I spend a very large amount of time reading investment-related material. In order to share some of the more interesting snippets with readers, I have decided to add a new section to the blog – Words from the Wise – where I will regularly publish a number of quotations from market commentators. The content will be updated on either a weekly or fortnightly basis and be representative of a diverse spread of opinions.
I hope you find browsing the paragraphs as stimulating as I do in attempting to figure out the most likely direction of financial markets.
The panic of 2007
“End of the world or muddle trough?
“The significance of today’s cut of the discount rate, and the willingness to look at up to 30 days of loans and high-quality asset-backed paper, is not the actual cut but more the boost to confidence. It is the Fed saying to the market, ‘Daddy’s home. Everything is going to be all right.’
“As an answer to my opening question, I think we are in for a return of the muddle through economy rather than the end of the world. Credit markets will get back to normal, as there is a lot of money that needs to find a home. It is just looking for a credible home and one that will feature higher risk premiums and spreads.”
John Mauldin, Thoughts from the Frontline, August 17, 2007.
Russell on the Fed
“Bernanke would like to get by without cutting the Fed Funds rate. The housing mess could force his hand. The worse the housing picture, the greater the chances that the Fed Funds will be lowered. Will the nation stand by as tens of thousands of home-owners lose their houses to foreclosure? I somehow doubt it. I think a plan will be advanced whereby mortgages can be “adjusted” or ‘done over’ with government help.
“The housing situation will be a problem for the government, not the Fed, to solve. My guess is that the government will step in with new guarantees or a revival of something like the FHA (Federal Housing Administration). And you can bet that Bennie and the Feds will fight any signs of recession ‘tooth and nail’.”
Source: Richard Russell, Dow Theory Letters, August 24, 2007.
US presidential election
We are in the third year of the US presidential cycle, with the prospect of a hotly contested election in just over a year. With the rumors of 2-million defaults circulating, housing is likely to become a serious election issue. At present the Fed seems to be relatively sanguine about letting the housing correction run its course. However they may be forced from that position if we are in a tight election race and a bailout for at-risk home owners is seen as a vote winner. If that were to happen the knock on effect for the stock market would be extremely positive.
Source: Eoin Treacy, Fullermoney, August 24, 2007.
Will financial market turmoil bring down the US economy?
“Importantly, with inflationary pressures receding, the Fed can be expected to ease aggressively if the economy appears headed towards recession. The fed funds target rate is roughly around neutral, providing the credit markets return to normal functioning in the very near run. Corporate sector trends suggest no worse than a soft landing. Expansion plans (hiring and investment) should only modestly slow because balance sheets are still fundamentally sound and profit margins are near multi-decade highs. Moreover, global growth is much more balanced than at any other time in the past two decades. Thus, while the economy will be weak through yearend, it should not spiral into recession as long as the credit channels reopen.”
Source: BCA Research, August 21, 2007.
A toolbox of useful indicators to gauge recession risk
“We still don’t have quite enough evidence to confidently anticipate a recession, but I think this is a good point to review the simple 4-indicator criteria set that has reliably preceded or accompanied the beginning of US recessions (without false signals).
“1) The ‘credit spread’ between corporate securities and default-free Treasury securities becomes wider than it was 6 months earlier.
“2) The ‘maturity spread’ between long-term and short-term interest rates falls to less than 2.5%, as measured by the difference between the 10-year Treasury bond yield and the 3-month Treasury bill yield.
“3) The stock market falls below where it was 6 months earlier, as measured by the S&P 500 Index.
“4) The ISM Purchasing Managers Index declines below 50, indicating a contraction in manufacturing activity.
“Presently, all of these conditions are in place except the fourth.
“The following are some additional early warning indicators of an oncoming recession:
“A sudden widening in the ‘consumer confidence spread’, with the ‘future expectations’ index falling more sharply than the ‘present situation’ index (currently in place). In general, a drop in consumer confidence by more than 20 points below its 12-month average has accompanied the beginning of recessions (not observed yet);
“Low or negative real interest rates, measured by the difference between the 3-month Treasury bill yield and the year-over-year rate of CPI inflation. Last week, T-bill yields plunged to about the same level as CPI inflation, so this indicator is now unfavorable;
“Falling factory capacity utilization from above 80% to below 80% has generally accompanied the beginning of recessions. This is not yet in place.
“Slowing growth in employment and hours worked. The unemployment rate itself rarely turns higher until well into recessions (and rarely turns down until well into economic recoveries). So while the unemployment rate is an indicator of past economic health, it should not be used as an indicator of oncoming economic changes. As for employment-related data, slowing growth in employment and hours worked tend to accompany the beginning of recessions. Specifically, when non-farm payrolls have grown by less than 1% over a 12-month period, or less than 0.5% over a 6 month period, the economy has always been at the start of a recession. Similarly, the beginning of a recession is generally marked by a quarterly decline in aggregate hours worked. All of these indicators are slowing considerably, but they have not crossed to levels typically associated with imminent recession.
“In short, the risk of recession is increasing, but we do not yet have the evidence to indicate that a recession is imminent or inevitable. Important data to monitor in the next few months will be the ISM figures, consumer confidence (especially a sharp drop), employment, hours worked, and capacity utilization.”
How strong is central bank epoxy?
“Three generations after the start of the Great Depression, the eggheads, pundits and wonks are still looking for a culprit. Was it the Smoot-Hawley tariff? Too-tight credit after the market crashed? The next time around, when the saga of the Second Great Depression is told, they need look no further than a Federal Reserve that succeeded in turning the concept of ‘free lunch’ into America’s only mainstream religion.”
Rick Ackerman quoted by Bill Bonner, The Daily Reckoning, August 24, 2007.
“More than 1.3 million borrowers took out over $389 billion worth of pay-option adjustable mortgages in 2004 and 2005. Many of these started to reset in 2006, just as the property market started to tank. Many more are set to reset this year, in 2007.
“As much, in fact, as $1 trillion in pay-option loans and other creative ARMs over the next 12 months alone – sending an atomic shockwave across the US economy between now and January 2008!”
Mish Shedlock quoted by Bill Bonner, The Daily Reckoning, August 24, 2007.
A Swiss view of the credit crisis
“Something unbelievable happened. People who had neither income nor capital got credit with very attractive conditions. Now reality is striking back.
“The aim of central banks should not be to eliminate volatility.”
Source: Jean-Pierre Roth, Governor, Swiss National Bank, August 19, 2007.
Impact of interest rate cuts on Wall Street
“Wall Street tends to get very excited whenever the Federal Reserve begins a new rate-cutting program. The Fed started a rate-cutting program 11 times since 1945. In the six-month period after the first cut, the S&P 500 advanced an average 12.3%, versus the average 9.0% in all years since 1945. Yet stock prices fell four of 11 times. Twelve months after the first rate cut, however, the S&P 500 gained an average 18.8% and posted an increase in 10 of 11 observations.”
Source: Standard & Poor’s, August 24, 2007
The gathering storm
“Only a lack of imagination would allow investors to think suddenly of the US dollar as today’s ‘quality’ refuge. Any respite for the dollar will surely be temporary; indeed, the bounce we saw during the sharpest stock-market losses so far may have simply been short-covering by dollar bears (of which there are plenty) rather than fresh buying of ‘quality’.
“Lower US rates on the back of America’s weakening domestic economy will re-kindle a dollar slide in due course. So the current lull may offer only a brief window, in which fewer, stronger dollars buy more gold than they soon will.”
Source: Paul Tustain, BullionVault, August 24, 2007.
Russell on gold bullion
The central bankers believe they can control the quantity of fiat money so that the junk they create will always possess purchasing power. History tells us that the central bankers are dreaming (or lying). When it becomes obvious that the central banks are producing too much paper and are therefore devaluing their fiat currencies, seasoned investors take that fiat currency and buy Picassos or homes near some shoreline or collectibles or gem-quality diamonds — or gold Gold moves up when people worry about fiat currency, and they want to accumulate real money.
Source: Richard Russell, Dow Theory Letters, August 23 2007.
Credit crunch won’t reduce commodity demand
“The secular bull market for industrial resources which began 5-years ago remains intact. It is being driven by the overwhelming demand for all resources from the developing economies of Asia and this is something that will not change any time soon. The mega-cap miners such as BHP Billiton are uniquely placed to benefit from this trend and we can expect profits to continue to grow as long as they can keep their costs under control.
“However while BHP Billiton’s customers are in the emerging world, the people who buy and sell their shares are mostly in the West and are influenced by other market events. This means that miners will continue to be subject to sell-offs when contagion selling in other areas affects the resources sector, but these should be viewed as buying opportunities because their long-term potential is outstanding.”
Source: Eoin Treacy, Fullermoney, August 22, 2007.