,” said Bespoke. “At the prior lows, the number got down to zero! The fact that the overall declines have been limited to a smaller area of the market is a positive for those hoping that the lows will hold.”

“As January goes, so goes the year”, is one of the most frequently quoted seasonal trends of the stock market. With the S&P 500 down by 5.9% after two weeks of the month, January is not off to a promising start. According to Jeffrey Hirsch (Stock Trader’s Almanac), every down January since 1950 has been followed by a new or continuing bear market or a flat year. Further research is provided by Jay Kaeppel of Optionetics.
The last word goes to Charles Kirk (The Kirk Report): “With the market closed Monday to observe Martin Luther King Jr., we are set to have another four-day work week and, in my experience, they tend to be some of the toughest. Not only will we have Obama’s inauguration, but lots of earnings reports to sort through.

“While the market managed to end the week above S&P 850, we still have a lot of work to do to confirm that we can manage at least a decent counter-trend rally during earnings season. We are still oversold, but we need to see the buyers return in force and with confidence. Both have been missing so far in 2009.”

For more discussion about the direction of stock markets, also see my post “Video-o-rama: Gloomy news batters investor sentiment“.

Economy
“Global business confidence remains very negative, but has improved a bit since hitting bottom at the very end of 2008. It is still too early to conclude that sentiment is improving in any measurable way,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. “Businesses are nearly equally pessimistic across the globe and across all industries. Hiring intentions have turned particularly negative in recent weeks. Pricing power has collapsed, suggesting that deflation is a significant threat.”

As far as the US is concerned, the Fed’s January Beige Book indicated continued and broad-based weakening throughout the nation. The latest round of economic data also confirmed that the recession was intensifying.

- Industrial production declined by 2% in December, with output falling in all three major categories – utilities, mining and manufacturing – for the first time since October. For the fourth quarter as a whole, industrial production fell at an annual rate of 11.5%, more than twice as fast as at any time during the 2001 recession. All indications are that manufacturers will further reduce production in order to bring inventories in line with free-falling final sales.

- Retail sales in December were significantly worse than expected, plunging by 2.7% – the sixth consecutive month of falling sales.

- The US trade deficit narrowed substantially to $40.4 billion (consensus $51.5 billion) in November, marking the fourth straight month of declining gross exports and gross imports.

News on the US inflation front was relatively good with both the PPI and CPI continuing to retreat in December, falling by 1.9% and 0.7% respectively. Core prices barely managed to stay in positive territory, with core CPI rising by 0.1% for 2008 – the lowest increase since 1954.

Jamie Dimon, chief executive of JPMorgan Chase, predicted in an interview with the Financial Times that the US financial and economic crisis would worsen this year as hard-hit consumers default on credit cards and other loans. “The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009,” said Mr Dimon.

Source: Daryl Cagle

Elsewhere in the world, evidence mounted that the recession was widespread and deepening.

- In a sign that the decline in economic activity in Japan was worsening, core machinery orders by Japanese businesses slumped by 16.2% in November – the sharpest monthly contraction since records began in 1987.

- Germany’s coalition parties agreed on a second economic stimulus package totaling €50 billion (including €36 billion in infrastructure investment and tax cuts), to be put into place in an effort to pull the economy out of its worst recession since the end of the Second World War, according to CEP News. The package also includes a €100 billion “Germany fund” that would guarantee the debt raised by cash-starved businesses.

- The European Central Bank on Thursday cut its main policy interest rate by 50 basis points to 2% – the lowest level ever. The total reduction since mid-October amounts to 225 basis points and highlights the Eurozone slipping deeper into recession and inflation dropping sharply.

- Eurozone manufacturing continued to fell for the seventh straight month in November, amounting to a decline of 7.7% in year-ago terms.

Source: Moody’s Economy.com

The International Monetary Fund’s managing director, Dominique Strauss-Kahn, “chided European leaders for failing to grasp the depth of the coming slump in their region, creating the risk of social upheaval,” said Bloomberg.

RGE Monitor reported that China had revised its 2007 GDP growth up to 13% from the 11.9% it previously reported. “With Chinese exports, industrial production and other economic indicators slowing sharply, there is speculation that Chinese officials might smooth growth statistics. Uncertainty about Chinese economic statistics has led many analysts to use proxies for economic output which are more difficult to doctor. These proxies include electricity demand, construction, etc. However, there is a consensus that Chinese economic statistics have improved,” said Nouriel Roubini’s research team.

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, January 16, 2009.

In addition to the Bank of Japan’s interest rate announcement (Thursday, January 22), the US economic highlights for the week, courtesy of Northern Trust, include the following:

1. Housing starts (January 22): Permit extensions for new homes fell 15.8% in November, inclusive of a 11.9% drop in permits issued for single-family homes. The weakness in permits is indicative of fewer housing starts in December (595,000 versus 625,000 in November). Consensus: 615,000.

2. Other reports: NAHB Survey (January 21).

Click the links below for the following reports:

- Wachovia’s Weekly US Economic & Financial Commentary (January 16, 2009)

- Wachovia’s Global Chartbook (January 2009)

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

Source: Wall Street Journal Online, January 16, 2009.

Chinese philosopher Lau-Tzu said: “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.” Wise words indeed, but hopefully thorough research and a dose of common sense will cast some light on the lie of the investment land.

On Tuesday a new President will be inaugurated in the US, but the old concerns about financial markets will unfortunately still be around. In the meantime, have a great long weekend in the US!

That’s the way it looks from Cape Town.

Source: Daryl Cagle

Clusterstock: Roubini – you’re all fools for buying into a sucker’s rally
“Yesterday Nouriel Roubini weighed in on the recent rally and said anyone that thought the worst was behind us is ‘delusional’ and as a matter of fact the worst is yet to come, citing the gruesome macro data that’s been released as of late, and the fact that that trend won’t reverse until at least the fourth quarter of 2009.

“RGE: For a few weeks since late November equity markets ignored the onslaught of much worse than expected macro news (and all the news were really worse than awful) and had a nice 25% bear market sucker’s rally. But the drumbeat of terrible – and worse-than-expected – macro news and earnings news and financial news has finally taken a toll on the delusional market belief that the worst was over for financial markets and for equity markets and that the US and global economy would recover in the second half of 2009. So equity prices have already reversed more than half of their most recent bear market rally as the lousy macro news have finally shocked in the last week the wishful thinkers.

“Indeed, the retail sales figures published today confirmed a shopped-out, saving-less and debt-burdened US consumer is now faltering as job losses, income losses, fall in home wealth, fall in equity wealth, high and rising debt and debt servicing ratios and a severe credit crunch take a severe toll on the ability of consumers to spend. And reduction in spending and deleveraging of the US consumer will take years to rebuild the savings rate of a household sector now hit by a severe shock to its net worth (as equity and home values fall while debts have been rising) and shocked in its ability to generate income as job losses mount and the unemployment rate surges.

“Our research at RGE Monitor suggests that the US and global recession will continue at least all the way until Q4 of 2009 (a nasty 24 months U-shaped recession) and that the recovery in 2010-11 will be very weak with growth in the 1% range that is well below a potential of 2.75%. And we cannot rule out that a more severe L-shaped stag-deflation (as in Japan in the 1990s) will take hold.”

Click here for CNBC video.

Source: Jay Yarow, Clusterstock, January 15, 2009.

CNBC: Pimco’s El Erian on the markets
“Discussing the global economic situation, with Mohamed El-Erian, Pimco co-CEO and Michael Spence, Philip H. Knight economics professor/Nobel Laureate.

Source: CNBC, January 15, 2009.

Barron’s: Roundtable – hang on tight
“Our go-to group of investment experts sees tough times for the economy – but good fortune for stockpickers.”

Click here for full article.

Source: Barron’s (via Fullermoney), January 13, 2009.

Grace Cheng (Daily Markets): Exclusive interview with Jim Rogers
Do you think the period of forced liquidation has ended or does it still have a ways to go?

Rogers: I’m sure it has not ended. It certainly has not ended for many asset classes and it probably has not ended for most. It may be over for a few things but it still has a long way to go.

As you’ve said many times, the US government is printing a lot of money right now, when do you think inflation will come around and bite us?

Rogers: Well there is inflation now in many things. There’s temporary deflation in raw material prices and in some property. But throughout history, whenever you’ve had gigantic printing of money and spending of borrowed money, it has always led to higher prices. Unless something is dramatic, it’s going to happen again. When I don’t know. It’s already happening in some things. I don’t know if you’ve bought any sugar recently or some other things, prices are up and that will continue and it will get worse.

You’ve been bullish on commodities for a long time, recently you said you’re buying the Rogers Metal Index. Do you think that the Obama stimulus plan will create more demand for commodities?

Rogers: Well of course, anything that causes a revival of economic activity causes a revival of demand for everything including commodities. I mean if you’re gonna build bridges you’ve got to build them out of something you cannot build virtual bridges you have to build real bridges, etc.

You’ve said that over the long term, the US dollar is doomed. What are your thoughts on the British Pound?

Rogers: More doomed. It will disappear sooner. If it weren’t for the North Sea, the British Pound would have already disappeared. It’s more doomed. The UK has been exporting oil for 26 years; within the decade, the UK will be a net importer of oil again, and they have nothing else to sell to the world once the oil dries up.

Do you think China will scale back on buying US bonds? And if that happens, how will it affect the US economy and the US dollar?

Rogers: Well if I were China, I would scale back. If I were everybody, I would scale back. The US bonds yield virtually nothing, the dollar is a flawed currency, inflation is coming, higher interest rates are coming. I would think everybody would be scaling back including China. We’re going to have higher interest rates down the road because somebody’s gonna scale back. If not China, Japan or Korea, or who knows, somebody.

Source: Grace Cheng, Daily Markets, January 15, 2009 (hat tip: Investorazzi).

Bloomberg: Bernanke urges “strong measures” to stabilize banks
“Federal Reserve Chairman Ben Bernanke speaks about the possible need for more capital injections and guarantees to further stabilize and strengthen the financial system. Bernanke, speaking at the London School of Economics, warns that a fiscal stimulus won’t be enough to spur an economic recovery and that the government may need to buy or guarantee banks’ tainted assets to revive growth. Bernanke also discusses the Fed’s balance sheet, inflation expectations and US unemployment.”

Click here for Financial Times article.

Source: Bloomberg, January 13, 2009.

Asha Bangalore (Northern Trust): Bernanke explains Fed’s options
“In the context of financial market stability, Bernanke calls on history to stress that a ‘modern economy cannot grow if its financial system is not operating effectively’. Bernanke noted that in order to support and mend the fragile financial system ‘more capital injections and guarantees may become necessary to ensure stability and normalization of credit markets’.

“He suggested that purchases of troubled assets, a provision of asset guarantees, and/or purchase of assets from financial institutions in exchange for cash and equity in bad banks are other avenues through which fiscal policy could support the financial system. Also, reducing preventable foreclosures would be useful in reducing mortgage losses and promoting financial stability.

“In sum, the conclusion we draw here is that additional fiscal policy stimulus is necessary to ensure the working of the financial system and revival of economic activity.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 13, 2009.

Financial Times: Democrats unveil $825 billion stimulus package
“Democratic lawmakers on Thursday unveiled a much-awaited $825 billion stimulus package to halt America’s vertiginous economic slide which Nancy Pelosi, the speaker of the House, said was only the ‘first step’ in a process that could take weeks to pass into law.

“The bill, which Barack Obama, the incoming president, wants enacted before mid-February when Congress goes into a short recess, comes in at $50 billion higher than the initial ceiling set by his transition team. But economists said they expected it to climb towards the important psychological threshold of $1,000 billion by the time it becomes law.

“The package was divided between $275 billion in tax cuts, mostly going towards a $1,000 tax credit for middle-class families and $500 for individuals, and $550 billion in public spending, which includes money for ‘shovel-ready’ infrastructure projects, aid to state governments and investments in information technology upgrades for healthcare and a drive to make federal buildings energy-efficient.

“Thursday’s bill coincided with Mr Obama’s announcement that he would hold a ‘fiscal responsibility’ summit next month that would address entitlement reform – an issue that has long been avoided by leaders from both sides of the aisle. ‘We’ve kicked this can down the road and now we are at the end of the road,’ he told an editorial board meeting of the Washington Post. ‘We need to send a signal that we are serious.’

“He said he did not know how long it would take for the proposed fiscal stimulus to take effect. ‘We are in uncharted waters here. I don’t have a crystal ball,’ he said.”

Source: Edward Luce, Financial Times, January 15, 2009.

Economix (The New York Times): Stimulus pie chart

Source: Catherine Rampell, The New York Times – Economix, January 15, 2009.

The New York Times: Senate releases second portion of bailout fund
“President-elect Barack Obama’s economic agenda advanced rapidly in Congress on Thursday as the Senate voted to release the second half of the financial industry bailout fund and House Democrats unveiled an $825 billion fiscal recovery plan aimed at putting millions of unemployed Americans back to work.

“The Senate action, by a vote of 52 to 42, spares Mr. Obama a messy legislative fight just as he takes office and gives him a $350 billion war chest to further stabilize the financial sector. The vote came amid renewed distress in the banking industry, including further deterioration of Citigroup and a pitch for more government aid by the Bank of America.

“Mr. Obama had personally lobbied reluctant senators to release the money. His top economic adviser, Lawrence H. Summers, made three visits to the Capitol and sent two letters to reassure lawmakers that the program would be better managed.

“In a statement, the president-elect applauded the outcome.

“‘I know this wasn’t an easy vote because of the frustration so many of us share about how the first half of this plan was implemented,’ Mr. Obama said. ‘Now my pledge is to change the way this plan is implemented and keep faith with the American taxpayer.’”

Source: David M. Herszenhorn, Financial Times, January, 2009.

Bloomberg: Seattle FHLB short of capital on mortgage ebt
“The Federal Home Loan Bank of Seattle said it will suspend dividends and ‘excess’ stock repurchases, becoming the second of the government-chartered lending cooperatives to say its capital may be running low.

“The likely capital shortfall as of December 31 was caused by ‘unrealized market value losses’ on residential mortgage bonds without government backing, the bank said in a US Securities and Exchange Commission filing today. Washington Mutual and Merrill Lynch had been the biggest stakeholders and borrowers in the Seattle Federal Home Loan Bank, or FHLB.

“Seattle joins the San Francisco FHLB in taking steps to guard its reserves after the US housing market collapse sent mortgage-backed bonds tumbling. The declines may leave as many as eight of the 12 FHLBs below capital requirements, Moody’s Investors Service has said, eroding a below-market rate source of about $1 trillion in financing for Citigroup, JPMorgan Chase and other companies that participate in the cooperatives.”

Source: Jody Shenn, Bloomberg, January 13, 2009.

BCA Research: It’s called credit easing, not quantitative easing
“Fed Chairman Bernanke argued in a key speech recently that the Fed’s current policy will not lead to an inflation problem.

“Bernanke explained how the Fed’s current policy, which he dubbed ‘Credit Easing’, differs from ‘Quantitative Easing’ (QE), as pursued by the Bank of Japan (BoJ) earlier this decade. Under QE, the BoJ set targets for excess bank reserves in the hope that the banks would increase lending. In contrast, the Fed is targeting an improvement in the functioning of the credit markets, an increase in the flow of credit, and lower private sector borrowing costs. There is no target for the size of the Fed’s balance sheet or the monetary base; both will fluctuate with the liquidity needs of borrowers who are using the Fed’s facilities.

“To the extent that banks keep excess liquidity on deposit at the Fed, Bernanke argued that there is little inflation risk in the near term. In terms of the exit strategy from the current policy, the Chairman explained that excess reserves and the monetary base will naturally decline when credit market conditions improve and recourse to the Fed’s liquidity facilities wanes.

“The Fed also plans to eventually sell the private sector assets it is purchasing, which will also soak up excess liquidity.

“Bottom line: The Fed’s ‘Credit Easing’ policy will not necessarily be inflationary, as long as the excess reserves are re-absorbed in a timely manner once the economy resumes growing.”

Source: BCA Research, January 14, 2009.

Paul Kedrosky (Infectious Greed): Dramatic changes in credit quality
“A fairly remarkable sea-change in Fitch Ratings’ view of rated companies/countries/sectors over the last two years. The stresses in Europe, in particular, caught my eye.”

Source: Paul Kedrosky, Infectious Greed, January 16, 2009.

BBC News: US banking giants in tie-up deal
“Struggling US banking giant Citigroup and its rival Morgan Stanley have agreed a deal which sees the tie-up of their brokerage operations. Morgan Stanley is paying Citigroup $2.7 billion for a 51% stake in the joint venture while Citigroup will have a 49% stake.

“Observers say the deal showed how much Citigroup wanted to slim down its operations and build up cash reserves. It received the largest government bail-out of any US bank last year.

“Citigroup’s retail brokerage, Smith Barney, was formerly a key part of its wealth management business.

“The new unit – to be called Morgan Stanley Smith Barney – will have more than 20,000 advisors, $1.7 trillion in client assets, and serve 6.8 million households around the world, the firms said.

“The Financial Times reports Citigroup will separate its higher risk US consumer finance and securities businesses from its global commercial banking operations.

“Analysts suggest that the government will end up buying some struggling parts of the business with the next tranche of its financial rescue programme. ‘I think within 12 months, Citigroup no longer exists. The new CEO of this company is the government,’ said William Smith of Smith Asset Management.”

Source: BBC News, January 13, 2009.

Barry Ritholtz (The Big Picture): The 45 billion dollar club
“The United States of Wall Street just added another major holding to its portfolio of financial garbage: Bank of America.

“Like Citi, B of A has now received MORE IN BAILOUT MONEY than its actually worth (BAC = $53B; C = $21B). How this can ever be a profitable investment, as some mathematically challenged Congress-critters have suggested, is all but impossible to imagine.

“Blaming ‘previously undisclosed losses from its Merrill Lynch’, B of A threatened to kill their purchase of Mother Merrill. Treasury made an emergency capital injection of $20 billion, on top of the $15B and $10B already received by B of A and MER respectively. The taxpayers will also backstop $118 billion of assets, setting up what is likely to be a jumbo money losing trade.

“What should have happened in both instances was an orderly liquidation, selling off the pieces to competent managers who understand risk, and can manage smaller portions of the firm. Instead, the same idiots who helped destroy all of companies involved are still running the show.

“The amazingly bad Bank of America plan mirrors an even worse bad deal made by the Feds with Citigroup in November. There, the taxpayers explicitly insured the bank against losses on 90% of $306 billion of toxic assets – Citigroup’s real-estate loans and securities.

“Like Citi, the B of A monies are a terrible deal for the taxpayer – not a lot of bang for the buck, and leaving the same people who created the mess in charge.

“Organ transplant medicine understands certain truths: You do not give a healthy liver to a raging alcoholic, as they will only destroy the organ via their disease/bad judgment/lifestyle.

“Why do we give billions of taxpayer dollars to incompetent managers who failed to protect their assets, who destroyed shareholder value? These people have demonstrated a marked INABILITY to run these firms. Why reward them with 10s of billions of dollars?

“Its nothing short of madness …”

Source: Barry Ritholtz, The Big Picture, January 16, 2009.

CNBC: Bair – banks in crisis
“Discussing big problems for big banks including Citi and Bank of America, with Sheila Bair, FDIC chairman.”

Source: CNBC, January 16, 2009.

Bloomberg: Shilling says banks may need “a lot more” government help
“Gary Shilling, president of A. Gary Shilling & Co., talks with Bloomberg’s Betty Liu about the potential for additional government aid for US banks. Shilling also discusses the future of Citigroup Inc. and Bank of America Corp., the state of the US economy, and the outlook for stocks.”

Source: Bloomberg, January 16, 2009.

CEP News: Trichet – central bankers see global economic recovery in 2010
“Central bankers expect the global economy to recover in 2010 according to European Central Bank President Jean-Claude Trichet speaking as head of the Bank for International Settlements on Monday morning.

“While the central banker declined to comment on the European Central Bank’s monetary policy ahead of the rate decision this Thursday, Trichet said that the global economic slowdown was due to a lack of confidence and pledged that the group would ‘do whatever is appropriate to reinforce [it].’

“He also said that attending members had not discussed exchange rates at the meeting, but agreed that emerging market growth continues to play an important role for the global economy.

“Earlier on Monday, in an interview with Bloomberg, IMF Managing Director Dominique Strauss-Kahn said that Europe is ‘behind the curve’ regarding stimulus packages, and that governments are underestimating how such measures are needed to help economies recover.”

Source: CEP News, January 12, 2009.

Financial Times: Larry Fink on what could derail recovery
“Larry Fink chief executive and chairman of BlackRock, talks to Henny Sender, FT’s international financial correspondent, about monetary policy, securities and risk management. He also discusses corporate governance, oversight and stabilizing troubled assets.”

Source: Financial Times, January 8, 2009.

Financial Times: JPMorgan chief says 2009 will be bleak
“The US financial and economic crisis will worsen this year as hard-hit consumers default on credit cards and other loans, Jamie Dimon, chief executive of JPMorgan Chase, has predicted in an interview with the Financial Times.

“Mr Dimon, whose bank will report fourth-quarter results on Thursday, gave his bleak assessment as shares on both sides of the Atlantic tumbled on rising fears that banks would need more capital and a larger-than-expected fall in US retail sales.

“‘The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009,’ said Mr Dimon. ‘In terms of our sector, we expect consumer loans and credit cards to continue to get worse.’

“Mr Dimon told the FT that JPMorgan was prepared for an expected deterioration in consumer-oriented businesses but added that if things were to get worse than expected it would have to cut costs again.

“Mr Dimon said the bursting of the credit bubble would force the banking industry to refocus on its traditional businesses of advising on deals and lending to companies and individuals.

“‘When we look back at industry excesses in areas such as highly leveraged lending and securitisation, it is clear that some of these markets will never come back,’ he said. ‘In the next few years, the industry will go back to basics: serving individual and corporate customers as best as we can.’”

Source: Francesco Guerrera, Financial Times, January 14, 2009.

Charlie Rose: A conversation with Lee Scott, CEO of Wal-Mart

Source: Charlie Rose, January 14, 2009.

CNBC: Nobel debate on the economy
“Weighing in on the economy with Edmund Phelps, 2006 Nobel Prize winner from Columbia University, and Michael Spence, 2001 Nobel Laureate from Stanford University.”

Source: CNBC, January 15, 2009.

Times Online: Leading economist fears decade of weakness in US
“One of the world’s leading economists has given warning that the United States is facing a decade of financial misery, with the number of unemployed Americans set to continue to rise for years.

“Robert Shiller, Professor of Economics at Yale University, who predicted the end of the internet bubble seven years ago, said: ‘We could have many years of a very weak economy. Big recessions are followed by years of weakness and typically unemployment keeps rising.

“‘To say that this will last years is not a dramatic statement. What is happening now is much worse than 1990. We could be facing a decade of real weakness. This is no ordinary recession. There are signs that people see this as a different story. People are talking about a depression, something that we haven’t seen previously.’

“Some economists, such as Kenneth Rogoff, the former chief economist at the International Monetary Fund and now a Professor of Economics at Harvard University, believe that America will be lucky if unemployment peaks at 9% of the workforce and that there is a high chance that it will reach at least 10%.

“Professor Shiller, who said that he has talked to the incoming Obama Administration about possible solutions to the housing crisis in the US, took a swipe at the Federal Reserve.

“He said: ‘This recession is by no means mechanical. People have lost a sense of confidence, a sense of trust in institutions and in each other. It is very hard for a central bank to address that by just cutting interest rates.’”

Source: Suzy Jagger, Times Online, January 12, 2009.

PRNewswire: Foreclosure activity increases 81% in 2008
“RealtyTrac today [Wednesday] released its 2008 US Foreclosure Market Report, which shows a total of 3,157,806 foreclosure filings – default notices, auction sale notices and bank repossessions – were reported on 2,330,483 US properties during the year, an 81% increase in total properties from 2007 and a 225% increase in total properties from 2006. The report also shows that 1.84% of all US housing units (one in 54) received at least one foreclosure filing during the year, up from 1.03% in 2007.

“Foreclosure filings were reported on 303,410 US properties in December, up 17% from the previous month and up nearly 41% from December 2007. Despite the spike in December, foreclosure activity for the fourth quarter was down nearly 4% from the previous quarter but still up nearly 40% from the fourth quarter of 2007.

“‘State legislation that slowed down the onset of new foreclosure activity clearly had an effect on fourth quarter numbers overall, but that effect appears to have worn off by December,’ said James J. Saccacio, chief executive officer of RealtyTrac. ‘The big jump in December foreclosure activity was somewhat surprising given the moratoria enacted by both Freddie Mac and Fannie Mae, along with programs from some of the major lenders and loan servicers aimed at delaying foreclosure actions against distressed homeowners.

“‘Clearly the foreclosure prevention programs implemented to-date have not had any real success in slowing down this foreclosure tsunami. And the recent California law, much like its predecessors in Massachusetts and Maryland, appears to have done little more than delay the inevitable foreclosure proceedings for thousands of homeowners.’”

Source: PRNewswire, January 14, 2009.

Richard Russell (Dow Theory Letters): Campbell – housing to trough in 2012
“I read a great deal about real estate, and I follow real estate trends closely. By far the best real estate guidance that I’ve come across is Robert Campbell’s ‘The Campbell Real Estate Letter’. Nothing I’ve read compares with Campbell’s great record.

“Robert uses an unusual and unique combination of fundamental and historical material along with his own specialty of technical analysis in real estate timing. Bob Campbell called the exact top of the real estate cycle in his report of August, 2005.

“What does Bob Campbell say now? He notes that historically, housing prices fall by an average of 35% after a financial crisis. He further states that he believes housing across the land will fall by another 8% from here to the final low of the housing cycle. And when will the low come? Campbell states that using five years as the average length of a housing downturn, ‘we can expect the US housing market to trough in the year 2012. Robert expects housing to fall to the prices that existed back in 2001.

“Writes Campbell, ‘And as I’ve stated in previous letters, this is where the problem arose: borrowers took on far more mortgage debt than they could ever pay back, and that’s why the real estate prices are crashing, and we are witnessing the destruction of the biggest credit bubble in history. And in the absence of dramatic increases in household incomes that are needed to service this massive amount of mortgage debt – all the bailouts in the world are unlikely to stop housing prices from eventually reverting back to the 2001 pre-bubble years – or close to it.’”

Source: Richard Russell, Dow Theory Letters, January 15, 2009.

Bespoke: Expected change in home prices
“The CME housing futures that track the S&P/Case-Shiller median home price indices of 10 major cities offer a clue into how much more investors think home prices have to fall.

“In the chart below, we highlight the percentage difference between the October ‘08 actual Case-Shiller numbers (the most recent set of numbers) and the current price of the November ‘09 futures contracts. The composite 10-city November ‘09 contract is currently trading 12% below its October ‘08 level. San Francisco is expected to fall the most in 2009 at -18%, followed by Los Angeles (-16.6%), and Las Vegas (-13%). The rest of the cities are expected to fall less than the composite, with Boston home prices expected to fall the least at -6%. Miami, Denver, DC, and San Diego are all expected to see home prices fall by less than 10% from 10/08 to 11/09.”

Source: Bespoke, January 12, 2009.

MarketWatch: 30-year mortgage under 5%
“The benchmark 30-year mortgage fell below 5% for the first time ever in Freddie Mac’s weekly rate survey as economic weakness continued to push interest rates lower, the mortgage agency said Thursday.

“The national average rate on the 30-year loan fell to 4.96% in the week ending January 15, down from 5.01% a week ago. That is the lowest on record. Freddie Mac began its rate survey in 1971. A year ago the loan averaged 5.69%.

“The 15-year fixed-rate mortgage, a popular refinancing choice, edged up to 4.65% from 4.62% a week ago. Last year at this time the loan averaged 5.21%. Refinancing activity has been strong as mortgage rates have plumbed historic lows.

“The two fixed-rate loans required the payment of an average 0.7 point to achieve the interest rate. A point is one percent of the loan amount, charged as prepaid interest.”

Source: Steve Kerch & Amy Hoak, MarketWatch, January 15, 2009.

Asha Bangalore (Northern Trust): Dreadful retail sales in December
“Retail sales in December were abysmal on every front. Total retail sales during December plunged 2.7% from 2.1% in November. Nearly all sub-components posted significant declines in sales.

“Retail sales have dropped at an annual rate of 24.6% in the fourth quarter versus a 5.1% drop in the previous quarter, a large part of it is due to the drop in gasoline prices. The weakness in retail sales supports expectations of a weak headline GDP number for the fourth quarter and also arithmetically consumer spending and GDP of the first quarter of 2009 are at a disadvantage.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 14, 2009.

Asha Bangalore (Northern Trust): Lower prices and weak non-oil imports translate to smaller trade gap
“The trade balance of the US economy narrowed to $40.4 billion in November from $56.7 billion in October. A 12.0% drop in nominal imports of goods and services partly due to lower imported oil prices was the main reason for the reduction in the trade gap. Weak economic conditions in the US have resulted in lower imports, while a similar status abroad has led to a 5.8% drop in nominal exports of goods and services.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 13, 2009.

Asha Bangalore (Northern Trust): Energy and food prices bring down headline wholesale price index
“The Producer Price Index (PPI) of Finished Goods fell 1.9% in December after a 2.2% drop in the prior month, reflecting lower prices for energy (-9.3%) and food (-1.5%). In 2008, the PPI fell 0.9% versus a 6.2% jump in 2007. The 20.3% drop of the energy price index was the main reason for a sharp reversal of the wholesale price index in 2008. The food price index climbed 3.7% in 2008 versus a 7.6% gain in 2007.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 15, 2009.

Asha Bangalore (Northern Trust): Inflation – issue of little importance, for now
“The Consumer Price Index (CPI) dropped 0.7% in December, the third consecutive monthly decline and the fourth drop in the last five months. During the twelve months ended December the CPI moved up only 0.1% (CPI rose 4.1% in all of 2007), which is the smallest gain on record in the post-war period with the exception of a 0.7% drop in the twelve months ended December 1954. The reversal of the energy price index (-21.3% versus +17.4% in 2007) is largely responsible for the significant deceleration of the CPI. The food price index fell 0.1% in December and advanced only at an annual rate of 1.4% during the three months ended December versus a 4.0% annualized increase in the prior three-month period.

“… going forward, given the projections of weak economic conditions, inflation could move below levels that are consistent with price stability for a short period. At the same time, we should bear in mind that the large fiscal and monetary stimulus in place, and more in the pipeline, inflation could once again be problematic but much farther down the road.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 16, 2009.

Jim Sinclair (MineSet): The unavoidable face of hyperinflation
“It is horrifying what the Fed and Treasury injected in percentage terms. A true measure of comparison can be seen in the three months of 2008 when the Fed accomplished more than in the seven years from 1929 to 1937.

“This is beyond all reason, having its own new and terrible consequences well in excess of the consequences of the 1929 and 1932 breaks.

“Markets have been run now for years by algorithms, manipulators and seeded interests that are like summer thunderstorms. They are loud and scary, but quite short term and in the end quite meaningless and non-productive.

“The dollar cannot and will not remain strong, nor can a planetary Weimar experience now be avoided.”

Click here or on the image below for a larger chart.

Source: Jim Sinclair, MineSet, January 14, 2009.

Bloomberg: Hedge fund assets fell record 36% in 2008
“Hedge fund assets fell a record 36% to $1.84 trillion in 2008 as tumbling global markets prompted investor withdrawals and fund liquidations, according to industry researcher HedgeFund.net.

“Hedge funds lost $512 billion through withdrawals and fund closures, while performance losses totaled $535 billion, the New York-based unit of Channel Capital Group said in an e-mailed statement. The decline is the biggest since Hedgefund.net began tracking the data in 2003.

“Funds suffered losses and client withdrawals last year, with some selling assets at fire-sale prices as the global credit crisis forced banks to withdraw loans to the industry. While defections and closures reached a record in December, a benchmark of performance rose for the month after declining in previous months, Hedgefund.net said.

“‘Investor asset flows lag performance, and the sharp rise of outflows in the fourth quarter are the result of yearlong aggregate losses,’ Hedgefund.net said in the statement. ‘Positive performance in December may be an indication that the biggest wave of investor outflows has passed.’”

Source: Tomoko Yamazaki, Bloomberg, January 15, 2009.

Bespoke: S&P sector returns year to date
“Below we highlight S&P 500 sector performance year to date through about noon today. As shown, just three sectors are underperforming the market so far this year, and the Financial sector is weighing heavily on the overall index’s declines. Energy, Health Care, Technology, Materials, and Utilities have actually held up pretty well.”

Source: Bespoke, January 16, 2009.

CNBC: Doll’s outlook for 2009
“A look ahead of the possible double-digit equities growth in 2009, with Bob Doll, BlackRock vice chairman/global CIO.”

Source: CNBC, January 12, 2009.

CNBC: Hendry – bonds still best bet
“Government bonds are still the safest bet for investors in these uncertain times, and the euro will face an uphill battle as weak economies will need more flexibility, Hugh Hendry from Eclectica told CNBC.”

Source: CNBC, January 12, 2009.

BCA Research: US employment will cap Treasury back-up
“The US December employment report was grim and included further downward revisions to prior months. Our forecast for the next six months is equally bearish, which implies that Treasury yields will be capped for a long time.

“The contraction in payrolls were roughly in line with expectations, with a broad-based decline in all industries. Our Model forecasts significant weakness in the first half of the year, with no bottom in sight. Labor and income insecurity will continue to keep consumers from spending, and the already deflationary retailing environment will continue to worsen.

“Historically, Treasury yields sustainably rebound only once the annual growth in payrolls turns up significantly. Thus, any back-up in government bond yields over the next few months will prove short lived. Deflation and a contracting economy will be the primary drivers of trends in the Treasury market, underscoring that fears of higher yields driven by mushrooming budget deficits are premature.”

Source: BCA Research, January 12, 2009.

Ambrose Evans-Pritchard (Telegraph): The bond bubble is an accident waiting to happen
“The bond vigilantes slumber. As the greatest sovereign bond bubble of all time rolls into 2009, investors are clinging to an implausible assumption that China and Japan will provide enough capital to keep the happy game going for ever.

“They are betting too that debt deflation will overwhelm the effects of near-zero interest rates across the G10 and nullify a £2,000 billion fiscal blast in the US, China, Japan, Britain, and Europe.

“Above all, they are betting that the Federal Reserve chief Ben Bernanke will fail to print enough banknotes to inflate the US money supply, despite his avowed intent to do so.

“Yields on 10-year US Treasuries have fallen to 2.4% – a level that was unseen even in the Great Depression. This is ‘return-free risk’, said bond guru Jim Grant.

“It is much the same story across the world. Yields are 1.3% in Japan, 3.02% in Germany, 3.13% in Britain, 3.26% in Chile, 3.47% in France, and 5.56% in Brazil.

“‘Get out of Treasuries. They are very, very expensive,’ said Mohamed El-Erian, the investment chief at the Pimco, the world’s top bond fund, in a Barron’s article last week.

“It is lazy to think that China, Japan, the petro-powers and the surplus states of emerging Asia will continue to amass foreign reserves, recycling their treasure into the US and European bond markets.

“These countries are themselves bleeding as exports collapse. Most face capital flight. The whole process that fed the bond boom from 2003 to 2008 is now going into reverse. Woe betide any investor who misjudges the consequences of this strategic shift.”

Click here for the full article.

Source: Ambrose Evans-Pritchard, Telegraph, January 12, 2009.

David Fuller (Fullermoney): Government bond bubble will burst
“Objectively, there is no doubt that government debt yields in the UK, USA and a number of other countries have moved well outside their historic, normal price ranges and values. This indicates a bubble, which some have described as a ‘return-free risk’.

“We need no reminding today that dire economic circumstances have contributed to these ultra-low yields. Indeed, governments have encouraged the move, with rate cuts and talk of quantitative easing, as part of their reflationary efforts. We also know that governments need to issue considerably more debt to finance their programmes, and they want to do this as cheaply as possible.

“My conclusion is that those who are lending to governments at record or at least near-record low yields, are walking into a trap. The government bond bubble has yet to burst, judging from the charts, but it will burst. With bubbles, it seldom pays to delay one’s exit until the downtrend is evident to all.”

Source: David Fuller, Fullermoney, January 14, 2009.

CNBC: Credit – still a good bet if yield curve steepens?
“Investment-grade credit looks very attractive to Richard Urwin, MD & head of asset allocation & economics research team at BlackRock. But what happens if the yield curve steepens by year-end? He gives his take CNBC’s Amanda Drury & Martin Soong.”

Source: CNBC, January 16, 2009.

Eoin Treacy (Fullermoney): 10-year Treasuries show negative real yield
“It is interesting that this is the first time since 1980 that the US 10yr has shown a negative real yield. The fact is that it has not had anything close to the size of the move, relative to CPI, as seen in 1974 or 1980 is also worthy of notice. Of course back then, high inflation expectations were much more of a factor in the movement of the spread, but that is certainly not the case today.”

Source: Eoin Treacy, Fullermoney, January 13, 2009.

Financial Times: Bond issuance by emerging nations surges
“Emerging market sovereign bond issuance has surged this week as governments take advantage of the dramatic drop in yields because of the sharply improving sentiment since the start of the year.

“The Philippines, Turkey, Brazil and Colombia have all issued debt in the past few days, raising a total of $4.5 billion. This compares with just one deal worth $2 billion from Mexico issued in the entire fourth quarter of 2008.

“Nigel Rendell, senior emerging markets strategist at RBC Capital Markets, said: ‘Sentiment has improved a great deal since January 1 in the emerging market space, so these countries see this as a window of opportunity to issue debt.’

“Since January 1, emerging market bond yields have fallen about 40 basis points compared with US Treasuries, the international benchmark for debt, close to eight-week lows, according to JP Morgan’s Embi+ Index. Emerging market bonds are now trading about 650 basis points above US Treasuries. Emerging market governments are also rushing to issue debt as they fear they could be ‘crowded out’ of the primary bond markets because of the record volumes of sovereign debt due from the industrialised nations.

“These emerging market countries need the cash, like their industrialized counterparts, to stimulate their economies.”

Source: David Oakley, Roel Landingin and John Aglionby, Financial Times, January 9, 2009.

Bespoke: US dollar testing resistance
“The US Dollar index has made a nice comeback after its free-fall from late November to mid December. The dollar is up 6.76% from its low on December 17, but as shown in the chart below, it is bumping up against key resistance at its 50-day moving average. If the dollar is able to break above its 50-day, a resumption of its multi-month uptrend will be solidified. If it fails to break through, however, the current level will be one peak of a newly formed downtrend.”

Source: Bespoke, January 14, 2009.

Edmund Conway (Telegraph): Shipping rates hit zero as trade sinks
“Freight rates for containers shipped from Asia to Europe have fallen to zero for the first time since records began, underscoring the dramatic collapse in trade since the world economy buckled in October.

“‘They have already hit zero,’ said Charles de Trenck, a broker at Transport Trackers in Hong Kong. ‘We have seen trade activity fall off a cliff. Asia-Europe is an unmitigated disaster.’

“Shipping journal Lloyd’s List said brokers in Singapore are now waiving fees for containers travelling from South China, charging only for the minimal ‘bunker’ costs. Container fees from North Asia have dropped $200, taking them below operating cost.

“Industry sources said they have never seen rates fall so low. ‘This is a whole new ball game,’ said one trader.

“The Baltic Dry Index (BDI) which measures freight rates for bulk commodities such as iron ore and grains crashed several months ago, falling 96%. The BDI – though a useful early-warning index – is highly volatile and exaggerates apparent ups and downs in trade. However, the latest phase of the shipping crisis is different. It has spread to core trade of finished industrial goods, the lifeblood of the world economy.”

Source: Ambrose Evans-Pritchard, Telegraph, January 12, 2009.

Bloomberg: Frontline says ships storing the most oil in 20 years
“Frontline Ltd, the world’s biggest owner of supertankers, said about 80 million barrels of crude oil are being stored in tankers, the most in 20 years, as traders seek to take advantage of higher prices later in the year.

“Traders are seeking to profit from a market situation called contango where futures prices are higher than the cost of immediate supplies. A purchaser could buy oil now, keep it for months at sea and fetch better prices by selling oil futures that are higher than the spot price.

“‘In this current financial situation I guess it’s one of the more safe bets to do,’ Jens Martin Jensen, Singapore-based interim chief executive officer of the company’s management unit, said by phone today. Thirty to 35 very large crude carriers, each designed to haul 2 million barrels of crude, are storing oil, with the rest on ships half the size called suezmaxes, he said.

“The contango pricing structure has been caused by excess near-term oil supply as demand slows and speculation that output cuts by the Organization of Petroleum Exporting Countries will reduce the glut later this year.”

Source: Alaric Nightingale, Bloomberg, January 14 2009.

Victoria Marklew (Northern Trust): Eurozone – interest rates, inflation, the economy – all fall down
“As widely expected, the European Central Bank (ECB) lopped another 50 bps off its refi rate this morning [Thursday], taking it to 2.0%. Rates have now come down by 225 bps in four successive steps, including a 75 bps cut in December, as the Eurozone economy hits the skids and inflation drops sharply.

“In his subsequent press conference, President Trichet acknowledged that economic data and surveys over the past month point to ‘a further weakening of economic activity around the turn of the year’ and warned that Eurozone demand is likely to be ‘dampened for a protracted period’ with growth risks to the downside. He also acknowledged that the slowing economy has reduced inflation risks, and that the rate of inflation is likely to ‘fall significantly’ in mid-year, in part because of base effects.”

Source: Victoria Marklew, Northern Trust – Daily Global Commentary, January 15, 2009.

Financial Times: German GDP contracts sharply
“Germany’s economy could have contracted by as much as 2% in the final quarter of 2008, the country’s statistical office warned on Wednesday, deepening a recession that looks likely to be the worst since the second world war.

“The sharp contraction in Europe’s largest economy would sound alarm bells across Europe because of Germany’s role as Europe’s economic powerhouse.

“German exports had benefited from strong global growth in recent years ‘but now that process has gone dramatically into reverse’, said Andreas Rees at Unicredit in Munich.

“The latest data came just hours after Berlin unveiled a two-year $66 billion package of growth-boosting measures. Michael Glos, economics minister, argued on Wednesday that the plan would have a ‘noticeable effect’ by later this year.

“Gross domestic product increased by 1 per cent in 2008 as a whole, after a 2.6% rise in the previous year, the federal statistics office reported. But in the final three months of the year, preliminary estimates suggested that GDP fell between about 1.5% and 2%, it said.”

Source: Ralph Atkins, Financial Times, January 14, 2009.

CEP News: Germany’s coalition parties agree on €50 billion stimulus package
“Germany’s coalition parties have agreed on a second economic stimulus package totalling approximately €50 billion, to be put into place over the course of the next two years in an effort to pull the economy out of its worst recession since the end of the Second World War.

“The package of measures will include approximately €36 billion in infrastructure investment and tax cuts. The announcement was made following six hours of talks between the Christian Democratic Union, the Christian Social Union and the Social Democratic Party in Berlin late on Monday.

“The second stimulus package follows a €31 billion plan already in existence.”

Source: CEP News, January 13, 2008.

Financial Times: Spain hit by public finance warning
“The growing dangers for Europe’s sharply slowing economies were highlighted yesterday as Spain became the third eurozone country to be warned over its deteriorating public finances in the space of three days.

“Standard & Poor’s, the rating agency, said Spain’s top-notch triple A credit ratings could be downgraded because of pressure on its public finances after it entered what is likely to be a deep recession in the fourth quarter. On Friday, Greece and Ireland were also warned by the agency that their ratings could be downgraded as economic conditions worsen. The warning is likely to help drive up borrowing costs for those countries.

“The euro weakened against the dollar and the yen after the announcement, which underlined the challenges facing European countries seeking to stimulate their battered economies and pay for bank bail-outs. Analysts say other European countries could face warnings in the coming days or weeks as governments take on record debt levels, which could jeopardise the sustainability of their public finances.”

Source: David Oakley and Victor Mallet, Financial Times, January 12, 2009.

Financial Times: China sees “success” in offsetting crisis
“Wen Jiabao declared China’s efforts to offset the effect of the global economic slowdown an ‘initial success’ on Sunday as the economy performed ‘better than expected’ last month.

“The premier’s hints that the country’s economy might not be locked in a downward spiral will be seen as good news in the rest of the world, where Chinese growth is viewed as a potential palliative for the global recession.

“Speaking during a three-day visit to industrial regions in eastern China, Mr Wen said sales at some companies had begun to rebound, stockpiles were falling and electricity consumption was rising.

“‘We have achieved initial success from the policies we adopted to counter the financial crisis,’ the premier said, according to China National Radio.

“Beijing announced an economic stimulus package of Rmb4,000 billion ($585 billion) in November, heavily weighted towards construction and heavy industry. It was not expected to improve economic growth until the middle of this year but some industries, such as steel, have already shown more confidence since the stimulus package was announced. Scores of Chinese steelmakers have resumed production in the hope that it will lead to a sustained recovery in steel prices.

“Mr Wen vowed that the central government would take other measures, including large investments, to combat the crisis before the legislature’s annual meeting in early March, according to a speech published separately.”

Source: Patti Waldmeir, Financial Times, January 11, 2009.

US Global Investors: Rebound in Chinese bank lending
“A significant rebound in money supply growth and bank lending in China during December suggests that the government’s stimulating policies may have achieved some success. However, challenges for the economy are likely to be sustained in the foreseeable future.”

Source: US Global Investors – Weekly Investor Alert, January 16, 2009.

Bloomberg: China passes Germany to become third-biggest economy
“China’s economy overtook Germany’s in 2007 to become the world’s third largest, underscoring the nation’s increasing economic and political clout.

“Gross domestic product expanded 13% from a year earlier, more than a previous estimate of 11.9%, to 25.731 trillion yuan ($3.38 trillion), the statistics bureau said on its website today. That topped Germany’s 2.424 trillion euros ($3.32 trillion), using average exchange rates for 2007.

“China’s economy is 70 times bigger than when leader Deng Xiaoping ditched hard-line Communist policies in favor of free-market reforms in 1978. After overtaking the UK and France in 2005, China became the third nation to complete a spacewalk, hosted the Olympic Games and surpassed Japan as the biggest buyer of US Treasuries.

“The figure was released as China faces the weakest economic expansion since 1990 after exports collapsed because of the global recession.”

Source: Nipa Piboontanasawat and Kevin Hamlin, Bloomberg, January 14 2009.

Financial Times: Jim O’Neill on the Bric economies
“Jim O’Neill, Chief Economist at Goldman Sachs, tells David Oakley about the reasons to be positive on China, finding value in Bric economies, and the problems facing Russia.”

Source: Financial Times, January 9, 2009.

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Words from the (investment) wise for the week that was (January 5 – 11, 2009)

Sunday, January 11th, 2009

Global stock markets reversed course during the last three days of the first full trading week of 2009 as investors were confronted with dreadful economic data, escalating layoffs and a bleak earnings outlook.

As investor sentiment soured, the MSCI World Index and the MSCI Emerging Markets Index declined by 2.5% and 1.7% respectively during “turnaround week”.

The US stock markets – leaders among mature markets since the November 20 low – were on the receiving end of the selling orders and recorded relatively large weekly losses of 4.8% for the Dow Jones Industrial Index and 4.4% for the S&P 500 Index. On the other end of the performance scale, Brazil (+11.8%) and Ireland (+11.0%) brought investors cheer. (The Dublin ISEQ Index was the worst bear market performer, losing 76.8% from June 2007 to November 2008.)

Source: Daryl Cagle

Elsewhere, the US Dollar Index (+1.0%) closed up for the week, but off its highs on the back of dismal US labor market data. As governments seek to raise record amounts of debt to stimulate declining economies, the increasing supply of sovereign paper pushed up yields of longer-dated bonds in the US, UK and eurozone. “The long-held assumption that US assets – particularly government bonds – are a safe haven will soon be overturned as investors lose their patience with the world’s biggest economy,” said respected economist Willem Buiter in The Telegraph.

Despite geopolitical problems and the disruption of European gas supplies, West Texas Intermediate Crude closed 11.9% down on the week as the severity of the global recession raised fresh concerns about demand. Platinum (+6.2%) made up lost ground relative to its precious metal cousins, gold (-2.8%) and silver (-1.5%). (Also see my post “Picture du Jour: Gold or platinum?“.)

The release on Tuesday of the minutes of the Federal Open Market Committee’s meeting of December 15 and 16 showed committee members very concerned about the economic outlook. It was decided to move beyond using the Fed funds rate as the key policy tool, expand the central bank’s balance sheet to buy assets to help reduce longer-term interest rates, and make it explicit to keep the Fed funds rate low for an extended period of time, also in an attempt to bring down longer-term rates.

The Fed on Monday started its $500 billion program of buying securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae, resulting in a decline in home loan rates.

Meanwhile, President-elect Barack Obama’s incoming administration is planning an economic stimulus package worth more than $800 million, including $300 million of tax cuts. Obama said: “The economy is very sick. Economists from across the political spectrum agree that if we don’t act swiftly and boldly, we could see a much deeper economic downturn …”

Source: Daryl Cagle

The past week saw some progress on the credit front, with the TED spread (down to 1.20% from 4.65% on October 10, 2008), LIBOR-OIS spread (down from 3.64% on October 10 to 1.07%) and GSE mortgage spreads having narrowed markedly since the record highs. More recently, high-yield spreads have also seen a strong improvement, with the Merrill Lynch US High Yield Index declining by 23.7% since its high of December 15 (see chart below).

Although credit spreads still have to narrow considerably before the world’s financial system functions normally again, the recent action has been a step in the right direction.

With many analysts warning that the bubble in Treasuries looks ready to pop, corporate credit seems to beckon. According to a Financial Times survey of 30 leading asset managers and strategists “high-grade corporate bonds are set to outperform other asset classes in 2009″.

The iBoxx Investment Grade Corporate Bond Fund (LQD) and High Yield Corporate Bond Fund (HYG) both rallied over the past week and increased by 2.0% and 3.8% respectively. These Funds have performed excellently since their October/November lows, with LQD up by 26.7% and HYG by 26.2% from November.

Next, a quick textual analysis of the dozens of articles I have read during the past week. Interestingly, many reports were concerned with “bonds” and “yields”.

Turning to the outlook for the stock market, Bennet Sedacca (Atlantic Advisors Asset Management) warned as follows in a guest post entitled “Setting the bull trap“: “The Fed has declared a war on savers, a war on prudence and provided the ultimate Moral Hazard Card – and with our money no less. They are also setting up the ULTIMATE BULL TRAP – a trap so large that when it is sprung, perhaps as early as the end of the first quarter/beginning of second quarter, there will only be sellers left.”

“It is difficult to see how equities can sustain an advance until the monetary transmission mechanism begins to function more normally,” added BCA Research. “In addition, the poor earnings outlook will be a persistent headwind for stocks throughout 2009 and analysts are likely to be disappointed in their overly optimistic profit forecasts: earnings could fall by as much as 25 to 30% as revenue growth slows and margins contract.”

Arguing the bullish case from Hong Kong, Puru Saxena’s MoneyMatters newsletter listed the following reasons to support his viewpoint that “the skies are clearing for a four- to five-year bull market”: surging liquidity, low interest rates, declining corporate bond yields, declining TED spread, low valuations, volatility has peaked, the US dollar rally has ended, global stock markets are making higher lows, and a huge amount of cash on the sidelines.

The short-term technical picture is tricky, with the Dow having pulled back below the 50-day moving average and the S&P 500 (shown in the graph below) testing both the 50-day line and the short-term trendline defining the bottom of a rising wedge (usually a negative chart pattern). The December 22 and 29 lows of 857 are also important initial levels for the uptrend to remain intact.

Commenting on the chart, Richard Russell (Dow Theory Letters) said: “My guess (and I do have to guess) is that the market will be doing work inside the bottom pattern. This is only natural since it takes a good deal of ‘work’ for stocks to break out of a bottom in the face of the ongoing abysmal news. It looks like we are going to have some bobbing and weaving inside the base that has formed. A breakout either way may be a matter of months away.”

An old stock market saw tells us the first five trading days of January sets the course for January, and if the month of January is higher, there is a good chance the year will end higher, i.e. the so-called “January Barometer”. So far so good, as the S&P 500 registered a gain of 0.7% over the first five days (although the Dow was down by 0.4%).

Jeffrey Hirsch (Stock Trader’s Almanac) said: “The return of seasonal bullish market action is encouraging. Since the week of Thanksgiving the market has been constructive. Thanksgiving week was bullish, as was the last half of December, the Santa Claus Rally and now the First Five Days. The final arbiter of these year-end/new-year indicators is of course the January Barometer at month-end.”

While a sustained stock market advance will rely on the thawing of credit markets, I am of the opinion that selective buying in global markets is in order. However, make sure to winnow the wheat from the chaff. The current default rate on American high-yield bonds is less than 4%, but Barclays Capital is predicting a rate of 14.3% by the second half of 2009. “If 2008 was the year of systemic risk [i.e. risk affecting all assets], 2009 seems likely to be a year dominated by specific risk [i.e. risk that is unique to each asset],” said The Economist.

For more discussion about the direction of stock markets, also see my post “Video-o-rama: Figuring out the lie of the financial land“.

Economy
“Global business confidence began 2009 as dark as it has ever been. While sentiment has improved a bit during the last two weeks, it remains near record lows,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. “Businesses are nearly equally pessimistic across the globe and across all industries. Hiring intentions have turned particularly negative in recent weeks. Pricing power has collapsed, suggesting that deflation is a significant threat.”

The eurozone economy contracted by 0.2% in the third quarter of 2008, according to Eurostat. Following a similar decline in GDP in the previous quarter, the monetary union has officially entered a recession.

The latest industrial production data for the UK, Germany and France continued a downward spiral. It therefore did not come as a surprise that the Bank of England (BoE) on Thursday lowered its repo rate by 50 basis points to 1.5% – the lowest level since the inception of the BoE in 1694. The European Central Bank (ECB) is also expected to lower interest next Thursday as a result of gloomy economic reports and the eurozone inflation rate last month falling below the ECB’s target.

Nouriel Roubini (RGE Monitor) said: “Manufacturing surveys reflect simultaneous contraction in manufacturing throughout the G7 and in key emerging markets like China, Brazil and Russia, verifying the global recession that is well on course. PMI and industrial production is at decade lows in key emerging markets, and the US and EU PMI surveys reflect the weakest levels in several decades.” The JPMorgan Global Manufacturing PMI, posting its weakest reading ever in December, bears this out.

As far as the US is concerned, 2008 ended on a depressing note for the US labor market. Payroll employment declined by 524,000 jobs in December, slightly more than expected and the largest one-month decline since December, 1974. Payrolls shrank by 2.6 million jobs over the course of 2008, recording the largest annual decline since 1945. The unemployment rate rose to 7.2% – the highest level since the early 1990s.

“The Bureau of Labor Statistics employed seasonal adjusting chicanery to mitigate job losses. Not seasonally adjusted (NSA), 954,000 jobs were lost. Additionally, the BLS’s hokey Net Business Birth/Death Model unfathomably created 72,000 jobs in December,” commented Bill King (The King Report).

Asha Bangalore (Northern Trust) summarized the US economic situation as follows: “The Fed is expected to stay on hold for all of 2009 in terms of implementing monetary policy changes via adjustments of the target Fed funds rate, but other non-interest avenues to support/ease financial market conditions remain open. The details of the employment report are grim and provide ample evidence for proponents of a large fiscal stimulus package to revive economic activity.”

Week’s economic reports

Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, January 9, 2009.

In addition to a speech by Fed Chairman Bernanke at the London School of Economics (Tuesday, January 13) and the European Central Bank’s interest rate announcement (Thursday, January 15), the US economic highlights for the week, courtesy of Northern Trust, include the following:

1. International Trade (January 13): The trade deficit is predicted to have narrowed in November ($54.5 billion versus a trade gap of $57.2 billion in October), largely reflecting lower prices of imported oil. Consensus: $51.5 billion.

2. Retail Sales (January 14): Auto sales moved up slightly in December (10.7 million versus 10.3 million in November). But lackluster non-auto retail sales and lower gasoline prices should bring down the headline reading. Consensus: -1.2% versus 0.3% in January; non-auto retail sales: 0.2% versus 0.3% in January.

3. Producer Price Index (January 15): The Producer Price Index for Finished Goods is expected to have declined by 1.7% in December, reflecting lower energy prices. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in November. Consensus: -2.0%, core PPI +0.1%.

4. Consumer Price Index (January 16): A drop in the overall CPI, due to lower energy prices, is nearly certain. The core CPI is expected to have increased by 0.1% after holding steady in November. Consensus: -0.9%, core CPI +0.1%.

5. Industrial production (January 16): The 2.4% drop in the manufacturing man-hours index in December is indicative of a large decline in industrial production (-1.3%). The operating rate is projected to have dropped to 74.5 in December. Consensus: -1.2%; Capacity Utilization: 74.5 versus 75.4 in November.

6. Other reports: Inventories, Import prices (January 14), Consumer Sentiment Index (January 16).

Click here for a summary of Wachovia’s weekly economic and financial commentary.

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

Source: Wall Street Journal Online, January 9, 2009.

And now for a few news items and some words from the investment wise that should be of help in keeping our investment portfolios on a winning path. As the Irish say: “Go n-éirí an bóthar leat. May the road rise with you.”

That’s the way it looks from Cape Town.

CNN Money: The wealthy self-destruct
“Millionaires and billionaires are turning to suicide in the wake of the financial crisis.”

Source: CNN Money, January 9, 2009.

CNBC: Marc Faber – markets to rally, but retest lows

Click here for article.

Source: CNBC, January 9, 2009.

Mish’s Global Economic Trend Analysis: Themes for 2009
“Looking ahead in 2009 here are some things I see as likely.

“Obama will pass a stimulus package of $850+ billion but $300 billion will be ‘tax relief’ amounting to $19 a week per household at most. $19 a week is not going to stimulate much of anything but it will add to the budget deficit. People will use that money to pay down bills, which is exactly what they should be doing with it.

“The first 3-5 months are going to be extremely weak on the jobs front with 400,000 or more jobs lost each month. Obama is going to need to create 2-3 million jobs just to counteract job losses in first half of the year. There is no way he is going to create jobs that fast given implosions in state budgets and retailers.

“In 2009 consumers will continue to retrench, housing will continue to decline, and as many as 100 small or regional banks will implode over falling commercial real estate prices. The Fed may arrange shotgun marriages with these banks instead of letting them go under.

“I am sticking with a thesis that says we are currently in a sucker rally in the stock market that will end soon after inauguration or moments after Obama signs a new stimulus package. My target is 600 on the S&P but 450 is not out of the question. However, it is better to think of this in ranges and that range would roughly be 450-700.

“It is quite possible the lows in treasury yields are in. Unlike 2008 where I was constantly beating the drums for lower yields, 2009 could be different. Here are the facts: 3 month and 6 month yields hit 0% and the 10 year came close to hitting 2%. Could there be lower yields still? Yes, quite easily. Is it worth playing for other than as a hedge or part of an overall investment strategy? No.

“Should treasuries be shorted? No, it is too early. Yields can easily make lower lows. Just because something is not a good long, does not make it a good short. Look at how long yields stayed low in Japan. I doubt we see a print of 4 on the 10-year treasury for a long time. If one wants to bet on yields rising for a reflation trade, there are better plays such as going long energy stocks that yield a nice dividend as well.”

Click here for the full article.

Source: Mike “Mish” Shedlock, Mish’s Global Economic Trend Analysis, January 6, 2009.

CNBC: President-elect Obama on the economy

Source: CNBC, January 8, 2009.

BBC News: Obama says US economy “very sick”
“US President-elect Barack Obama has described America’s economy as ‘very sick’ and has said that the situation was worsening. Earlier, he met politicians in Washington to discuss ways to boost the economy and create new jobs.

“US media reports say he is planning a stimulus package worth more than $800 billion, including $300 billion of tax cuts.

“Mr Obama has said he wants a plan that will create 3 million jobs by 2011.

“The president-elect hopes to be able to enact the package shortly after his inauguration on 20 January.

“‘The economy is very sick,’ he said. ‘We have to act and act now to break the momentum of this recession. We’ve got an extraordinary economic challenge ahead of us, we’re expecting a sobering job report at the end of the week.’

“‘Economists from across the political spectrum agree that if we don’t act swiftly and boldly, we could see a much deeper economic downturn that could lead to double-digit unemployment and the American dream slipping further and further out of reach,’ Mr Obama said.”

Source: BBC News, January 06, 2009.

CNBC: Barney Frank on TARP
“Rep. Barney Frank comments on the revisions to the TARP.”

Source: CNBC, January 9, 2009.

Fox Business: Outraged! – Peter Schiff on the economy

Source: Fox Business, January 7, 2009.

Financial Times: New York Fed starts $500 billion home loans aid
“The Federal Reserve Bank of New York on Monday said it had started its $500 billion plan to drive down US mortgage rates by buying securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae, the government-run mortgage financiers.

“Mortgage bond yields fell sharply as a result, extending a dramatic decline that followed the New York Fed’s announcement of the programme on November 25. Thirty-year agency mortgage securities yielded 190 basis points over Treasuries on Monday, compared with 208bp on Friday.

“The Fed did not disclose the amount of its purchases on Monday, but said it would provide weekly updates on its buying programme from Thursday.

“Last week, the New York Fed pushed forward with its plan by setting a goal of buying $500 billion in mortgage-backed securities by mid-2009, part of a sustained effort to help the US weather the financial crisis.

“A reduction in financing costs for the mortgage agencies translates into lower rates for US home loans. Average interest rates on 30-year fixed-rate mortgages have fallen from 6% to about 5.3% since the program was announced in November, according to Bankrate.com.”

Source: Saskia Scholtes, Financial Times, January 5, 2009.

The Seattle Times: Steel industry hopes for big stimulus shot
“The steel industry, having entered the recession in the best of health, is emerging as a leading indicator of what lies ahead. As steel production goes, and it is now in collapse, so will go the national economy.

“That maxim once applied to the Big Three car companies. Now they are losing ground in good times and bad, and steel has replaced autos as the industry to watch for an early sign that a severe recession is beginning to lift.

“The industry itself is turning to government for orders that, until the collapse, came from manufacturers and builders.

“Its executives are waiting anxiously for details of President-elect Obama’s stimulus plan and adding their voices to pleas for a huge public investment program – up to $1 trillion over two years – that will lift demand for steel to build highways, bridges, power grids, schools, hospitals, water-treatment plants and rapid transit.

“New spending should provide an immediate jolt to the steel business, which has already gone through the painful makeover now demanded of the Big Three.”

Source: Louis Uchitelle, The Seattle Times, January 2, 2009.

Financial Times: US deficit set for postwar record
“The US budget deficit will hit nearly $1,200 billion this fiscal year even without the cost of Barack Obama’s planned fiscal stimulus, Congress’s budget watchdog warned on Wednesday.

“The warning came as the president-elect said that the stimulus would be ‘on the high end of our estimates’ – implying close to $775 billion over two years – but ‘will not be as high as some economists have recommended, because of the constraints and concerns we have about the existing deficit’.

“The estimate, published by the Congressional Budget Office, threw into stark relief the dilemma facing the president-elect, highlighting the urgent need for stimulus and the fraught state of public finances.

“The CBO said that the budget deficit for the fiscal year 2009 would ‘shatter the previous post-World War Two record’ relative to the size of the US economy. Without a stimulus, it said that the deficit would reach 8.3% of gross domestic product. Its numbers imply that the proposed stimulus could push the US fiscal deficit close to or over 10% of GDP.”

Source: Krishna Guha, Edward Luce and Andrew Ward, Financial Times, January 7, 2009.

Financial Times: Auto sales hit fresh lows in December
“Motor vehicle sales plumbed fresh lows around the world last month, adding to pressure on carmakers, their suppliers and dealers.

“General Motors, Toyota, Ford and Honda all reported declines of more than 30% in the US, the biggest market, compared with December 2007. Total fourth-quarter sales were the lowest since 1981.

“Car sales in Japan, including buses, dropped 22% to the lowest December level on record, according to the Japan Automobile Dealers Association.

“In Europe, registrations in Spain plunged by almost half, in France by 24% and Italy 13.2%.

“The slump in the US and Europe reflected flagging consumer confidence and tight credit.”

Source: Bernard Simon, Financial Times, January 5, 2009.

Bloomberg: Nouriel Roubini – worst is still ahead of US
“The global financial system in 2008 experienced its worst crisis since the Great Depression of the 1930s. Major financial institutions went bust. Others were bought up on the cheap or survived only after major bailouts. Global stock markets fell by more than 50% from their 2007 peaks. Interest-rate spreads spiked. A severe liquidity and credit crunch appeared. Many emerging-market economies on the verge of a crisis had to ask for help from the International Monetary Fund.

“So what lies ahead in 2009? Is the worst behind us or ahead of us?

“Unfortunately, the worst is ahead of us. The entire global economy will contract in a severe and protracted U-shaped global recession that started a year ago. The US will certainly experience its worst recession in decades, a deep and protracted contraction lasting at least through the end of 2009. Even in 2010 the economic recovery may be so weak – 1% growth or so – that it will feel terrible even if the recession is technically over.

“There also will be recessions in the euro zone, the UK, continental Europe, Canada, Japan and the other advanced economies.

“A hard landing for emerging-market economies may also be at hand. Among the so-called BRICs, Russia will be in an outright recession in 2009. Growth in China will slow to 5% or less, representing a hard landing for a country that needs expansion of close to 10% to move 10 million to 15 million poor rural farmers into the urban industrial sector every year. Brazil will barely grow in 2009. Even India will experience a sharp slowdown.”

Click here for the full article.

Source: Nouriel Roubini, Bloomberg, January 1, 2009.

E.S. Browning (The Wall Street Journal): Rebound Wrinkle – recession
“Since the Great Depression, only two recessions have run longer than this one, the first ending in 1975 and the other in 1982. Each lasted 16 months, according to the National Bureau of Economic Research, the government-designated recession tracker.

“The current recession, beginning in December 2007, has run 13 months and could easily surpass those two. If it goes past March, as many economists expect, it will become the longest-running since the 43-month beast that ended in 1933.”

Source: E.S. Browning, The Wall Street Journal, January 5, 2009.

BCA Research: FOMC Minutes – Fed’s balance sheet to balloon further
“The Minutes from the mid-December FOMC meeting confirmed that policymakers are very concerned about the possibility of a prolonged economic slump and a sustained bout of deflation.

“With the fed funds rate virtually zero, the Minutes highlighted that the policy focus would shift to unconventional tools. The first such tool is communication strategy. This includes signalling that the policy rate would stay ‘exceptionally low for some time’, in order to keep longer-term borrowing rates low.

“The Fed also would reinforce its commitment to keep inflation from falling below ‘desired levels’ on a sustained basis, in order to avoid an unwelcome rise in real rates of interest if expectations for deflation mushroom (as occurred in Japan).

“The second major unconventional tool is quantitative easing, in which the Fed’s balance sheet and excess bank reserves would grow as needed while purchasing large amounts of assets (including Agencies and Agency-backed MBS).

“Although not mentioned in the Minutes, the Fed’s next move could be to purchase high-quality corporate bonds if yields on these instruments do not fall in the near term. Bottom line: Investors should expect falling private sector bond yields and a long period of zero short-term rates.”

Source: BCA Research, January 8, 2009.

Trader Dan (JS Mineset): Fed monetizing US agency debt
“The reason they [the Fed] are being forced into buying the debt is because no one else wants it. We have been charting this for some time by monitoring the Custodial data from the US Federal Reserve system.

“… chart … see how foreign central banks are dumping Fannie and Freddie debt in large amounts onto the market. Without the Fed monetizing that debt, there would be a significant drop off in the amount of funds for mortgages.

“The Fed is going to need every bit of that $500 billion they are going to create out of thin air to acquire what the foreign central banks are unloading.”

Source: Trader Dan, JS Mineset, January 5, 2009.

Asha Bangalore (Northern Trust): December employment report – further deterioration of labor conditions
- Civilian Unemployment Rate: 7.2% in December versus 6.8% in November, cycle low is 4.4% in March 2007.

- Payroll Employment: -524,000 in December versus -584,000 in November, net loss of 154,000 jobs after revisions of payroll estimates for October and November.

- Hourly earnings: +5 cents to $18.36, 3.7% yoy change versus 3.8% yoy change in November; cycle high is 4.28% yoy change in December 2006.

“The Fed is expected to stay on hold for all of 2009 in terms of implementing monetary policy changes via adjustments of the target federal funds rate but other non-interest avenues to support/ease financial market conditions remain open. The details of the employment report are grim and provide ample evidence for proponents of a large fiscal stimulus package to revive economic activity.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 9, 2009.

Paul Kedrosky (Infectious Greed): There’s unemployment, and then there’s unemployment
“I have been sent this Reuters story from yesterday umpteen times, so I may as well post it, as well as the underlying graph. The gist: If unemployment were being measured the same way as it was during the Depression, the US would be well on its way to similar numbers.

“Check the SGS line in the following graph from John Williams’ ShadowStats:

“Eye-opening, is it not?

“A few quick comments:

- Unemployment by SGS’s measure is at almost 18%, but it’s also not been under 10% in recent history.

- The whole idea of employment/unemployment has changed a great deal over time, with, for example, there being more part-time and flex work etc., messing with figures.

- The existence of a social safety net has, for better or worse, made it possible for people to withdraw permanently from the workforce without having to live on the streets.

- There is no denying that there are far more able-bodied people out of work than the skewed-low US BLS figures purport to show.”

Source: Paul Kedrosky, Infectious Greed, January 9, 2009.

Bloomberg: Pimco’s McCulley says US economy in “nasty recession”
“Paul McCulley, managing director at Pimco, talks with Bloomberg’s Kathleen Hays about the outlook for the US economy in 2010. McCulley says the Fed is using the right policy response to the current crisis and that he has ‘very small’ concerns about inflation.”

Source: Bloomberg, January 9, 2009.

Comstock Partners: The cycle of deflation

Source: Comstock Partners, January 2009.

Asha Bangalore (Northern Trust): Further declines in pending Home Sale Index
“The Pending Home Sales Index (PHSI) of the National Association of Realtors dropped 4.0% to 82.3 in November after a 4.2% drop in the prior month. Although mortgage rates have dropped in recent months, the positive impact on the housing market in terms of an increase in sales is yet to be seen.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 6, 2009.

Asha Bangalore (Northern Trust): Non-manufacturing ISM Survey close to record low
“The Non-manufacturing ISM composite index increased to 40.6 in December from 37.3 in November. But the level is significantly below the expansion cut off mark of 50.0, implying that the non-manufacturing sector continues to lose momentum.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 6, 2009.

Bloomberg: US retail sales fell 0.8% in week after Christmas
“Purchases at US retailers declined last week as post-Christmas markdowns failed to overcome what may have been the worst holiday shopping season in four decades.

“Sales at stores open at least a year dropped 0.8% in the seven days through January 3, the International Council of Shopping Centers and Goldman Sachs Group said today [Tuesday] in a statement. ICSC Chief Economist Michael Niemira said November-December sales declined as much as 2%.

“‘December was relatively chaotic in price, with more discounts than retailers planned, especially in department stores,’ Richard Hastings, a consumer strategist at Global Hunter Securities, said in a telephone interview. ‘Consumers have discovered that the industry is responding with lower and lower and lower prices.’”

Source: Heather Burke, Bloomberg, January 6, 2009.

Bloomberg: US shopping mall vacancies reach 10-year high
“Vacancies at US malls and shopping centers approached 10-year highs in the fourth quarter, and are set to rise further as declining retail sales put more stores out of business, research firm Reis Inc. said.

“Regional mall vacancies rose to 7.1% last quarter from 6.6% in the third quarter. It was the highest vacancy rate since Reis began tracking regional malls in 2000, as well as the largest quarter-to-quarter jump in vacancies, according to New York-based Reis.

“More than a dozen retailers, including Circuit City, Linens ‘n Things and Sharper Image, filed for bankruptcy protection in 2008 as the credit squeeze and recession drained sales. Vacancies will rise further until the job market recovers, housing prices stabilize and lending resumes, restoring consumer confidence, said Reis.”

Source: Hui-yong Yu, Bloomberg, January 7, 2009.

Bespoke: “Official” 2009 strategist S&P 500 price targets
“Below we list the 2009 S&P 500 strategist price targets in the final Bloomberg survey of 2008 (on 29 December). The average 2009 year-end S&P 500 estimate of the 11 sell-side strategists that participated is 1,056, or 16.9% above the S&P’s year-end price of 903.25.

“UBS strategist David Bianco is the most bullish of the group with a year-end target of 1,300 (a 43.9% gain). Deutsche Bank’s Binky Chadha is the second most bullish with a target of 1,140, followed by Goldman, Strategas, and JP Morgan, who are all looking for a gain of 21.8%. Only one strategist, Barclays’ Barry Knapp, believes the S&P 500 will fall in 2009, but only by 3.2%.

“The consensus estimate for year-end 2008 was 1,632 at the start of last year, which translated into an expected gain of 11.12%. Let’s hope the strategists are a little closer to the mark this year.”

Source: Bespoke, January 6, 2009.

Bespoke: Crazy gains since November 20 low
“While no one is calling it that, we are technically in a new cyclical bull market and have been since December 8. Since the 11/20 lows, the S&P 500 is up 24%, which meets the standard bull market definition of a 20% rally that was preceded by at least a 20% decline. But the unwillingness for the majority to call it a bull market is what bulls should be thankful for, since the market typically climbs a wall of worry where investors are full of doubt throughout the rally.

“Regardless of what you call it, some of the performance numbers since the 11/20 lows are downright crazy. Even though the S&P 500 is up 24% since 11/20, the average stock in the index is up 41.25%. This means the smaller cap names in the index are up much more than their larger cap brethren. And the stocks that were down the most during the 10/9/07 to 11/20/08 bear are up much more than the ones that were down the least. As shown below, the average performance since 11/20 of the 50 stocks that were down the most during the bear market is 112%! The 50 best-performing stocks during the bear market are only up an average of 8.3%.

“And while 20 stocks in the S&P 500 are down since November 20, 29 of them are up more than 100%!”

Source: Bespoke, January 6, 2009.

Bespoke: Investor sentiment shows improvement
“When gauging investor sentiment, the two most popular surveys that track bullish sentiment are the polls conducted by Investors Intelligence of newsletter writers and the American Association of Individual Investors (AAII) survey of its members. As shown below, both measures have shown improvement in recent weeks and have broken their downtrends of the last several months. Given that investor sentiment is typically a contrarian indicator, high readings of bullishness are generally considered negative for the market. However, with current bullish sentiment readings below 50%, these are hardly levels that can be considered extreme.”

Source: Bespoke, January 8, 2009.

Investment Week: Mobius reduces cash holdings
“Franklin Templeton’s Mark Mobius has reduced his cash positions over the past couple of months, saying he is positive on the prospects for the global economy.

“Manager of the Emerging Markets Investment Trust, Mobius says he is ‘quite bullish on the future despite all the negative news’ and predicts the beginning of a recovery in the second quarter of this year.

“‘Valuations look good and with interest rates at one or below and stocks yielding up to 20% on dividends this looks very tempting for investors,’ he says.

“Mobius claims that while he is actively investing, others are not: ‘I don’t think this is the consensus – people have the feeling we are nearing the bottom but they are not putting their money there. Bull markets are built on a bull market, not a bear market. However we are being proactive.’

“Having ramped up his cash allocations going into the big fall, Mobius started reinvesting in November. He favours energy and emerging market consumer stocks – including banks which weren’t hit by the debt crisis – and maintains oil and commodities valuations are still strong.”

Source: Beth Brearley, Investment Week, January 6, 2009.

BCA Research: A challenging equity outlook
“Equity markets could have a healthy January effect this year after the fallout in 2008. However, the macro backdrop remains risky.

“Last year’s violent selloff left global equity prices down nearly 50% from their cyclical highs, making this the second deepest bear market in the past 40 years. In other words, a lot of bad news has been discounted as sentiment became crushed and investors rushed for safety. It now appears that selling pressures may finally be abating: equity prices have edged higher in recent trading days on the back of tentative improvements in the credit markets and an easing in implied option volatilities from sky-high readings.

“Upside momentum could persist in the weeks ahead as investors and money managers reposition their portfolios and redeploy some of the cash piled on the sidelines. That said, it is difficult to see how equities can sustain an advance until the monetary transmission mechanism begins to function more normally. In addition, the poor earnings outlook will be a persistent headwind for stocks throughout 2009 and analysts are likely to be disappointed in their overly optimistic profit forecasts: earnings could fall by as much as 25% to 30% as revenue growth slows and margins contract.

“Bottom line: Equities seem poised to edge higher from oversold levels but a sustained advance will rely on the stabilization of credit markets.”

Source: BCA Research, January 5, 2009.

Bloomberg: Saut says “decent chance” equity markets have bottomed
“Jeffrey Saut, chief investment strategist at Raymond James Financial, talks with Bloomberg’s Carol Massar about his investment strategy in the stock market. Saut also discusses the outlook for the US economy and the impact of rising credit costs on corporate margins.”

Source: Bloomberg, January 7, 2009.

The New York Times: China losing taste for US debt
“China has bought more than $1 trillion of American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home, a move that could have painful effects for American borrowers.

“In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.

“But now Beijing is seeking to pay for its own $600 billion stimulus – just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to local governments to build new roads and other projects.

“‘All the key drivers of China’s Treasury purchases are disappearing – there’s a waning appetite for dollars and a waning appetite for Treasuries, and that complicates the outlook for interest rates,’ said Ben Simpfendorfer, an economist in the Hong Kong office of the Royal Bank of Scotland.”

Source: Keith Bradsher, The New York Times, January 7, 2009.

Barron’s: Stay away from Treasury bonds
“The bubble in Treasuries looks ready to pop, sending prices on government debt sharply lower. But just about every other corner of the bond market beckons.”

Click here for the article.

Source: Barron’s, January 3, 2009.

John Authers (Financial Times): A bond bubble?

Source: John Authers, Financial Times, January 6, 2009.

Bloomberg: Treasury bond market not a bubble, Goldman Sachs says
“Goldman Sachs Group said the US Treasury market hasn’t turned into an asset bubble even as investors debate the wisdom of buying government bonds with yields near record lows.

“The US economy is likely to expand below its potential for the next six to eight quarters, resulting in lower ‘core’ inflation, according to a report released today by the New York- based firm. Inflation erodes the fixed payments of bonds.

“‘By mapping one-year ahead macro expectations to long-dated government yields through our Sudoku framework we find that global bonds are, in the aggregate, currently trading close to the model’s measure of fair value,’ Francesco Garzarelli, chief interest-rate strategist at Goldman Sachs in London, wrote in a research note.

“As the year progresses and investors’ focus shifts to the prospects for recovery into 2010, yields will likely drift higher, though in line with Goldman Sachs’ forecasts, Gazarelli wrote. Treasury 10-year note yields will likely trade at 3% to 3.25% by year-end, he said. During the current quarter, yields will trade in a 2.50% to 2.75% range, Goldman Sachs’ predicts.”

Source: Liz Capo McCormick, Bloomberg, January 8, 2009.

Financial Times: German bond sale’s fate signals trouble ahead
“A German sovereign bond auction failed on Wednesday as investors shunned one of the most liquid and safe assets in the world in a warning for governments seeking to raise record amounts of debt to stimulate slowing economies.

“The fate of the first eurozone bond auction of 2009 signals trouble ahead as governments around the world hope to issue an estimated $3,000 billion in debt this year, three times more than in 2008.

“The 10-year bonds failed to attract enough bids to reach the €6 billion the German government wanted. Bids of €5.24 billion, a cover of only 87%, amounted to the second worst auction on record in terms of demand.

“Analysts said the vast amount of supply is deterring investors and a growing number of countries, including those with deep and mature bond markets, such as Germany, the UK and Italy, are struggling to attract buyers.”

Source: David Oakley, Financial Times, January 7, 2009.

Financial Times: Asset managers turn to corporate bonds
“High-grade corporate bonds are set to outperform other asset classes in 2009, fund managers and market strategists surveyed by the Financial Times have forecast.

“More than half those surveyed said high-quality corporate credit was trading at cheap levels and that this was the asset class most likely to see a rally in 2009.

“In contrast, government bonds were the least-favoured asset class, with many of the 30 leading asset managers and strategists surveyed arguing that yields had plummeted too far in 2008, prompting talk of a possible price bubble.

“A majority of those polled said high-quality corporate bonds had been oversold after investors had abandoned corporate credit of all grades over the past year in favour of the safest and most liquid assets, such as government bonds and gold.

“Tim Bond, global head of asset allocation at Barclays Capital, said: ‘I like credit as an asset class the best. Investment-grade corporate bond spreads are at levels last seen in 1932, which happened to be an excellent point to buy credit – even though it was the middle of the Great Depression.’

“John Paul Smith at Pictet Asset Management said corporate credit offered the best potential returns while the severe global recession continued. ‘While we don’t anticipate any immediate improvement in the economic outlook, with corporate credit yields currently at unprecedented levels, investors are being paid to wait.’

“Credit market prices are consistent with an unprecedented risk of default, even for the highest quality corporate bonds.

“US investment-grade corporate bond prices, for example, imply a cumulative default rate of 36% over five years, assuming a typical recovery of 40 cents in the dollar, according to analysts at Morgan Stanley. This is more than 7.5 times higher than the worst default rate in any previous five-year period.”

Source: Esther Bintliff, Financial Times, January 5, 2009.

Bespoke: High yield spreads narrow for 13th straight day
“High yield bond spreads (based on Merrill Lynch indices) narrowed for the 13th straight trading day on Monday. This marks the longest streak of declines since April 2003, and the second longest streak since the series began in 1997.

“At a current level of 1,744 basis points above Treasuries, high yield spreads are now down 20% from their peak level from December 15 (2,182 basis points) and back to levels we saw before the election and the run on Citibank.

“Make no mistake that at current levels high yield spreads are still extremely high, but given the widespread view that the market cannot stage a meaningful rally until spreads begin to narrow, the current move is a step in the right direction.”

Source: Bespoke, January 6, 2009.

Edmund Conway (The Telegraph): Willem Buiter warns of massive dollar collapse
“The long-held assumption that US assets – particularly government bonds – are a safe haven will soon be overturned as investors lose their patience with the world’s biggest economy, according to Willem Buiter.

“Professor Buiter, a former Monetary Policy Committee member who is now at the London School of Economics, said this increasing disenchantment would result in an exodus of foreign cash from the US.

“The warning comes despite the dollar having strengthened significantly against other major currencies, including sterling and the euro, after hitting historic lows last year. It will reignite fears about the currency’s prospects, as well as sparking fears about the sustainability of President-Elect Barack Obama’s mooted plans for a Keynesian-style increase in public spending to pull the US out of recession.

“Writing on his blog, Prof Buiter said: ‘There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place.’”

Source: Edmund Conway, The Telegraph, January 06, 2009.

FT Alphaville: Beware, commodity index rebalancing ahead
“The major commodity indices rebalance their respective asset weightings once a year (or occasionally more) – and with that comes a mass dose of buying and selling. The 2009 rebalancing is expected to start sometime this week.

“Luckily, JP Morgan has produced its best guess of how the 2009 reweightings of the DJ AIGCI and the S&P GSCI indices will impact the market.

“The weightings for both indices are released ahead of time, but begin to kick in the first few working days of the new year. In the case of the DJ-AIGCI – which JP Morgan estimates has $25 billion in funds tracking it – the new weightings come into force during the roll period that begins January 9. The S&P GSCI index weightings kick-in after its January roll which commences January 8. JP Morgan estimates about $50 billion of investment into that index.

“JP Morgan see the most significant change coming in the DJ-AIGCI rebalance. Here the market weight of crude oil is expected to increase from 9.6% to 13.8%, gold from 10.8% to 7.9%, copper (COMEX) from 4.5% to 7.3%, live cattle from 6.4% to 4.3% and sugar from 4.7% to 3.0%. Meanwhile, S&P GSCI crude oil weight will go from 32% to 33.8%”.

Source: Izabella Kaminska, FT Alphaville, January 5, 2009.

Ambrose Evans-Pritchard (Telegraph): Merrill Lynch says rich turning to gold bars for safety
“Merrill Lynch has revealed that some of its richest clients are so alarmed by the state of the financial system and signs of political instability around the world that they are now insisting on the purchase of gold bars, shunning derivatives or ‘paper’ proxies.

“Gary Dugan, the chief investment officer for the US bank, said there has been a remarkable change in sentiment. ‘People are genuinely worried about what the world is going to look like in 2009. It is amazing how many clients want physical gold, not ETFs,’ he said, referring to exchange trade funds listed in London, New York, and other bourses.

“‘They are so worried they want a portable asset in their house. I never thought I would be getting calls from clients saying they want a box of Krugerrands,’ he said.

“Merrill predicted that gold would soon blast through its all time-high of $1,030 an ounce, and would hit $1,150 by June.”

Source: Ambrose Evans-Pritchard, Telegraph, January 9, 2009.

Reuters: Pickens – oil prices to top $100 by end of 2010
“Texas billionaire T. Boone Pickens said on Tuesday that oil prices will rise above $100 a barrel by the end of 2010 as the global economy recovers.

“Oil prices in the $40 a barrel range are ‘not going to be around much longer,’ Pickens told a gathering at Rice University in Houston.

“Oil prices have tumbled from over $147 a barrel in July to about $48 a barrel on Tuesday as demand in the United States and other developed countries slows due to the global economic crisis.

“By late 2010, Pickens sees a rebound in oil demand sparked by a global recovery, pushing prices higher. If the US continues to rely on imported oil for 70% or more of its supply, prices could reach $200 to $300 per barrel in another decade, Pickens said.

“As an investor, Pickens said he remains ‘on the sidelines’, with just 10% of his BP Capital hedge fund invested in energy. The fund lost $2 billion last year before shifting to cash as energy prices and stocks declined.”

Source: Reuters, January 6, 2009.

Bespoke: New bull market for oil
“Based on the standard bull/bear market move of 20%, oil is already well into a new bull market with its move of 44.7% since its closing low of $33.87 on December 19. Since 2000, the average oil bull market has seen the commodity rise 89%, while the average bear has seen oil decline by 39%.

“The 88-day decline in oil from 9/22 to 12/19 of 72% was by far the steepest drop the commodity has ever seen without a 20% rally. The last four bull and bear markets in oil have all come within 6 months, highlighting the extreme volatility in the commodities market.

“As shown in the bottom chart, the number of days that the last four market cycles have lasted has been much lower than normal. It’s likely that we’ll continue to see these big swings in short periods of time until the financial markets cool down.”

Source: Bespoke, January 6, 2009.

CEP News: Euro zone services PMI falls to series low in December
“Following the release of Italian purchasing managers index figures, along with final estimates on both the French and German services PMIs, Markit Economics reported that the services sector in the euro zone continued to deteriorate as the services PMI fell to a series low in December with a revision to 42.1 from the original estimate of 42.0.

“December’s reading is much lower than November’s 42.5 print.

“‘The final euro zone PMI indicates a 0.6% fall in GDP in the fourth quarter. Although some encouraging – but only tentative – signs of a bottoming-out were evident in Spain and Italy, the downturn gathered momentum in Germany and France,’ said Markit Economics chief economist Chris Williamson.”

Source: CEP News, January 6, 2009.

Financial Times: Alistair Darling on the economy
“UK chancellor Alistair Darling talks to Chris Giles about the outook for the UK economy and what can be done by global governments.”

Source: Financial Times, January 6, 2009.

Victoria Marklew (Northern Trust): UK – record low repo rate
“As widely expected, the Bank of England (BoE) cut its repo rate another 50bps today [Thursday], taking it to a record low 1.50%. In its rather terse statement, the bank noted that output is likely to keep falling sharply in the first half of this year, but also cited a ‘substantial’ decline in the pound as helping to offset the impact of a slower global economy. There was no obvious commitment to cut again at the February 5 Monetary Policy Committee (MPC) meeting, which probably explains the small bounce in sterling this morning.

“Today’s policy statement from the BoE said that ‘further measures’ are needed to increase lending to business and consumers, but it did not specify what, and nor did it include any comment on quantitative easing. Boosting money supply would require the approval of the government but Chancellor Darling has dismissed the idea, telling reporters that ‘nobody is talking about printing money’.”

Source: Victoria Marklew, Northern Trust – Daily Global Commentary, January 8, 2009.

Bloomberg: Is China’s economy crisis-bound?
“Anyone who said a year ago that China’s economy was crisis-bound was dismissed out of hand. Today, skeptics have lots of company.

“‘This year is going to be characterized by much, much weaker growth in China than I think people are anticipating,’ says Jim Walker, chief economist at Asianomics in Hong Kong.

“That may be news to the World Bank, which forecasts China will expand 7.5% in 2009. The government is targeting 8% growth, believing the $586 billion stimulus package it announced in November will boost the world’s fourth-biggest economy.

“Citigroup agrees. ‘The most important reason supporting our confidence about 8% growth is the government’s will and ability,’ says Huang Yiping, the bank’s chief Asia-Pacific economist in Hong Kong.

“That’s the problem. Chinese officials have done a masterful job generating growth, creating jobs and reducing poverty. They have done so with impressive regularity and earned the trust of many economists and investors. It’s important to remember, though, that external trends made China’s success possible.

“There’s no doubt that China’s leaders have the will to support growth. The question is their ability to do so while all of the world’s economic engines sputter. Yes, all.”

Source: William Pesek, Bloomberg, January 7, 2009.

US Global Investors: Below-trend economic growth in store for China
“2008 could register the first below-trend economic growth for China after five straight years of supernormal expansion. Based on China’s post-reform history, however, a cyclical downturn would typically last more than four years on average, which means a potential, multiyear cycle of growth moderation has yet to arrive.”

Source: US Global Investors – Weekly Investor Alert, January 9, 2009.

Reuters: What is Russia’s end-game in gas row?
“Russian Prime Minister Vladimir Putin raised the stakes in his gas conflict with Ukraine by slashing supplies to Europe, a measure that has left some EU states struggling to heat homes in sub-zero temperatures.

“Russian gas export monopoly Gazprom said it was forced to take that step because Ukraine – locked in a dispute with Moscow over gas pricing – was stealing gas being pumped across its territory for customers in Europe.

“What was Putin seeking to achieve by reacting in this way? There is so far no consensus among diplomats and analysts about what Russia’s end-game is.

“The Kremlin started out with the modest aim of persuading Ukraine to pay closer to market prices for its gas, but has now been out-manoeuvred by Kiev.

“‘Russia and Gazprom have walked into a trap,’ said Fyodr Lukyanov, editor of the journal Russia in Global Affairs.

“He said Ukraine – desperate not to pay more for its gas because of the fragile state of its economy – seized the initiative from Moscow by endangering exports to Europe.

“‘They are calculating, and I think not without basis, that the longer this drags on the more the blame will be laid at Moscow’s door,’ said Lukyanov.

“He said Gazprom, under pressure from a Europe angry its supplies are being disrupted and fearful for its reputation as an energy supplier, will now be forced to cut the price it is demanding Ukraine pay for its gas. ‘Ukraine wants to go back to the negotiations from a position of strength … And it is working,’ he said.”

Source: Reuters, January 7, 2009.

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Words from the (investment) wise for the week that was (Dec 29, 2008 – Jan 4, 2009)

Sunday, January 4th, 2009

Changing the digits on the calendar from ’08 to ’09 may not have transformed the dire outlook for the global economy, but during the holiday-shortened New Year week investors appeared adamant to put the rout of 2008 behind them.

Although mercifully the door has been closed on 2008, let’s recap some of the unprecedented movements experienced in financial markets during the year.

Equities:
– MSCI World Index: -42.1% (worst yearly performance since start of Index in 1970)

- S&P 500 Index: -38.5% (worst annual percentage decline since 1937 and 3rd worst on record; largest quarterly [4th quarter: -298] and daily [September 29: -107] points decline ever; 6th worst daily percentage decline [October 15: -9.0%])

- Dow Jones Industrial Index: -33.8% (worst annual percentage decline since 1931 and 3rd worst on record; largest quarterly [4th quarter: -2,330] and daily [September 29: -778] points decline ever; 6th worst daily percentage decline [October 15: -7.9%])

- S&P 500 and Dow Jones: There was no point in 2008 where the indices were up for the year at the close of a trading day. Since 1900, 2008 was only the 4th year (after 1910, 1962 and 1977) where the Dow never had a single day where it closed up for the year, according to Bespoke.

- FTSE Eurofirst 300 Index: -44.8% (worst yearly percentage fall since its creation in 1986)

- Nikkei 225 Average: -42.1% (biggest annual percentage decline on record)

- CBOE Volatility Index (VIX): Historical high in November based on new calculation, but remained below levels seen during the 1987 crash based on an previous calculation.

Treasuries:
– US Treasuries: Yields dropped to lowest levels since 1950.

- US 10-year Treasury Notes: Yields fell by 182 basis points – biggest yearly points decline since 1995 and the second biggest in the last 20 years.

Currencies:
– Japanese Trade-weighted Index: +25.0% (largest annual rise since currency was allowed to float freely in 1973)

- Pound against US dollar: -26.2% (worst annual decline since gold standard was abandoned in 1971)

- Pound against euro: -22.8% (worst yearly decline since launch of single currency in 1999)

Commodities:
– Reuters/Jeffries CRB Index: -36.0% (worst annual performance since inception of Index in 1956)

The table below highlights the performance of the principal asset classes for 2008. While West Texas Intermediate Crude (-53.5%), the S&P 500 Index (-38.5%) and the Reuters/Jeffries CRB Index (-36.0%) recorded large losses, US 30-year Treasury Bonds (+18.6%) fared very well, and the US Dollar Index (+6.0%) and gold bullion (+5.5%) also provided safe havens for risk-averse investors. (The returns for indices in individual countries are given in my December 31 “Stock market performance round-up”.)

But the few trading days since Christmas Eve witnessed a strong rebound in global stock markets as investors brushed aside bleak economic data. This resulted in market participants scooping up beaten-down stocks and commodities, mending some of the bruising sustained earlier in 2008. The better spirit of equities was reflected in losses for some government bonds.

Despite a grim ISM report (see section on Economy below), the S&P 500 Index jumped by 3.2% after the release of the data, propelling many stock market indices to almost two-month highs. The MSCI World Index (+5.9%), MSCI Emerging Markets Index (+5.3%), Dow Jones Industrial Index (+6.1%), S&P 500 Index (+6.8%), Nasdaq Composite Index (+6.7%) and the Russell 2000 Index (+6.1%) all gained handsomely (albeit on thin volume) during the week straddling New Year’s day.

Source: Daryl Cagle

December also marked the first monthly gain since August for the major US indices, with the Dow Jones and S&P 500 now up by 19.6% and 23.9% respectively since the lows of November 20, 2008.

The “storm” of 2008 has undoubtedly grown quieter in December, with the CBOE Volatility Index (VIX) having declined from 80.9 in November to 39.6 on Friday. Also, the average daily swing in the Dow Jones has fallen to ~300 points compared to ~430 points in November and ~590 points in October, according to Briefing.com.

Christmas Eve trading on Wednesday, December 24 marked the start of the Santa Claus Rally period, made up of the last five trading days of December and the first two of January. With one trading day to go on Monday, the combined gain for the S&P 500 Index for the first six days was 8.0%. The absence of a rally – and one now seems highly unlikely – has often been the harbinger of a sizeable correction or a bear market in the coming year. Hence the saying: “If Santa Claus should fail to call; bears may come to Broad & Wall.”

But risks remain plentiful and Bill King (The King Report) reminds us that “just as night follows day, international conflicts follow economic crises”. Escalating violence in the Middle East and tensions between Russia and the Ukraine served as a reminder and caused a 22.9% spike in the price of West Texas Intermediate Crude on the week.

Next, a quick textual analysis of my week’s reading material (done between New Year’s celebrations). No surprises here with keywords such as “economy”, “financial”, “market”, “prices” and “rates” featuring prominently.

Readers often ask me about Richard Russell’s (Dow Theory Letters) viewpoint on the stock market. Here is his latest take on matters: “It occurs to me that this is a good time to remember my old friend Marty Zweig’s classic warnings: ‘Don’t fight the tape, don’t fight the Fed’. Well, if you are bearish on 2009, you are indeed fighting the Fed and probably the tape. Why do I say that? Because the Bernanke Fed is going all out in its effort to turn the US economy around. Bernanke says the Fed will do whatever it takes to halt the current trend to deflation and to bring back prosperity and mild inflation to the US.

“The stock market seems to have finally climbed aboard the Fed’s bullish bandwagon. All of which brings us to a very dramatic and critical juncture. If the market heads higher in early January, I believe that money on the sidelines [$8.85 trillion – 74% of US market cap] could begin to turn optimistic and even bullish,” said the R man.

From across the pond, David Fuller (Fullermoney) added: “The crucial missing ingredient for stock markets to date has been confidence. Nevertheless that could change in January, given the high levels of cash held by most institutional investors. … if stock market indices surprise the bearish consensus and start to break upwards rather than downwards from their trading ranges, institutional investors will be under increasing pressure to participate.”

What the market does over the next few days will give a clue as to the rest of the year, according to Jeffrey Hirsch (Stock Trader’s Almanac). “S&P gains during January’s first five trading days preceded full-year gains 86% of the time.” He also draws attention to the so-called “January Barometer” which states “as the S&P 500 Index goes in January, so goes the year”. “The January Barometer predicts the year’s course with a .741 batting average. 12 of the last 14 post-election years followed January’s direction,” said Hirsch. Also, the “ninth” year of decades is generally an up year for the stock market with the Dow Jones down only three times in the last twelve decades.

The table below shows the key resistance and support levels for the major US indices. With most global indices having breached the 50-day moving average (and after year-end also having taken out the December peaks), the next target is the November 4 highs, followed by the key 200-day average. On the downside, the December 1 (not shown on table) and the all-important November 20 lows must hold for the uptrend to remain intact.

In my opinion, selective buying in global markets is in order, and ’09 may turn out to be a good year for a discerning stock picker. However, make sure to separate the wheat from the chaff because many companies will fall by the wayside during the new year. (Also see my posts “Stock market internals: further headway in 2009” and “Video-o-rama: Ring out the old, ring in the new” for more discussion of the outlook for stock markets in 2008.)

Economy
“Overall business confidence improved just a bit at the close of to 2008, but remains very dark with hiring intentions and expectations regarding the outlook in mid-2009 dropping to record lows,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. The Survey results indicate that the entire global economy is solidly in recession.

Further evidence of the worldwide economic crisis came from the Semiconductor Industry Association, reporting that global sales of semiconductors declined by 9.8% in November compared with a year ago, and by 7.2% since the previous month.

Data reports released in the US during the New Year week mostly confirmed the dismal economic outlook.

- The Institute for Supply Management’s Manufacturing Index is still contracting and fell by a larger-than-anticipated 3.8 points to 32.4 in December. The index is at its lowest level since 1980, with the forward-looking details also downbeat as new orders plunged to their lowest level since January 1948.

- The S&P/Case-Shiller Home Price Indices reported record annual declines, with the 10-City and 20-City Composite Indices falling by 19.1% and 18.0% respectively.

- The Conference Board’s Consumer Confidence Index declined in December to a historic low of 38 – down by 6.6 points from November’s 44.7. With consumer confidence in a perilous state, the outlook for spending appears dismal.

- Initial jobless claims decreased by 94,000 to 492,000 for the week ended December 27. Fewer-than-expected claims were filed, but holidays have been known to be more volatile for this indicator. Overall, labor market trends suggest persistent weakening.

- The ECRI Weekly Leading Index increased from 106.8 to 108 during the week ended December 26, but does not alter the Index’s overall downward trend. The meaningful decline in the ECRI indicates a severe slowdown that could last deep into 2009.

Commenting on the implications of the worsening employment situation for the US consumer, Mark Vitner (Wachovia Economics Group) said credit availability and housing affordability were two important elements of consumer buying decisions, but that an even more important variable was consumers’ comfort about their own employment and income prospects.

“Consumers typically have to have a job if they are going to buy a home or automobile. And even if consumers have a job, they are less likely to borrow and spend if they feel their job is at risk or their income could take a hit,” said Vitner.

Elsewhere in the world, major economies remain mired in a severe slump. “Europe, Germany, France, and the UK all reported declines in indexes of purchasing managers in December,” said Asha Bangalore (Northern Trust). China’s factory sector has contracted for the fifth month running according to the CLSA China Purchasing Managers’ Index. … the Australian … Manufacturing Index has recorded readings below 50 for seven consecutive months … In sum, weak economic conditions across the world is a challenge for policy makers in the months ahead.”

Source: US Global Investors – Weekly Investor Alert, January 2, 2009.

Assessing the global economic outlook, Nouriel Roubini (RGE Monitor) posed the following questions on RealClearMarkets: “So what lies ahead in 2009? Is the worst behind us or ahead of us?

“The United States will certainly experience its worst recession in decades, a deep and protracted contraction lasting about 24 months through the end of 2009. Moreover, the entire global economy will contract. There will be recession in the Eurozone, the UK, Continental Europe, Canada, Japan, and the other advanced economies. There is also a risk of a hard landing for emerging-market economies, as trade, financial and currency links transmit real and financial shocks to them,” said Roubini.

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, January 2, 2009.

In addition to the Federal Open Market Committee (FOMC) releasing the minutes of its December 16 meeting (Tuesday, January 6) and the Bank of England’s interest rate announcement (Thursday, January 8), the US economic highlights for the next week, courtesy of Northern Trust, include the following:

1. Employment Situation (January 9): Payroll employment is predicted to have dropped by 450,000 in December after a loss of 533,000 jobs in the prior month. The unemployment rate is expected to have risen to 7.0% during December from 6.7% in November. Consensus: Payrolls – -478,000 versus -533,000 in November, unemployment rate – 7.0% versus 6.7% in November.

2. Other reports: Consumer Confidence (December 30), Construction Spending, Auto Sales (January 5), Factory Orders, ISM Non-manufacturing, Pending Home Sales Index (January 6).

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

Source: Wall Street Journal Online, January 2, 2009.

Good riddance to 2008! Let’s hope that after one of the most tumultuous years in history, conditions will calm down – as always happens after a storm. And may this compilation of news items and words from the investment wise assist in keeping our portfolios on a profitable course.

To all the Investment Postcards readers, thank you for your loyalty and support. And remember, the biggest compliment you could give us is to broadcast word about the site and encourage your family, friends and colleagues to subscribe to the e-mail updates or RSS feeds.

Here’s wishing you a blessed and calm 2009!

Source: Daryl Cagle

YouTube: Uncle Jay’s review of 2008
“It’s been a whole year since Uncle Jay has SUNG an entire episode, and here’s the reminder why! It’s the year-end review of the news, and maybe it’ll seem a little better with music.“

Source: YouTube, December 21, 2008.

The New York Times: The year in the markets
Click the image for an interactive graph.

Source: The New York Times, December 31, 2008 (hat tip: Barry Ritholtz).

Bloomberg: A recap of 2008
“A two-minute look into the year that changed the economic landscape.”

Source: Bloomberg (via YouTube), December 31, 2008.

Win Rosenfeld (The Big Money): The five worst days of 2008
“You know it’s been a bad year when you’re arguing about what the five worst days were. Between the massive market fluctuations and the biggest banks going belly up, it’s hard to know where to start. From a crowded field of contenders, here are The Big Money’s five biggest buzz-killers.”

Source: Win Rosenfeld, The Big Money, December 30, 2008.

Bloomberg: Marc Faber’s 2009 outlook
Marc Faber says the global economy is going into severe recession and emerging markets will be hit the hardest.

Source: Bloomberg (via YouTube), December 31, 2008.

Bloomberg: Jim Rogers – “I’m prepared for the worst”

Source: Bloomberg (via YouTube), December 29, 2008.

CNBC: Map of the markets
“Where to put your money in 2009, with Michael Pento, Delta Global Advisors; David Kotok, Cumberland Advisors; Diane Brady, BusinessWeek; Dave Maney, Headwaters MB; and CNBC’s Rebecca Jarvis.”

Source: CNBC, December 31, 2008.

Bill King (The King Report): Unlikely that ’09 will be as ugly as ’08
“2008 will be a year of historic imfamy. The S&P 500 declined 38.5%, the biggest drop since 1937. The Dow Jones Industrial Average declined 33.8%, the largest drop since 1931.

“It is highly unlikely that 2009 will be as ugly. But this does not suggest that it will be a ‘good’ year.

“Back in October we commented that the stock market is following a clear historic pattern. A summer folly rally amid a receding economy and percolating financial duress produced an autumn collapse.

“And an October panic did not generate a low for stocks because during recessions, like in 1907 and 1929, October panic lows yield to new lows in November.

“But then a yearned rally appears. This usually extends into the first day or two of the New Year. But then January turns ugly on anticipated horrid earnings reports that will appear during the second and third weeks of the month. Finally there is a performance gaming rally over the last few days of January.

“When bonds rally sharply in Q4, they tend to make a significant peak early in January. Bonds by then are extended, even ‘over-invested’, and corporations and governments tend to burst the dyke by issuing beaucoup bonds for financing needs in the coming year.

“However, this year will be tricky because Weimar Ben is monetizing everything in sight. Weimar Ben can continue to monetize everything and anything – until the market revolts. And the revolt will likely come from the dollar.

“Though Ben and US solons desire a lower dollar in the hope of papering over the US’s intractable structural problems, there is a line of demarcation for the dollar. If the dollar descents below that incalculable threshold, it’s checkmate, Ben.”

Source: Bill King, The King Report, January 2, 2009.

Financial Times: 2009 – predictions of some known unknowns
“The Financial Times team of pundits is back, once again, to risk its professional reputation on bold predictions of some known unknowns.

“Will the recession end in 2009?

“No, as far as the US, the UK, Spain and Ireland are concerned; possibly Yes for other European economies and Japan. Whatever happens, 2009 will not be pleasant. For all the cuts in interest rates and taxes, higher unemployment will be the dominant issue of the first half of the year, outweighing gains to real incomes from these policies and lower commodity prices. Uncertainty will be the watchword for the year, making any prediction precarious, but there is still a good chance that rising incomes will become powerful forces in the continental European and Japanese economies later in the year. For those economies that need much bigger rises in household savings rates to adjust for the recession, recoveries will be delayed. There is also a good chance the world will enter a debt-deflation trap, although I hope the authorities will do everything to avoid this. But even if we experience genuine green shoots of recovery, as I expect, 2009 will be a year to forget.”

Click here for the full article.

Source: Financial Times, December 30, 2008.

Financial Times: Survey of economists – outlook for 2009
The Financial Times polled 67 leading economists for their views on the outlook for 2009. The full breakdown of their answers is given below.

1) Recession: How will this recession develop over the next twelve months? Will we see the green shoots of recovery by this time next year?

2) Risks: What are the three main risks that could profoundly exacerbate the recession? How concerned should people be?

3) Global outlook: Which part of the world will recover first and why?

Click here for the full article.

Source: Financial Times, January 1, 2009.

Edmund Conway (The Telegraph): Global economy to shrink for first time since the Second World War
“HSBC has warned that global gross domestic product will contract in 2009, describing this as ‘an extraordinary development in the modern era’. In a comprehensive examination of the economic crisis, it predicts that next year will be the worst in peacetime both for rich countries and the wider global economy since the Great Depression.

“And in a further blow to the Chancellor Alistair Darling, the bank warned that the UK will endure its worst year of growth since the bleak winter recession of 1947, forcing the Bank of England to slash interest rates to only a quarter percentage point above zero. The gloomy forecasts are far more pessimistic than those from the Treasury or the International Monetary Fund.

“Stephen King, HSBC’s chief economist, said: ‘For a while, it was possible to pretend that the financial and economic crisis was merely a problem for the major industrialised countries.

“‘Over the last three months, however, that theory has been blown out of the water. We have made savage downgrades to our forecasts with some of the emerging markets bearing the brunt of the bad news. On the basis of nominal GDP weights, we expect global GDP to shrink in 2009, an extraordinary development in the modern era.’

“He added that the serious risk now is that families and businesses will begin to hoard cash rather than spending it, as deflation rears its head across the rich world.

“‘Stuffing cash under the mattress, however, will only end in cumulative tears,’ he said. ‘This, after all, was part of the dynamic associated with the Depression in the 1930s.’”

Source: Edmund Conway, The Telegraph, December 27, 2008.

Wolfgang Münchau (Financial Times): World economy in 2009 �”� three priorities for recovery
“It is easy and difficult at the same time to predict the economy in 2009. It is easy to predict it will be an awful year for the US, Europe and large parts of Asia. The industrialised world will be in a deep synchronised recession. Global gross domestic product will probably contract also for the first time since the 1930s. There is not a great deal we can do to prevent this.

“The difficult part of the forecast is to predict whether policymakers will succeed in preventing the recession turning into a depression and lay the foundations for a sustainable recovery in 2010. What I can predict with near certainty is that policy will matter a great deal next year.

“We know that the current driving force behind this downturn is ‘deleveraging’. Overindebted households and undercapitalised banks are adjusting their balance sheets, building up savings in the first case and restricting lending in the latter. There is no chance of a sustained economic recovery until that process is almost complete.”

Click here for full article.

Source: Wolfgang Münchau, Financial Times, December 28, 2008.

Times Online: Car production faces global fall until 2010“Car production in North America will sink to its lowest level for more than 20 years next year and output in Europe will fall to a 12-year low, with Britain hit the hardest, according to PricewaterhouseCoopers (PwC).

“The accountancy firm is forecasting a 17% drop in the United States to 10.8 million cars and a 12% fall in the European Union to 15.5 million vehicles. Asia Pacific will experience the smallest fall, with a 5% decline to 26 million cars.

“PwC expects world production to fall by 10% to levels of output last seen in 2003.

“Calum McRae, automotive analyst at PwC, said: ‘These figures demonstrate that there is further gloom to come before we can possibly see the effect of any bailouts or incentives.’”

Source: Christine Buckley, Times Online, December 30, 2008.

Financial Times: IMF argues for large stimulus packages
“Across-the-board tax cuts or bail-outs of troubled industries such as the automotive sector are likely to waste government money while doing little to stimulate the global economy, the International Monetary Fund warned on Monday.

“As governments around the world bring in tax cuts and boost spending to combat the global recession, a study by the IMF said such programs must be large but carefully designed.

“‘There is a strong case for doing too much rather than too little,’ said Olivier Blanchard, the fund’s chief economist. But, he added, tax cuts should be aimed at people likely to spend money rather than save it.

“Although the IMF said it would resist giving a running commentary on policies, Mr Blanchard said signs of the stimulus plan emerging from the camp of US president-elect Barack Obama appeared to be hopeful. ‘The size corresponds roughly to what we think is needed,’ he said.

“Mr Obama’s team is reportedly considering a fiscal stimulus worth $675 billion to $775 billion, or 5% to 6% of US gross domestic product, likely to include substantial long-term investment spending.”

Source: Alan Beattie, Financial Times, December 29, 2008.

CNBC: Martin Feldstein on the stimulus package
“Discussing the kind of stimulus that should come out of Washington, with Martin Feldstein, Harvard University professor, President Emeritus of the National Bureau of Economic Research, & Council of Economic Advisors former chairman under President Reagan, with CNBC’s Steve Liesman.”

Source: CNBC, January 2, 2009.

Financial Times: GMAC gets $6 billion injection from US Treasury
“The US Treasury department late on Monday unveiled up to $6 billion in aid for GMAC, the financial services group which is critical to part-owner General Motors‘ turnaround.

“The Treasury said in a statement it would buy $5 billion in senior preferred equity with an 8% dividend from GMAC, characterizing the investment as part of ‘a broader program to assist the domestic automotive industry in becoming financially viable’.

“It will also lend GM up to $1 billion to participate in a rights offering at GMAC in support of GMAC’s reorganization as a bank holding company.

“Diminished access to capital had forced GMAC to cut back on vehicle financing, which in turn jeopardized GM itself.

“‘With the Treasury investment, we intend to resume our automotive lending quickly,’ GMAC spokeswoman Gina Proia said.

“The aid, which is being made under the Troubled Assets Relief Program (Tarp), comes after the Treasury earlier this month said it would extend a $17.4 billion emergency loan package to GM and Chrysler.”

Source: Nicole Bullock, Henny Sender and Bernard Simon, Financial Times, December 29, 2008.

Karl Denninger (Market-Ticker): GMAC’s “money-losing strategy” makes no sense
“The government ‘buys’ preferred equity that pays an 8% coupon. GMAC must pay that 8% coupon (9% if the government exercises the warrants).

“GMAC turns around and loans out money at 0% which it has to pay 8% to acquire, and at the same time decides that it will make loans to people with credit scores significantly worse than average, when before they would make loans only to people with scores that were slightly better than average. And we wonder how we got into this mess?

“The Federal Reserve and Treasury approved an application that contained as it’s essence an intentional money-losing business strategy, enabling the literal looting of the public treasury under the false pretense of an ‘investment’.”

Source: Karl Denninger, Market-Ticker, December 31, 2008.

Financial Times: Fed pushes on with mortgage bond plan
“The Federal Reserve pushed ahead with its plan to buy mortgage bonds issued by Fannie Mae and Freddie Mac on Tuesday, saying it would start buying early next month and purchase up to $500 billion by the end of June.

“The aggressive tactics – the Fed had previously said it would buy this amount over ‘several quarters’ – highlights the central bank’s determination to hammer down the risk spreads on the mortgage bonds and thereby reduce mortgage rates.

“The Fed also announced that it had selected four asset managers – BlackRock, Goldman Sachs, Pimco and Wellington Management – to manage the process. It had agreed a ‘competitive fee structure’ but did not disclose this.

“The Fed said ‘the program is being established to support the mortgage and housing markets and to foster improved conditions in financial markets more generally’.

“The move comes as policymakers at the central bank and in both the outgoing Bush and incoming Obama administrations look to target mortgage rates in the hope that lowering them would arrest the decline in house prices and thereby support financial asset prices.”

Source: Krishna Guha, Financial Times, December 30, 2008.

Bloomberg: Barclays’s head says “worst is ahead” for US economy
“Ethan Harris, co-head of US economic research at Barclays Capital, and Richard DeKaser, chief economist at National City Corp., talk with Bloomberg’s Peter Cook about the outlook for the US economy.”

Source: Bloomberg (via Blinx), December 31, 2008.

Paul Krugman (The New York Times): The yield curve is wonkish
“I’m a little late getting to this, but … I see that economists at the Cleveland Fed are taking some comfort from the positive slope of the yield curve. Long-term interest rates are higher than short-term rates, which is usually a sign that the economy will expand.

“Not this time, I’m afraid. It’s all about the zero lower bound.

“The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.

“But here’s the thing: the Fed can’t cut rates from here, because they’re already zero. It can, however, raise rates. So the long-term rate has to be above the short-term rate, because under current conditions it’s like an option price: short rates might move up, but they can’t go down.

“Indeed, if we look at Japan we find that the yield curve was positively sloped all the way through the lost decade. In 1999-2000, with the zero interest rate policy in effect, long rates averaged about 1.75%, not too far below current rates in the United States.

“So sad to say, the yield curve doesn’t offer any comfort. It’s only telling us what we already know: that conventional monetary policy has literally hit bottom.”

Source: Paul Krugman, The New York Times, December 27, 2008.

Karl Denninger (Market-Ticker): Uh oh … monetary multiplier below zero

“What is this?

“I could go through the derivation of how money supply works in a fractional reserve monetary system, but won’t, because most readers would have their eyes glaze over.

“The important part of this graph is what it denotes. Bernanke has lost control of ‘N’ (or velocity), which is the actual knob that he is trying to diddle when borrowing rates are changed (and in fact its the market that sets that, despite his protests).

“In fact the most useful tool in The Fed’s box in terms of influencing monetary policy is the soapbox, that is, jawboning (whether it be by cajoling or threatening.)

“The problem with an M1 multiplier below one is that the effect of printing money is of course multiplied by the velocity. That is, if you print up $10 into the economy the impact it has on economic activity depends on how many times that $10 circulates in a given amount of time. The more it circulates the higher the impact and the more your efforts do for the economy.

“The bad news is that when the multiplier is less than one the more money you spew into the economy the worse the impact, as you get less for each additional dollar.”

Source: Karl Denniger, Market-Ticker, December 30, 2008.

John Silvia (Wachovia Economics Group): ISM Manufacturing – economy remains in teeth of the recession
“December’s ISM manufacturing index came in at 32.4, well within recession territory and consistent with levels of the 1980-82 recession period. Weakness remains in new orders, production and employment. The inventory correction is ongoing. Prices paid fell sharply to 1949 lows and suggests lower inflation ahead.”

Source: John Silvia, Wachovia Economics Group, December 30, 2008.

Standard & Poor’s: Case-Shiller – home price declines worsen
“Data through October 2008, released today [Tuesday] by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, shows continued broad based declines in the prices of existing single family homes across the United States, with 14 of the 20 metro areas showing record rates of annual decline and 14 now reporting declines in excess of 10% versus October 2007.

“The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Home Price Indices. Following the lead of the 14 metro areas described above, the 10-City and 20-City Composites set new records, with annual declines of 19.1% and 18.0%, respectively.

“‘The bear market continues; home prices are back to their March, 2004 levels.’ says David Blitzer, Chairman of the Index Committee at Standard & Poor’s. ‘Both composite indices and 14 of the 20 metro areas are reporting new record rates of decline.’”

Source: Standard & Poor’s, December 30, 2008.

Mark Vitner (Wachovia Economics Group): Consumer confidence falls to a new low“Worries about employment and income prospects were likely weighing on consumers’ minds this holiday season, contributing to a larger than expected drop in consumer confidence. The Consumer Confidence Index fell 6.7 points to an all-time low of 38.0 in December, with most of the drop in the present situation series.

“While the present situation index is responsible for most of December’s drop, the record low in the overall index is due mostly to consumers’ extremely pessimistic view of future economic conditions. The present situation index plunged 12.9 points in December to 29.4, which is the lowest reading since the aftermath of the 1990/91 recession. The future expectations component, however, remains near all-time lows, even though it declined just 2.4 points to 43.8 December and remains above its October low.

“The Consumer Confidence Index is one of the longest running measures of consumer behavior, dating all the way back to 1947. The index has a very good record of tracking the performance of overall economic activity but has a very mixed record as a leading indicator.”

Source: Mark Vitner, Wachovia Economics Group, December 30, 2008.

The Wall Street Journal: Retail sales plummet
“Price-slashing failed to rescue a bleak holiday season for beleaguered retailers, as sales plunged across most categories on shrinking consumer spending, according to new data released Thursday.

“Despite a flurry of last-minute shoppers lured by the deep discounts, total retail sales, excluding automobiles, fell over the year-earlier period by 5.5% in November and 8% in December through Christmas Eve, according to MasterCard Inc.’s SpendingPulse unit.

“When gasoline sales are excluded, the fall in overall retail sales is more modest: a 2.5% drop in November and a 4% decline in December. A 40% drop in gasoline prices over the year-earlier period contributed to the sharp decline in total sales.

“But considering individual sectors, ‘This will go down as the one of the worst holiday sales seasons on record,’ said Mary Delk, a director in the retail practice at consulting firm Deloitte LLP. ‘Retailers went from ‘Ho-ho’ to ‘Uh-oh’ to ‘Oh-no’.’

“Luxury goods, once considered immune from economic turmoil, were hardest hit, with sales falling 21.2%, compared with a jump of 7.5% a year ago, when the economy had just begun to sputter. Including jewelry sales, the luxury sector plunged by a whopping 34.5%.

“During the same period last year, overall retail sales rose a modest 2.4%, helped by late-season discounting that enticed procrastinating shoppers. But this year, after a moderate uptick in shopping activity boosted by steep promotions the Friday after Thanksgiving, shoppers closed their wallets and reopened them only cautiously, worried by job losses, a sinking stock market and a recession climbing into its second year.”

Source: Ann Zimmerman, Jennifer Saranow and Miguel Bustillo, The Wall Street Journal, December 26, 2008.

Reuters: Bush signs pension relief bill into law
“President George W. Bush on Tuesday signed into law a measure intended to help company pension plans and retirees that have been hard hit by the financial crisis.

“Despite some concerns about the legislation, Bush decided that in the current financial environment the benefits outweighed the problems, the White House said.

“Generally healthy multi-employer pension plans hurt by the stock market decline would not have to make drastic pension plan contribution increases and worker benefit cutbacks that many companies had feared.

“A multi-employer pension plan, unlike a traditional single-employer plan, covers workers from more than one company and allows workers to move from job to job and still contribute to the plan.

“People 70-1/2 years old or older would not have to take distributions from their retirement plans as required under current law, allowing them to keep savings intact and avoid a bear-market tax hit.

“White House spokesman Tony Fratto said the administration had concerns that the legislation would increase the costs of near-term claims on the Pension Benefit Guaranty Corporation and could result in some benefits lost to workers over the long term. ‘Our concerns with the legislation remain, but we do believe that, in this current economic environment and current economic circumstances, that the benefits of the legislation outweighed our objections,’ he said.”

Source: Tabassum Zakaria, Reuters, December 23, 2008.

Financial Times: Auditors urge rethink on pension
“Auditors are pressing companies to reconsider how they calculate their pension liabilities and urging them to use formulas that could give rise to much larger reported deficits than would be the case if they stayed with the current approach.
Market volatility has raised questions over the so-called ‘discount rate’ used to calculate the present-day value of a fund’s future liabilities.

“The lower the rate used, the higher the present liabilities will be. The rates currently used by companies to calculate those liabilities are roughly equivalent to those on less risky high-grade corporate bonds. However, these have soared amid the market turmoil, sharply shrinking reported fund deficits.

“Some schemes have actually reported a surplus even as the values of the stocks they hold have plunged.”

Source: Norma Cohen and Jennifer Hughes, Financial Times, December 30, 2008.

Financial Times: Money flows out of hedge funds at record rate
“Investors pulled a net $32 billion from hedge funds last month, making 2008 the first year in their recorded history that the funds have had significant outflows and ending the industry’s 18 years of asset growth.

“Money has been taken out of funds following every strategy, even those – such as macro funds – which were showing returns, according to data from fund trackers Hedge Fund Research.

“The funds enjoyed net inflows for the first part of the year, even as the financial crisis hit and traditional mutual funds began to show outflows.

“However, in September a tide of redemptions began, according to TrimTabs, another fund tracker.

“Conrad Gann, chief operating officer of TrimTabs, said: ‘We estimate outflows in November were $32 billion, and there is an additional pipeline of redemptions that have not been filled, there could be $80 billion [of redemptions] in December.

“‘There are $57 billion of redemptions that we know are in, that are not reflected yet,’ he said.

“Mr Gann said it was difficult to estimate outflows for coming months because hedge funds had different redemption cycles.

“In recent months funds have also tried to halt outflows by limiting or suspending investor withdrawals. This means that data on outflows, which reflect actual repayments to investors, understates the true picture.

“This is the first year since at least 1990 that hedge funds have seen a drop in assets.”

Source: Deborah Brewster, Financial Times, December 30, 2008.

MarketWatch: Sam Stovall bullish on 2009, his father less so
“It’s been a horrible year for stocks overall – the worst, in fact, since 1931. Oft-cited market pundit Sam Stovall of Standard & Poor’s and his father, Robert Stovall, a veteran money manager at Wood Asset Management, review the past year with MarketWatch’s Steve Gelsi.”

Source: MarketWatch, December 31, 2008.

Richard Russell: Stock crashes have look of completed declines
“Over the weekend, I reviewed the charts of hundreds of leading NYSE stocks. Many of these stocks have crashed. In almost all cases, RSI has plunged to severely oversold levels. I note that at the end of each crash, the price action has been forming a sideways pattern. These numerous crashes have the look of completed declines – declines from which bases are forming. Following a true crash, stocks and stock averages have a habit of recovering roughly 50% of the action lost in the crash.

“And I’m wondering whether these patterns are now indicating that a tradeable low has been reached by this bear market. The news continues awful, and yet these various stock bottoms, following crashes, appear to be holding.”

Source: Richard Russell, Dow Theory Letters, December 29, 2008.

Bloomberg: Leuthold – cash at 18-year high makes stocks a buy
“There’s more cash available to buy shares than at any time in almost two decades, a sign to some of the most successful investors that equities will rebound after the worst year for US stocks since the Great Depression.

“The $8.85 trillion held in cash, bank deposits and money-market funds is equal to 74% of the market value of US companies, the highest ratio since 1990, according to Federal Reserve data compiled by Leuthold Group and Bloomberg.

Leuthold, Invesco Aim Advisors, Hennessy Advisors and BlackRock, which together oversee almost $1.7 trillion, say that’s a sign the Standard & Poor’s 500 Index will rise after $1 trillion in credit losses sent the benchmark index for American equities to the biggest annual drop since 1931. The eight previous times that cash peaked compared with the market’s capitalization the S&P 500 rose an average 24% in six months, data compiled by Bloomberg show.

“‘There is a store of cash out there that is able to take the market higher,’ said Eric Bjorgen, who helps oversee $3.4 billion at Leuthold in Minneapolis. ‘The same dollar you had last year buys you twice as much S&P 500 as it did a year ago.’

“Leuthold Group, whose Grizzly Short Fund returned 83% in 2008 thanks to bets against equities, said in its December bulletin to investors that stocks offer ‘one of the great buying opportunities of your lifetime’.”

Source: Eric Martin and Michael Tsang, Bloomberg, December 29, 2008.

David Fuller: 10 tangible reasons for a rally
“I have listed and illustrated 10 tangible reasons for a rally (no cheerleading here), and also discussed a crucial missing ingredient.

1. Governments have flooded the system with liquidity. It takes time for this to filter through to the economy but it will reach the stock market more quickly.

2. Interest rates are at record lows for the US and UK, both short-term and long-term, and heading lower elsewhere. This is an ideal background for stock market recoveries.

3. Valuations are much improved, despite legitimate concerns over the earnings outlook for at least the first half of 2009. Equity yields are competitive with government bond yields, despite the near certainty of more dividend cuts than increases over the next six months.

4. Corporate bond yields peaked in October and November and have fallen significantly. They have also begun to improve their performance relative to government bonds.

5. Various measures of investor/advisor sentiment reached extreme lows in October.

6. The VIX Index peaked in October and is trending lower.

7. Commodity indices have fallen significantly, lowering inflationary pressures. Historically, equities have done best in disinflationary environments.

8. In many countries, the financial sector is showing strength relative to the broader indices. This is a key lead indicator.

9. Levels of cash are at record highs.

10. Most broad stock market indices show some evidence of base formation development. This is less clear for the DOW, but can be seen for the FTSE 100, DAX, SX5E, FSSTI and NKY, to mention a few of many.

“In conclusion, technical evidence remains more conducive to a stock market rally rather than another slump. Over the last three weeks we have repeatedly mentioned the December reaction lows. They need to hold to remain consistent with our expectations for a ranging stock market recovery extending well into Q1 2009.

“The crucial missing ingredient for stock markets to date has been confidence. Nevertheless that could change in January, given the high levels of cash held by most institutional investors. If stock markets languish in the New Year, as many expect, there will be little reason for investors to reinvest in the stock market. However, if stock market indices surprise the bearish consensus and start to break upwards rather than downwards from their trading ranges, institutional investors will be under increasing pressure to participate. Failure to do so would put them at a competitive disadvantage in terms of 2009’s performance.

“Lastly, if the global economy does not show evidence that the recession is ending by Q3 2009, in response to the stimulus programmes, stock markets will be susceptible to a significant retracement of gains achieved during the first half of the year.”

Source: David Fuller, Fullermoney, December 30, 2008.

Barron’s: Seasonal patterns for the market
“Barron’s Michael Santoli discusses what market patterns to expect in the closing days of 2008 and the beginning of 2009.”

Source: Barron’s, December 29, 2008.

Bespoke: Estimated earnings growth for the S&P 500
“Below we highlight historical earnings growth estimates for the S&P 500 for Q4 2008 and full-year 2009. As shown, EPS estimates have dropped sharply over the last few months, and analysts are currently expecting the S&P 500 to see year-over-year earnings fall by 12% in the fourth quarter.

“At the start of September, analysts were actually expecting growth of 40%, which was largely because financial companies were expected to bounce back from a very poor Q4 in 2007. Instead, these companies are struggling much more than they were at this time last year.

“Estimates for 2009 have been dropping significantly as well. Back in September, analysts were expecting 2009 earnings growth of 24.7% versus 2008. But estimates are now at just 4.5%, and judging by the current trend, analysts will be looking for negative 2009 growth in no time.

“Earnings for Materials are expected to fall the most at –63%, while Consumer Staples and Health Care are the only two sectors expected to see year over year growth.”

Source: Bespoke, December 29, 2008.

John Hussman (Hussman Funds): Prices of Treasury bonds at dangerous levels
“… bond yields at this point are vulnerable to very sharp reversals. Given the level of extension in yields, it would not be difficult for the bond market to generate losses of say 10% in the 10-year Treasury bond, and as much as 20% to 25% in the 30-year Treasury bond over a very short period of time. Straight Treasuries may have safety from default risk, but the price risk is becoming downright dangerous.

“Corporate yields are much more reasonable, but there will be more fallout in this sector, and as I’ve noted before, taking a significant position in corporate would be essentially like a ‘bottom call’ in stocks, since corporate bonds tend to trade much like stocks during periods of elevated default risk.

“For our part, we strongly prefer Treasury inflation protected securities here. Despite near term deflationary prospects, the enormous expansion in government liabilities is unlikely to be accompanied by long-term inflation rates near zero, which is essentially the level that is priced into TIPS at present.”

Source: John Hussman, Hussman Funds, December 29, 2008.

Bespoke: Economists’ interest rate projections
“Below we highlight average estimates for the 10-Year Treasury Yield and the Fed Funds Rate going out to Q1 ‘10 based on Bloomberg’s survey of more than 50 economists. As shown, economists are expecting the 10-Year Yield to increase steadily in 2009, while they don’t expect the Fed Funds Rate to move back up to 50 bps until the third quarter. By the first quarter of 2010, economists expect the Fed Funds Rate to be back up to 1.00%. It’s hard to find an economist or analyst on the street that doesn’t think Treasuries will fall after the gains they’ve had in recent months. However, just like oil’s rally from $110 to $120 to $140, asset classes can move in one direction a lot more than most people expect.”

Source: Bespoke, December 31, 2008.

Forbes: Big Brother investing
“William Gross has buying power few can match. The founder of money manager Pimco in Newport Beach, Calif. oversees $790 billion, most of it invested in fixed income. But now there’s a new bully on the block: Uncle Sam. The government is on a buying spree the likes of which has never been seen, its purchases of corporate debt held back only by the speed of the dollar printing presses.

“Many of the targets of Washington’s largesse are shaky financial outfits that Gross normally wouldn’t touch, like AIG. Its bonds trade now at 12% yield to maturity – junk level last summer. Investors may be fleeing, but Gross knows when he’s been outmuscled. In the past year the 64-year-old King of Bonds has bought $100 billion of preferred shares and senior debt of financial companies receiving taxpayer loans. His bet is that the government will throw good money after bad rather than let them fail.

“Gross may be buying what others are anxious to sell, but don’t interpret this as meaning he thinks the economy is soon recovering. In fact, he’s quite bearish. With stocks down 40% this year, he predicts Americans will shift from risk to thrift for at least a generation. He says higher savings, plus a move away from leverage by businesses and money managers, means the US economy will grow no more than 2% annually for years, a third slower than its 20-year average. Profit margins will narrow, stock gains will slow to a crawl and the government will find itself lending to the private sector for a long time.

“Gross’ theory is that the government will arrange to get itself paid back and that his investors can safely travel on the government’s coattails. Gross figures Washington is getting a return on its preferred securities, including the value of its equity warrants, of 6% annually. With investors fleeing banks, though, his yield is much higher for essentially the same securities: 10% to 13%. He says these issues are like $20 bills on the street that no one picks up because they can’t believe it’s true. ‘It’s the most incredible value I’ve ever seen,’ he says.”

Click here for the full article.

Source: Bernard Condon, Forbes, January 12, 2009.

Bespoke: High yield spreads contract 10% from December highs
“While it may be cold outside, the thaw we have been seeing in the credit markets reached a notable milestone on Friday. Based on data from Merrill Lynch indices, high yield spreads tightened from 1,979 to 1,955 basis points. From their peak reading of 2,182 basis points on December 15, high yield spreads have now contracted by 10.4%.

“While these levels are still extremely high, they are moving in the right direction. The hope now for the bulls is that this move is sustainable in the new year, when trading desks are back at fully staffed levels.”

Source: Bespoke, December 29, 2008.

BBC News: China to allow freer yuan trades
“China has said it is to allow some trade with its neighbours to be settled with its currency, the yuan. The pilot scheme was announced in a package of measures designed to help exporters hit by the global downturn.

“It means if the two parties to a trade have yuan available, they need not enter world exchange markets to pay. Most of China’s foreign trade is settled in US dollars or the euro, leaving exporters vulnerable to exchange rate fluctuations.

“The yuan is not yet a freely convertible currency.

“Officials did not say when the trial scheme would start. When it does, the yuan could be used to settle trade between parts of eastern China (Guangdong and the Yangtze River delta) and the territories of Hong Kong and Macau, and between south-west China (Guangxi and Yunnan) and the Asean group of countries (Brunei, Burma, Cambodia, Indonesia, Laos, Malaysia, the Philippines, Singapore, Thailand and Vietnam).”

Source: BBC News, December 25, 2008.

Gulfnews: Single currency to increase clout
“A single currency backed by a common economic agenda and a unified monetary policy could make the Gulf a strong regional economic bloc, say economists and financial experts.

“‘The single currency is a huge opportunity for the Gulf region to make its economic clout felt in the international arena. Creation of a strong currency supported by nearly 50% of world’s oil wealth will prove to be a major stabilising factor for the regional economies,’ said Dr Nasser Saidi, Chief Economist of Dubai International Financial Centre.

“Besides attracting foreign investments, analysts say, a strong currency could become a key factor in preserving the region’s financial wealth and help recycle oil wealth within the region.

“Analysts believe the current global economic environment presents an ideal opportunity for the creation of a strong common currency that could emerge stronger than many international currencies such as the dollar, euro, yen and sterling.

“‘The Gulf common currency supported by the region’s resource wealth could become a major reserve currency attracting global reserves into the region. It could also help regional financial centres emerge as global financial centres competing with others such as New York and London,’ said Dr Saidi.

“Economists and currency experts believe the pegged currency regimes in the region and the direct link to the US monetary policy was one of the main reasons for the recent economic volatility in the region. Once the currency union is launched, the immediate priority of the Gulf Central Bank will be to launch a flexible monetary policy that ensures exchange rate stability.”

Source: Babu Das Augustine, Gulfnews, December 29, 2008.

Financial Times: Steel output set for historic drop
“The steel business faces a fall in production in 2009 of at least 10%, analysts say. This would be the biggest year-on-year fall for more than 60 years.

“According to the gloomiest projections, it could be at least four years before output returns to the levels of 2007.

“This would make the period of the expected downturn only the fifth occasion in the past century, leaving aside times of world war, when a slump in the steel industry has lasted four years or longer.

“The sector has been among those worst hit by this year’s financial storms, with share prices in many steel groups having fallen by more than two-thirds since the middle of 2008.

“Hit by a sudden reduction in orders in September and October from businesses such as construction, cars and white goods, many producers including Lakshmi Mittal’s ArcelorMittal, Severstal of Russia and Corus, owned by India’s Tata Steel, have sharply cut production.”

Source: Peter Marsh, Financial Times, December 28, 2008.

Asha Bangalore (Northern Trust): Global factory activity mired in a slump
“In Europe, Germany, France, and the UK all reported declines in indexes of purchasing managers in December.

“The overall Markit Eurozone Purchasing Managers’ Index (PMI) for the manufacturing sector declined to 33.9 in December, a record low in the 11-year history of the survey.

“The German Markit Purchasing Managers’ Index fell to 32.7, the lowest since the survey began in 1996, and the December decline marks the fifth monthly contraction in factory activity.

“The French Markit/CDAF purchasing managers’ index for manufacturing dropped to 34.9 in December versus 37.3 in November. This reading is the lowest since record keeping for this series began in April 1998.

“Britain’s manufacturing sector contracted for an eighth straight month running in December.

“China’s, factory sector has contracted for the fifth month running according to the CLSA China Purchasing Managers’ Index.

“Although the Australian Industry Group-PricewaterhouseCoopers Australian Performance of Manufacturing Index rose one point in December from November to 33.7 index points, this index has recorded readings below 50.0 for seven consecutive months, indicating an extended period of contraction in factory activity.

“In sum, weak economic conditions across the world is a challenge for policy makers in the months ahead.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 2, 2009.

International Herald Tribune: Germany resists calls to spend its way out of trouble
“With battle lines sharpening, the German government appears determined to resist calls to spend an additional €40 billion to fight its way out of the recession, according to officials attending a meeting in the Chancellery in the past week.

“Chancellor Angela Merkel is being pulled in all directions as she plans a January 5 follow-up to a meeting of German government officials, business executives and union leaders she called two weeks ago to discuss ways to counter the recession.

“The business community, leaders of German states and other European Union nations are calling for the additional spending, which would amount to $56 billion. Industry chiefs, meanwhile, are calling for tax cuts.

“Merkel, facing federal elections in September, has said the focus of any spending measures must be preserving jobs. At the meeting two weeks ago, industry lobbyists promised to go along on that point, but now they have backed away even as they exert more pressure on her.

“The European Union, while weakening its criticism of Merkel’s cautious approach to dealing with the economic crisis, still wants the German government to do more because of its size: It has the largest economy in Europe.

“Merkel, so far, has kept the lobbyists, the state leaders and the EU guessing about her final package.”

Source: Judy Dempsey, International Herald Tribune, December 26, 2008.

Reuters: Further house price declines in store for UK
“Housing prices in England and Wales fell 8.7% in 2008, bringing the average price of a house to 159,900 pounds, property consultant Hometrack said in its monthly survey on Monday.

“At 0.9%, the pace of monthly decline eased slightly from November’s 1.1% drop, although prices have now fallen consistently over the last 15 months and 9.3% since the start of the credit crunch in August 2007.

“British house prices tripled in the 10 years running up to their peak in the middle of last year, but have since fallen as much as 15% in other surveys as the global financial crisis has caused the supply of mortgages to dry up.

“‘The onset of recession and the prospect of rising unemployment over 2009 will continue to dampen confidence and in turn demand, which will inevitably lead to further house price falls over the next 12 months,’ said Richard Donnell, director of research at Hometrack.

“Two other key indicators – time taken to sell a property and proportion of the asking price achieved – demonstrate the current weak housing market.

“Hometrack found the average time to sell a property in December was 12 weeks, up from 8.3 weeks a year ago and a low of six weeks in April 2007. The proportion of the asking price being achieved reached 88.6%, down from 93.5% a year ago, and well down on the high of 95.7% seen in April 2007.”

Source: Maureen Bavdek, Reuters, December 29, 2008.

US Global Investors: China’s manufacturing PMI remains in contraction
“According to CLSA, China’s manufacturing activity, responsible for 43% of the country’s GDP, contracted for a fifth month in December though the figures were an improvement from November. A sustained de-stocking cycle in the industrial sector has pushed the employment situation to a 56-month low, a tangible menace for consumer confidence and social stability.”

Source: US Global Investors – Weekly Investor Alert, January 2, 2009.

CNBC: Expect a V-shaped recovery in China
“Sun Mingchun, senior China economist at Nomura, sees a V-shaped recovery in China, with GDP growth starting to rise in the second-quarter of 2009. He explains his optimistic outlook to CNBC’s Martin Soong.”

Source: CNBC, December 29, 2008.

Bloomberg: Japanese economy may shrink 12.1%“Japan’s economy will probably shrink at an annual 12.1% pace this quarter, the sharpest drop since 1974, as exports collapse, Barclays Capital said.

“Gross domestic product in the three months ending tomorrow will fall at almost three times the 4.1% rate previously predicted, said Kyohei Morita, chief Japan economist at Barclays in Tokyo, after reports last week showed industrial production and exports posted the biggest declines on record in November.

“‘Given the speed and the length of the contraction, this recession could be the most severe in the postwar era,’ Morita said. ‘We expect negative growth will continue for a fifth straight quarter to the April-June period of 2009.’

“A 12.1% annualized contraction would be the steepest since the first quarter of 1974, when the oil shock caused the economy to shrink 13.1%, according to Barclays.”

Source: Keiko Ujikane and Tatsuo Ito, Bloomberg, December 30, 2008.

CEP News: Singapore GDP contracts more than expected
“Singapore’s preliminary gross domestic product (GDP) contracted 12.5% in the fourth quarter, against expectations for a 3.4% quarter-over-quarter contraction and the upwardly revised 5.4% decrease seen in the third quarter, originally reported as -6.3%.

“GDP was down 2.6% year over year, against a 0.3% annual decline in the third quarter.

“The report, released by Singapore’s Ministry of Trade and Industry Friday morning said the sharpest annual declines were in the manufacturing sector, down 9.0% from one year ago. The construction sector was up 13.3% annually and the services and producing component was up 1.1%.”

Source: CEP News, January 2, 2009.

US Global Investors: Brazil’s manufacturing confidence plunges
“The Brazilian Manufacturing Industry Survey compiled by the Getúlio Vargas Foundation in Brazil revealed a significant decline in the seasonally-adjusted Industry Confidence Index, from 83.9 in November to 74.7 in December. This was the fourth consecutive decline in this leading indicator of economic activity. In December, the index fell to its second-lowest level since the data series was created in April 1995.”

Source: US Global Investors – Weekly Investor Alert, January 2, 2009.

Financial Times: Russia braced for unrest
“Russia is bracing for further unrest as the rouble on Friday slid to a new low against the euro after a succession of moves to devalue its currency.

“A cut on Friday extended six weeks of devaluations by Russia’s central bank designed to offset the impact of the global economic crisis and falling oil prices as the country’s main export commodity approached its lowest level since 2004.

“Mikhail Gorbachev, the former Soviet leader, warned Russia faced ‘unprecedentedly difficult and dangerous circumstances’ and could be ‘heading into a black hole’. ‘It is not clear what the fate of our rouble will be or if society has sufficient financial and moral resources,’ he said.

“After the depreciation, which was the eighth so far this month, the rouble declined as much as 1.2% to Rbs29.06 versus the dollar on Friday, a four year low. The rouble has now lost nearly 20% of its value against the US currency since August.

“Analysts at Barclays Capital said the best case scenario would see Russian policymakers, facing the mounting evidence of a recession, allowing a one-off depreciation of 10% or more.

“The rouble’s slide comes as the government faces scrutiny over its policies. A demonstration earlier this month in the far eastern city of Vladivostok marked the first major challenge to the Kremlin since the onset of the global financial crisis.

“Mikhail Sukhodolsky, a deputy interior minister, warned on Christmas Eve that there could be further protests. ‘The situation may be exacerbated by a growth in frustration of workers over the non-payment of wages or those threatened with dismissal,’ he said.

Source: Isabel Gorst and Anuj Gangahar, Financial Times, December 26, 2008.

The New York Times: Russia cuts off gas deliveries to Ukraine
“In the face of mounting economic troubles, Russia cut off deliveries of natural gas to Ukraine on Thursday after Ukraine rejected the Kremlin’s demands for a sharp increase in gas prices.

“A similar reduction in supplies to Ukraine in 2006 caused a drop in pressure throughout Europe’s integrated natural gas pipeline system and led to shortages in countries as far away as Italy and France.

“But with a recessionary drop in demand, ample supplies and assurances from both countries that gas would flow westward without interruption, there were few signs of the near hysteria in Europe that accompanied the 2006 cutoff.

“Even Ukraine, which says it has enough gas in reserve to last through the winter, took Russia’s action in stride, underscoring how the political potency of the Kremlin’s energy card has plunged along with the price of oil and gas.

“Gazprom, the Russian natural gas monopoly, likened its actions to a utility cutting off service to a deadbeat customer. “The message is very simple,” Ilya Y. Kochevrin, the executive director of Gazprom’s export arm, Gazexport, said in a telephone interview. ‘If you receive a product, you have to pay for it. If you don’t pay, you don’t receive it.’

“But energy experts said that the Kremlin’s decision to employ the gambit again in a pricing dispute with Ukraine was an indication as well of Russia’s deepening economic woes.”

Source: Andrew Kramer, The New York Times, January 2, 2009.

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Words from the (investment) wise for the week that was (Dec 15 – 21, 2008)

Sunday, December 21st, 2008

“Americans have always been able to handle austerity and even adversity. Prosperity [greed!] is what is doing us in,” said James Reston, former New York Times journalist and Pulitzer Prize winner.

Another chapter in dealing with the current credit and economic adversity was written on Tuesday when the US Federal Reserve announced a no-holds-barred set of measures in a determined attempt to fix the broken credit machine, revive economic activity and stem the deflationary tide.

The Federal Open Market Committee’s (FOMC) policy statement noted: “The Fed will employ all available tools to promote the resumption of sustainable economic growth … In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the Fed funds rate for some time.”

Although the FOMC slashed the Fed funds rate to a target range of 0 to 0.25% – the lowest the central bank’s key rate has been on record – the Fed was actually simply aligning its target rate with the effective rate, thereby pushing the US into an era of Zirp – a zero-interest-rate policy like that used by Japan for six years in its own fight against deflation.

The Fed’s communiqué also said: “The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.” The statement discussed specific actions that would move the Fed further towards a quantitative easing approach to monetary policy.

Source: Daryl Cagle

President-elect Barack Obama told reporters the fact that the Fed had no more room to cut rates underscored the case for a big fiscal stimulus. “We are running out of the traditional ammunition that’s used in a recession, which is to lower interest rates,” he said according to the Financial Times. Word circulated that Obama may ask Congress next year to approve a stimulus plan of about $850-billion.

Investors’ concerns about the outlook for the global economy deepened on the back of the Fed’s announcement, as seen from government bond yields plunging to record lows and a sharp sell-off in oil prices (despite the announcement of the largest supply cut in Opec’s history). Furthermore, the dollar also tumbled on worries about the US’s public debt expansion and the potential inflationary implications of the “printing press”, although a relief rally did take place on Friday. (Also see my post “Greenback slumped on the canvas”.)

As far as stock markets are concerned, investors have again been shrugging off bad news – a pattern seen since the poor manufacturing and payrolls data of more than two weeks ago. “The newspapers may be giving us a parade of bad news, but the stock market is beginning to march to a different drummer,” said venerable newsletter writer Richard Russell (Dow Theory Letters). This is evidenced from the MSCI World Index (+2.4%), S&P 500 Index (+0.9%) and the MSCI Emerging Markets Index (+5.5%) all improving for a second week running.

The scamster Bernard Madoff’s Ponzi scheme also vied for a place in the history books, causing more billions to evaporate to money heaven – yet another example of how greed clouded the minds of people during the halcyon days. (Click here to track the fallout from the fraud.)

Bill King (The King Report), never one to mince his words, commented as follows: “Madoff allegedly engaged in a scheme that is similar to what the US government has been perpetrating for years – giving people benefits now and promising future benefits, even though the benefits are mathematically impossible to pay, by using new cash flows from taxpayers.”

On the bailout front, the White House gave Detroit their Christmas wish, announcing that General Motors (GM) and Chrysler will receive $13.4 billion in emergency government loans in exchange for substantially restructuring their businesses, according to Bloomberg. “Another $4 billion will be available to GM in February provided Congress releases the second half of the $700 billion TARP fund originally set up to bail out financial institutions.”

Some cheer has also been seen in the credit markets, with the TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) declining by 43 basis points to 1.48% – the lowest level since the Lehman bankruptcy in September. Although this measure is moving in the right direction, credit spreads need to narrow further to indicate that confidence is returning and liquidity is starting to move freely again.

The cost of buying credit insurance for US and European companies also eased as shown by the narrower spreads for both the CDX (North America, investment grade) Index (down from 263 to 213) and the Markit iTraxx Europe Index (down from 214 to 191). High-yield credit indices also improved.

There is also some encouragement from the weekly average rates for US 30-year fixed mortgages having declined to 4.94% from 6.30% at the beginning of November, according to Zillow.com.

Next, a tag cloud from the dozens of articles I have read during the past week. This is a way of visualizing word frequencies at a glance. The key words include the usual suspects such as “bank”, “economy”, “Fed”, “market”, “prices” and “rate”.

Regarding the outlook for the stock market, the Wall Street Journal’s MarketBeat blog reported legendary money manager Jeremy Grantham as predicting that beaten-down equities will rally until spring, at which time the bear market will resume.

“While he said that equities in the last couple of months had reached a level of cheapness than had not been seen in years, he still expects more pain to come. Those who can invest with a seven-year time horizon should do well, saying that ‘we’ve popped all of the bigger bubbles’, but he expects ‘we’ll overrun on the downside’.

“He says that the market will likely continue to rally into the spring, and it ‘will be big enough to convince about three-quarters of the players that [the bear market] is all over’. However, he doesn’t believe it is over – expecting a ‘good rally and a different kind of decline, on the sheer grinding of bad news’. He expects something similar to 1974, where the market takes a step forward and a couple steps back, and is fed ‘a diet of ugly earnings’.”

From across the pond, David Fuller (Fullermoney) added: “… markets had fallen sufficiently so that one could nibble on weakness, taking a long-term view. My guess is that China has not only bottomed but is also leading the way back up. However the case is not proven, and will not be until we see base formations for China and most other markets, plus breaks above the 200-day moving averages, which have also turned up. At that point, the next bull market should be well under way.”

The S&P 500 could fall to as low as 600 in 2009 and “alternative assets” like commodities and currencies will provide no shelter for investors, said Gary Shilling in an interview on Tech Ticker (hat tip: Clusterstock). “Having been appropriately bearish heading into this year, Shilling sees ‘few good places to hide’ in 2009. His ‘S&P 600’ prediction, a 33% drop from current levels, is based on a view that S&P earnings will be $40 per share next year (versus the consensus of $83) and the index will trade at a P/E multiple of 15. (Here’s the math: $40 EPS x 15 P/E = 600.)”

Jeffrey Hirsch (Stock Trader’s Almanac) draws our attention to the so-called Santa Claus Rally. This is the trading period from the day after Christmas to the close of the second trading day of the New Year. During this period stocks historically tended to advance, but when recording a loss, it was frequently a sign of trouble ahead.

In my opinion, stock markets are still caught between the actions of central banks pulling out all stops to stabilize the financial and economic situation on the one hand, and a worsening economic and corporate picture on the other. The major US indices seem locked in a short-term trading range, having fallen back below their 50-day moving averages.

The CBOE Volatility Index (VIX) has declined from more than 80 in October and November to 44.9 on Friday. It is not uncommon for short-term volatility to be at extreme levels at bottom turning points, and for stocks to improve as the “storm” grows quieter. It nevertheless remains too early to tell whether a secular stock market low has been recorded on November 20 and, failing further technical and fundamental evidence, I remain distrustful of rallies. In short, we are in a wait-and-see mode. (Also see my post “Stock markets: is this it?”.)

Economy
“Global business confidence continues to slide, falling to another new record low last week. Sentiment is equally negative in North America, South America and Europe, and while Asian business confidence is not quite as dark, it is weakening rapidly,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. The Survey results indicate that the entire global economy is mired in recession.

Economic reports released in the US during the past week confirmed a world of “depression economics” (to coin Nobel Prize winner Paul Krugman’s phrase). According to Briefing.com, industrial production declined by 0.6% in November, housing starts plummeted by 18.9% (marking the largest decline since March 1984), building permits hit a record low, and weekly initial jobless claims held near a 26-year high. Furthermore, the seasonally unadjusted CPI fell 1.9% in November, the largest drop since the 1930s.

Elsewhere in the world, data releases compounded anxiety about a severe global recession, as seen from the following:

- Germany’s Ifo Business Climate Index fell to a record low in December. The outcome reflects the ongoing stresses in the financial markets and weaker global and domestic economic activity, which have weighed on business sentiment. The downward trend in the Ifo suggests that economic activity in Germany will be very weak in the fourth quarter and prospects going forward remain bleak.

- BBC News reports that France will enter recession in the first quarter of 2009, according to Insee, the country’s national statistics agency. France is the Eurozone’s second biggest economy, and would be the latest major world economy to enter recession.

- The Bank of England’s Monetary Policy Committee voted unanimously in favour of the decision to cut the main repo rate by 100 basis points to 2% at the December monetary policy meeting. However, the minutes revealed that the central bank had considered an even more aggressive interest rate cut, heightening expectations that the UK could follow the US in adopting a quantitative easing policy.

- Confidence among Japanese businesses capitulated during the fourth quarter, with the Tankan Survey Index for large manufacturers recording its biggest decline in more than three decades. Business sentiment in Japan is now at its lowest level in more than six years.

- The Bank of Japan followed the lead of the Fed and moved to a near-zero interest rate environment at its December monetary policy meeting. The central bank cut its overnight call rate target by 20 basis points to 0.10%.

- China’s industrial production growth rose only 5.5% year-on-year in November, the slowest gain since 1999 and steeply slower than the 17% growth reported in March, said RGE. Electricity production fell 9.6% – more than in October, which had marked the first fall in a decade.

Source: Financial Times, December 16, 2008.

Summarizing the economic situation, Nouriel Roubini, professor at New York University and chairman of RGE, said in an article in Forbes: “The outlook for the US and the global economy is now very bleak and getting worse as the global economy experiences its worst recession in decades. In the US, recession started last December and will last at least 24 months until next December – the longest and deepest US recession since World War II, with the cumulative fall in gross domestic product possibly exceeding 5%.”

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, December 19, 2008.

Next week’s US economic highlights, courtesy of Northern Trust, include the following:

1. Real GDP (December 23): The final estimate of third-quarter Real GDP is expected to be left at -0.5%. Consensus: -0.5%.

2. Existing Sales (December 23): Consensus: 4.90 million versus 4.89 million in October.

3. New Home Sales (December 23): Consensus: 420,000 versus 433,000 in October.

4. Durable Goods Orders (December 24): Consensus: -3.0% versus -6.2% in October.

5. Personal Income and Spending (December 24): Consensus: Personal income +0.0% versus +0.3% in October; Consumer spending: -0.7% versus -1.0% in October.

Click here for a summary of Wachovia’s weekly economic and financial commentary.

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

Source: Wall Street Journal Online, December 19, 2008.

This week I am giving the customary review of the various asset class movements a skip as family time calls, especially as we have just moved into a new house (located in the scenic Stellenbosch winelands region – about 35 minutes from Cape Town).

On a different note, Madoff’s jeer at the investing public, keeps reminding me of the old adage: “If something sounds too good to be true, that must be because it is too good to be true.” Let’s hope that the news items and words from the investment wise below will assist in bringing cheer to our portfolios during 2009.

Thank you for your friendship and support in making Investment Postcards such a fulfilling experience. Here’s wishing you a great festive season full of fun, laughter and joy. May you have a wonderful 2009.

Source: Daryl Cagle

Krishna Guha (Financial Times): Fed slashes rates to near
“The Federal Reserve moved deeper into uncharted waters on Tuesday, heralding further unconventional measures to support the economy as it slashed interest rates from 1% to virtually zero.

“In a historic statement, the US central bank said it would target a record low interest rate, expressed as a range of between zero and 0.25%. It said it expected to keep rates at ultra-low levels ‘for some time’ and vowed to use ‘all available tools to promote the resumption of sustainable growth and to preserve price stability’.

“The Fed said it ‘stands ready’ to step up its planned purchases of securities issued by Fannie Mae and Freddie Mac, the mortgage giants now under government control. It also said it was ‘evaluating the potential benefits of purchasing longer-term Treasury securities’.

“The aggression of the statement caught the markets by surprise. Mohamed El-Erian, chief executive at Pimco, the bond fund manager, said it was ‘an incredibly strong public declaration that the Fed will throw everything it has in attempting to stabilize the financial and economic situation’.

“The US central bank laid out a strategy that aims to drive down actual borrowing costs for households and companies. It seeks to do so by supporting demand for such loans, reducing the risk spreads on them. At the same time, it wants to keep government bond yields low.

“This means expanded credit and outright asset purchase programs, likely to be funded, at least for now, by expanding reserves and therefore the money supply. Jan Hatzius, chief US economist at Goldman Sachs, called this ‘quantitative easing’. But a senior Fed official said its policy was different from the quantitative easing pursued in post-bubble Japan. The Fed policy is driven by its credit operations whereas Japan targeted bank reserves.

“The Fed said the outlook for economic activity had ‘weakened further’ and acknowledged that ‘inflationary pressures have diminished appreciably’.

“The decision to set a range for interest rates reflects an admission that the US central bank cannot tightly control the actual rate that prevails in the market in current conditions.

“Barack Obama, president-elect, told reporters that the fact that the Fed had no more room to cut rates underscored the case for a big fiscal stimulus. ‘We are running out of the traditional ammunition that’s used in a recession, which is to lower interest rates,’ he said.”

Source: Krishna Guha, Financial Times, December 17, 2008.

BCA Research: US monetary policy – unconventional easing underway
“The FOMC clearly crossed over the line into quantitative-easing territory by cutting the Fed funds target rate virtually to zero, promising to hold it low for a long period, and committing to large purchases of mortgage-related assets and possibly long-term Treasurys.

“In the statement that followed, the FOMC shifted emphasis away from the target rate as the Fed’s primary means of implementing monetary easing in favor of aggressively expanding its balance sheet to drive private sector borrowing rates lower.

“Early clues to its latest thinking were provided late last month upon the launch of its agency and MBS purchase programs and Term Asset-Backed Liquidity Facility (TALF). At that time, it promised to increase the size, the scope and the term of its liquidity facilities as necessary to get credit markets moving again. These comments were echoed in the FOMC statement, which confirms the Fed is prepared to do whatever it takes to restore order to the financial system and head off a potentially damaging bout of deflation.

“The Fed will drive agency and agency-backed MBS yields lower, and will keep Treasurys well bid. If investment-grade corporate bond yields do not fall in the coming months, the Fed could add new facilities to support this market as well.”

Source: BCA Research, December 17, 2008.

Nouriel Roubini (Forbes): Helicopter Ben goes ZIRP!
“The Fed decision to cut the Fed Funds range to 0% to 0.25% has formalized the fact that, over the last month, the Fed had already moved to a zero-interest-rate policy, or ZIRP, and started a policy of quantitative easing (QE) as its balance sheet has surged over the last few months from $800 billion to over $2 trillion.

“The Fed is now undertaking even more unorthodox policy actions. These actions are occurring while the US and the global economy are at risk of a protracted bout of ‘stag-deflation’ (stagnation and deflation).

“While it is now fashionable to talk about such deflationary risks (and the latest US Consumer Price Index figures confirm that we are entering into deflation), some of us were worrying about the coming deflation well before the mainstream – concerned with short-run and unsustainable increases in commodity prices – discovered the deflationary risks in the global economy.

“It was clear to those who saw, early on, the risks of a severe US and global recession, that deflationary rather than inflationary pressures would emerge alongside a slack in goods, labor and commodity markets. Welcome to the world of stag-deflation or, as Paul Krugman would put it, the world of ‘depression economics’.

So what is the outlook for 2009? And what is the likely policy response to the risks of a global stag-deflation?

“The outlook for the US and the global economy is now very bleak and getting worse as the global economy experiences its worst recession in decades. In the US, recession started last December and will last at least 24 months until next December – the longest and deepest US recession since World War II, with the cumulative fall in gross domestic product possibly exceeding 5%.”

Click here for the full article.

Source: Nouriel Roubini, Forbes, December 18, 2008.

John Authers (Financial Times): The Fed’s morning after
“Markets expect the Bank of Japan to cut interest rats to zero; the Fed’s decision has drastically undercut the dollar, oil prices continue to fall despite low rates, a week dollar and a cut in output.”

Click here for the article.

Source: John Authers, Financial Times, December 17, 2008.

Paul Kedrosky (Infectious Greed): ZIRP-ishness around the world
“A quick-and-dirty chart of ZIRP-ishness – the degree to which countries’ nominal interest rates are approaching zero – around the world. Note: The whiter the country the more ZIRP-ish it is, while the more orange you are the further that country’s rate is from zero. Finally, gray means no rate data currently in the dataset.

“It is interesting how, for the most part, ZIRP neatly breaks down into the BRIC/emerging markets versus the rest of the world.”

Source: Paul Kedrosky, Infectious Greed, December 18, 2008.

Bloomberg: Obama may seek a stimulus plan exceeding $850 billion
“Barack Obama may ask Congress next year to approve a stimulus plan of around $850 billion, an amount that has grown as the US economy sinks deeper into recession, an adviser to the president-elect said.

“Obama’s transition team believes the amount, about 6% of the US’s $14 trillion economy, is needed to reverse rising unemployment, said the adviser, who spoke on condition of anonymity. The sum would exceed initial estimates by House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, as well as surpassing what some economists and the International Monetary Fund say is required.

“The latest proposal is circulating in Congress as Obama’s advisers work with lawmakers to craft a package aimed at improving roads, bridges and other parts of the US’s crumbling infrastructure. The plan probably will also include state aid for unemployment and health-care programs and incentives such as tax credits to promote renewable energy production, lawmakers have said.

“The president-elect wants to create as many as 2.5 million jobs over the next two years. As unemployment has increased, estimates of what is needed to pull the nation out of the slump have continued to grow, with some economists calling for a $1 trillion spending program.

“They include Kenneth Rogoff, a Harvard University professor who was an adviser to Republican presidential candidate John McCain, and Joseph Stiglitz, a Nobel Prize winner who served in President Bill Clinton’s White House.

“UBS AG economists calculate a global stimulus of 1.5% of gross domestic product has so far been lined up for next year. The IMF has called for packages of at least 2% of GDP to stem the economic crisis that’s sweeping the globe.”

Source: Lorraine Woellert, Bloomberg, December 18, 2008.

Bloomberg: $1 trillion stimulus
“Stimulus competition grows as companies vie for funds; Caterpillar wants a piece of the highway projects; GE is pushing to build an electric ‘smart grid’; Daimler AG hopes to build new buses for mass transit systems; Obama promises huge infrastructure investment.”

Source: Bloomberg (via YouTube), December 18, 2009.

Bloomberg: GM and Chrysler will get $13.4 billion in loans
“General Motors and Chrysler will get $13.4 billion in emergency government loans in exchange for substantially restructuring their businesses, President George W. Bush announced.

“Another $4 billion will be available to GM in February provided Congress releases the second half of the $700 billion Troubled Asset Relief Program fund originally set up to bail out financial institutions. The automakers have until March 31 to meet the conditions of the loans, including demonstrating they have a plan to become profitable, or be forced to repay.

“Winning the assistance is a reprieve for GM, the biggest US automaker, and No. 3 Chrysler after they said they would run out of operating funds as soon as this month. Bush is stepping in after Senate Republicans’ refusal last week to take up a House- approved rescue raised the prospect that the companies would fail, costing millions of jobs.

“‘These are not ordinary circumstances,’ Bush said at the White House today. ‘In the midst of a financial crisis and a recession, allowing the US auto industry to collapse is not a responsible course of action.’

“The cost of letting automakers fail would lead to a 1% reduction in the growth of the US economy and mean about 1.1 million workers would lose their jobs, including those in the auto supply business and among dealers, the White House said in a fact sheet.

“President-elect Barack Obama endorsed the plan, calling it a ‘necessary step’ to avoid a major blow to the economy.

“‘The auto companies must not squander this chance to reform bad management practices and begin the long-term restructuring that is absolutely required to save this critical industry,’ Obama said in a statement.

“The United Auto Workers are ‘disappointed’ that Bush added ‘unfair conditions singling out workers’, the union’s president, Ronald Gettelfinger, said in a statement. ‘We will work with the Obama administration and the new Congress to ensure that these unfair conditions are removed,’ Gettelfinger said.

“The package is intended for GM and Chrysler initially. Ford Motor Co., the second-biggest US automaker, has said it can continue operating without aid for now.”

Source: Roger Runningen and John Hughes, Bloomberg, December 19, 2008.

Bloomberg: Fed becoming lender of last resort – interview with Merrill Lynch chief economist David Rosenberg

Source: Bloomberg (via YouTube), December 17, 2008.

CNN Money: Economy rescue – adding up the dollars
“The government is engaged in an unprecedented – and expensive – effort to rescue the economy. Here are all the elements of the bailouts.”

Click on the thumbnail for a large table.

Source: CNN Money, December 15, 2008.

FT Alphaville: Welcome to debt central
“US total debt to GDP is beginning to worry a number of market commentators – even those previously convinced it wasn’t a problem. Most recently, Dennis Gartman of the Gartman Letter, has turned jittery on the issue:

“‘We have never been given to wailing and gnashing our teeth over the US’ growing debt, for during our nearly six decades of life and three and one half decades of trading in markets, we’ve seen the nation’s debt grow even as the quality of life and wealth of the country grew faster. But now, even we are becoming concerned; now even we see potential disaster looming; now even we are depressed … Now even we are considering that double hemlock!’

“As can be seen in the chart below, the figure has certainly ballooned somewhat substantially of late.

“But Americans shouldn’t feel too lonely. There’s at least one other G7 country that can rival the States in the debt to GDP rankings. Have you guess which one it is? Some clues: Land of the Great British Krona, home to Team GB … Yes – it’s the grand old United K. Just take a look at this chart from the Spectator.

“And that’s not even total debt, just external.”

Source: Izabella Kaminska, FT Alphaville, December 12, 2008.

CEP News: Leading nations’ GDP poised to decline in 2009
“US, Japan and euro zone GDPs are expected to decline in 2009, according to the Institute of International Finance (IIF) global economic forecast.

“The IIF forecast is calling for the US economy to decline by 1.3% after rising 1.2% this year, while the euro area economies are projected to decline by 0.9% in 2008 and 1.5% in 2009. Japan’s economy is expected to fall by 1.2% after a flat performance this year.

“IIF Managing Director Charles Dallara said, ‘we now face extraordinary challenges. The extent of the declines in the major economies in the current quarter and in the next quarter or two may be substantial, with the US and the euro area likely to see falls in real GDP in the fourth quarter of this year of respectively 5% and 3%.’

“The IIF is also predicting the downturn in the major economies to impact the leading emerging-market economies. They project the growth in emerging markets to average 5.9% in 2008 and 3.1% in 2009. Weak growth is anticipated to hit central, eastern and southern Europe with growth of just 0.3% for 2009, while the IIF is forecasting growth in South America to come in at 1% next year.

“Overall, global economies are poised to grow 2.0% in 2008 and fall 0.4% in 2009.”

Source: Steve Stecyk, CEP News, December 18, 2008.

The Times: IMF fears unrest without action on economy
“Violent unrest may be sparked around the world by a prolonged global slump unless governments act with greater urgency to jump-start stalled economies, the head of the International Monetary Fund said on Monday.

“Dominique Strauss-Kahn sounded a stark warning over the consequences of what he argued was weak and uncertain government reaction to the economic crisis. He used a hard-hitting speech in Madrid to single out eurozone nations over what he attacked as an inadequate response.

“The broadside from the IMF’s managing director came as fears over a protracted global recession, and political fallout, mounted after China said that its factories’ output registered the weakest growth in almost a decade last month.”

Source: Gary Duncan, The Times, December 16, 2008.

George Magnus (Financial Times): Five ways to start the world economic recovery
“After the Minsky Moment – where euphoria tips into crisis, named after Hyman Minsky – the capitulation of economic activity has been rapid and severe. The outlook is as dark as the doomsayers assert. The only thing that stands between today’s dire economic prospects and a lost decade similar to Japan’s in the 1990s is the competence and authority of macroeconomic policy. We have a long way to go, but for five reasons, even doomsayers can start to feel the force, so to speak.

“First, governments have already acted decisively to preserve the integrity of the formal banking system, while the so-called shadow banking system is collapsing. Over $8,000 billion of programmes to stem the collapse in credit and housing have been announced but it is too soon to declare victory. To strengthen banks in the recession and sustain lending, European banks will need a further $100 billion to $150 billion of capital, while US banks, including regional banks, should quickly be allocated most of the unspent Tarp money of $350 billion.

“Second, governments must continue to facilitate the enormous task of sustaining credit flows and restructuring debt. Bankruptcies are inevitable but additional direct lending programmes, asset purchases and government guarantees are needed to keep liquidity flowing to good corporate and residential borrowers, especially while bank balance sheets are constrained by the need to soak up bad assets that were previously held off-balance sheet. Equity-for-debt swaps will be required for companies with excessive debt.”

Click here for the full article.

Source: George Magnus, Financial Times, December 18, 2008.

CNBC: Feldstein – digging out of the recession
“An outlook on the economy, with Martin Feldstein, former Council of Economic Advisors chairman/National Bureau of Economic Research president emeritus.”

Source: CNBC, December 18, 2008.

Duke University: CFO Survey – historic recession to last another year
“Chief financial officers in the United States and around the world are more pessimistic than at any time in the history of the Duke University/CFO Magazine Global Business Outlook Survey. The majority of chief financial officers in the US and Europe say their firms will slash spending and employment in 2009, and their firms will post losses. The recession will last another year, according to nearly two-thirds of CFOs.

“These are some of the findings of the year-end 2008 quarterly survey, which asked 1,275 CFOs from a broad range of global public and private companies about their expectations for the economy.

CFO Optimism Index: Key Measures

“Weak consumer demand is the top corporate concern. CFOs also continue to worry about credit markets, which are devastating lower-rated firms. Companies rated B or lower face interest rates that are 225 basis points higher than their cost of borrowing before the crisis began.

“The CFO optimism index has proven accurate in predicting future GDP growth, employment and capital spending. This quarter’s extreme pessimism foretells a poor economy in 2009. Thirty-nine percent say the economy will not begin to recover until 2010.”

Source: Duke University, December 10, 2008.

Casey’s Charts: Foreign buyers help drive rates to zero
“Foreign purchases of US Treasury Bills hit a record $147 billion in October, helping drive yields to near zero percent on short-term government debt. Traditionally, foreigners have invested primarily in long-term bonds. This surprising shift into T-Bills reveals that nervous foreigners are transferring their mounds of dollars into more liquid assets. They must think there’s no alternative – why else would they accept a zero return?”

Source: Casey’s Charts, December 17, 2008

The New York Times: Chart of the day – deflation

Source: The New York Times, December 17, 2008 (hat tip: Barry Ritholtz).

Asha Bangalore (Northern Trust): CPI plunges
“The Consumer Price Index (CPI) fell 1.7% in November following a 1.0% drop in October. On a year-to-year basis, the CPI has fallen 1.1% versus a 4.1% increase in all of 2007 and a cycle high of 5.6% year-to-year increase in July 2008. In November 2008, the seasonally unadjusted CPI, which goes back to 1921, fell 1.9%, the largest drop since the 1930s.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 16, 2008.

Asha Bangalore (Northern Trust): Money supply growth trims decline of LEI
“The Index of Leading Economic Indicators (LEI) dropped 0.4% in November, after a revised 0.9% decline in the prior month. The index has fallen in ten out of the last fourteen months. The October-November average of the LEI as a proxy for the fourth quarter is down 3.6% from a year ago, a magnitude that is comparable with declines seen in the 1980’s recession.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 18, 2008.

Asha Bangalore (Northern Trust): Construction of new homes at new low
“Home builders remain reluctant to break new ground. Housing starts fell 18.9% in November to an annual rate of 625,000, the lowest on record since record keeping for this series began in 1959.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 16, 2008.

Washington Post: New poll shows 63% are already hurt by downturn
“The deepening recession has eroded the financial standing and optimism of a broad swath of Americans, nearly two-thirds of whom say that they have been hurt by the downturn and that the country has slipped into long-term economic decline.

“A new Washington Post-ABC News poll also found that a rapidly increasing share of Americans – 66%, up from just over half a year ago – are worried about maintaining their standard of living. Nearly two in 10 said they or someone living in their household had lost a job in the past few months, and more than a quarter said they had their pay or hours reduced. And 15% said that at some point in the past year they fell behind on their rent or mortgage.

“The poll captures the widening fallout from the faltering economy that policymakers are struggling to contain.

“The poll found that nearly two-thirds of Americans support new federal spending to stimulate the economy, and majorities of both Democrats and Republicans back the idea. Concern about deficit spending, however, mutes enthusiasm for the stimulus plan. When respondents were asked whether they would back the plan if it increased the deficit, support dropped to 47%. Overall, nearly nine in 10 said they are worried about the size of the federal budget deficit, including nearly half who are ‘very concerned’.”

Source: Michael Fletcher & Jon Cohen, Washington Post, December 17, 2008.

Bloomberg: Retailers may be weeded out during “Darwinian” competition
The US retail industry will undergo a weeding-out process next year as companies run out of cash as soon as January and competition forces store closings, according to private-equity buyers and restructuring experts.

“‘The United States is massively over-stored in all categories,’ Gregory Segall, a managing partner at buyout firm Versa Capital Management, said today during a panel discussion held at Bloomberg LP’s New York offices. ‘You could probably see 50,000 retail outlets close and it wouldn’t impact the availability and selection and choice of what you buy.’

“Only retailers with healthy balance sheets will survive the recession, said Matthew Katz, a managing director at consulting firm AlixPartners.‘This is a very Darwinian time,’ Katz said.

“Plunging home prices, rising unemployment and tightening credit have led consumers to rein in spending, resulting in what may be the worst holiday season in at least four decades. Macy’s, Kohl’s Corp. and other retailers have marked down items 50% to lure customers, eroding margins at a time when store owners hope to make a third or more of their annual profit.”

Source: Allison Schwartz, Bloomberg, December 17, 2008.

Clusterstock: Bernie Madoff’s victims: the slideshow
“The Bernie Madoff Ponzi scheme is a mess. Bernie himself says $50 billion has vanished. The tales of woe seem to fall into four categories: Superrich Individuals, Little Guys, Funds + Banks, and Charities + Universities + Hospitals. We’ve selected some of each, along with some scenes of the crime.

Click here to view the slideshow

Click here for a more comprehensive text list of Madoff’s victims.

Source: Clusterstock, December 14, 2008.

Bespoke: If you ever see a chart like this, run away fast
“We’ve all heard how Bernie Madoff’s returns sounded too smooth and consistent to be true. In picture form, however, the returns are even more eyebrow raising. The chart below shows the cumulative returns of $1 invested in the hedge fund Fairfield Sentry Limited, which was a fund run by Fairfield Greenwich Group that essentially directed all of its assets to the stewardship of Bernie Madoff. As shown, $1 invested in Madoff back in 1990 was supposed to be worth $6.75 today. NPB Bank, out of Zurich, even offered a version of this fund with three times the leverage. Talk about too good to be true.”

Source: Bespoke, December 16, 2008.

BCA Research: Still a bond-friendly world
“While most of the upside in government bonds has likely already been made, we maintain our long duration call.

“Aggressive monetary easing by each of the major central banks has helped fuel the rally at the long-end of the curve. While the recent drop in yields leaves most government bond markets well into overvalued territory, we are in no rush to take profits on our long duration call. Government bond prices may not have much more upside but value is not a timing tool and the growth and inflation backdrop is likely to keep yields suppressed for an extended period.

“However, we do advise clients to shift their long bond allocations to high quality nongovernment spread product, as we expect a significant narrowing in early 2009. We will await evidence that the global economy is beginning to stabilize, which will most likely take until the second half of 2009, before shifting further down in quality. The time-frame would move up if the Fed signaled that it would begin buying corporates in the interim. While legislation prevents the central bank from directly buying these issues, the Fed could purchase corporate bonds off balance sheet by setting up an SIV.”

Source: BCA Research, December 15, 2008.

Bespoke: 30-year fixed mortgage rates down to 5.28%
“Thirty-year fixed mortgage rates have declined significantly in recent weeks, down from 6% on November 20 to 5.28% as of yesterday [Wednesday]. The Fed is definitely happy to see rates fall, and they’ve still got further to go to get to the 10-year record low of 4.88% seen in 2003.”

Source: Bespoke, December 18, 2008.

CNN Money: Stock picks from the experts
“The crash has driven prices so low that even extreme value investors see some safe buys. The stakes are high whenever you invest, but they’re extra high when you’re managing your money amid a historic financial mess and record volatility.

“For advice equal to the task – in a setting chosen to inspire thoughts of security – we invited five champion fund managers to sit down inside a massive underground vault that’s now part of a restaurant a block from Wall Street: Bob Rodriguez of First Pacific Advisors, who manages the FPA Capital and New Income funds; Susan Byrne, who heads Westwood Holdings Group; Leslie Christian, president and chief investment officer of Portfolio 21 Investments; Tom Forester, manager of the Forester Value fund; and Jeremy Grantham, chairman of asset manager GMO.

“Fortune’s Geoff Colvin led the discussion. Edited excerpts follow; stock prices are as of December 1.

“Let’s get right down to business. Bob, you’ve held a lot of cash in recent years because stocks looked too expensive. Are stocks finally cheap?

“BOB RODRIGUEZ: My value screen went to a new record low in June of 2007, and only 33 companies out of 10,000 qualified. In January of this year we went north of 200 for the first time since the summer of 2002. We went to 250 in the Bear Stearns crisis. And the week of October 16, we hit 447 – the most qualifiers in more than 20 years.

“So stocks are cheap by historical standards. However, we’re being very cautious because what we’re experiencing now is a major shift, the culmination of failed policies in the regulatory system and the private sector that have been building up for 30 years.

“Susan, are stocks cheap?

“SUSAN BYRNE: The markets are providing real returns for the risk that you take all along the spectrum, from equities to debt. So, yes, I think that prices reflect the fact that people are quite rightly very afraid of the risk in the stock market.

“Jeremy, you’ve written that stocks will get cheaper.

“JEREMY GRANTHAM: If you look back at 1982 and 1974, the market was much cheaper than it is today. In ‘74 it was about 40% cheaper, and in ‘82 it was about 60% cheaper. Look at the bad times we had in ‘74 and ‘82, and I think several of us would conclude that this time is likely to be as bad – possibly worse. Bubbles like this always overcorrect.

“How bad will you feel if you put in your cash reserves and the market continues to go down? You’re going to feel awful. And how will you feel if you don’t buy in the cheapest market for 20 years and it runs away and leaves you? Horrible. You have to step your way through so that the regret, which is going to be huge anyway, is about neutral.”

Click here for the full article.

Source: Geoff Colvin, CNN Money, December 15, 2008.

David Stevenson (MoneyWeek): Stock markets might not bottom out until 2014
“Tobin’s Q ratio … This is a ratio developed by Nobel Prize-winning economist James Tobin to compare the market value of companies to the cost of their constituent parts, i.e. their real net asset value.

“When the gauge is more than 1.0, it indicates that the market is overvaluing company assets, while a reading of less than 1.0 suggests shares are undervalued because it’s cheaper to buy quoted companies than build them up.

“The Q ratio on US equities has now dropped to 0.7 from a 1999 peak of 2.9. That could indicate shares are now cheap.

“But think again. The ratio needs to fall to 0.3 to signal the final stage of a major bear market like this one, says Russell Napier at CLSA. How does he know? Because that’s what it did at the end of the four largest US stock price declines in 1921, 1932, 1949 and 1982. That translates into the US S&P 500 index plunging another 55% by 2014. Ouch.

“But between now and then, there’s certainly a good chance of a bear market rally – maybe up to two years long, so those strategists may be right about 2009 – as Obama and the US Fed manage to delay the start of deflation with New Deal II. But those efforts will eventually blow up as ballooning government debt devalues the dollar and prompts a massive share sell-off – on both sides of the Atlantic.

“‘Bear markets always end when they begin ‘pricing in’ deflation, as the value of assets falls and the value of debt stays up, so equity gets crushed’, say Napier. ‘The results are always horrific, and equities will become incredibly cheap.’

“Albert Edwards at SocGen has christened this period the Ice Age. Another bull market will start in time. But as Edward’s description suggests, it’s still a long way away.”

Source: David Stevenson, MoneyWeek, December 11, 2008.

Jeffrey Saut (Raymond James): A rally of some import is in the works
“The call for this week: The two questions du jour are: 1) when will the credit crunch end? and 2) how long will the economy remain weak as it attempts to correct the housing situation?

“Speaking to the first question, participants need to monitor the credit spreads, which so far have not improved.

“As for question two, delinquencies and bank repossessions appear to finally be stabilizing. If the stock market is a discounting mechanism, the 50% decline in the S&P 500 may have already discounted everything.

“Moreover, my sense is that just like participants were conditioned to believe that any decline would not gather much traction back in 1999 and 2000, they are now being conditioned to believe that any rally will not sustain. With stocks’ aggregate value currently below the year’s GDP, we continue to think a rally of some import is in the works”.

Source: Jeffrey Saut, Raymond James, December 15, 2008.

Bespoke: Strategists’ 2009 S&P 500 price targets
“Bloomberg recently surveyed market strategists for their 2009 S&P 500 price targets, and collectively, they’re looking for a gain of 21.8% from the index’s current price level.

“As shown below, UBS is the most bullish of the group with a year-end 2009 price target of 1,300 (a 47.2% gain). UBS was the most bullish last year as well with a 2008 price target of 1,700. Goldman and Strategas are the second most bullish this year with price targets of 1,100. Credit Suisse has a target of 1,050 (for mid-year ‘09), Citi and HSBC are at 1,000, and Merrill Lynch is at 975. Merrill is the least bullish strategist of those surveyed, but they’re still looking for a gain of 10.4% from current levels.

“For those looking for direction from these strategists, their 2008 projections should be noted. All were looking for gains this year, and their targets at the start of the year are far above where the S&P 500 is currently trading.”

Source: Bespoke, December 16, 2008.

King Report: US Dollar Index is collapsing
“What does this mean and what are the implications?

“Bernanke can continue to expand the Fed’s balance sheet until a critical mass of investors loose confidence in either Ben or the Fed’s balance sheet. And the confidence is reflected in the dollar.

“After Ben monetized an enormous amount and assortment of assets after the Bear Stearns, GSE, Lehman, AIG and Big Nine ‘problems’ the dollar rallied sharply. This showed confidence in Ben and the Fed.

“But now the dollar is in collapse. This is a clear sign of something other than confidence in Ben/the Fed. The dollar collapse implies that Ben and the Fed are now ‘on the clock’ and investors will react negatively to further Fed balance sheet hyper expansion.

“Here’s the really big problem with Ben’s gambit. It is the same thing that FDR attempted – devalue the dollar to avert deflation and depression. However, devaluation exports deflation and depression to other countries and they will retaliate, which they did to FDR. This is another reason for The Great Depression.

“So key questions are: How long will it take for China, Japan, Germany or others to retaliate against Ben’s scheme to export deflation and depression to them? And what will be the retribution?”

Source: Bill King, The King Report, December 18, 2008.

Bespoke: Biggest six-day decline for the dollar ever
“The US Dollar index fell another 2.2% today [Tuesday] for its biggest 6-day decline ever. As shown in the table below, the current 6-day decline of 8.07% tops the prior record decline of -7.48% set back in September of 1985. If it’s not one asset falling these days, there’s sure to be another.”

Source: Bespoke, December 17, 2008.

James Turk (GoldMoney): Whatever it takes
“The Federal Reserve today made clear its intention to continue flooding the system with newly created dollars. It says in effect that it will do whatever it takes. Its Federal Open Market Committee (FOMC) lowered the federal funds interest rate target to a range of 0%-to-0.25%, which is an historic low, but it didn’t stop there. The FOMC also announced that it would “employ all available tools” in an attempt to jumpstart the moribund economy. That means it will monetize assets of all sorts. It will turn debt into more US dollar currency.

“The consequences of the Fed’s actions will debase the dollar, perhaps irreparably so. The dollar’s bear market rally that began in July ended last month.

“Since last month’s peak in the Dollar Index, gold has climbed 6.3%, while silver did even better. It has climbed 12.6%. These precious metals are clearly the place to be, given the path of monetary debasement being taken by the Fed.”

Source: James Turk, GoldMoney, December 16, 2008.

David Fuller (Fullermoney): Positioning for an upside move in gold
“I think all gold bulls are currently onto something. These are scary times. Gold feels comfortable in this environment. It is still appreciating against most currencies, including sterling, and also stock markets.

“Against this background, gold could spike higher once again – watch out if / when it maintains a break above that last high just over $900. I am not saying a huge move will occur, because I do not know. However I want to be positioned for an upside move in precious metals at this time. The price charts are increasingly showing us that gold and gold shares are performing once again.”

Source: David Fuller, Fullermoney, December 15, 2008.

I-Net Bridge: Platinum now cheaper than gold
“It is now cheaper to buy platinum than it is to buy gold. On Friday (November 12) the price of gold surpassed the price of platinum for the first time in 12 years.

“Both precious metals eased despite the dollar weakness, bringing a two-day rally to an end as sentiment in global markets after plans to bail out the US automotive industry collapsed.

“The $14 billion bailout for the US automotive industry, besides being a lifeline for faltering vehicle manufacturers, would have boosted platinum demand.

“Platinum, which is mainly used as a component in catalytic converters, is particularly vulnerable to a downturn in the automotive sector since the sector makes up 50% of total demand.

“Failure to provide US carmakers with the financial lifeline they so desperately need has triggered concern over additional job cuts and a possible industry collapse.

“The BullionDesk’s James Moore said gold’s movement over the past few days was ‘very encouraging’, But he said it ‘does raise a few questions about its sustainability short-term, which we suspect won’t be answered until early next year.’

“‘Overall though we would look for gold to continue trading sideways to higher as the Fed’s printing presses further erode the value of the greenback,’ Moore said.

“Turning to platinum, Moore said while the news from the US auto makers may generate some bearish sentiment, the ongoing downgrading of production forecasts should see the metal remain near equilibrium. He expected platinum to remain in the broad $780 to $880 range for the time being.”

Source: I-Net Bridge, December 12, 2008.

Bloomberg: Goldman expects crude to fall to $30 early next year
“Goldman Sachs cut its forecast for oil prices in the first quarter by half to $30 a barrel as the global economic slowdown curbs consumption.

“Crude demand will fall by 1.7 million barrels a day in 2009, analysts Jeffrey Currie and Allison Nathan said in a note. Goldman previously expected West Texas Intermediate, the US benchmark oil, to average $62 in the first quarter.

“The worldwide economic decline has reduced consumer spending and weakened demand for fuel. Demand growth in China and other non-member states of the Paris-based Organization for Economic Cooperation and Development is ‘on the cusp of a sharp deceleration’, the analysts said.

“Crude has fallen for five straight months since trading at a record $147.27 a barrel, as countries including the US, Japan and Germany have entered recessions. Goldman Sachs forecast in July that oil would recover to $149 by the end of this year because consumer demand was ‘restrained, but not destroyed’.”

Source: Rachel Graham, Bloomberg, December 12, 2008.

Bespoke: What a difference seven months makes
“We all remember back in May when Goldman Sachs issued a report predicting that oil’s ‘super spike’ would likely send the commodity to $200 ‘over the next 6-24 months’.

“Seven months later, Goldman is now advising clients that ‘oil prices will fall to $30 a barrel in the next three months’. If the call for $30 oil is as accurate as the call for $200 oil, investors may want to fill up their gas tanks and lock in their heating oil prices asap.”

Source: Bespoke, December 15, 2008.

Financial Times: Record oil cut fails to lift prices
“The depth of the world’s economic downturn was highlighted on Wednesday when the Opec oil cartel appeared powerless in its quest to drive up prices even after agreeing a record cut in its production.

“Opec, which controls about 40% of the world’s oil supplies, announced a further 2.2 million barrel a day cut on top of the 2 million b/d it has already pledged since September. It said it would cut 4.2 million b/d from its September output of 29.045 million b/d, bringing its production ceiling to 24.845 million b/d in January.

“Russia said its companies would be forced to cut another 320,000 b/d early next year only if low oil prices persisted.

“The oil market, however, took a dim view of Opec’s action. Nauman Barakat, of Macquarie in New York, said: ‘A cut of 2.2 million b/d is a pretty decent cut but it will take a while for the market to see the Opec cut actually filtering into the market.’

“Even Washington questioned whether Opec members would comply fully with the announced cuts. ‘It’s not clear that Opec’s actions will be effective, given the shift in global demand and the ability of Opec members to meet the cartel’s targets,’ said Tony Fratto, the White House spokesman.

“‘Regardless, Opec has an obligation to keep the market well supplied and to consider the health of the global economy, so efforts to limit the benefits of lower energy prices are short-sighted,’ he said.

“But Chakib Khelil, Opec president, said Opec had a long-established record in meeting the challenges it faced.”

Source: Carola Hoyos, Financial Times, December 17, 2008.

Bespoke: Baltic Dry Index rally?
“The Baltic Dry Index has been getting some attention recently after rallying more than 15% from its lows. One headline we came across even said that shipping companies were benefiting from the ‘revival’ of the Baltic Index. Revival? While the Baltic Index is indeed up from its lows, it is still down 93.5% from its highs in May, and as the chart below illustrates, the recent gain is barely even visible to the naked eye. Global shipping rates will bottom at some point, and may have already done so, but to call the action of the last two weeks a revival seems a bit premature.”

Source: Bespoke, December 15, 2008.

Financial Times: Shipping charter rates soar
“One of the world’s key shipping markets has begun to recover from a slump, with a revival in Chinese demand for iron ore and coal pushing some average charter prices up almost threefold in the past week.

“The revival in prices, after a disastrous six months for the industry in which charter rates fell nearly 99% for the largest vessels, could encourage ship owners to bring mothballed vessels back into service.

“One participant said yesterday that some owners were able to charge enough to cover the costs of operating Capesize ships, the largest dry bulk carriers. Average rates for these ships, which move coal and iron ore, have nearly tripled over the past week.

“The return of mothballed ships to the market could lead to a repeat of the over-supply which, combined with disappearing demand for coal, iron ore and wheat, depressed prices this year.”

Source: Robert Wright, Financial Times, December 14, 2008.

IFO Business Survey: Business climate in Germany continues to decline
“The Ifo Business Climate for industry and trade in Germany has clearly fallen in December, continuing its decline of more than one year. The dominant feature of the December decline is the worsening of the firms’ current business situation. With regard to the six-month business outlook, the scepticism of the survey participants remains nearly unchanged. A similarly low level of the business climate index was last reached during the second oil crisis at the end of 1982.

“The downturn is affecting above all the manufacturers of export and capital goods and less, up until now, retailing and construction.”

Source: IFO Business Survey, December 18, 2008.

BBC News: France set for 2009 recession
“France will enter recession in 2009, according to Insee, the country’s national statistics agency.

“The agency says the French economy has shrunk by 0.8% in the last three months of 2008 and will contract by another 0.4% in the first quarter of 2009.

“France is eurozone’s second biggest economy, and would be the latest major world economy to enter recession.

“Figures have already shown that Germany and Japan have endured two quarters of negative economic growth, while economists in the US have declared that its economy has been in recession since earlier in 2008.

“France only narrowly avoided negative economic growth between July and September, posting growth of 0.1%.”

Source: BBC News, December 18, 2008.

Victoria Marklew (Northern Trust): Increasingly grim outlook for UK
“The economic news out of the UK is ever more grim. Today was the turn of employment. Claimant count unemployment surged by 75,700 last month, taking the number of unemployed by this measure past the psychologically-important one million mark for the first time since 2001. The broader ILO-basis jobless rate rose from 5.8% in the three months to September, to 6.0% in August-October. As unemployment is usually a lagging indicator, the fact that jobs are being shed at this fast a pace this early in the economic downturn points to a harsh year ahead for employment.”

Source: Victoria Marklew, Northern Trust – Daily Global Commentary, December 17, 2008.

Bloomberg: Japan’s Tankan confidence plunges most in 34 Years
“Sentiment among Japan’s largest manufacturers fell the most in 34 years, signaling companies are likely to cancel spending plans and cut more jobs, pushing the economy further into recession.

“An index that measures confidence among large makers of cars and electronics dropped to minus 24 from minus 3, the Bank of Japan’s quarterly Tankan survey showed today. A negative number means pessimists outnumber optimists.

“The yen’s surge to a 13-year high last week has compounded woes for Japanese manufacturers who are already reeling from a collapse in export markets. Job cuts by companies including Sony and Toyota have brought the recession home to households and increased the risk of a prolonged slump.

“‘The overseas situation is worsening so quickly and so dramatically; it’s really getting dangerous,’ said Tomoko Fujii, head of economics and strategy at Bank of America in Tokyo. ‘The next few months are going to be a very severe period.’”

Source: Jason Clenfield, Bloomberg, December 14, 2008.

Asha Bangalore (Northern Trust): Japan – that sinking feeling

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 15, 2008.

Reuters: Ecuador defaults – fighting “monster” creditors
“President Rafael Correa declared a default on Ecuador’s foreign sovereign bonds on Friday, vowing to fight ‘monster’ debt-holders in court in one of the most aggressive moves against investors in the region for years.

“Ecuador’s dollar-denominated debt prices plunged on news of its second default in a decade and the first in Latin America since Argentina in 2002, although the decision was not expected to lead to similar moves around the region.

“Correa, a US-trained economist and ally of Venezuela’s anti-US President Hugo Chavez, refused to make a $31 million interest payment due on Monday on 2012 global bonds, saying the debt was contracted illegally by a previous administration.

“‘I gave the order not to pay the interest and to go into default,’ Correa said. ‘We know very well who we are up against – real monsters.’

“‘If we have to face international litigation due to this, we will,’ he added at a news conference in the OPEC nation’s largest city of Guayaquil.

“The default is unlikely to have a knock-on effect in other Latin American countries’ debt policies even if some, such as Venezuela, have pledged to investigate any irregularities in their own debt …

“Correa, who had often threatened to default, will offer bond-holders a tough restructuring deal. Last month, Ricardo Patino, a top debt adviser to Correa, said investors should expect a reduction of more than 60% in the nominal value of the global paper in any negotiations.

“Ecuador’s global bonds – the 2012s, 2015s and 2030s – total $3.8 billion of its roughly $10 billion debt.”

Source: Maria Eugenia Tello, Reuters, December 12, 2008.

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Stock Markets: Is This It?

Wednesday, December 17th, 2008

The US Federal Reserve yesterday pulled out all the stops in a frantic effort to save the US economy from collapse and stem the deflationary forces. The Fed funds rate was slashed from 1% to a target range between 0 and 0.25% – the lowest the central bank’s key rate has been since records began in 1954.

In reality, the Fed is simply aligning its target rate with the effective rate and thereby pushing monetary policy into an era of Zirp, i.e. a zero-interest-rate policy.

The Federal Open Market Committee’s (FOMC) statement said the “outlook for economic activity has weakened further” from its previous meeting in late October, indicating that the “Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability”. The statement also discussed specific actions that would move the Fed further toward quantitative easing.

In my opinion, the Fed’s communiqué in reality signalled the large-scale monetizing of the US debt markets.

Hat tip: Mish, Global Economic Analysis

Sharing my sentiments, Bill King (The King Report) commented: “Ben Bernanke and the Fed just screwed everyone in the US, and some abroad, that played by the rules, was prudent and live on fixed incomes. Ben, just like Easy Al, is once again redistributing wealth from the prudent, the savers and retirees to the reckless and the boobs that created this mess. But the Fed, via its communiqué, is admitting that it is petrified of what is occurring in the economy and financial system so it is now in all-out money/credit dump mode.”

An e-mail just received from Bennet Sedacca (Atlantic Advisors Asset Management) said: The “Fed has declared war on prudence and savers and rekindled the ‘Moral Hazard Card’ – except this time, I believe they have created the largest moral hazard ever seen. Of note is that this intervention has occurred in the third week of the month (options expiry for the greatest impact – playing games with an already dysfunctional system that they created) and may force prudent, risk-avoidance types, to take risk, at precisely the wrong time.

“I respect markets, and will not sell short against this force that seems invincible, but as always, will remain cognizant of the Big Picture, one that Bernanke and Co. cannot see, it seems. In fact, it feels like they are making a mockery of our system, that they are desperate and will print enough dollars that will force other central bankers to do the same.

“With stated short-term interest rates at 0 (and likely to stay there for the foreseeable future), 30-year Treasuries at 2.7% and stocks at gargantuan price/earnings ratios, we will look to continue to protect our investor’s capital as we have done to date. I do not like being forced into a game of ‘Liar’s Poker’.”

With Treasuries and agency debt potentially subject to a great deal of price risk at these levels, and the US dollar appearing to be topping out, where does the Fed’s “betting the ranch” policy leave the stock market?

Firstly, for some historical perspective, the MSCI World Index and the MSCI Emerging Markets Index have improved by 18.9% and 23.2% respectively since the November 20 lows. As far as the US markets are concerned, the Dow Jones Industrial Index has gained 18.2% since the low, the S&P 500 Index 21.4%, the Nasdaq Composite Index 20.8% and the Russell 2000 17.1%.

In addition to the Fed’s attempts to inflate asset prices, there are a number of short-term positives for equities.

(1) The period post Thanksgiving through the end of the year has usually been a bullish time for stocks, based on studies by Jeffrey Hirsch (Stock Trader’s Almanac).

(2) With the exception of the Russell 2000 Index, all the major US indices yesterday breached their 50-day moving averages. Should the bullish seasonal tendencies provide a further tailwind, the next targets for the various indices are the November 4 highs and the key 200-day moving averages, as shown in the table below. On the downside, the December 1 lows (not shown in the table) must hold for the rally to remain intact.

The number of S&P 500 stocks trading above their respective 50-day moving averages has increased to 53.4% from almost zero in October. However, only 5.4% of the index constituents are trading above their 200-day lines.

(3) The CBOE Volatility Index (VIX) (green line) has declined from the 80s in October and November to 52.4 yesterday. It is not uncommon for short-term volatility to be at extreme levels at bottom turning points, and for stocks to improve as the “storm” grows quieter.

(4) I have mentioned in a previous post that “for a more lasting market turnaround to happen, I would like to see … a 90% up-day …” Yesterday was likely another 90% up day, the first since December 1. The Lowry’s figures are looking better and the Buying Power Index has just broken out above its declining trend line.

(5) Since the peak of the TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) at 4.65% on October 10, the measure has eased to 1.83%. Although this measure is moving in the right direction, credit spreads need to narrow further to indicate that confidence is returning and liquidity is starting to move freely again.

(6) On a fundamental note, it is hard to get a grip on the “E” component of price-earnings multiples, but it will be remiss to ignore the fact that 39% of the constituents of the MSCI World Index sell at a discount to shareholders’ equity. “The cash-rich companies allow investors to pay nothing for future earnings streams,” said Jean-Marie Eveillard in an interview with Bloomberg.

(7) Markets have been shrugging off bad news since the poor ISM manufacturing and payrolls data of two weeks ago. I quoted Richard Russell (Dow Theory Letters) in my “Words from the Wise” review on Sunday, saying: “This is all the more dramatic since this potential upturn has arrived in the face of black-bearish news. Markets bottoming and rising in the face of bearish news are often the most profitable ones. I have never seen a bear market hit its low amid happy news headlines.”

Notwithstanding the improvement since the November lows, it remains too early to tell whether a secular low has been recorded. The chart below shows the long-term trend of the S&P 500 Index (green line) together with a simple 12-month rate of change (or momentum) indicator (blue line). Although monthly indicators are of little help when it comes to market timing, they do come in handy for defining the primary trend. An ROC line below zero depicts bear trends as experienced in 1991, 1994, 2000 to 2003, and again since December 2007.

Stock markets are still caught between the actions of central banks furiously fending off a total economic meltdown on the one hand, and a worsening economic and corporate picture on the other. The rally may have more legs, but failing further technical and fundamental evidence, I remain distrustful as to whether “this is it”.

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Words from the (investment) wise for the week that was (Dec 8 – 14, 2008)

Sunday, December 14th, 2008

Despite a litany of bleak economic and corporate news confronting investors during the past week, global stock markets digested the bearish fodder with a sense of aplomb. The MSCI World Index and the MSCI Emerging Markets Index gained 4.4% and 10.9% respectively on the week, with other reflation trades such as gold (+9.1%) and oil (+20.4%) also putting in a strong performance.

But investor angst was never completely allayed as seen from the yields on US one- and three-month Treasury Bills briefly trading in negative territory for the first time since 1940, indicating the willingness of risk-averse investors to pay the government for the “privilege” of holding their money. Three-month T-Bills ended the week in positive territory but barely so at a minuscule 0.036% yield, indicating that liquidity was still being hoarded. (Also see my “Credit Crisis Watch“.)

Source: Nick Anderson, Slate

The week kicked off on a positive note after US president-elect Barack Obama had spelled out his plans on Sunday for the biggest infrastructure investment in the US since the 1950s. According to CNN, Obama said: “We understand that we’ve got to provide a blood infusion to the patient right now to make sure that the patient is stabilized. And that means that we can’t worry short term about the deficit [which might surpass $1 trillion before his spending plans are included]. We’ve got to make sure that the economic stimulus plan is large enough to get the economy moving.”

“The resultant infrastructure and physical assets will be far better than endowing busted banks, insurance companies and other financial entities with US taxpayers’ cash, which effectively goes down a black hole,” remarked Bill King (The King Report).

Financial markets reacted negatively to the US Senate’s failure to agree on a $14 billion loan to the troubled automakers. The prospect of the biggest industrial failure in US history caused a sell-off on global stock markets, a widening of credit spreads and an onslaught on the US dollar.

However, the US Treasury was quick to signal its readiness to provide funds to prop up the “Big Three”, as quoted in the Financial Times: “Because Congress failed to act, we will stand ready to prevent an imminent failure until Congress reconvenes and acts to address the long-term viability of the industry.” This indication resulted in an improved tone on financial markets by the close of the week.

Next, a tag cloud from the plethora of articles I have devoured over the past week. This is a way of visualizing word frequencies at a glance. Key words such as “credit”, “debt”, “economy”, “Fed”, “government”, “market”, “rates” and “stock” occur often, but “gold” is also becoming increasingly prominent.

Back to the issue of markets shrugging off bad news for the second week running. Richard Russell (Dow Theory Letters) commented as follows: “On top of everything else, Lowry’s Selling Pressure Index dropped substantially yesterday [Wednesday] and is now in a definite declining trend. At the same time, Lowry’s Buying Power Index is trending higher. Thus, the odds are saying that the trend of the stock market is turning up.

“This is all the more dramatic since this potential upturn has arrived in the face of black-bearish news. Markets bottoming and rising in the face of bearish news are often the most profitable ones. I have never seen a bear market hit its low amid happy news headlines.”

On a fundamental note, 39% of the constituents of the MSCI World Index sell at a discount to shareholders’ equity. “The cash-rich companies allow investors to pay nothing for future earnings streams,” said Jean-Marie Eveillard in an interview with Bloomberg.

A positive for the bulls is that the period post Thanksgiving through the end of the year has usually been a bullish time for stocks, based on studies by Jeffrey Hirsch (Stock Trader’s Almanac). Should the bullish seasonal tendencies provide a tailwind on this occasion, possible first targets are the 50-day moving averages of 8,784 for the Dow Jones Industrial Index (current level 8,630) and 910 for the S&P 500 Index (current level 880).

The last word on equities goes to Hong Kong-based Puru Saxena: “I cannot say with any certainty whether we are already in the early stages of the next cycle. Under my best case scenario, we are in the very early stages of a new multi-year bull market. And under my worst case scenario, we are going to get a very strong rebound (30% move higher in the S&P 500) over a short period of time, which will probably take the markets back to their 200-day moving averages.”

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

Economy
“Global business confidence has been shattered. Sentiment is equally negative in North America, South America and Europe. Asian business confidence is not quite as dark, but it is falling rapidly,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. “Pricing power is quickly evaporating and approaching that which prevailed in 2003, the last time deflation was a concern.” According to the survey results, the global economy is suffering a severe recession.

Economic indicators released in the US during the past week mostly pointed to a deepening recession.

BCA Research said: “The year-end spending season will be the biggest bust in several decades, as consumers have been hit by a double whammy: a meltdown in financial and residential asset prices; and a sharp rise in layoffs. The government’s failure to deliver a fiscal stimulus plan and unfreeze the credit markets imply that the recession will deepen and any recovery will be pushed farther into the future.

“The contraction in payrolls and economic growth will persist until there are some signs that policy actions are finally becoming effective. The fiscal stimulus plan needed to stabilize the economy will be massive and policy rates will stay near zero for a long time.”

The precarious position of the US consumer is illustrated by a plunge of 21.9 points to 63.7 in the annual average of the University of Michigan Consumer Sentiment Index – the largest annual average decline in the history of the Index which began in 1952, according to Asha Bangalore (Northern Trust).

The Fed fund futures are pricing in a 76% chance of a 75 basis-point cut in rates from 1.0% to 0.25% when the FOMC meets on December 16.

However, Bill King questioned the Fed’s approach: “[Effective] Fed funds traded at zero late last night. We have screamed for months that the official or ‘target’ Fed funds rate was irrelevant because the effective funds rate was much lower, and near zero. Now Fed funds are trading at zero. Yet there will be pundits and experts that will assert that the Fed might cut its target funds rate this week to 0.50% or even 0.25% – even though the cut in the target rate is meaningless. Now that the Fed is paying interest to banks, why did the Fed allow the funds rate to trade at zero? Yep, they are terrified by something.”

Also, the Fed is considering issuing its own debt to further expand money supply without clogging up bank balance sheets and making it harder for the Fed to maintain interest rates at the desired level. RGE Monitor said: “… there are upper limits to Treasury issuance and lower limits to the amount of Treasuries the Fed can sell off from the asset side of its balance sheet. One hurdle to issuing Fed bills: The Federal Reserve Act doesn’t explicitly permit the Fed to issue notes beyond currency.”

Elsewhere in the world, economic reports compounded anxiety about a severe global recession. Specifically, Chinese exports in November declined by 2.2% from a year earlier as a result of a drastic slowdown in demand in many of its main markets. The figures were far below forecasts and the +19% figure for October. “This is the worst collapse in Chinese exports since 1999 and is probably just the beginning of a prolonged export contraction,” said Isaac Meng, economist at BNP Paribas, as reported by the Financial Times.

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, December 12, 2008.

In addition to interest rate announcements by the FOMC (Tuesday) and the Bank of Japan (Thursday), next week’s US economic highlights, courtesy of Northern Trust, include the following:

1. Industrial Production (December 15): The 1.4% drop in the manufacturing man-hours index in November suggests a 1.0% decline in industrial production. The operating rate is projected to have dropped to 75.7. Consensus: -0.8%; Capacity Utilization: 75.7 versus 76.4 in October.

2. Consumer Price Index (December 16): A 0.7% decline in the CPI is forecast for November versus a 1.0% drop in October, reflecting largely lower energy prices. The core CPI is expected to have moved up by 0.1% after a 0.1% decline in October. Consensus: 1.3%, core CPI +0.1%.

3. Housing Starts (December 16): Permit extensions for new homes fell by 9.2% in October, inclusive of a 12.6% drop in permits issued for single-family homes. These figures suggest a sharp drop in housing starts (730,000). Consensus: 740,000 versus 791,000 in October.

4. Leading Indicators (December 18): Interest-rate spread and money supply are the only two components likely to make a positive contribution in November. Stock prices, initial jobless claims, manufacturing workweek, consumer expectations, vendor deliveries, and building permits are expected to make negative contributions. Forecasts of money supply and orders of consumer durables and non-defense capital goods are used in the initial estimate. The net impact is a 0.5% drop in the leading index during November, assuming building permits fell. Consensus: -0.5 %

5. Other reports: NAHB Survey (December 15), Current Account (Q4) (December 17), Philadelphia Fed Survey (December 18).

Click here for a summary of Wachovia’s weekly economic and financial commentary.

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

Source: Wall Street Journal Online, December 12, 2008.

Equities
Global stock markets rallied strongly during the past week as bargain-hunters looked past the grim economic and corporate reports. Both mature and emerging markets participated in the rally, as shown by the gains of the MSCI World Index (+4.4%) and the MSCI Emerging Markets Index (+10.9%). Notwithstanding the improvement, these indices were still down by 47.4% and 58.8% respectively since the peaks of October 2007.

Particularly noteworthy, the MSCI Emerging Markets Index has been outperforming the Dow Jones World Index since late October (rising green line), after a period of solid underperformance from May to October (falling line).

The chart below shows the performance of the four BRIC countries since the November 20 lows. Brazil (orange line), India (green) and Russia (red) have all recovered sharply, but China (blue) has underperformed after initial outperformance following the climactic[MR2] November 10 sell-off.

Click here or on the thumbnail below for a (pleasantly green) market map, obtained from Finviz, providing a quick overview of last week’s performances of global stock markets (as reflected by the movements of ADR stocks).

The Dow Jones Industrial Index was one of the few major indices to record a negative return during the past week, with US markets in general lagging other bourses as shown by the major index movements: Dow -0.1% (YTD -34.95), S&P 500 Index +0.4% (YTD -40.1%), Nasdaq Composite Index +2.1% (YTD �‘41.9%) and Russell 2000 Index +1.6% (YTD -38.8%).

The bar chart below shows the US sector performances over the week, and specifically how strongly energy and materials have recovered. Nine of the ten best-performing groups were related to commodities (diversified metals & mining, coal & consumable fuel, aluminum, steel, gold, oil & gas drilling, oil & gas exploration & production, gas utilities[MR3] , and oil & gas equipment & services).

Jamie Dimon, JPMorgan Chase’s (JPM) chief executive, prompted a sharp fall in financial shares with a warning that his bank was having a tough fourth quarter after a “terrible” November and December. Goldman Sachs’ (GS) earnings report on Tuesday is keenly awaited.

Based on the outperformance of emerging-market stocks and the sharp recovery of commodity-related groups, it would appear that investors are becoming less risk averse. Another example is the outperformance of small caps since the November 20 lows. A study published by Bespoke on December 8 highlighted the decile performance of stocks in the S&P 500 Index based on market cap. As shown by the chart below, the two deciles of the largest-cap stocks in the S&P 500 increased by about 17%, while the decile of the smallest-cap stocks was 54% higher.

Fixed-income instruments
The yields on government bonds generally edged up during the past few trading days after a record-breaking plunge since the beginning of November.

The UK ten-year Gilt yield increased by 17 basis points to 3.60% and the German ten-year Bund rose by 26 basis points to 3.30%. Although the US ten-year Treasury Note yield declined by 7 basis points to 2.59% on the week, the yield edged up from an earlier five-decade low of 2.48%.

John Hussman (Hussman Funds) expressed his concern about the level of Treasuries: “The problem with Treasury yields here is that while there are good economic reasons for the downward yield pressures, the levels are low enough to invite explosive spikes that can easily wipe out a year or more of yield-to-maturity in a few days.”

Emerging-market bonds moved in an opposite direction to mature bonds, with the JPMorgan EMBI Global Index gaining 2.4% during the week.

US mortgage rates were almost unchanged on the week, with the 30-year fixed rate rising by 2 basis points to 5.71% and the 5-year ARM declining by 1 basis point to 5.95%

The CDX and iTraxx credit indices, US Treasury Bills and high-yield spreads are still at distressed levels. Some improvement has been seen as a result of the central banks’ actions, notably the tightening of the TED and LIBOR-OIS spreads, and lower mortgage rates. However, credit spreads need to narrow further to indicate that liquidity is moving freely again and credit markets are starting to thaw. (Also see my “Credit Crisis Watch“.)

Currencies
The US dollar fell sharply as the recent relationship between risk aversion and dollar strength weakened as a result of US-specific factors like the deterioration in the US trade balance and the automaker woes. The greenback plummeted to a 13-year low against the Japanese yen and touched its lowest level against the euro for seven weeks.

As shown by the chart below, the dollar has broken below its 50-day moving average and seems to be topping out. Are foreign investors coming to the conclusion that the US currency, which briefly last week yielded a negative yield, is no longer an attractive option?

Over the week the US dollar lost ground against the euro (-5.0%), the British pound (-1.8%), the Swiss franc (-3.6%), the Japanese yen (-1.8%), the Canadian dollar (-2.0%), the Australian dollar (-3.0%) and the New Zealand dollar (-2.2%). The US currency also fell against emerging-market currencies[MR4] , like the South African rand (-2.0%).

The British pound came under renewed pressure as the worsening economic situation triggered concerns of a currency crisis. Sterling’s trade-weighted index fell to its lowest level since record-keeping began in 1981.

Commodities
The Reuters/Jeffries CRB Index (+8.8%) closed higher by the end of the week – only its sixth positive week since commodities peaked early in July. The Baltic Dry Index – a benchmark for shipping major raw materials including coal, iron ore and grain – bounced by 15.2% from very oversold levels.

The graph below shows the movements of various commodities over the past week, indicating an improvement across the whole complex (with the exception of natural gas) as a weak US dollar pushed prices higher.

The International Energy Agency urged a “substantial” cut in Opec output when the oil cartel meets next week, as global oil demand this year is expected to contract for the first time in 25 years. The price of West Texas Intermediate crude surged by 20.4% in expectation of a cut of at least 1 million to 1.5 million barrels a day.

Gold bullion (+9.1%) remained in favor with investors as a result of a solid supply/demand situation, store-of-value considerations and a weaker US currency. The chart below illustrates the strong inverse relationship between gold (green line) and the dollar (red line). In addition, gold has broken above its 50-day moving average (blue line) and trades at about the same level it started off in January 2008 – quite a feat in these difficult markets. Platinum (+4.9%) and silver (+8.5%) improved in tandem with the yellow metal.

After the storm comes the calm. With only 12 more trading days remaining before we wish the tumultuous 2008 goodbye, let’s hope the calm lies just ahead. And as Richard Russell reminds us: “Calm after a bearish trend is usually bullish.” Meanwhile, the news items and words from the investment wise below will hopefully assist in steering our portfolios on a profitable course.

That’s the way it looks from Cape Town.

Source: Dave Granlund

YouTube: The twelve days of bailouts
A bailout song for the holidays.

Source: YouTube, December 6, 2008.

New York Magazine: Oracles of doom
They always knew the economy would collapse. What do they think will happen next?

FORTUNE TELLER: Gerald Celente
Trends Research Institute founder; owner of collapseof09.com

TRACK RECORD
Predicted 1987 crash, 1997 Asian currency crisis; said in 2007 that US was headed for “economic 9/11″ in 2008.

CURRENT PREDICTION
“Products are going to be cheaper to buy, but guess what? You’re going to need more dollars to buy them because your dollar’s going to be worth less. There is no fiscal or monetary policy that can save this. You cannot save it by printing more money.”

FORTUNE TELLER: Nouriel Roubini
NYU business professor; chairman of RGE Monitor

TRACK RECORD
Predicted this year’s crisis in 2006, pointing to a housing bust, oil shocks, and interest-rate increases.

CURRENT PREDICTION
“It’s becoming a global recession. I expect it to be the worst US recession of the last 50 years. I expect a cumulative fall in output from the peak of 4% and the unemployment rate going all the way to 9%.”

FORTUNE TELLER: Peter Schiff
President of Euro Pacific Capital

TRACK RECORD
Published “Crash Proof: How to Profit From the Coming Economic Collapse in February 2007″; star of YouTube video “Peter Schiff Was Right 2006-2007.”

CURRENT PREDICTION
“I predicted that the economy would collapse. The bigger risk I saw was the government’s attempt to solve the problem by doing exactly what they’re now doing. They’re going to create another Great Depression, but worse, because the cost of living will go through the roof.”

FORTUNE TELLER: Richard Russell
Founder of the Dow Theory Letters

TRACK RECORD
Predicted bottom of 1974 bear market; exited market before crashes in 1987 and 2000.

CURRENT PREDICTION
“As long as we can hold the Dow above 7,470, I think the situation is hopeful. That’s the halfway level from when the bull market started in 1982 and when it ended in 2007. My guess is that it will break that level. Most bear markets have wiped out more than 50% of a bull market.”

FORTUNE TELLER: Barry Ritholtz
CEO and equity research director of Fusion IQ; blogger at The Big Picture

TRACK RECORD
Predicted downturn last year.

CURRENT PREDICTION
“In March, the first-quarter numbers start coming out, and that’s potentially a problem. It’s just going to be an issue of dealing with the market. If earnings continue to drop and you end up with multiple contractions, that basically takes you to a really bad, ugly place, which is an S&P at 400 or 500. I don’t think that’s likely, but it’s certainly possible.”

FORTUNE TELLER: Jeremy Grantham
Co-founder and chairman, GMO LLC

TRACK RECORD
His 1998 ten-year forecast showed severe market declines in 2007 and 2008; warned of global bubble in April 2007.

CURRENT PREDICTION
“I would think, just to guess, that the period of heroic volatility will end pretty soon and will be replaced by a rather 1974-ish environment, where you quietly get bitterly resigned to your steady diet of bad news.”

Source: Jeff VanDam, New York Magazine, December 7, 2008.

CNBC: Merrill Lynch – outlook for 2009
“An economic and investment outlook for 2009, with Merrill Lynch’s Richard Bernstein and Davis Rosenberg.

Source: CNBC, December 11, 2008.

Financial Times: Obama to focus on stimulus not deficit
“Barack Obama on Sunday spelled out his plans for the biggest infrastructure investment in the US for half a century. The president-elect argued that with the economy reeling, his incoming administration could not afford to worry about a spiralling budget deficit.

“Mr Obama’s proposals for government works on roads, bridges, internet broadband and school buildings, together with energy efficiency measures and health spending, are far more detailed than the normal announcements during a time of transition.

“At a time of deepening economic gloom – with half a million jobs lost last month alone – president George W. Bush has been largely absent from the recent economic debate. Mr Obama is highlighting his concern at the depth of the recession he will inherit, while fast-tracking his plans to counter it.

“‘Things are going to get worse before they get better,’ Mr Obama said on Sunday on NBC’s Meet The Press. He emphasised that his plans represented the largest US infrastructure programme since the federal highway system in the 1950s.

“‘The key is making sure we jump-start the economy in a way that doesn’t just deal with the short term, doesn’t just create jobs immediately, but also puts us on a glide path for long-term sustainable economic growth.’

“Noting the US budget deficit might surpass $1,000 billion before his spending plans are factored in, Mr Obama added: ‘We understand that we’ve got to provide a blood infusion to the patient right now to make sure that the patient is stabilised. And that means that we can’t worry short term about the deficit. We’ve got to make sure that the economic stimulus plan is large enough to get the economy moving.’

“He wanted a strong set of financial regulations to make banks, credit ratings agencies, mortgage brokers and others ‘much more accountable and behave much more responsibly’.

“‘I am absolutely confident that if we take the right steps over the coming months that not only can we get the economy back on track but we can emerge leaner, meaner and ultimately more competitive and more prosperous,’ Mr Obama said at a subsequent press conference.”

Source: Daniel Dombey, Financial Times, December 7, 2008.

Bill King (The King Report): Obama Plan one of the better plans
“The Obama Plan to spend massive amounts of money on infrastructure in the US is one of the better plans being proffered to keep the US out of a depression. But it has its drawbacks.

“Other stimulus plans put money or entitlements in US consumers’ pockets. Most of the money ends up in China, Japan or OPEC. Most infrastructure spending will remain in the US. And instead of just passing out checks or larger entitlements, jobs, mostly temps, will be created and permanent assets will result.

“The resultant infrastructure and physical assets will be far better than endowing busted banks, insurance companies and other financial entities with US taxpayers’ cash, which effectively goes down a black hole.

“Obama’s Plan will boost blue collar employment, provided a limited number of illegals are hired. This will produce an income shift to blue collar and lower middle class households. But fired employees of financial, high tech and other high-end jobs are unlikely to participate. So the multiplier effect of increased income will be less on the economy in general.

“The negatives of the plan, besides the massive debt and likely corruption, is that it does not remedy structural problems in the US economy and financial system. There will be few new industries spawned and therefore few permanent well-paying jobs. Nothing addresses the savings and investment problems.

“There is too much capacity in the world. There are hundreds of empty or abandoned factories in China alone. Until excess capacity is scuttled and new industries appear, stable employment is a fantasy.

“The real problem, the one that solons will not address, is the US welfare state is busted. The Keynesian and monetary stimuli that were abused over many decades to paper over welfare state spending are now being escalated to an unsustainable degree in a last grand attempt to salvage the welfare state system.

“Like all state attempts to stave off a debt deflation by running the printing press and nationalization, it will likely result in a massive inflation that destroys the nation’s fabric and the financial assets of the upper middle class and elites. The middle and lesser classes have few financial assets.”

Source: Bill King, The King Report, December 9, 2008.

Financial Times: Treasury signals rescue for carmakers
“The US administration was on Friday scrambling to save Detroit’s troubled car industry, as General Motors said it was closing most of its North American manufacturing plants for the month of January in the wake of the Senate’s failure to agree a $14 billion loan for GM and Chrysler.

“The US Treasury signaled it was ready to step in with funds intended to prop up the financial system to prevent the biggest industrial failure in US history.

“‘Because Congress failed to act, we will stand ready to prevent an imminent failure until Congress reconvenes and acts to address the long-term viability of the industry,’ the Treasury said.

“GM’s bonds fell to a new low of 9-10 cents on the dollar on fears of a bankruptcy by America’s largest domestic carmaker, before recovering to 15 cents on the news that the Bush administration was looking for alternative financing.

“For weeks George W Bush, the US president, has resisted using the $700 billion troubled asset relief program to provide aid to the carmakers, arguing that such an interventionist step would be a misuse of funds.

“However, facing the prospect of the collapse of one or more of the Detroit companies, the White House indicated it had few other options. ‘A precipitous collapse of this industry would have a severe impact on our economy and it would be irresponsible to further weaken and destabilize our economy at this time,’ said Dana Perino, White House spokeswoman, specifically noting the possibility of using Tarp funds.

“A Chapter 11 bankruptcy filing by GM, the world’s biggest carmaker, would mark the biggest industrial failure in US history.”

Source: Daniel Dombey, John Reed and Bernard Simon, Financial Times, December 12, 2008.

Reuters: Fed mulls issuing own debt
“The US Federal Reserve is considering issuing its own debt for the first time, the Wall Street Journal said, citing people familiar with the matter.

“Fed officials have approached Congress about the move, which could include issuing bills or some other form of debt and would provide the central bank with more flexibility to tackle the financial crisis, the Journal said.

“The Fed can already print as much money as it wants, but issuing debt is largely the province of the Treasury Department.

“The Fed stepped in with emergency credit for investment bank Bear Stearns in March and insurer AIG in September, and threw open its direct loan window to Wall Street firms this year in a bid to stabilize financial markets amid a credit freeze.

“But with the credit crisis showing no signs of abating, and the narrow scope for further interest rate cuts from the present levels of 1%, economists expect the Fed to look at new ways to boost the supply and circulation of money to avoid a deflationary slump.”

Source: Reuters, December 10, 2008.

Paul Kasriel (Northern Trust): The credit rating on a benevolent counterfeiter’s debt – infinity A?
“Why would the Fed be contemplating issuing its own debt? To soak up in the future some of the massive credit the Fed has created in the past year or so. Why would the Fed not just sell US Treasury securities from its portfolio in order to soak up this excess Fed credit? Because, as shown in the chart below, the Fed’s outright holdings of US Treasury securities has dropped from a shade under $800 billion to about $475 billion as Fed credit outstanding has risen from a little over $800 billion to about $2.1 trillion. In percentage terms, the Fed’s outright holdings of US Treasury securities has gone from a bit over 90% of reserve bank credit outstanding to about 22-1/2%. The Fed is afraid it might run out of US Treasury securities to sell!

“I can see nothing sinister about all this. It is not a conspiracy to print money. Just the opposite. It is a way to destroy some of the paper the Fed already has ‘printed’.”

Source: Paul Kasriel, Northern Trust – Daily Global Commentary, December 10, 2008.

Bloomberg: Fed refuses to disclose recipients of $2 trillion
“The Federal Reserve refused a request by Bloomberg News to disclose the recipients of more than $2 trillion of emergency loans from US taxpayers and the assets the central bank is accepting as collateral.

“Bloomberg filed suit November 7 under the US Freedom of Information Act requesting details about the terms of 11 Fed lending programs, most created during the deepest financial crisis since the Great Depression.

“The Fed responded December 8, saying it’s allowed to withhold internal memos as well as information about trade secrets and commercial information. The institution confirmed that a records search found 231 pages of documents pertaining to some of the requests.

“If they told us what they held, we would know the potential losses that the government may take and that’s what they don’t want us to know,” said Carlos Mendez, a senior managing director at New York-based ICP Capital, which oversees $22 billion in assets.

“The Fed stepped into a rescue role that was the original purpose of the Treasury’s $700 billion Troubled Asset Relief Program. The central bank loans don’t have the oversight safeguards that Congress imposed upon the TARP.

“Congress is demanding more transparency from the Fed and Treasury on bailout, most recently during December 10 hearings by the House Financial Services committee when Representative David Scott, a Georgia Democrat, said Americans had ‘been bamboozled’.

Source: Mark Pittman, Bloomberg, December 12, 2008.

The Wall Street Journal: Mayors get in line for US funds
“Big-city mayors will arrive on Capitol Hill Monday to lobby for more federal spending to be funneled to urban areas that they say drive the country’s economic engine.

“The push comes after a strong Democratic turnout in metropolitan areas helped President-elect Barack Obama – who is set to become America’s first urban president in almost half a century – win by such a decisive margin in November.

“A delegation of mayors, including Michael Bloomberg of New York and Antonio Villaraigosa of Los Angeles, plans to ask the federal government to distribute funds directly to cities instead of going through state governments. The group is set to present a list of more than 4,600 infrastructure projects that they say are ‘ready to go’.

“Tom Cochran, executive director of the US Conference of Mayors, which is organizing Monday’s event, said the next administration has signaled that it will coordinate financing for projects for an entire metropolitan area instead of dealing with cities and suburbs separately.

“‘I am of the opinion, based on our conversations with President-elect Obama, that he gets it,’ said Mr. Cochran. ‘You can’t just have a transportation system that stops at the city line.’

“Mr. Obama’s transition office is drawing up plans to create a White House office on urban policy, which would report directly to the president, to coordinate funding for cities from different federal agencies. Mr. Obama has pledged to provide new funding for job training, education and grants for local governments and organizations.”

Source: T.W. Farnam, The Wall Street Journal, December 8, 2008.

Bloomberg: Interview with Martin Feldstein
“Harvard University professor Feldstein discusses auto bailout, how to fix the housing market as well as Fannie and Freddie, and 3-month T-Bill rates below zero.”

Source: Bloomberg (via YouTube), December 9, 2008.

Ambrose Evans-Pritchard (Telegraph): Deflation virus is moving the policy test beyond the 1930s
“Debt deflation is tightening its grip over the entire global system. Interest rates are creeping towards zero in Japan, America, and now across most of Europe.

“We are beyond the extremes of the 1930s. The frontiers of monetary policy are being pushed to limits that may now test viability of paper currencies and modern central banking.

“You cannot drop below zero. So what next if the credit markets refuse to thaw? Yes, Japan visited and survived this policy hell during its lost decade, but that was a local affair in an otherwise booming global economy. It tells us nothing.

“This time we are all going down together. There is no deus ex machina to lift us out. Certainly not China, which is the most vulnerable of all.

“As the risk grows, officials at the highest level of the British Government have begun to circulate a six-year-old speech by Ben Bernanke – at the time of its writing, a garrulous kid governor at the US Federal Reserve. Entitled ‘Deflation: Making Sure It Doesn’t Happen Here’, it is the manual of guerrilla tactics for defeating slumps by monetary means.

“‘The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost,’ he said.

“His point was that central banks never run out of ammunition. They have an inexhaustible arsenal. The world’s fate now hangs on whether he was right (which is probable), or wrong (which is possible).

“As a scholar of the Great Depression, Bernanke does not think that sliding prices can safely be allowed to run their course. ‘Sustained deflation can be highly destructive to a modern economy,’ he said.

“Bernanke’s central claim is that the big guns of monetary policy were never properly deployed during the Depression, or during the early years of Japan’s bust, so no wonder the slumps dragged on.

“The Fed can create money out of thin air and mop up assets on the open market, like a sovereign sugar daddy. ‘Sufficient injections of money will ultimately always reverse a deflation.’

“Bernanke said the Fed can ‘expand the menu of assets that it buys’. US Treasury bonds top the list, but it can equally purchase mortgage securities from US agencies such as Fannie, Freddie and Ginnie, or company bonds, or commercial paper. Any asset will do.

“The Fed can acquire houses, stocks, or a herd of Texas Longhorn cattle if it wants. It can even scatter $100 bills from helicopters. (Actually, Japan is about to do this with shopping coupons).”

Source: Ambrose Evans-Pritchard, Telegraph, December 9, 2008.

Asha Bangalore (Northern Trust): Household net worth is shrinking rapidly
“Household net worth in the third quarter of 2008 was $56.5 trillion, down 4.7% from the second quarter. This is the largest quarterly decline since the second quarter of 1962 when net worth of households dropped 5.0%.

“Household spending will suffer as setback a household net worth shrinks, which is already visible in consumer spending data, and the proclivity of households to borrow will show a reduction. The chart below indicates that growth of both mortgage and consumer debt have fallen in the third quarter. The sharp drop in mortgage debt (-2.4%) reflects the impact of mortgage foreclosures and a drop in home purchases, while consumer debt grew at a 1.2% pace in the third quarter versus a 7.2% jump a year ago.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 11, 2008.

Asha Bangalore (Northern Trust): Weak trajectory for retail sales
“Retail sales fell 1.8% in November, after a 2.9% decline in the prior month. Retail sales have dropped for five straight months, the longest string of declines since record keeping for retail sales began in 1967. The wide swings of gasoline prices influence the headline of retail sales. Excluding gasoline, retail sales dropped 0.2% in November after a 1.6% plunge in the prior month. Retail sales excluding gasoline have recorded six consecutive monthly declines. Unit auto sales have fallen in ten out of eleven months of the year.

“The upshot is that with or without gasoline and autos, retail sales show an extraordinary weakness that is seen the overall consumer spending data and this weak trajectory for retail sales and overall consumer spending is predicted to prevail in the near term.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 12, 2008.

Asha Bangalore (Northern Trust): Consumer spending in post-war recessions
“The chart below illustrates the history of consumer spending during recessions. Consumer spending typically declines in recessionary periods with the exception of the 1948 and 2001 recessions.

“Our forecast includes five consecutive quarterly declines in consumer spending, possibly another record for the books if our forecast is accurate. The highly leveraged household balance sheet of households underlies this prediction.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 8, 2008.

Bloomberg: Inside look – housing crisis
“From Housing Forum in Washington D.C.: Interview with PIMCO Managing Director Scott Simon.”

Source: Bloomberg (via YouTube), December 8, 2008.

BusinessWeek: Unretired – retirees are back, looking for work
“They saved. They planned. Then housing tanked and the markets melted. Now they need jobs, and there aren’t any.

“Six years ago, Paul Nelson gave up his long career in the defense industry for what he thought would be a peaceful retirement in Tucson. The weather was mild, the neighbors friendly. He had plenty of time to volunteer and garden.

“But retirement hasn’t worked out the way he planned. In 2006 his wife of 46 years died unexpectedly. He tried to swap their house for a smaller one and lost a chunk of his retirement savings in the process. Then this year the stock market cratered, wiping out almost everything he had left. Now the 71-year-old is looking for work at local hardware stores and Home Depot and contemplating filing for personal bankruptcy. ‘I have nothing left,’ says Nelson, a former Raytheon engineer. ‘I am not alone, I think.’

“Far from it. An increasing number of people who retired in recent years, confident they had set aside enough to live on comfortably, are finding themselves strapped. The stock market plunge and the housing downturn have affected many Americans, of course. But retirees have been particularly pinched because their homes and investments are the primary assets they depend on for income. As a result, many of the country’s elderly are finding themselves in Nelson’s situation, low on money and looking for work. ‘Suddenly the rug has been pulled out from under them,’ says Alicia H. Munnell, director of the Center for Retirement Research at Boston College.”

Click here for the full article.

Source: Heather Green, Business Week, December 4, 2008.

Asha Bangalore (Northern Trust): Oil imports lead to wider trade gap in October
“The trade deficit widened to $57.2 billion in October from $56.6 billion in September. During October, exports (-2.2%) and imports (-1.3%) of goods and services fell.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 11, 2008.

Reuters: Jim Rogers calls most big US banks “totally bankrupt”
“Jim Rogers, one of the world’s most prominent international investors, on Thursday called most of the largest US banks ‘totally bankrupt’, and said government efforts to fix the sector are wrongheaded.

“Speaking by teleconference at the Reuters Investment Outlook 2009 Summit, the co-founder with George Soros of the Quantum Fund, said the government’s $700 billion rescue package for the sector doesn’t address how banks manage their balance sheets, and instead rewards weaker lenders with new capital.

“Dozens of banks have won infusions from the Troubled Asset Relief Program created in early October, just after the September 15 bankruptcy filing by Lehman Brothers. Some of the funds are being used for acquisitions.

“‘Without giving specific names, most of the significant American banks, the larger banks, are bankrupt, totally bankrupt,’ said Rogers, who is now a private investor.

“‘What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent,’ he said. ‘What’s happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics.’

“Rogers said he shorted shares of Fannie Mae and Freddie Mac before the government nationalized the mortgage financiers in September, a week before Lehman failed.

“Now a specialist in commodities, Rogers said he has used the recent rally in the US dollar as an opportunity to exit dollar-denominated assets.

“While not saying how long the US economic recession will last, he said conditions could ultimately mirror those of Japan in the 1990s. ‘The way things are going, we’re going to have a lost decade too, just like the 1970s,’ he said.

” … Rogers said sound US lenders remain. He said these could include banks that don’t make or hold subprime mortgages, or which have high ratios of deposits to equity, ‘all the classic old ratios that most banks in America forgot or started ignoring because they were too old-fashioned’.

“‘Governments are making mistakes,’ he said. ‘They’re saying to all the banks, you don’t have to tell us your situation. You can continue to use your balance sheet that is phony … All these guys are bankrupt, they’re still worrying about their bonuses, they’re still trying to pay their dividends, and the whole system is weakened.’

“Rogers said he is investing in growth areas in China and Taiwan, in such areas as water treatment and agriculture, and recently bought positions in energy and agriculture indexes.”

Source: Jonathan Stempel, Reuters, December 11, 2008.

CNBC: Meredith Whitney – outlook grim for banks

Source: CNBC, December 7, 2008.

Financial Times: Post-Lehman company defaults to soar
“Default rates for speculative grade companies are forecast to jump threefold next year following the fall of Lehman Brothers, the world’s biggest bankruptcy, according to Moody’s, the US ratings agency.

“The implosion of Lehman on September 15 is widely regarded as a significant milestone, turning the credit crunch into a fully blown economic crisis.

“Jim Reid, credit strategist at Deutsche Bank, said: ‘We are at a turning point for default rates, with much bigger monthly rises from now on.

“‘Two or three months after Lehman’s collapse, we are starting to see the impact on the real economy, particularly for those companies on short-term funding.’

“European companies defaulting on their bonds are also set to outpace those in the US, although analysts suggest this is because the European junk-grade market is smaller, meaning any rise in defaults has a greater impact in percentage terms, rather than pointing to a deeper recession.

“Global default rates are forecast to rise to 10.4% by November 2009 – from 3.1% last month – to levels last seen in 2001 following the dotcom crash. Rates are forecast to jump to 4.2% by the end of this year.

“A year ago, the global rate was 0.9 per cent.

“The ratings agency’s distressed index, which measures the number of companies with bonds trading at more than 1,000 basis points over government paper, rose to 51.8% at the end of last month, up from 48.5% at the end of October, and the highest level since Moody’s launched the index in 1996. This reflects the deepening problems for company funding. Even some investment grade companies are now trading at distressed levels.”

Source: David Oakley and Paul J Davies, Financial Times, December 8, 2008.

Bespoke: 10-Year Treasuries overbought
“It’s an understatement to say that Treasuries are overbought at current levels. We’ve been monitoring the spread between its price and its 50-day moving average, and the 10-year Note has finally gotten to a level that is usually met with selling pressure in the near term. Since 1977, the 10-year has only gotten more than 12% above its 50-day moving average on three different occasions. As shown in the table below, the returns over the next week, month, and 3 months lean to the negative side. The average change of the 10-year over the next three months when getting this overbought has been -3.23%.”

Source: Bespoke, December 9, 2008.

Bespoke: Want to lend money to uncle Sam? It’s going to cost you
“What would your reaction be if you had a friend who had reached the limit on 20 different credit cards and then came to you to borrow $100? Then imagine that you actually said yes, and when you went to give your friend the $100, he or she actually asked for $101 just for the privilege of loaning the money. Well, that is exactly what is happening (to a lesser degree) in the US T-bill market. As just another example of the crazy times we are living in, the yield on 3-month Treasuries went negative today. There was a time when an event such as this was unimaginable. Today it barely gets noticed.”

Source: Bespoke, December 9, 2008.

John Hussman (Hussman Funds): Unusually unfavourabale yield levels for Treasuries
“In bonds, the market climate last week was characterized by unusually unfavorable yield levels and generally favorable yield pressures. As I have frequently noted, yield levels are much more important than market action in driving subsequent total returns in bonds. This is because bonds are less susceptible to ‘bubbles’ as a result of their payment stream being known, so favorable market action can’t be taken as evidence of favorable surprises in those payments.

“The problem with Treasury yields here is that while there are good economic reasons for the downward yield pressures, the levels are low enough to invite explosive spikes that can easily wipe out a year or more of yield-to-maturity in a few days.

“Corporate yields have increased significantly, but default rates tend to pick up in the later stages of recessions, and there isn’t much historical evidence to suggest that corporate bonds reach their lows any earlier than stocks do. For that reason, corporate bonds are essentially equity-equivalents here, and the same considerations about quality apply as well here as they do for stocks. Generally speaking, corporate bonds are currently priced to deliver both lower long-term returns than stocks, but as a group, will probably have lower volatility than stocks as well.”

Source: John Hussman, Hussman Funds, December 8, 2008.

Bloomberg: US Treasury risk surpasses Campbell Soup as debt increases
“The cost to hedge against losses on US Treasuries surpassed the price of default protection on bonds from Campbell Soup and drug-maker Baxter International as government spending on stimulus packages grows.

“Credit-default swaps protecting US government debt in euros for five years are trading at 65 basis points, according to CMA Datavision, meaning costs 65,000 euros ($84,200) to protect 10 million euros of debt. Contracts on Campbell were at 52.5 basis points and Baxter contracts were 57.5 basis points at the close of trading [on Wednesday] in New York.

“The Federal Reserve’s assets have more than doubled from a year ago to $2.14 trillion as the central bank seeks to revive credit markets. Economists including Harvard University professor Kenneth Rogoff and Nobel Prize winner Joseph Stiglitz say President-elect Barack Obama should push for a stimulus package of at least $1 trillion to lift the economy out of a yearlong recession. The US government’s total cost to bail out the economy may exceed $4 trillion, according to strategists including Ira Jersey at Credit Suisse Group AG in New York.

“Contracts protecting U.K. government debt for five years were quoted at a mid-price of 114.75 basis points today [Wednesday], according to CMA. Swaps on Italy are at 190, and the Netherlands at 99.5. France was quoted at 58.75 and Germany at 51.5, CMA data show.

“Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to meet its debt obligations. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.”

Source: Shannon D. Harrington, Bloomberg, December 10, 2008.

Jean-Paul Calamaro (Deutsche Bank): Credit markets offer stunning opportunities
“The crisis gripping financial markets has produced some stunning investment opportunities in credit markets. Among the best is the returns available on ‘basis trades’ between corporate bonds and credit default swaps, says Jean-Paul Calamaro, global head of quantitative credit strategy at Deutsche Bank.

“‘Investors buy a corporate bond and also buy default protection on the issuer via a CDS. When the basis is negative [CDS protection costs less than the bond’s spread to swaps] this produces protected cash flows and further profits if the difference between the bond and CDS narrows, or if the issuer defaults. The basis between bonds and CDS has been at historic wides recently, giving significant returns without using leverage,’ he says.

“‘The trade works for many investment grade and high yield issuers in Europe and the US, but high yield trades look most attractive.

“‘This is because investors can earn high returns more quickly when an issuer defaults and at this point in the credit cycle we think defaults are more likely. The trades also work in investment grade, not because we expect defaults but because we expect the basis between bonds and CDS to narrow.

“‘The major cheapening of bonds versus CDS across corporate credit has been due to the heightened funding crisis since the Lehman bankruptcy in mid-September. We believe conditions will start to ease after year end, which makes these types of trades unusually attractive now.’”

Source: Jean-Paul Calamaro, Deutsche Bank (via Financial Times), December , 2008.

Bloomberg: Cheapest stocks since 1995 show cash exceeds market
“Stocks have fallen so far that 2,267 companies around the globe are offering profits to investors for free. That’s eight times as many as at the end of the last bear market, when the shares rose 115% over the next year.

“Bank of New York Mellon in New York, Danieli in Italy and Seoul-based Namyang Dairy Products hold more cash than the value of their stock and debt as the slowing world economy wiped out $32 trillion in capitalization this year. Companies in the MSCI World Index trade for an average $1.17 per dollar of net assets, the lowest since at least 1995, and 39% sell at a discount to shareholder equity, data compiled by Bloomberg show.

“The cash-rich companies allow investors to pay nothing for future earnings streams, providing opportunities to buyers concerned about deflation, according to Jean-Marie Eveillard, whose $16 billion First Eagle Global Fund has beaten 98% of competitors this year. Microsoft and Novo Nordisk, which generate the most money compared with debt, can expand even if lower consumer demand erodes profits.

“‘Cash is king, not necessarily for the investor but for corporations,’ Eveillard said in an interview from New York last week. ‘It’s useful to sit on a ton of cash, No. 1 to survive, as opposed to going bankrupt, and No. 2 to seize opportunities either to make acquisitions cheaply or to squeeze competitors.’”

Source: Michael Tsang and Alexis Xydias, Bloomberg, December 8, 2008.

Richard Russell (Dow Theory Letters): “I’m beginning to like what I see”
“If they create enough of it, will they come and spend it? That’s what Mr. Bernanke is going to find out. The government has created over a trillion dollars of currency. There’s now over $8 trillion on the sidelines in money markets and T-bills – all frozen with fear and waiting for something better and safer to come along. There’s too much money now in relation to the quantity of goods and merchandise available. This is the formula for inflation or even hyper-inflation. What’s holding it all back? Lack of confidence, fear.

“What would change that? The stock market rising steadily would bring back confidence. Which is why I monitor the stock market so closely. Yes, it’s quite a game, and it’s the most important and fascinating game in the world. No wonder I’m in this business. I read the markets, and I’m beginning to like what I see!

“My guess is that the market is establishing a tradeable bottom with a rally that will last into the first quarter of next year. What we’re seeing now might not be the final bottom but it will serve until the real one comes along.”

Source: Richard Russell, Dow Theory Letters, December 8, 2008.

Richard Russell (Dow Theory Letters): Adding some selected stocks
“Up to now, our favored position has been cash and gold (preferably physical gold). Our new position is cash, gold and, for the bolder crowd, a few selected stocks (DIA if you’re a fearless, speculative type).

“Backing off: Subscribers may think Russell’s lost his mind. He’s turning just a bit bullish. The answer is that I’m reporting exactly what I’m seeing. And if what I see doesn’t jibe with what I’m reading in the newspaper and it doesn’t jibe with prevailing sentiment, then I think it’s that much more important. I keep hearing the most horrendous stories about unemployment and companies in trouble, and my thought is always, ‘Has this been discounted by one of the worst bear markets since the ’30s?’ Which is why I report every item that I see, every item that might suggest that the market has already discounted the bad news. The question always is ‘cut through the BS, what is the market saying?’”

Source: Richard Russell, Dow Theory Letters, December 11, 2008.

Puru Saxena: Sowing the seeds
“This nasty bear-market is in its latter stages and I suspect that the bulk of the declines are now behind us. Although it is premature to claim that the bear-market definitely ended on October 10, it does look increasingly likely that the lows recorded on November 21, were in fact a successful ‘test’ of the prior month’s lows.

“History shows that following a major bear-market, it is common for the major indices to retest the lows. In a recent study undertaken to review recovery patterns, JP Morgan examined all the bear-markets going back to 1900 and it came up with a few interesting observations. The study revealed that market bottoms were almost always retested and that such ‘tests’ resulted in a new marginal low about 40% of the time.

“The study also found that 75% of the retesting events occurred within 44 days of a major bottom; so if October 10 marked the bottom of this bear-market, the retest on November 21 was bang on target from a timing perspective.

“At this stage, I am only guessing that October 10 was the pivotal turnaround of this bear-market. It may well be that this market breaks below those lows in the days ahead, however given the favourable technical and sentiment data, at the very least, there is a strong possibility that we will get a multi-month rally from these oversold conditions.

“It is worth noting that new bull-markets are always born amidst abject pessimism; at a time when the majority are convinced that economic activity will never pick up again. Furthermore, it is interesting to note that frightening economic news continues to surface, long after a new bull-market has begun. So, the time to buy is during such scary times. This was also highlighted by Warren Buffet who recently wrote – ‘If you wait for robins, spring will be over’.

“Now, I cannot say with any certainty whether we are already in the early stages of the next cycle. However, the recent rout in the markets has set the stage for above-average long-term returns. Under my best case scenario, we are in the very early stages of a new multi-year bull-market. And under my worst case scenario, we are going to get a very strong rebound (30% move higher in the S&P500) over a short period of time, which will probably take the markets back to their 200-day moving averages.”

Source: Puru Saxena (via Fullermoney), December 10, 2008.

David Fuller (Fullermoney): S&P 500 at extreme divergence from its 200-day moving average
“We first posted this indicator on October 10 when the relevant spreadsheet was created for us by a subscriber. The indicator remains at a historically low level but has risen considerably from its early October nadir. This has been achieved by the relevant indices having gone mostly sideways for the last two months. The moving average is now starting to come down towards the price and while it still has a long way to go, mean reversion is taking place.

“This is not a guarantee that the market will not go lower later but, historically, when the market has diverged from its mean by such a margin, important stock market lows have occurred relatively soon afterwards.”

Source: David Fuller, Fullermoney, December 8, 2008.

Bespoke: Percentage of stocks above 50-day moving averages
“Even though the S&P 500 is in a new bull market, the percentage of stocks in the index trading above their 50-day moving averages is still at oversold levels. As shown in the chart below, at 26%, this indicator has a long way to go before becoming overbought.

“On a sector basis, Telecom, Utilities, and Consumer Discretionary have the highest percentage of stocks above their 50-days, while Energy and Financials have the lowest.”

Source: Bespoke, December 10, 2008.

Bespoke: Third worst bear market on record
“The S&P 500 finally had its first 20%+ rally in 408 days yesterday [Monday], which means we’re currently in a bull market by the standard definition (20% rally preceded by a 20% decline).

“… below we highlight historical bear markets for the S&P 500 since 1927. As shown, the bear market that ran from 10/9/07 to 11/20/08 is the third worst ever with a decline of 51.93%. The bears that ended in June of 1932 (-61.81%) and March of 1938 (-54.47%) are the only two that had bigger declines without a rally of 20%.”

Source: Bespoke, December 9, 2008.

Bespoke: US sector and stock buy ratings
“Below we highlight the average percentage of buy ratings for stocks in each of the ten S&P 500 sectors. As shown, Financial stocks have the lowest percentage of buy ratings of any sector at 35%, while Energy has the highest at 63%. Consumer Discretionary, Materials, and Consumer Staples are the three other sectors (along with Financials) that have below average buy ratings compared to all stocks in the S&P 500.

Source: Bespoke, December 8, 2008.

David Fuller (Fullermoney): Commodities – are they the most promising asset class today?
“I do think commodities have significant recovery potential, despite the global economic slump, deflation threat and depression fears. Moreover, I believe that the fundamentals for commodities have now improved more than for all other asset classes.

“Consider the following bull points:

1. Interest rates have fallen, which is currently better for commodity speculators than commodity producers, because contangos have shrunk considerably, lowering rollover costs.

2. However, the credit crunch means that it is now more difficult for commodity producers to obtain necessary financing. Consequently, miners and oil producers are deferring development projects and laying off workers, while farmers find it more difficult to finance the purchase of fertilizers and equipment. These problems are not fully offset by the lower cost of energy.

3. Prices for all commodities are much lower today than during the first half of 2008, not least because speculators have been shaken out and traders are actually short. This is good news for those who wish to buy oversold commodities. However it is a big disincentive for commodity producers, many of whom are now reducing production.

4. While the global economic slump has reduced demand for commodities somewhat, these are essential resources which the world cannot do without, unlike luxury goods, the latest fashions, lavish holidays or expensive restaurants.

5. The US dollar has peaked and commenced what is likely to be a significant retracement of gains seen since July. This is bullish for commodities because most are priced in US dollars.

“What could significantly delay or even prevent a big rally for commodities? The reflationary efforts could fail, or more likely take many more months before they turn a global economy that is still contracting. If so, there could be some additional downside risk and base formation development would most likely be lengthy. The US Dollar Index could fail to maintain its downward break. Improved weather patterns could lead to increased supplies of agricultural commodities.

“For these reasons, Fullermoney maintains that commodities are best purchased following setbacks. Positions are most safely built incrementally.”

Source: David Fuller, Fullermoney, December 11, 2008.

Financial Times: So long, super-cycle
“The severity of the crisis has surprised natural resources companies’ executives, commodity traders and Wall Street bankers alike. After all, the commodities boom of 2003-08 has been the most notable for a century in its magnitude, duration and the number of commodities whose prices it has lifted. The sudden plunge poses a fundamental question: is this just a temporary blip within an upward trend, with prices likely to rebound in the medium term, or is it the conclusion of another commodities cycle of boom and bust, with a period of relatively stable prices coming ahead?

“The common belief in the industry itself, and among most Wall Street analysts, is that the market is undergoing a correction but that the boom years have not ended. As many point out, the main drivers of what many have come to see as a commodities super-cycle – such as strong pent-up demand in emerging countries and supply constraints caused by a lack of investment over the past 20 years, along with the rise in resource nationalism – are intact. The current drop is, in the words of one senior mining executive, a ‘reset’ of the boom, not the end of it. Prices will rebound, in this view, and continue rising.”

Click here for the full article.

Source: Javier Blas and Krishna Guha, Financial Times, December 9, 2008.

Bespoke: Consensus gold estimates
“Below we provide the consensus price target for gold through 2012. These target prices are based on the median of 21 gold analysts surveyed by Bloomberg. As shown, analysts currently aren’t expecting a big rally or a big decline in gold over the next few years. By mid-year 2009, analysts are expecting gold to be at $825/ounce, which is less than $10 from its current price of $816. At the end of 2011, analysts expect gold to be down to $790, and then down to $762 by the end of 2012.”

Source: Bespoke, December 12, 2008.

Casey’s Charts: Gold stocks – time to bottom feed
“The previous low point for the ratio of the XAU gold stock index to the price of gold was 0.16, when gold was trading around $270 an ounce in October of 2000. Today, the XAU is trading a mere 57% higher than it was in October of 2000, compared to a gold price that has increased by 184%. As a general rule of thumb, anytime the ratio is above the 25-year average is the time to sell, and below its average says gold stocks are cheap. With the ratio bouncing off the lowest level since the inception of the XAU index, it signals a SCREAMING buy for gold stocks!

“Picking the bottom of any market is near impossible, but knowing when something is grossly undervalued can be easy. Gold has long been considered a hedge against inflation, and with trillions of new government bailout dollars ready to circulate into the system, buying precious metal stocks at these distressed prices is the chance of a lifetime.”

Source: Casey’s Charts, December 5, 2008.

Profit NDTV: Asia beats US in gold futures trading
“Asia, which accounts for 60% of the world gold imports, has overtaken the US in gold futures trading, with Mumbai and Shanghai exchanges growing rapidly, leading trade magazine Futures Industry has reported.

“According to the latest edition of the US-based magazine, data from the first eight months of this year show that the combined volumes in gold futures trading at exchanges in Shanghai, Tokyo, Taiwan and Mumbai reached 49.8 million contracts, far ahead of the 34.3 million contracts traded in the US.

“‘From January through August this year, seven of the top 10 gold contracts in the world were Asian,’ it said, adding that much of that growth was in Mumbai and Shanghai.

“‘Some of the boom is undoubtedly driven by the search for a safe haven as the value of stock investments continues to evaporate,’ the magazine said noting that Asian investors may also have a greater cultural predisposition toward gold than Westerners.

“Asia imports 60% of the world’s gold and its exports 40%. India is the largest consumer of physical gold in the world, followed by the US, and then China. And this year, China became the world’s largest gold producer – a title south Africa had held for more than 100 years.”

Source: Profit NDTV, December 9, 2008.

BBC News: UK economic slowdown “worsening”
“The UK economy contracted 1% between September and November, the National Institute of Economic and Social Research (NIESR) has estimated.

“This fall followed after a 0.8% drop in the three months to the end of October, said the think tank. Indicating that the rate of output decline is ‘accelerating’, the NIESR now expects a fall of more than 1% in the last three months of the year.

“Official data showed that the economy shrank 0.5% from July to September. But it will not be until January that the Office for National Statistics reports on the final quarter’s GDP.

“If it reports a decline for the three months to December, then the UK will be in officially in recession under the generally accepted definition of two consecutive quarters of decline.

“The NIESR says it has a good track record in forecasting GDP growth in advance of the official figures. The latest data from NIESR is just the latest indication that the UK economy is most probably falling into a recession.”

Source: BBC News, December 10, 2008.

Victoria Marklew (Northern Trust): Swiss rates head toward zero
“The Swiss National Bank (SNB) effectively lopped another 50bps off its main policy rate today, lowering its target band for three-month Swiss franc LIBOR to 0.0-1.0% (down from 0.5-1.5%) and aiming for the mid-point of 0.5%. This brings the easing total to 225bps since October 8.

“The SNB warned that the sharply worsening global climate will push Switzerland into recession next year. Chairman Roth stated that growth is likely to be negative, not just in the first two quarters of 2009 but for the year as a whole. The bank is now forecasting a contraction in real GDP of between 0.5% and 1.0% next year. The inflation forecast was also revised down, with the bank now seeing the annual rate averaging 0.9% next year and 0.5% in 2010.”

Source: Victoria Marklew, Northern Trust – Daily Global Commentary, December 11, 2008.

Financial Times: Japan contracts faster than expected
“Japan’s gross domestic product contracted much more rapidly in the third quarter than previously thought, official data showed on Tuesday, amid new indications of distress in the world’s second-biggest economy.

“The revised GDP data showed a quarter-on-quarter fall of 0.5% for the three months to September, compared with last month’s preliminary estimate of a 0.1% decline.

“The economy contracted at an annualised rate of 1.8% between July and September – a much more precipitous pace than the annualised 0.5% decline suffered in the same quarter by the US, centre of the global financial crisis.

“Analysts said the revision, though bigger than expected, reflected relatively technical factors involving inventories and government spending rather than worrying new information and so would not dramatically change assessments of the economy’s prospects.

“‘The downgrade in headline growth does not look as bad as the headline suggests,’ UBS said in a research note.

“However, the news the recession was deeper than thought came as the Cabinet Office said its latest composite index of business conditions showed the economy ‘worsening’.”

Source: Mure Dickie, Financial Times, December 9, 2008.

Financial Times: China’s export fall worse than predicted
“The impact of the global financial crisis on China became clear on Wednesday when the government revealed that exports fell in November for the first time in almost seven years.

“With demand in many of its main markets slowing sharply, Chinese exports declined 2.2% from a year earlier. Imports also fell 17.9% from a year earlier, according to Chinese customs figures, prompting the government to announce plans to further boost the economy.

“The Chinese data shocked economists. The figures were far below forecasts, even in the light of sharp slumps in exports in November from both Taiwan and South Korea.

“‘This is the worst collapse in Chinese exports since 1999 and is probably just the beginning of a prolonged export contraction,’ said Isaac Meng, economist at BNP Paribas.

“The drop in imports, the biggest since the early 1990s, helped push the monthly trade surplus to a record $40 billion, the fourth month in a row that the surplus has broken records.

“The government pledged on Wednesday to do everything it could to maintain ‘stable, healthy’ growth next year. At the conclusion of the three-day Central Economic Work Conference, an annual meeting of top policy-makers, officials said they would boost public spending in order to promote domestic demand.

“A report on state radio about the meeting said the government had reaffirmed its policy of keeping the exchange rate ‘basically steady’, but would take other measures to deal with falling domestic demand.

“Until last month, China’s exports had held up much better than most observers had expected, increasing by 19% in October compared to the same month last year.”

Source: Geoff Dyer and Jamil Anderlini, Financial Times, December 10, 2008.

Financial Times: China inflation falls as growth slows
“China’s consumer price inflation fell to a 22-month low of 2.4% in November, giving the central bank free rein to cut interest rates further to offset an abrupt slump in the world’s fourth-largest economy.

“Economists had expected inflation to moderate to 3.0% from 4.0
% in the year to October. In the event, the reading was the lowest since January 2007.

“Nie Wen, an analyst with Huabao Trust in Shanghai, said the plunge meant real, inflation-adjusted interest rates in China were now back in positive territory even though the economy had run into fierce headwinds.

“‘The government will become more decisive in cutting rates,’ Nie said.

“Jing Ulrich, head of China equities at J.P. Morgan agreed. ‘We believe there is further scope for the central bank to ease monetary policy in an effort to avoid an excessive slowdown and stave off deflation,’ she said in a note to clients.

“‘Definitely we are going to move into a deflationary environment in China, probably through the first six months of the year,’ said Glenn Maguire, chief Asia-Pacific economist for Societe Generale in Hong Kong.”

Source: Financial Times, December 11, 2008.

Bespoke: Deflation coming in China?
“It wasn’t too long ago that one of the biggest worries facing the global economy was that improved standards of living in China would lead to higher wages for its workers. This, it was feared, would cause the country to begin exporting inflation around the world. As recently as August, PPI data from China showed that inflation was running at a rate of 10.1% year over year (y/y). Since then, however, pricing power in China has collapsed as evidenced by last night’s [Tuesday] release of the November PPI, which showed that prices are now up by just 2.0% y/y. At this rate, it won’t be long before we start seeing minus signs.”

Source: Bespoke, December 10, 2008.

Financial Times: Rouble exodus hits Russia’s credit rating
“Russia on Monday became the first G8 country since the start of the financial crisis to have its credit rating downgraded after Standard and Poor’s took fright at the recent exodus from the rouble and sharp drop in oil prices.

“S&P said it had lowered Russia’s foreign currency credit rating by one notch from BBB+ to BBB because of the ‘rapid depletion’ of the country’s foreign exchange reserves and the ‘difficulty of meeting the country’s external financing needs’. It said the outlook for the rating was negative.

“Russia’s reserves have fallen by $128 billion since August to $455 billion, as the country battles the capital flight that began following the war with Georgia and escalated as the oil price fell and the global crisis worsened.

“S&P said Russia could be forced to spend all $200 billion now parked in its two sovereign wealth funds on recapitalising the banking system and covering fiscal deficits in 2009 and 2010.

“The agency expects Russia to run a current account deficit next year of 2.6% of gross domestic product due to the oil price fall, putting further pressure on the balance of payments.

“‘There are a lot of layers of concern,’ said Frank Gill, primary credit analyst at Standard and Poor’s. ‘There are macroeconomic and political risks … and Russia has not operated a current account deficit since 1997 and that was less than 1% of GDP.’

“The thought of devaluation raises the spectre of the 1998 rouble crash that wiped out Russians’ savings, although economists say any devaluation this time would be far less severe.”

Source: Catherine Belton, Financial Times, December 8, 2008.

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Hendry: 10-20 Years to Recover Thanks to ECB

Thursday, October 23rd, 2008

Hugh Hendry, CIO, Eclectica Asset Management told Power Lunch Europe that it will take 10-20 years to heal from the current turmoil in markets. This is a must see interview.

click image for video

Here is the summary of the interview:

Hendry has avoided risk the last few years. His hedge fund is up 20% YTD and 42% this month. He has been investing more heavily in long term US treasuries recently. Hendry is looking at increasing the risk exposure in his hedge-fund’s portfolio.

He pointed to Mervyn King’s hinting toward the “R” word as putting it mildly, that the big “D” is in the forecast.

“It’s not a question of losing out in a recession, I’m talking about 10 or 20 years before we recover from this. This is a catastrophe,” Hendry told “Power Lunch Europe.”

Hendry made an example of Hungary. He lambasted the Hungarian central bank governor, Mr. Andra Simor, who described the situation as akin to “the slower antelopes in a chase being devoured by lions one after the other.”

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This stems from Hendry’s past involvement in discussions with European financial officials about European convergence.

Hendry specifically alludes to discussions he’d had with the Hungarian governor in particular regarding the integration of Hungary into the EU and that he warned against the way in which they planned to finance their move with Swiss Francs and Yen via the carry trade.

While in violin-playing posture, Hendry claimed,”It’s tragic.”

“What it [the reel] doesn’t reveal is that I sat there, he just said, you’re rubbish. I’m Hungary. I’m going join the EU. My interest rates are 8% and they’re going to be 4%. You’re a fool, You can’t catch me Mr. Lion, I can outsmart you, I can outrun you. And I said “I dare you.”

I said, “I’ll give you a head start.”

They suspended all economic rationality. Mortgages were given to poor people in Swiss Francs and Japanese Yen. They took on an enormous foreign exchange risk, because they thought that the little antelope could outrun the lions of economic intelligence. And you can’t.

Hendry said, “You can game the system, but you can’t beat it.”

There’s nothing crude, there’s nothing moral here. They were wrong.”

Dominoes. Iceland, Hungary, Latvia, Bulgaria, Eastern Europe, the dominoes are crashing. There’s economic disequilibrium. The economic chaos which we ignored for 5 years because we were bribed to ignore it, because they paid high interest rates. It was a bribe to ignore reality. But in a world where everything is falling down, the dominoes just crash. There is no answer.

Hendry’s beef is with EU and UK regulators and officials.

“I’m the heretic. I was laughed at, scoffed at, dismissed, ignored, at a time when investment bankers who advise governments, and who manage money, took reckless risk upon reckless risk.

We reached a point at which the Royal Bank of Scotland had a bigger balance sheet than the economy. Everyone looked the other way. Its not a question of losing out in a recession. I’m talking about 10 or 20 years before we recover from this. This is a catastrophe.

Forget about Mervyn King, UK Finance Minister, saying the “R” word. You wait until he says the “D” word.; depression. We had interest rates in the UK at 5% for a year as everything collapsed.

There’s a notion of stall speed. Never allow an aircraft to reach stall speed. That is the pledge central bankers must make. ” We won’t allow the economy to reach stall speed,” because everything below that you’re pushing on a string.

Interest rates in the UK will be 2% at the end of next year, and they’ll be 2% at the end of the year after that.

The ECB, the most hideous, intellectually conceited group of bankers, raised interest rates this summer; history will send the ECB to damnation because they have sent us to damnation. That’s the reality.

Thank you Mr. Hendry.

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