Words from the Investment Wise 1.17.10

Words from the (investment) wise for the week that was (January 11–17, 2010)

“Words from the Wise” this week comes to you in a somewhat shorter format as I do not have access to all my normal research resources while spending a few days with the gnomes in Geneva (also see my post “Blogging gone AWOL – to Switzerland“). Although the commentary is not as comprehensive as usual, a full dose of excerpts from interesting news items and quotes from market commentators is included.

With investors’ hopes of an economic recovery that might have gotten ahead of reality, the Dow Jones Industrial Index experienced its largest one-day drop (-0.9%) of the year in a sell-off on Friday – unnerved by China starting to rein in liquidity and cautious earnings guidance – causing the benchmark US indices to register a fourth down-week over an eight-week period. Not surprisingly, the CBOE Volatility (VIX) Index, also referred to as the “fear gauge” of US stocks, gained 1.2% over the week.

Providing “entertainment” of a dubious kind and reminding one of the 1933 Pecora Commission, the Financial Crisis Inquiry Commission on Wednesday started interrogating four of Wall Street’s top executives in Washington and promised to use wide-ranging powers to establish the causes of the financial crisis and pursue any wrongdoing.

Meanwhile, Christina Romer, who heads the president’s Council of Economic Advisers, said (via MoneyNews) the payment of big year-end bonuses for bailed-out financial institutions would be “ridiculous” and “offensive” and “is going to offend the American people. It offends me”.

Similarly, according to The Canadian Press, President Barack Obama said with reference to his proposed plans to impose a levy on big financial institutions to recoup some of the costs of the financial crisis: “If the big financial firms can afford massive bonuses, they can afford to pay back the American people.”


Source: Steve Sack, Comics.com

The past week’s performance of the major asset classes is summarized in the chart below – a set of numbers indicating a degree of risk aversion has crept back into financial markets. Steps by the People’s Bank of China to tighten liquidity by increasing the bank reserve requirement ratio and raising inter-bank interest rates negatively impacted oil and other commodities, causing the first decline in five weeks.


Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The MSCI World Index and the MSCI Emerging Markets Index declined by 0.2% and 0.6% respectively during the past week. Among mature markets, Japan (+1.7%) bucked the trend and added a seventh consecutive week of gains – coinciding with a weaker yen over the period. (Also see my post “What to expect from Japan’s new finance minister“.) Among emerging countries, Russia (+7.2%) performed solidly, while China (+0.9%) also eked out a gain after having to balance adverse monetary developments in that country with impressive trade data early in the week.

Notwithstanding the huge rally since the March lows, only the Chile Stock Market General Index – again a solid performer on the expectation of a positive election result – has been able to reclaim its 2007 pre-crisis peak and is now trading 8.1% higher. Mexico could be the next country to eliminate the bear market losses.

As far as the US indices are concerned, Wall Street managed to hit 16-month highs on Monday and then again on Thursday, but reversed course on Friday as traders closed positions before the Martin Luther King long weekend, pulling indices into the red.

Seven of the ten economic sectors (as measured by the SPDR exchange-traded funds [ETFs]) closed lower for the week, with the defensive sectors outperforming the cyclical ones. Health Care (+1.4%), Consumer Staples (+0.8%) and Utilities (+0.6%) returned gains, whereas all the other sectors were under the water. Small caps, in particular, led the way down on Friday.

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


Top performers among stock markets this week were Estonia (+15.6%), Venezuela (+9.6%), Lithuania (+8.7%), Kazakhstan (+7.2%) and Kenya (+5.7%). At the bottom end of the performance rankings, countries included Greece (-7.9%), Jamaica (-6.7%), Cyprus (-6.5%), Luxembourg (-4.9%) and Portugal (-1.2%). “Greece on Thursday announced an ambitious three-year plan to curb its runaway budget deficit but failed to convince skeptical markets that its targets for growth and fiscal reform were feasible,” reported the Financial Times.

Of the 96 stock markets I keep on my radar screen, 53% recorded gains (last week 79%), 41% (15%) showed losses and 6% (6%) remained unchanged. The performance map below tells the past week’s rather bullish story

Emerginvest world markets heat map


Source: Emerginvest (Click here to access a complete list of global stock market movements.)

John Nyaradi (Wall Street Sector Selector) reports that as far as ETFs are concerned the winners for the week included iShares MSCI Japan (EWJ) (+4.8%), Claymore/Delta Global Shipping (SEA) (+3.6%), Vanguard Extended Duration Treasury (EDV) (+3.3%) and iShares MSCI Austria (EWO) (+2.7%).

At the bottom end of the performance rankings, ETFs included Claymore/MAC Global Solar Energy (TAN) (-8.7%), PowerShares WilderHill Clean Energy (PBW) (-7.2%), Claymore/AlphaShares China Real Estate (TAO) (-6.6%) and United States Oil (USO) (-5.7%).

Referring to the modern robber barons, or “banksters”, and Obama’s proposed bank tax to recoup bailout costs, the quote du jour this week comes from long-timer Richard Russell, writer of the Dow Theory Letters. He said: “Obama is fighting two wars, the war in Afghanistan and the war in Iraq. Now he’s got a third war going, the war on Wall Street. He’s joining the populist fury over Wall Street and its bonuses. It’s ‘payback time’, and Obama proposes a $90 billion tax on Wall Street’s banks.

“The Prez utters the words the crowd loves to hear, ‘We want our money back, and we’re going to get it.’ Obama’s words dovetails with Democrats’ worries that they would be blamed for the recession and the debts. Blame it on Wall Street, and get even with those greedy devils; maybe tax the greedy devils out of existence or at least tax their stinkin’ bonuses away. As Obama’s assistant Rahm Emanuel put it, ‘Its a shame to let a good crisis go to waste.’

“The $90 billion Obama will extract from Wall Street won’t even begin to shrink the monster deficit the Fed has run up. Let the next administration (probably Republicans) deal with that problem.”

How the lie of the land has changed! The Financial Times yesterday headlined an article: “Obama is right to clobber Wall Street”.

Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. As to be expected with the banking shenanigans moving to center stage, “banks” commanded poll position.


The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town when not traveling) are given in the table below. With the exception of the Shanghai Composite Index (discussed above), the indices in the table are all trading above their 50-day moving averages, with all the indices also comfortably above their respective key 200-day moving averages.

As far as the S&P 500 Index is concerned, an upward sloping trend line extends from the August lows. A break below this line’s support level of 1,080 (and the December low of 1,092) could signal a deeper pullback.

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


Last week I discussed a long-term chart of the S&P 500. Let’s now also consider monthly data, going back to 1998, for the 10-year Treasury Note. As shown below, the MACD oscillator provided a sell signal about seven months ago and Treasuries are still classified as being in a primary bear market.


Source: StockCharts.com

This raises the question of when rising long-term rates start ruining the equity party. “For me, a sustained move above 4% by ten-year Treasuries will be equivalent to a yellow caution light for equity investors. Above 5%, stock markets could be in dangerous territory, as we saw in the last cycle,” commented David Fuller (Fullermoney). “I will continue to view US Treasury 10-year yields as a lead indicator. Currently, they are still in a ‘sweet spot’. However, when they move higher I will monitor stock market indices, particularly for Wall Street, even more closely for signs of fatigue in the form of inconsistencies, not least a loss of upward momentum.”

Looking beyond the low-growth economies of mature countries, Jeremy Grantham of GMO said (via Fortune): “I think there is a nascent bubble in emerging markets. Over the next three to five years, emerging markets are likely to sell at a handsome premium P/E because of the respect for their higher GDP growth.”

To which money man Bill Gross, head honcho of Pimco, added (according to Fortune): “If you’re looking for growth, you should venture outside the US. Brazil, China and other Asia equities are the cherry on top of the melting sundae. It’s not only their internal economies; they’re in better shape from the standpoint of reserves and balances. Ten years ago Brazil was a basket case and beggar. Now it has hundreds of billions of dollar reserves.”

Back to the US stock markets, John Hussman (Hussman Funds) is treading carefully with the current stock market make-up, saying: “There’s no denying that the beliefs of investors have been far more important, in the intermediate term, than economic realities, which are revealed more slowly and sporadically. Yet despite the high level of bullishness here, the market has gained only a few percent beyond its September highs. Most of what we are seeing now is a tendency to make marginal new highs, back off slightly, and then recover that ground enough to register another marginal new high.

“As I’ve noted frequently, when market conditions are characterized by unfavorable valuations, overbought conditions, over-bullish sentiment, and upward yield pressures, the market’s tendency is exactly that – to make continued marginal new highs for some period of time, followed by abrupt and often steep losses virtually out of nowhere.”

As we embark on the earnings season, the S&P 500 as a whole is expected to grow by 62.1% in Q4 2009 versus Q4 2008. As shown in the graph below, courtesy of Bespoke, the bulk of the growth is expected to come from the Materials and Financial sectors – the only two sectors with Q4 growth expectations that are higher than the S&P 500. Technology and Consumer Discretionary are the other two sectors expected to see growth. On the other hand, “Energy and Industrials are both expected to see earnings decline by more than 20% in the fourth quarter, while Telecom is not far behind at -19.2%. Health Care, Consumer Staples, and Utilities are all expected to see a drop of about 5%,” said Bespoke.


Source: Bespoke, January 12, 2010.

I do not have much to add to my conclusion of last week and repeat it: “It goes without saying that the strong rally since March is bound to be followed by a correction at some stage. But rather than pre-empting (and more often than not getting it wrong as a result of short-term noise), I will be guided by the longer-term charts and the yield curve to identify a major top. Meanwhile, I am watching valuations carefully, and specifically how the Q4 earnings reports stack up. (See my post “Earnings into focus“.)

“Although I am treading with caution after the 74% rally in the mature markets and 108% in emerging markets, I am not ignoring good old stock-picking, and specifically those companies with strong balance sheets that will be growing their dividends over time with a reasonable degree of certainty.”

For more discussion on the economy and financial markets, see my recent posts “Lessons from Bernstein, Rosenberg and Farrell“, “El Erian: Markets not facing reality of slow economy“, “Mark Mobius on emerging market valuations“, “Earnings into focus“, “Picture du Jour: Dow rally in perspective“, “Wealthtrack – making money in 2010 in stocks, bonds and foreign markets“, “Doug Casey: ‘Stock market set to crash’” and “Picture du Jour: Weak hands are heavily long the greenback“. (And do make a point of listening to Donald Coxe’s webcast of January 15, which can be accessed from the sidebar of the Investment Postcards site.)

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“Global business sentiment has remained largely unchanged since the summer, consistent with a global economic recovery that is holding its own but is not gaining significant traction. Confidence is generally stronger in South America and among business services firms and weakest in North America and among those that work in real estate,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. Businesses are most upbeat when responding to broad questions about current conditions and expectations through mid-2010, but remain cautious when responding to specific questions about sales, pricing, inventories and hiring.


Source: Moody’s Economy.com

Meanwhile, sovereign debt default looms, according to George Magnus, senior economic adviser at UBS Investment Bank. He said (as reported by the Financial Times): “Concerted fiscal restraint could trigger another recession, but the lack of it could end up in bigger default risks. Even Japan, now into its third ageing decade, may be vulnerable, while some eurozone countries, though sheltered from currency turbulence, may yet falter in their deflation commitments and compromise the integrity of the single currency as we know it. The UK still lacks a credible debt management strategy, and the US cannot take investor goodwill for granted.”

Interestingly, the Financial Times says mounting fears about government debt has now caused the cost of insuring against the risk of debt default by European nations to exceed that for top investment-grade companies for the first time. “It now costs investors more to protect themselves against the combined risk of default of 15 developed European nations, including Germany, France and the UK, than it does for the collective risk of Europe’s top 125 investment-grade companies, according to indices compiled by data provider Markit.”

A snapshot of the week’s US economic reports is provided below. (Click on the dates to see Northern Trust‘s assessment of the various data releases.)

Friday, January 15
• Inflation – “Don’t worry, be happy”, for now
• December industrial production – mixed news from the nation’s factories

Thursday, January 14
• December retail sales – mixed news, focus on details necessary
• Ballooning Treasury deficits – it takes both outlays and receipts to tango
• Total continuing claims matter the most

Wednesday, January 13
• Recent Fed rhetoric and highlights from the Beige Book

Tuesday, January 12
• Trade deficit widens in November, volume of trade maintains upward trend

Monday, January 11
• Inflation expectations approach pre-crisis range

The latest Beige Book, published on Wednesday in preparation of the next Federal Open Market Committee (FOMC) meeting on January 26-27, indicates a modestly improving economy.

Regarding the benign CPI numbers, Asha Bangalore (Northern Trust) said: “The Fed continues to be a sweet spot with regard to inflation and can continue to focus on economic growth for several more months. Although the Fed has begun examining the ways in which inflation emerges at the December Federal Open Market Committee (FOMC) meeting, the more vigorous debate and concern about inflation is topic for several months ahead.”

“The Federal Reserve is unlikely to raise interest rates before next year,” Richard Clarida, global strategic adviser for money manager Pimco, told Bloomberg (via MoneyNews). “The Fed has never hiked until they have seen a sustained decline in unemployment. By the Fed’s own forecast, that is at least a year away. I don’t think the Fed’s going to do anything with rates until 2011 or perhaps very late in 2010.”

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

Date Time (ET) Statistic For Actual Briefing Forecast Market Expects Prior
Jan 12 08:30 AM Trade Balance Nov -$36.4B -$31.0B -$34.6B -$33.2B
Jan 13 10:30 AM Crude Inventories 1/08 3.70M NA NA 1.33M
Jan 13 02:00 PM Fed’s Beige Book
Jan 13 02:00 PM Treasury Budget Dec -$91.9B -$97.0B -$92.0B -$120.3B
Jan 14 08:30 AM Initial Claims 01/09 444k 450K 437K 433K
Jan 14 08:30 AM Continuing Claims 1/2 4596K 4725K 4750K 4807K
Jan 14 08:30 AM Retail Sales Dec -0.3K 1.0% 0.5% 1.8%
Jan 14 08:30 AM Retail Sales ex – auto Dec -0.2% 0.5% 0.3% 1.9%
Jan 14 08:30 AM Export Prices ex – agriculture Dec 0.5% NA NA 0.6%
Jan 14 08:30 AM Import Prices ex – oil Dec 0.4% NA NA 0.4%
Jan 14 10:00 AM Business Inventories Nov 0.4% 0.5% 0.3% 0.4%
Jan 15 08:30 AM Core CPI Dec 0.1% 0.1% 0.1% 0.0%
Jan 15 08:30 AM CPI Dec 0.1% 0.2% 0.2% 0.4%
Jan 15 08:30 AM Empire Manufacturing Survey Jan 15.92 5.00 12.00 4.50
Jan 15 09:15 AM Capacity Utilization Dec 72.0% 72.3% 71.8% 71.5%
Jan 15 09:15 AM Industrial Production Dec 0.6% 1.0% 0.6% 0.6%
Jan 15 09:55 AM Michigan Sentiment Jan 72.8 71.5 74.0 72.5

Source: Yahoo Finance, January 15, 2010.

Click the links below for three research reports from Wells Fargo Securities:

Weekly Economics & Financial Commentary (January 15, 2010)
Global Chartbook (January 2010)
Monthly Economic Outlook (January 2010)

US economic data reports for the coming week include the following:

Tuesday, January 19
• Net long-term TIC flows

Wednesday, January 20
• Building permits
• Housing starts
• Core PPI

Thursday, January 21
• Jobless claims
• Leading indicators
• Philadelphia Fed

The performance chart for various financial markets usually obtained from the Wall Street Journal Online is unfortunately not available this week.

Final words
Morris King “Mo” Udall, American politician (19221998) said: “If you can find something everyone agrees on, it’s wrong.” (Hat tip: David Fuller.) Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist readers of Investment Postcards in guarding against popular (and often wrong) market views.

That’s the way it looks from an icy cold Geneva (from where I will be making my way back to Cape Town on Monday).


Source: RJ Matson, Comics.com

CNN Money: Four pros – investing in the next decade
“The coming 10 years won’t necessarily resemble the past 10. Fortune enlisted four investing sages – Rob Arnott, Jeremy Grantham, Bill Gross and Jeremy Siegel – who lay out the opportunities and pitfalls.”

Click here for the full article.

Source: CNN Money, January 14, 2010.

Richard Russell (Dow Theory Letters): Pondering a deflation scenario
“I’ve been pondering over the following strange situation. The Dow is actually lower today than it was ten years ago. What does this really mean? To me, it means that the market over the last ten years has been discounting ‘no growth’ ahead. When you take an unbiased look at the picture, compared with gold almost everything today is cheaper than it was a few years ago. Since gold is the universal immutable standard around which everything else (including the dollar) fluctuates, this means that the price of literally everything has been going DOWN against the standard which is gold.

“This is deflationary. Of course you can say that a loaf of bread costs more now than it did a year ago, and this is inflationary. True, it’s inflationary in terms of dollars, but the dollar is lower in terms of gold. So in terms of gold, everything is deflating.

“This deflationary trend is continuing, and what’s more it’s continuing against a veritable ocean of central-bank created currencies. Subscribers know that I believe this bear market will end, as most others have, with stocks selling at extreme great values – dividends high, price/earnings low. And you ask, ‘How can this possibly occur?’

“This is the question I’ve asked myself. And the answer I come with is that stocks will be hit by brutal world deflation. That’s what the miserable performance of the Dow is telling me. That’s what the poor performance of everything else against gold is telling me. I’m not talking about the performance over recent months, but their performance over the years.

“Yes, I know that the conventional wisdom is that we’re heading for all-out inflation. This forecast is based on the thesis that the only way to handle America’s deadly multi-trillion debts is to inflate them out of existence. But suppose the Fed is unable to engineer inflation? Look how hard they’ve been trying over the last year to restart inflation. And what’s happened to housing, the chief object of the Fed’s inflation target? Housing prices have gone nowhere, well maybe they’re less weak then they were six months ago. But inflation in home prices? It’s just not happening.

“And now political pressure is on the Fed to cut back on stimulus, money-creation and at the same time raise interest rates. This, if it happens, will definitely be deflationary, and it will hit housing and the economy.

“Ever since World War II the Fed has been on the inflation path. Leverage, rising debt, speculation, and higher prices have been the ‘law’ of the land. Now, I believe we have hit the inflection point; we are just entering the huge deflationary spiral that will unwind six decades of leverage and inflation.

“In the big picture what I see is that China and Asia will become (they already are) phenomenal producers. The developed nations will not be able to compete with them. The result will be a crushing decline in the price of manufactured goods, which, in turn, will impact on all goods including foodstuffs and services and medical services. In a vain effort to compete with China, India and Asia, currencies will be devalued across the board.

“Currencies will sink in the face of competitive devaluations (think Venezuela), and whatever can go bankrupt will go bankrupt. Debt will become a dirty word again, as it was during the 1930s (if you can’t pay for it with cash, live without it).

“The one item that will withstand this crushing force of deflation will be gold, whereas most items have been sinking against gold. If the deflation that I foresee arrives, items will be plunging in price against the standard – gold. This will be the great deflation that nobody foresees and nobody understands and nobody has protected themselves against.

“When you’re willing to agree that gold, not the dollar, is the universal immutable standard, you can see that the forces of deflation are taking over.

“For the sake of argument, let’s just say that I am correct. Then as the great deflation envelopes the land, all things (merchandise, stocks, currencies) will sink against gold. So gold then becomes the single item that is not declining, because gold is the standard, and the standard can’t go down against the standard. In that case, everyone will opt for the safety of gold. Gold will be seen as the final and ultimate protection against deflation.

“Question – Russell, let me play the devil’s advocate. Suppose you are dead wrong, and suddenly all the money that the central banks have injected into the system ‘catches on’. Then what?

“Answer – In that case gold surges higher. It goes higher because the amount of fiat currency being produced is far greater than the available amount of gold. The sheer amount of new currencies overwhelms the relatively fixed amount of gold.

“Question – Then, Russell, you’re saying that gold is the place to be whether inflation or deflation materializes.

“Answer – Yes, that’s the way I see it. Gold will be ‘the last man standing’, as it is now in Venezuela and Zimbabwe.”

Source: Richard Russell, Dow Theory Letters, January 14, 2010.

George Magnus (Financial Times): Sovereign default risks loom large
“The sustainability of sovereign debt hangs heavily over bond markets, and the prospects for economic and financial stability.

“Since 2007, OECD government deficits have risen by 7 per cent of GDP to just over 8 per cent, and debt, excluding contingent liabilities, has risen by about 25 per cent of GDP to just over 100 per cent.

“The biggest increases have occurred in Iceland, Ireland, the US, Japan, the UK, and Spain. There is no peacetime precedent for the current speed and scale of public debt accumulation and it is difficult to assess the social tolerance for high debt levels, and for the pain of protracted fiscal restraint. In several EU member states, the threshold has already been breached. The spectre of sovereign default, therefore, has returned to the rich world.

“Default does not have to mean outright debt repudiation. It can mean some type of moratorium on interest payments, and the restructuring of loan terms. Richer nations are assumed to be above such measures, but not in extreme circumstances. The US abrogated the gold clause in government and private contracts in 1934, and in 1971, it abandoned the gold standard altogether.

“Default can also occur via inflation, currency debasement, the imposition of capital controls, and the imposition of special taxes that break private contracts. Seen in this light, a few countries in eastern and western Europe may already be technically at risk of default.

“At the moment, higher spreads on sovereign bonds and credit default swap rates do not provide convincing evidence of an imminent default crisis, per se. Japan’s public debt has already risen above 200 per cent of GDP, but the government can borrow for 10 years at 1.4 per cent, while Australia’s government debt is about 25 per cent of GDP, but it pays over 5.5 per cent. Other rich countries with varying debt ratios all pay roughly 3.5-4 per cent. However, the status quo is not sustainable.

“Concerted fiscal restraint could trigger another recession, but the lack of it could end up in bigger default risks. Even Japan, now into its third ageing decade, may be vulnerable, while some eurozone countries, though sheltered from currency turbulence, may yet falter in their deflation commitments and compromise the integrity of the single currency as we know it.

“The UK still lacks a credible debt management strategy, and the US cannot take investor goodwill for granted.”

Click here for the full article.

Source: George Magnus, Financial Times, January 13, 2010.

CNBC: Bullard on US interest rates
“The greenback extended declines partly because of comments from St Louis Federal Reserve Bank president, James Bullard, that interest rates may remain low for quite some time. In an exclusive interview with Cheng Lei, Bullard says that maintaining low interest rates is all data dependant.”

Click here for a BusinessWeek article.

Source: CNBC, January 12, 2010.

MoneyNews: Pimco’s Clarida – Fed unlikely to hike rates this year
“The Federal Reserve is unlikely to raise interest rates before next year, says Richard Clarida, global strategic adviser for money manager Pimco.

“‘The Fed has never hiked until they have seen a sustained decline in unemployment,’ now 10 percent, he told Bloomberg.

“‘By the Fed’s own forecast, that is at least a year away.’ And thus, so is a rate hike, Clarida says.

“‘I don’t think the Fed’s going to do anything with rates until 2011 or perhaps very late in 2010.’

“In addition to improvement in the labor market, the Fed would want to see durable sources of demand in the economy before it raises rates, Clarida says.

“‘We had very modest growth in the third quarter (2.2 percent) and perhaps somewhat stronger growth in fourth quarter,’ he said.

“‘But all that is being driven by an inventory rebound and some temporary fiscal stimulus. The Fed’s going to want to see some durable demand from consumers, exports and investment.’

“It’s too soon to say the consumer sector has stabilized, Clarida says.

“‘If you believe as I do that the household sector in the next five years will be deleveraging, that means there will be more (trouble) to come.'”

Source: Dan Weil, MoneyNews, January 11, 2010.

Reuters: White House plans more to trim joblessness
“President Barack Obama plans more economic stimulus measures to bring down the high US unemployment rate, while cutting the bulging budget is a longer-term challenge, a top White House economic aide said on Sunday.

“‘We are … talking about actions right now to jump-start job creation,’ White House Council of Economic Advisers Chairwoman Christina Romer said on CNN’s State of the Union.

“‘You don’t get your budget deficit under control at a 10 percent unemployment rate,’ she said.

“Beating back unemployment will be a key yardstick by which US voters will measure Obama’s success in November congressional elections and will go a long way to determining his own long-term political future.

“Also troubling to many is a budget deficit that has ballooned from spending aimed at cushioning workers and businesses through the worst recession in decades.

“‘We have to do something,’ Romer said. ‘There are more targeted actions that we think absolutely will help.’

“Obama will focus is on getting the US fiscal house in order over the longer run, she said.

“Congress is considering proposals to help labor markets that include a $155 billion jobs package that has already cleared the House of Representatives.”

Source: Mark Felsenthal, Reuters, January 10, 2010.

Asha Bangalore (Northern Trust): Recent Fed rhetoric and highlights of Beige Book
“In speeches late yesterday [Tuesday], Fed Presidents Plosser and Fisher of Philadelphia and Dallas, respectively, were of the opinion that unemployment rate is most likely to trend higher than the December jobless rate of 10.0%. However, both of these non-voting hawkish members of the FOMC expressed concerns about inflation.

“Plosser was of the opinion that the Fed needs to be pre-emptive such that inflationary expectations remain anchored and an inflationary situation is avoided. He also noted that there is ‘extraordinary uncertainty about the prospects for inflation over the next two to five years.’

“President Fisher’s speech focused on lawmakers in Washington attempting to reduce the power and independence of the Fed.

“This morning [Wednesday], President Evans of Chicago, also a non-voting member of the FOMC, presented the Chicago Fed’s forecast for the economy in 2010. He reiterated that restrictive bank credit and cautious households and businesses are restraining the pace of recovery but indicated that these ‘headwinds’ would fade in the latter half of 2010.

“The next FOMC meeting is on January 26 and 27, with four new regional Fed Presidents as voting members – Presidents Bullard of St. Louis, Sandra Pinalto of Cleveland, Rosengren of Boston and Hoenig of Kansas City. President Hoenig is the most hawkish of these new voting members, with President Bullard painted as a hawk, while President Pinalto is seen as a centrist and President Rosengren is classified as a dove.

“The latest Beige Book, published today in preparation for the FOMC Meeting, indicates a modestly improving economy. Ten Districts indicated improving conditions compared with the last Beige Book reporting increased activity in eight Districts. Mixed conditions were reported for the Districts of Philadelphia and Richmond.

“The Beige Book assessment of consumer spending in the holiday season is consistent with the tally of chain store sales reports which indicated gains in retail sales from a year ago but below the levels seen in 2007.

“The labor market information in the Beige Book confirms the grim details of the December employment report published last week.

“Price and wage pressures were not problematic.

“The housing market was depicted as recovering from the lows of early-2009, with low mortgage rates and home buyer tax credit program lifting sales. The non-residential real estate sector remains a source of serious concern in nearly all Districts.

“On the financial side, weak demand for all loans, excluding residential mortgages, a deterioration of credit quality, increased loan delinquencies and defaults were noted. Against this backdrop, it is certain the Fed will hold the monetary policy stance unchanged. The minutes of the December FOMC meeting included differences in opinion about the Fed’s mortgage purchase program and prospects about inflation. The latest information does little to clarify these muddy waters. The nature of the incoming data after a deep recession and a financial crisis is bound to be mixed and present differences in the evaluation of the status of a recovering economy. Criticisms about the Fed’s handling of crises in the past suggest that the Fed is likely to err on the side of being cautious with an emphasis on economic growth.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 13, 2010.

Paul Kasriel (Northern Trust): Ballooning Treasury deficits – it takes both outlays and receipts to tango
“On Wednesday, the US Treasury reported a record cumulative deficit over the 12 months ended December 2009 of $1.472 trillion. Although the editorial board of the Wall Street Journal surely will rail against exploding federal spending, it will probably fail to mention another key driver of ballooning federal deficits – collapsing federal receipts.


“Yes, as shown below, the year-over-year growth in 12-month cumulative federal government outlays remains in double digits, which it entered in October 2008. But notice that the growth rate in federal outlays is slowing. It peaked at 19.2% in July 2009. As of December 2009, the year-over-year growth in 12-month cumulative federal outlays had slowed to 11.8% – the slowest since December 2008’s 12.8% growth. But look at what has been happening to the year-over-year rate of contraction in 12-month cumulative total federal receipts. In the 12 months ended December 2009 vs. the 12 months ended December 2008, total federal receipts contracted by 17.1%, a slightly slower rate of contraction than the 17.6% rate of contraction in the 12 months ended November.

“Of course, receipts are contracting. The US economy has only recently emerged from its longest and deepest recession in the post-war era in which both corporate profits and wage/salary income collapsed. Moreover, personal income taxes were cut by both the Bush (Jr.) and Obama administrations, something the editorial board of the Wall Street Journal presumably approved of.


“In sum, although high growth in federal spending is contributing mightily to our record federal deficit, the rate of growth in that spending is slowing. What often is forgotten is that the rate of contraction in federal receipts has accelerated.”

Source: Paul Kasriel, Northern Trust – Daily Global Commentary, January 14, 2010.

Asha Bangalore (Northern Trust): US trade deficit widens
“The trade deficit of the US economy widened to $36.4 billion in November from a revised $33.9 billion in the previous month. The inflation adjusted trade deficit of good in the October-November months nearly matches the average of the third quarter of 2009. The trade deficit is predicted to post a smaller deficit in the fourth quarter and help to lift overall GDP.


“Following the recession when world trade shrunk significantly, the volume of exports and imports now show a noticeable upward trend. In November, exports of goods and services rose only 0.9% to $138.2 billion, the highest since in the past year. Imports of goods and services increased 2.6% in November to nearly $175 billion, also the highest in the past year.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 12, 2010.

Clusterstock: Shipping into US unexpectedly jumped in December
“Shipping into the US climbed from November to December, defying typical seasonal trends and perhaps demonstrating growing demand in the US

“‘December was a surprisingly good month that put a promising end to 2009,’ the research company Panjiva said in a report issued today.


“There was a 3% increase in the number of global manufacturers shipping to the US market.

“There was a 2% increase in the number of US companies receiving waterborne shipments from global manufacturers.

“Traditionally, these numbers decline from November to December (-5% in 2009 and -1% in 2008).

“You can expect that the good news will continue, although it may be more confusing than clarifying. For the first quarter, the year-over-year comparisons will likely look very good. But that will largely be a result of the global trade free fall in 2009. A better comparison is probably against 2008 or 2007.”


Source: John Carney and Kamelia Angelova, Clusterstock – Business Insider, January 12, 2010.

Asha Bangalore (Northern Trust): Industrial production – mixed news from the nation’s factories
“The Industrial Production Index rose 0.6% in December after a similar increase in November. However, the reasons for the gain were different. The December increase in production reflects a 5.9% jump in activity at utilities due to inclement weather, while the November gain was largely due to a 0.9% increase in factory production. In December factory production slipped 0.1%. “A mixed performance is seen in factory data for December. Production of consumer goods (+0.6%) and business equipment (+0.9%) increased but construction supplies fell 2.0%. Industrial production has risen 4.7% from the cycle low in June 2009.


“Production at factories has risen 4.5% from the cycle low in June 2009, while on a year-to-year basis, factory production dropped 1.9% in December. The decelerating pace of decline of factory production is noteworthy. The operating rate of the factory sector (68.9%) is still close to the historical low of 65.1%, which implies that businesses have room to meet a growth in demand without undertaking an expansion of capacity. There is nothing in this report that points to an inflationary threat and it is not likely to be seen for several more months.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 15, 2010.

Asha Bangalore (Northern Trust): Retail sales – mixed news
“Retail sales fell 0.3% in December, after an upwardly revised estimate for November (1.8% increase vs. 1.3% in the previous estimate). At first blush, the headline for December looks weak and contradicts the chain store sales reports published last week. These details should help to sort out the report.

“First, unit auto sales increased in December (11.2 million vs. 10.9 million in November) vs. the decline (-0.8%) reported in the retail sales report. Unit auto sales matter for consumer spending in the GDP report for the fourth quarter. But, the fourth quarter average for unit auto sales fell at an annual rate of 20.4% after a nearly 108% jump in the third quarter due to the cash for clunkers program. Therefore, unit auto sales will be a negative for fourth quarter consumer spending. Second, the upbeat chain store sales information published last week were comparisons from a year ago. Retail sales from a year ago presented in today’s report also show strong gains (see chart 4). The 2009 sales numbers look rosy compared with the 2008 weak holiday sales numbers. Third, on a quarterly basis, retail sales excluding autos or excluding auto and gas are stronger in the fourth quarter compared with the third quarter (see table below). Fourth, the level of retail sales excluding gasoline ($318.44 billion) in December compared with the fourth quarter average ($318.2 billion) is virtually flat, implying the absence of an arithmetical advantage.

“The main take away is that consumers are spending but gains are essentially lackluster when the details are sorted out.”


Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 14, 2010.

Asha Bangalore (Northern Trust): Inflation – “Don’t worry, be happy,” for now
“If there is good cheer to go around, it is from inflation, for now. The Consumer Price Index (CPI) edged up 0.1% in December, putting the year-to-year change at 2.7%. The large jump after a string of declines in the eight months ended October 2009 is primarily due to higher energy prices. The energy price index moved up 0.2% in December, but was up 18.2% from a year ago. Food prices rose 0.2%, which translates into a 0.5% drop in food prices in all of 2009.


“Excluding food and energy, the core CPI, inched up 0.1% in December, with the year-to-year increase at 1.8%, matching the gain seen in 2008. The cycle low for the year-to-year increase of the core CPI is a 1.4% gain posted in August 2009. The main reason for the significantly contained core CPI is the decelerating trend of the shelter index (the single-largest component of the core CPI). The 0.3% year-to-year gain of the shelter index in December is smallest increase since record keeping began in 1953 for this price index.

“The Fed continues to be a sweet spot with regard to inflation and can continue to focus on economic growth for several more months. Although the Fed has begun examining the ways in which inflation emerges at the December FOMC meeting, the more vigorous debate and concern about inflation is topic for several months ahead.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 15, 2010.

Reuters: Fannie, Freddie re-defaults reach 34 pct
“More than a third of US residential loans modified by Fannie Mae and Freddie Mac early last year were in arrears again after six months, though the default rate has improved, according to the regulator of the two largest mortgage finance companies.

“About 34 percent of homeowners with loans guaranteed by the companies modified in the first quarter of 2009 were at least 60 days delinquent, the Federal Housing Finance Agency said in a quarterly report on Friday.

“That compares with 39 percent of mortgages going bad after the companies agreed to ease terms of the loans in the last quarter of 2008, the report said.

“The re-default measures cover loans modified before the start of President Barack Obama’s Home Affordable Modification Program that gives lenders a standard blueprint to ease terms of loans for troubled borrowers.”

Source: Al Yoon, Reuters, January 8, 2010.

Financial Times: US commercial property attracts new wave of money
“The beleaguered US commercial real estate sector has been attracting a new wave of money from sources including foreign banks, US private equity firms, and a leading Chinese sovereign wealth fund.

“Market participants warn that the activity represents ‘bottom-feeding’ by opportunistic investors whose strategies could be derailed by rising interest rates. Also, sums are tiny compared with the debts that need refinancing. Nevertheless, the growing interest from investors is a sign of stabilisation, making it less likely that worsening commercial real estate conditions will sink banks and choke off a US recovery.

“‘We believe the real story is that capital is ready to buy, even though it may not be so visible today,” said Bob Steers, co-chairman of Cohen & Steers, a real estate investment firm.

“Recently, state-owned China Investment Corporation has enlisted Cohen & Steers, Angelo Gordon and Morgan Stanley to identify commercial real estate opportunities, people familiar with the matter say.

“A public sign of such activity came on Friday when Colony Capital won a Federal Deposit Insurance Corporation auction for $1bn of commercial property loans formerly held by failed banks in states hit hard by the real estate downturn.

“The deal valued the loans at 44 cents on the dollar and was structured so the FDIC contributes $136m and holds 60 per cent of the equity, while Colony, a Los Angeles investment firm, puts in $90m for the remaining 40 per cent.

“Tom Barrack, Colony founder, called the investment ‘an implicit bet that rates stay low’ and warned: ‘If rates go up, everyone will be crushed.'”

Source: Henny Sender, Financial Times, January 10, 2010.

MoneyNews: Boskin: US economic data is almost criminal
“Former White House economist Michael Boskin says American investors no longer place much credibility in the economic and fiscal statistics being reported by the US government, and are ‘increasingly inclined to disbelieve them’.

“Boskin, the one-time economic adviser to President George H.W. Bush, says that solid, reliable information is needed by investors, because ‘as a society, and as individuals, we need to make difficult, even wrenching choices, often with grave consequences’.

“To base those decisions on misleading, biased, or manufactured numbers, is not just wrong, ‘but dangerous’, he wrote in The Wall Street Journal.

“But, due to the obvious fudging of numbers involved in the government’s health care insurance industry reform effort, most Americans now believe the health-care legislation will actually raise their insurance costs, rather than reduce them, and increase the federal budget deficit, rather than contain it.

“That’s not the only area where cynicism over official statistics is growing.

“‘Most Americans are highly skeptical of the claims of climate extremists,’ writes Boskin, now a professor of economics at Stanford University and a senior fellow at the Hoover Institution.

“And because of the spin over ‘jobs created and saved’ by the stimulus, they have a ‘more realistic reaction to the extraordinary deterioration in our public finances than do the president and Congress,’ Boskin adds.

“Squandering their credibility with these numbers games will only make it more difficult for America’s elected leaders to garner support for difficult decisions from a public increasingly inclined to disbelieve them, writes Boskin.”

Source: Gene Koprowski, MoneyNews, January 14, 2010.

Financial Times: FDIC chief blames Fed for crisis
“The Federal Reserve was blamed by a fellow regulator for contributing to the financial crisis on Thursday as the central bank and one of its former chairmen fought back against congressional moves to curb its powers.

“In unusually pointed criticism, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, told the Financial Crisis Inquiry Commission that ‘much of the crisis may have been prevented’ had the Fed dealt with subprime mortgages seven years before it did.

“In New York, Paul Volcker, former Fed chairman and now White House economic adviser, was making the case for the defence.

“He said there was ‘a compelling case that central banks should have a strong voice and authority in regulation and supervisory matters’.

“Both Ms Bair and Mr Volcker carry weight on Capitol Hill, where the Fed has drawn blame for aspects of the crisis.

“Mr Volcker told the Economics Club of New York he was ‘particularly disturbed’ about moves to take away the Fed’s regulatory function.

“Chris Dodd, Senate banking committee chairman, has proposed consolidating bank supervision into a single regulator.

“The Fed published a paper on Thursday, which had been sent to Mr Dodd on Wednesday, arguing that its financial stability and monetary policy roles were complemented by supervising bank holding companies.

“Mr Volcker said: ‘What seems to me beyond dispute, given recent events, is that monetary policy and the structure and condition of the banking and financial system are irretrievably intertwined.'”

Source: Tom Braithwaite, Financial Times, January 14, 2010.

Bloomberg: Federal Reserve seeks to protect US bailout secrets
“The Federal Reserve asked a US appeals court to block a ruling that for the first time would force the central bank to reveal secret identities of financial firms that might have collapsed without the largest government bailout in US history.

“The US Court of Appeals in Manhattan will decide whether the Fed must release records of the unprecedented $2 trillion US loan program launched after the 2008 collapse of Lehman Brothers Holdings Inc. In August, a federal judge ordered that the information be released, responding to a request by Bloomberg LP, the parent of Bloomberg News.

“‘This case is about the identity of the borrower,’ said Matthew Collette, a lawyer for the government, in oral arguments today. ‘This is the equivalent of saying ‘I want all the loan applications that were submitted.”

“Bloomberg argues that the public has the right to know basic information about the ‘unprecedented and highly controversial use’ of public money. Banks and the Fed warn that bailed-out lenders may be hurt if the documents are made public, causing a run or a sell-off by investors. Disclosure may hamstring the Fed’s ability to deal with another crisis, they also argued. The lower court agreed with Bloomberg.

“”The question is at what point does the government get so involved in the life of the institution that the public has a right to know?’ said Charles Davis, executive director of the National Freedom of Information Coalition at the University of Missouri in Columbia. Davis isn’t involved in the lawsuit.

“The ruling by the three-judge appeals panel may not come for months and is unlikely to be the final word. The loser may seek a rehearing or appeal to the full appeals court and eventually petition the US Supreme Court, said Anne Weismann, chief lawyer for Citizens for Responsibility and Ethics, a Washington advocacy group that supports Bloomberg’s lawsuit.

“New York-based Bloomberg, majority-owned by Mayor Michael Bloomberg, sued in November 2008 after the Fed refused to name the firms it lent to or disclose the amounts or assets used as collateral under its lending programs. Most were put in place in response to the deepest financial crisis since the Great Depression.”

Source: David Glovin and Thom Weidlich, Bloomberg, January 11, 2010.

Financial Times: Wall Street titans face the flak
“Four of Wall Street’s top executives offered some contrition and a defence of their actions on Wednesday, as the head of the Financial Crisis Inquiry Commission promised to use wide-ranging powers to establish the causes of the financial crisis and pursue any wrongdoing.

“Lloyd Blankfeinof Goldman Sachs, Jamie Dimon, chief executive of JPMorgan Chase, John Mack of Morgan Stanley and Brian Moynihan of Bank of America maintained a united front as the Financial Crisis Inquiry Commission, headed by Phil Angelides, probed the bail-out of AIG, risk management and executive compensation.

“Mr Blankfein, whose bank has become a lightning rod for public anger at Wall Street, bore the brunt of the panel’s questions. He mounted a robust defence after being asked whether part of his business was akin to selling a car with faulty brakes and then buying an insurance policy. But he added: ‘Anyone who says I wouldn’t change a thing, I think, is crazy.’

“The Goldman boss said that he and his rivals had been insufficiently sceptical of loose credit standards.

“‘We rationalised [it] because a firm’s interest in preserving and growing its market share, as a competitor, is sometime blinding – especially when exuberance is at its peak.’

“Mr Angelides, a former California treasurer appointed head of the panel by Congress last year, told the witnesses on the first day of public hearings: ‘We’re after the truth … the hard facts … we’ll use our subpoena power as needed. And if we find wrongdoing, we’ll refer it to the proper authorities.’

“Bonuses are drawing increasing political fire on Capitol Hill as the banks prepare to announce billions of dollars in pay-outs over the next few days.

“‘Clearly Wall Street has to be a lot more attuned to what’s going on in the economy,’ said Mr Mack. But he said that compensation had to allow the banks to compete for staff. ‘I have to run a company.’

“As part of a plan to quell anger and ensure that any government bail-out losses are recouped, the Obama administration is planning to impose a levy on banks.

“Mr Dimon told reporters: ‘Using tax policy to punish people is a bad idea.’ He added that the banks should not be paying for losses caused by car companies and other industries.

“Mr Dimon acknowledged that ‘certain subprime mortgages__… _weren’t great products. I think there were some unscrupulous mortgage salesmen and mortgage brokers. And, you know, some people mis-sold.’

“Mr Dimon and Mr Moynihan agreed that banks should not be considered ‘too big to fail’.

“Mr Obama will on Thursday announce a new levy on banks to try to recoup some of the stimulus funding they received.”

Source: Tom Braithwaite and Francesco Guerrera, Financial Times, January 13, 2010.

The Wall Street Journal: Goldman Sachs CEO singled out
“The Wall Street Journal’s Jerry Seib joins the News Hub from Washington, where he says Goldman Sachs CEO Lloyd Blankfein became a target at a hearing before the Financial Crisis Inquiry Commission.”

Source: The Wall Street Journal, January 13, 2010.

MoneyNews: Romer – big bonuses to bankers are offensive, ridiculous
“A White House economic adviser says big year-end bonuses for bailed-out financial institutions would be ‘ridiculous’ and ‘offensive’.

“Christina Romer says the Bush administration’s $700 billion bailout was necessary to avoid a collapse of the financial system.

“Now that banks are returning to profitability as a result of government help, Romer says that paying out billions of dollars in bonuses ‘does seem really ridiculous’.

“Romer, who heads the president’s Council of Economic Advisers, say that kind of big payout ‘is going to offend the American people. It offends me.'”

Source: MoneyNews, January 11, 2010.

Financial Times: Obama vows to recover crisis cash
“Barack Obama slammed ‘obscene’ bank bonuses on Thursday, as the US president formally revealed plans to impose a levy on big financial institutions to recoup some of the costs of the financial crisis.

“‘We want our money back and we’re going to get it,’ Mr Obama said, pledging to ‘recover every single dime the American people are owed’ for the troubled asset relief programme bail-out fund.

“Appearing keen to pick a political fight with the big banks, Mr Obama faulted them for trying to ‘return to business as usual’ with ‘risky bets to reap quick rewards’ and compensation practices that did not reflect the state of the nation.

“‘I’d urge you to cover the costs of the rescue not by sticking it to your shareholders or your customers or your citizens but by rolling back bonuses,’ he said. Aides said the levy would recover at least $90bn from 50 of the largest institutions, including US subsidiaries of foreign banks and insurance companies as well as US banks.

“Treasury secretary Tim Geithner told the Financial Times that the US would urge other countries to adopt a similar principle of recouping bailout costs from the financial sector. ‘We are going to see if we can encourage policymakers in other important financial centres to do something similar,’ he said.”

Source: Krishna Guha, Financial Times, January 14, 2010.

Financial Times: Banks braced for Basel battle
“Banks are gearing up to fight a proposal by global regulators to sharply increase capital requirements for institutions that bring in outside investors to fund subsidiaries, saying it will cripple their ability to expand in emerging markets.

“Bank executives fear the provision would create huge holes in the capital stocks of a wide range of UK, European and Japanese financial institutions, at a time when they are already under pressure to increase their regulatory capital.

“Analysts described the proposal as one of the most ‘draconian’ and ‘potentially devastating’ parts of a package of measures put forward in December by the Basel committee, which sets global standards that are implemented by local regulators.

“Credit Suisse analysts calculate the rule would substantially reduce the estimated equity buffers that banks hold against potential losses.

“They estimate the so-called equity tier one capital ratio, a key measure of balance sheet strength which excludes hybrid capital such as preference shares, would be cut by 0.7 percentage points from the current 9.6 per cent.

“In essence, the Basel committee wants to force banks to stop counting minority-owned stakes as part of their equity capital but insists they continue to recognise the entire potential losses of any subsidiary.

“Regulators are essentially saying that banks are on the hook for all the losses of their subsidiaries, but that equity owned by minority investors in a particular subsidiary would not be available to absorb group losses elsewhere in the world.

“Banking analysts at Citi and Evolution have concluded that HSBC, BNP Paribas, Credit Agricole and Natixis would be particularly hard hit. The banks either did not respond or declined to comment.”

Source: Brooke Masters and Patrick Jenkins, Financial Times, January 12, 2010.

The Wall Street Journal: Beware of bond bubble
“Bond traders are leery of a possible growing bond bubble. If the bubble bursts, people’s retirement savings may be in jeopardy, SmartMoney’s Russell Pearlman reports.”

Source: The Wall Street Journal, January 12, 2010.

Financial Times: Rate rise fears spark rush to issue bonds
“Businesses and governments have rushed to raise tens of billions of dollars from bond markets in a frenetic round of new year fundraising amid fears that interest rates are set to jump.

“A flurry of issuers, including Virgin Media, BMW and Manchester United football club, turned to the capital markets on Monday aiming to raise more than $20bn.

“Poland and Mexico were among a number of governments that also tapped international investors.

“So far this month more than $75bn has been raised, more than two-thirds of this by financial institutions trying to repair their balance sheets in the wake of the economic crisis.

“Last week, the US corporate bond market had its second busiest day on record.

“Wayne Hiley, of Barclays Capital, said a recent rally in the corporate bond markets had lowered the interest rate premium to government bonds that businesses pay. ‘There are issuers who are saying ‘let’s take advantage of this’ even if they hadn’t planned to come to the market until later on,’ he said.

“Companies usually aim to sell bonds early in the year when investors have fresh funds and before many companies enter a ‘purdah’ period ahead of earnings announcements.

“However, the current round of capital raising is particularly intense. Some companies believe a recovery in economic growth this year will lead to central banks raising interest rates, pushing up the cost of borrowing.

“Other companies, fearing market turbulence as the authorities begin to unwind last year’s emergency monetary and fiscal measures to prop up the economy – which have included buying bonds – are borrowing as much as they can while demand for debt remains strong.”

Source: Jennifer Hughes and Aline van Duyn, Financial Times, January 11, 2010.

Financial Times: Sovereign bonds seen as riskier than corporates
“The cost of insuring against the risk of debt default by European nations is now higher than for top investment-grade companies for the first time, as mounting government debt prompts fears over the health of many leading economies.

“It now costs investors more to protect themselves against the combined risk of default of 15 developed European nations, including Germany, France and the UK, than it does for the collective risk of Europe’s top 125 investment-grade companies, according to indices compiled by data provider Markit.

“Markit’s iTraxx Europe index of 125 companies is trading at 63 basis points, or a cost of $63,000 to insure $10m of debt over five years. This compares with 71.5bp, or $71,500, for Markit’s SovX index of 15 European industrialised nations.

“Fears over sovereign risk have risen sharply in the past few months as investors have become increasingly alarmed over rising budget deficits and record levels of government bond issuance needed to pay off public debt.

“By contrast, hopes of a recovery have helped support corporate credit markets. Since September, the SovX index has jumped 20bp, while the iTraxx Europe index has narrowed 30bp.

“Bankers are even warning that big economies, such as the US and the UK, could lose their top-notch triple A status because of the deterioration in public finances.”

Source: David Oakley, Financial Times, January 12, 2010.

MoneyNews: Gross – German, Brazil bonds better than Treasuries
“Bill Gross, who manages the world’s biggest bond fund for Pimco, expects German and Brazilian bonds to outperform US Treasuries.

“In the US, the budget deficit, which totaled $1.4 trillion last year, will push up Treasury yields faster than German government bonds, Gross said.

“And while the US will likely endure huge deficits for years, Germany has a constitutional amendment requiring a balanced budget by 2016.

“‘(It) is the most fiscally conservative, has half the deficit of the United States, potentially has a low inflation rate, and they yield about the same,’ Gross told Bloomberg, comparing US and German 10-year government bonds.

“The 10-year US Treasury now yields about 45 basis points more than the equivalent 10-year bund.

“Brazilian bonds, which make up 2 percent of Gross’ Pimco Total Return Fund, also are attractive, he says.

“‘Brazil has the highest real interest rates in the world,’ he pointed out.

“Brazil’s 10-year government bond yields 11.22 percent.”

Source: Dan Weil, MoneyNews, January 14, 2010.

Bespoke: Strategists get stock happy
“Each week Bloomberg asks Wall Street strategists (the same ones polled for their year-end S&P 500 price targets) for their recommended portfolio allocations to stocks, bonds, and cash. Currently, the consensus recommended stock allocation is 60.5%. As shown in the chart below, this number has spiked significantly in recent weeks. Throughout the financial crisis, strategists lowered their recommended stock allocations pretty much every week. They missed the bottom, however, as the market turned before their consensus hit bottom. During the week of the Lehman collapse, strategists were recommending that investors have 56.6% of their portfolio in stocks.

“Add this as another indicator that is currently back to its pre-Lehman levels, while the S&P 500 is still has about 9% to go.

“The current reading of 60.6% is up quite a bit from its level at the market lows. This doesn’t yet suggest that strategists are too bullish, however, as their average recommendation during the ’03-’07 bull market was about 64%.”


Source: Bespoke, January 14, 2010.

Bespoke: And you thought the rally in equities was impressive
“Even though the S&P 500 has rallied more than 60% off its March 2009 lows, the index is still well below the 1,251.70 level it closed at on the Friday before Lehman’s bankruptcy filing. While the rally has been quite impressive, it pales in comparison to the gains we’ve seen in the corporate bond market. As of last week, the spread between Baa rated corporate bonds and 30-year US Treasuries had narrowed to its lowest levels since July 2007! Yes, you read that right – July 2007. Back then, the S&P 500 was trading above 1,500.”


Source: Bespoke, January 11, 2010.

Bespoke: Estimated Q4 S&P 500 and sector earnings growth
“S&P 500 earnings are currently expected to grow by 62.1% in Q4 ’09 versus Q4 ’08. In the first chart below, we highlight how this growth estimate has changed since the start of the fourth quarter. As shown, estimates are essentially right where they were at the start of Q4, but there was a lot of movement in the estimate throughout the quarter. From October to the end of November, the growth estimate rose on a weekly basis all the way up to 75.7%. Since peaking, however, estimates headed lower by quite a bit until finally bumping up from 60% to 62.1% in the last week. As we enter earnings season, it’s probably a good thing for the bulls that expectations have come down a little.


“While the S&P 500 as a whole is expected to grow by 62.1% in the fourth quarter, the bulk of this growth is expected to come from the Materials and Financial sectors. As shown below, these are the only two sectors with Q4 growth expectations that are higher than the S&P 500. And more sectors are still expected to see a decline in earnings than a rise. Energy and Industrials are both expected to see earnings decline by more than 20% in the fourth quarter, while Telecom is not far behind at -19.2%. Health Care, Consumer Staples and Utilities are all expected to see a drop of about 5%. Technology and Consumer Discretionary are the other two sectors expected to see growth.”


Source: Bespoke, January 12, 2010.

John Authers (Financial Times): Too soon for complacency
“Markets have set themselves up for some bad news to send them spinning. On Tuesday, the bad news broke.

“Markets move on the interaction of news with flows of greed and fear among investors. When fear is lowest, the danger of a fall is greatest.

“This week the CBOE Vix Index, measuring volatility in US stocks, hit its lowest level since May 2008, when a lull after the Bear Stearns rescue gave way to an implosion.

“Another great contrarian indicator is the survey of sentiment by the American Association of Individual Investors. Last week, this showed the lowest proportion of self-described “bears” since February 2007 – when volatility first started to spike as investors at last began to grasp the severity of the subprime mortgage crisis in the US.

“Bearishness in this survey hit an all-time high in March last year when the current rally first started, showing how much money can be made by betting against extremes of sentiment.

“Even bulls should concede that this optimism looks overdone. Stock market valuations enshrine very strong earnings growth for this year, while there are numerous possibilities of macroeconomic shocks around the world.

“Tuesday, China tightened monetary policy, in a necessary action which displeased the market, while the European Commission condemned Greece for falsifying data, in a broadside that raised fears once more that Greece could default without being bailed out by fellow eurozone members.

“Meanwhile, Alcoa, the aluminium producer, revealed disappointing results to launch the US earnings season for the fourth quarter of last year.

“If not exactly the sum of all fears, this combination of bad news showed that it is too soon for complacency. There are real risks in many different places and the chance of a sharp correction looks high. In that context, Tuesday’s falls for stock markets around the world look surprisingly muted.”

Source: John Authers, Financial Times, January 12, 2010.

Bespoke: Volatility at lowest level since May 2008 – should you care?
“Now that the VIX index is at its lowest levels since May 2008, and down nearly 80% from its record high in late 2008, there is a growing concern among some investors that there is not enough fear in the marketplace. As the chart below indicates, the current level of 17.55 is lower than the long-term average of 20.3 since 1990. However, during the mid-nineties and the middle part of this decade, which were both good periods for equity investors, the VIX not only traded at and below current levels, but it also remained at those levels for several years.

“While the VIX’s decline over the last year indicates that investors are not as fearful as they were a year ago, can you blame them for not being so? Things haven’t quite returned to normal, but they are a lot closer now than they were then.”


Source: Bespoke, January 12, 2010.

CNBC: Kass’ correction
“The man who called the bottom now calls for a correction, with Douglas Kass of Seabreeze Partners.”

Source: CNBC, January 13, 2010.

David Fuller (Fullermoney): Treasuries above 5% could harm equities
“The main risk to economic recovery will surface when long-dated interest rates back up, presumably as quantitative easing (QE) is phased out. However, every seasoned financial observer, including those at the Fed and US Treasury, will be aware of this risk. Therefore, will they blur the date at which QE supposedly ends? Will they extend it? Might they agree to no more than a partial phase-out, retaining the freedom to squeeze ‘bond vigilantes’ if rates rise too quickly?

“My guess in response to these questions is, yes, one way or another. After all, the Fed has always been active in government bond markets and it will not want to leave yields looking exposed, like ducks in a shooting gallery. Whether the Fed and US Treasury can prevent rates from rising too quickly, possibly later this year, remains to be seen.

“I will take my cue from the chart action, with particular interest in how higher yields affect stock markets. For me, a sustained move above 4% by US 10-year Treasuries will be equivalent to a yellow caution light for equity investors. Above 5%, stock markets could be in dangerous territory, as we saw in the last cycle.

“However every forecast for a precise repetition of a previous cycle assumes that all other factors remain equal, which of course, is never the case. Therefore stock markets, which remain mostly in consistent uptrends today, could weaken sooner or later relative to long-term rates.

“Consequently I will continue to view US Treasury 10-year yields as a lead indicator. Currently, they are still in a ‘sweet spot’. However when they move higher I will monitor stock market indices, particularly for Wall Street, even more closely for signs of fatigue in the form of inconsistencies, not least a loss of upward momentum.

“Lastly, an eventual break in 10-year yields to the downside below 3%, which I do not expect, could also be bearish for equities by signalling weaker GDP growth and rising deflationary pressures.”

Source: David Fuller, Fullermoney, January 11, 2010.

Bespoke: The smaller the better
“The average S&P 500 stock is up 3.50% so far in 2010. We broke the index into 10 deciles (10 groups of 50 stocks) based on market cap and calculated the average YTD percent change of the stocks in each decile to see how a company’s size has impacted performance so far this year. As shown below, the 50 biggest stocks in the S&P 500 are up an average of 2.4% year to date. The 50 smallest stock in the index are up an average of 6.5%. In general, the bigger the stock, the smaller the gain so far in 2010.”


Source: Bespoke, January 14, 2010.

MoneyNews: Goldman – big banks, Latin America are best buys for 2010
“A recent report from Goldman Sachs’ shows the investment bank forecasting that big banks with consumer exposure and commodities will be among the best bets for 2010.

“Goldman says that corporate profits will grow, especially in tech, business travel, office supplies and advertising – and that excess corporate cash will drive more mergers and acquisitions, bigger dividends and more stock buybacks.

“Tech growth will be built on the move towards cloud computing and a corporate level refresh of personal computers and servers.

“E-commerce will also continue to grow, taking advantage of its strength to draw business away from traditional competitors.

“Commodity prices will rise as demand outpaces supply, and inflation on key agricultural and protein commodities will boost the agricultural and supermarket industries, but damage internationally underexposed restaurant companies because increased foreign demand won’t benefit their bottom lines.

“Market-oriented Latin American nations and China are best positioned for what Goldman describes as the “post-crisis economy” and will outpace slow US recovery.

“As a supplier of natural resources, Latin America is becoming the go-to destination for new commodities consuming behemoths, particularly China.

“Obamacare, Goldman claims, is less important than the fundamentals for health care, where financial engineering increasingly generates med-tech earnings per share.

“Brazil’s economy will not need additional stimulus in 2010, although some measures introduced in 2009 could become permanent.”

Source: Julie Crawshaw, MoneyNews, January 12, 2010.

BCA Research: Interest rate differentials are likely to weigh against the US dollar
“The upturn in the global economy, a renewed widening of the US current account deficit and a Federal Reserve that keeps interest rates near zero will spell trouble for the US basic balance and keep the dollar under downward pressure.

“During 2002-2008, there was a marked divergence between the widening US current account deficit and falling real yields, which weighed on the dollar. The current account represents the US’s need for foreign capital. Meanwhile, real interest rates help to attract the required inflows. As these two variables moved in opposite directions, i.e. the current account widened and real rates fell, the dollar suffered as a consequence. Then, the Great Recession narrowed the US current account deficit and the deflationary pressures lifted real interest rates. This combination helped support the dollar in late 2008 and into early 2009. But with the deflationary impulse receding, real interest rates are falling again. As the US current account begins to widen and diverge with real interest rates, the dollar will face renewed downward pressure.

“Bottom line: Low real interest rates and a renewed cyclical widening of the US current account deficit should push the dollar lower in the coming months. This dynamic will be in place at least until the Fed begins to normalize interest rates, i.e. for most of 2010.”


Source: BCA Research, January 12, 2010.

CNBC: Implications of a strengthening yuan
“Beijing will probably appreciate the yuan by about 3-3.5% in 2010, predicts Tony Raza, director of asset allocation at UOB Asset Management. He outlines the implications this yuan appreciation will bring.”

Source: CNBC, January 11, 2010.

Bespoke: Commodity prices and the consumer
“Since the start of 2010, the rally in commodities has been a boon for companies and investors in the Energy and Materials sectors. Consumers, on the other hand, are increasingly feeling the impact on their wallets. In the chart below we have calculated the cumulative daily price change of the major food and energy commodities in the CRB index (Corn, Soy, Wheat, Cattle, Hogs, Oil and Natural Gas) since the beginning of 2008. We then multiplied the changes by the annual per capita consumption of each item. When the line is in positive territory, commodity prices are acting as a tax on consumers, while readings in negative territory are indicative of a windfall for consumers. Although this method may oversimplify the actual costs, it provides a good idea of how changes in commodity prices have impacted consumers’ wallets over the last 24 months.

“As shown in the chart, the rally in commodities in 2008 was especially painful on consumers. During the Summer of 2008, commodity prices were acting as a $4.77 per capita daily tax on US consumers versus the start of the year. When the credit crisis escalated, commodities tanked, thus erasing the entire tax (and then some) on consumers. By the time commodity prices bottomed in early 2009, US consumers were now benefitting from nearly a $5 daily windfall due to the decline. Since commodity prices bottomed early last year, however, that windfall has been slowly dwindling away. While US consumers are still benefitting from lower commodity prices compared to the start of 2008, the windfall is less than 30% of what it was nearly a year ago.”


Source: Bespoke, January 11, 2010.

MoneyNews: Pickens – forget the wind, go with natural gas
“Famed Texas billionaire T. Boone Pickens is dramatically changing his position on alternative energy.

“Pickens spent most of the last two years, and $62 million of his oil investing fortune, on an advertising campaign in which he sought to persuade Americans to adopt his plan for wind-based energy.

“The scheme called for a massive expansion of wind energy to displace natural gas, leaving natural gas for use in vehicles, thus displacing foreign oil.

“‘No American with a television set could escape Mr. Pickens’s argument last year. But somehow, a mass conversion to natural gas cars failed to ensue,’ a recent report in The New York Times stated.

“But, now Pickens is changing his pitch.

“Pickens said Wednesday he has cut in half an order for General Electric Co. wind turbines and plans to use the rest in other areas instead of Texas, where he once planned a massive wind farm, the Associated Press reported.

“Pickens, who heads the hedge fund BP Capital Management LP in Dallas, purchased 333 turbines from GE, which was about half his initial order of about 687 turbines.

“Pickens scrapped his plan for a 1,000-megawatt wind farm in West Texas last summer because of technical problems in getting power from the site to transmission facilities.

“Pickens now is spending millions more on a new campaign, with the first advertisements scheduled to be broadcast Thursday on cable stations across the country.

“His aides reckon that a stronger message, concentrating on the national security aspects of energy independence, will be quite effective after the thwarted Christmas Day airliner bombing and other, recent terrorist actions in the United States.

“Natural gas is said to be the cleanest fossil fuel, emitting fewer greenhouse gases than either coal or oil.

“Many energy experts say they think it is underutilized as a fuel, especially since new technologies recently unlocked huge reserves in shale gas fields across the country.

“Some, however, say putting in place the infrastructure for natural gas vehicles would be too costly, and battery-powered electric cars and hybrids are a much better alternative.”

Source: Gene Koprowski, MoneyNews, January 14, 2010.

Financial Times: China’s exports rise as economy picks up
“China’s exports rose in December for the first time in 14 months, providing fresh evidence of recovery in the global economy but also placing renewed pressure on Beijing to appreciate its currency.

“Following strong export figures last month from South Korea and Taiwan, China said on Sunday that its exports climbed 17.7 per cent, well ahead of the modest increase that economists had predicted. These numbers put China on track to overtake Germany as the world’s largest exporter.

“Chinese imports surged by 55.9 per cent in December, the latest indication of buoyant domestic demand in China, although the figures are also likely to increase concerns about potential inflationary pressures.

“Exports to China’s two biggest markets both rebounded last month, with sales to the US increasing 15.9 per cent and to the European Union 10.2 per cent.

“However, the year-on-year comparisons were inflated by the low base of the previous year’s figures. Economists said some of the improvement was due to restocking by companies that had run down inventories.

“‘While December’s export figures are encouraging … a recovery to pre-crisis levels appears some time away,” said Jing Ulrich, head of China equities and commodities for JPMorgan.

“Andy Rothman, CLSA’s chief China economist, said a resumption of export growth was necessary before Beijing restarted appreciation of the renminbi, suspended over a year ago in the crisis. He said Beijing was unlikely to act on one month’s figures alone. But if the export recovery continued, China’s leaders would have the political cover to resume renminbi appreciation by mid-year, with a possible rise of 3 per cent for 2010.

“‘Beijing has been waiting for three things to happen before resuming gradual appreciation: strong economic recovery in China; stability in the US and European economies; and several months of [positive] Chinese export growth, which is important to sell appreciation to the domestic audience.’

Source: Patti Waldmeir, Financial Times, January 10, 2010.

Financial Times: China raises bank reserve requirements
“China has increased the amount banks must set aside as reserves in the clearest sign yet that the central bank is trying to tighten monetary conditions amid mounting concerns of overheating and inflation as a result of the credit boom.

“The People’s Bank of China also raised interest rates modestly in the inter-bank market on Tuesday for the second time in less than a week, as it engages with commercial banks in a tug-of-war over rapid lending.

“Stock markets and commodities fell in Asia on Wednesday after the surprise decision, sparking concerns that the move could slow China’s purchases of natural resources and other imported goods from around the region.

“Economists said that Tuesday’s announcements were a warning to the banks against lending too aggressively following reports in state media that loans in the first week of 2010 reached Rmb600bn ($88bn), not far short of the monthly average last year.

“‘This is a warning across the bows of the commercial banks,’ said Tom Orlik, of Stone & McCarthy in Beijing. ‘The central bank said that the high level of bank lending needs to come to an end but that the commercial banks do not seem to be taking it seriously.’

“Reserve requirements were raised by 0.5 percentage points, while rates on one-year paper increased by 0.08 per cent and on three-month paper by 0.04 per cent.

“The moves underline the increasingly delicate task the PBoC is facing in managing the consequences of China’s credit binge, when lending more than doubled from Rmb4200bn in 2008 to above Rmb9000bn last year.”

Source: Geoff Dyer, Financial Times, January 12, 2010.

The Wall Street Journal: China’s hot money headache
“While Beijing battles its coldest winter in half a century, Chinese officials are battling a major hot money problem. Heard on the Street’s Andrew Peaple ponders the government’s efforts to restrain the flow of funds into China.”

Source: The Wall Street Journal, January 12, 2010.

Bloomberg: China’s property prices rise most in 18 months
“Rong Ren, chief executive officer of Harvest Capital Partners, talks with Bloomberg’s Bernard Lo about the implications of China’s increase in the proportion of deposits banks must set aside as reserves. Ren, speaking in Hong Kong, also discusses his strategy for investing in China’s retail malls and development projects.”


Click here for the full article.

Source: Bloomberg, January 14, 2010.

Financial Times: Greece unveils 3-year plan to curb deficit
“Greece on Thursday announced an ambitious three-year plan to curb its runaway budget deficit but failed to convince sceptical markets its targets for growth and fiscal reform were feasible.

“The stability and growth plan calls for the budget deficit to be cut from 12.7 per cent to 2.8 per cent of gross domestic product by the end of 2012.

“The economy is projected to shrink by 0.3 per cent this year before rebounding with growth of 1.5 per cent in 2011 and 1.9 per cent in 2012.

“The deficit would be reduced this year by 4 percentage points of GDP, with deep cuts made in hospital and defence spending where waste and corruption are widespread, according to officials. Revenue increases would be driven by higher excise taxes on tobacco and alcohol, an overhaul of the tax system and a crackdown on tax evasion.

“‘This plan can be achieved, we’re confident of that,’ said George Papandreou, the prime minister, after an outline was presented at a televised cabinet meeting.

“The plan is seen as Greece’s passport to borrowing almost €54bn ($78bn) on international markets to fund a swollen public debt expected to rise this year from 113 per cent to more than 120 per cent of GDP.

“But markets reacted negatively almost as soon as George Papaconstantinou, finance minister, finished his presentation at a cabinet meeting broadcast live on Greek television under the government’s policy of promoting transparency.

“The cost to insure Greek debt rose to fresh heights as investors continued to worry about the parlous state of the country’s finances. The Greek bond markets also sold off, dipping to 12-month lows.

“‘We think these forecasts are too optimistic … we doubt the government will meet its fiscal targets – the recent renewed surge in government bond yields may therefore have further to go’, said Ben May of Capital Economics in note published on Thursday.

“‘The two targets – growth and public deficit – are inconsistent and at least one won’t be achieved,’ BNP Paribas said in a note.”

Source: Kerin Hope and David Oakley, Financial Times, January 14, 2010.

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