Dober dan (“hello”) from Ljubljana, capital of Slovenia, right in the heart of continental Europe. This must surely rate as one of the most delightful cities in the world – from its natural beauty to its all-embracing cultural emphasis to its vibrant café society. Is it a coincidence that the word “love” (s-love-nia) is embedded in the country’s name?
Before highlighting some memorable quotes from market commentators during the past week, let’s briefly review the week’s market action on the basis of a few performance charts.
US equities ended the week in positive territory as selling pressure abated in low-volume trading in the run-up to Tuesday’s FOMC meeting. The large international companies (beneficiaries of the declining US dollar) in the Dow Jones Industrial Index stole the show, propelling the Index to its best weekly performance since April.
Elsewhere in the world markets were higher throughout, with Hong Kong’s Hang Seng Index registering a new high (33% above its March low) and India’s BSE Sensex Index hovering close to its peak. The resignation of the Japanese prime minister weighed on the Nikkei 225 Index.
GLOBAL STOCK MARKETS
US bond yields were higher across the yield curve during the past week, correcting from overbought levels. US 3-month Treasury Bills, however, declined as liquidity fears calmed somewhat. On the exchange rate front, the US dollar came under further pressure in anticipation of easier monetary policy. The yen also eased, with carry trade concerns taking a back seat prior to the US fed funds announcement of September 18. One of the weakest currencies (not shown here) was sterling on the back of concerns about Northern Rock and other UK mortgage lenders.
FIXED-INTEREST AND CURRENCY MARKETS
Commodities were characterized by strong increases across the board, helped in no small way by the weakening dollar. Energy was the strongest performer where supply concerns, notwithstanding increased OPEC production levels, pushed the price of crude to an all-time high. Gold bullion looked strong above the $700 level, but silver was battling to play catch-up.
Now for some words from the investment wise to help make sense of financial markets.
Economy.com: Business confidence for world
“Global business confidence stabilized last week, after plunging in August. Sentiment firmed largely outside the US, however, and sentiment remains consistent with an economy that is very near recession. Assessments of present conditions and expectations regarding the six-month outlook remain very negative. Financial service firms appear near panic, as their confidence has plummeted to a record low. Investment and hiring have notably softened and pricing pressures have evaporated.”
Source: Moody’s Economy.com, September 5, 2007.
Gavekal: Interest rates and global growth
“ … it is hard to escape the conclusion that a) the velocity of money and the willingness of the private sector to take risk is collapsing, and b) economic growth is decelerating. Needless to say, this is a harder environment in which to make money than the prevalent massive liquidity and booming growth environment that prevailed just a few months ago.
“Given the above, most of our clients are asking themselves two questions: a) What will central banks do, and b) Is Asia strong enough to withstand a slowdown across the G7? With regard to the first question (on central bank actions), we, along with the market, tend to believe that the Fed will cut and cut aggressively to prevent the rot from spreading (though the risk clearly is that, with a weak US$ and stronger gold, the Fed decides to sit on its hands). Meanwhile, the ECB and the BoE will take more time to act (which is another reason we need to be wary of European assets). As for the second question, we would answer that growth in Asia remains strong, and liquidity is plentiful. Asia (ex-Japan) thus remains the place to maintain long equity positions.”
Source: Checking the Boxes, GaveKal Research, September 10, 2007.
John Hussman (Hussman Funds): Outlook for bonds
“ … it is important to recognize that while credit concerns and widening risk spreads tend to be quite good for the Treasury market (as investors seek safe havens), it is also important to recognize that, say, 10-year Treasuries are priced to deliver long-term returns of, well, their yield to maturity of about 4.38%. At that level of yields, with a relatively flat yield curve and still moderate inflation, speculation at the long end of the maturity spectrum can be quite dangerous, and gains can be abruptly reversed. Yes, recessions tend to be good for long-term bonds, but bond yields typically start at much higher levels at the beginning of weak economic periods. Recessions tend to produce a steepening in the yield curve, so it’s not at all clear that even lower short-term yields will produce much ‘give’ at the long-end. Overall, long-term bonds may still perform well in a credit implosion, but with a good bit of volatility. I believe that it is more appropriate to nibble on longer durations during periodic sell offs (yield surges) rather than chasing low yields when bonds are already quite overbought.”
Source: Dr. John Hussman, Hussman Funds, September 10, 2007. (Click here for a direct link to the full article.)
Bloomberg: Treasury investors to fear for their profits
“Treasury investors basking in the biggest rally in four years have reason to fear for their profits: The largest owners of US government debt are heading for the exit. Two-year Treasuries returned 1.09 percent in August, the best monthly performance since 2003, according to indexes compiled by Merrill Lynch & Co. At the same time, holdings of US bonds by governments and central banks at the Federal Reserve fell 3.8 percent, the steepest decline since 1992.
“The dollar’s slump to a 15-year low against six of its most actively traded peers is turning the gains into losses for international bondholders, prompting China, Japan and Taiwan to sell. Overseas investors own more than half of the $4.4 trillion in marketable US government debt outstanding, up from a third in 2001, according to data compiled by the Treasury Department.”
Source: Bloomberg.com, September 10, 2007
Richard Russell: Dollar trouble
“We print ’em, the world takes ’em in. The world is choking on too many Federal Reserve Notes, laughingly mislabeled as dollars. The US depends on our foreign friends (and enemies) taking in dollars to balance our huge trade and current account deficits. But it’s come to the point where the rest of the world is fearful of continuing to increase their dollar hoards. ‘Enough is too much’ is the sentiment.
“Actually, our foreign friends don’t have to halt their buying of dollars, they just have to cut back on the amount of Treasuries they take in – and pressure will increase on the dollar. Which, is what is happening now. Normally, when a currency is in trouble, that nation will increase interest rates in order to render their currency more attractive for others to accumulate or at least to hold. But the subprime mess has caused the Fed to think in terms of lowering rates, rather than raising them. This dilemma is not lost in the FOREX (foreign exchange) trade. No, the FOREX boys and girls have been pushing the dollar lower. When it comes to money; emotions and kind feelings don’t enter the picture.”
Source: Richard Russell, Dow Theory Letters, September 12, 2007.
Richard Russell: Favoring gold
“A number of phenomena have now come together, all favorable for gold.
Chaos in the currency markets, and therefore growing suspicion regarding the ultimate worth of all fiat currencies.
Last Friday, the Dollar Index closed below 80 for the first time, raising fears that the dollar could be on the edge of a major decline.
Governments throughout the world are diversifying out of dollars and into other currencies. In Asia, banks and individuals are buying gold, even as European treasuries sell their gold (Britain and Switzerland are leading sellers).
The constriction of credit and possibly slowing business will force the Fed to lower rates and pump up the money supply. Both activities are bullish for gold.
Japan will shortly have a Gold Exchange Traded Fund. The Chinese government has eased restrictions on its citizens owning gold and has really encouraged them to buy gold. Gold buying in both China and India is rising rapidly.
There is a massive build-up of call options in the October and December gold contracts. This is similar to the November 2005 period, prior to gold surging by more than 50%.”
|Source: Richard Russell, Dow Theory Letters, September 10, 2007.|
BCA Research: Further upside in gold price is likely
“The precious metals complex (especially gold) is sniffing out more plentiful liquidity conditions. Real interest rates will fall in the US both in absolute terms and relative to the rest of the world in the wake of the housing debacle. This will spur a flood of liquidity and drive up gold prices as investors and central banks search for alternatives to paper currencies. Demand for gold should also benefit from further depreciation in the US dollar. Moreover, the Tokyo Stock Exchange is planning on introducing a gold ETF in the near future, which should further increase demand, albeit marginally. Finally, our fair value model has also been trending higher, suggesting that the bull market in gold is genuine and still has further upside.”
Source: BCA Research, September 12, 2007.
Eoin Treacy (Fullermoney): Gold carry trade
“The gold carry trade has been one of the darling arguments of the gold bugs for many years. In fact I have seen some argue that the amount of gold lent out is far in excess of what the banks actually hold. While gold was in a bear market it paid to have a large hedge book and to lock in future prices as soon as possible. This is not a suitable strategy for a bull market and as gold reasserts its uptrend, shorts are going to be squeezed. When investing in gold miners, the best performers are likely to be those with no hedge book to speak of.
“At some point central banks will stop selling gold, which will be a major bonus for the market and could lead to an acceleration, but we’re not there yet and may not be for a good many years to come. For the moment gold is consolidating above $700 and as long as it holds around this level we can give the upside the benefit of the doubt.”
Source: Source: Eoin Treacy, Fullermoney, September 13, 2007.
Marc Faber: No option for Fed except to bail out!
“ …if I look at the investment environment I cannot get excited about participating in the ongoing battle between market fundamentals, which are, in my opinion, a disaster, and the manipulation by the Fed (and possibly at some point also by the government), which could boost US asset prices or at least prevent them from declining as much as the bears (including myself) would like them to do. In military battles even the victors have a very high casualty rate.
“Therefore, I suppose that in the ongoing financial battle between the optimists, who expect a new high shortly, and the pessimists, who expect a new low before the end of October, the best course of action may be to only take small positions and to be patiently awaiting better entry points both on the long and the short side.
“However, if some of my readers are very optimistic, I recommend them to buy gold and gold shares rather than the S&P 500 and other major US indices. At the same time, I would continue to avoid the financial sector, which is in a credit contraction the most vulnerable industry.”
Marc Faber, AME Info, September 10, 2007.
Asha Bangalore (Northern Trust): Lowering of fed funds rate
A lower federal funds rate appears very likely at the September FOMC meeting. The soft readings of retail sales and the drop in factory output, which probably do not reflect the impact of the current crisis entirely, are important indications that the economy was already slowing before the financial turmoil hit the global economy. In light of the weakness of these reports, lowering of the federal funds rate should be seen as macroeconomic policy management and not liquidity crisis management.
Source: Asha Bangalore, Northern Trust’s Daily Global Commentary, September 13, 2007.
Asha Bangalore (Northern Trust): Private residential investment points to downswing in GDP
“Here is a picture that is worth repeating. The chart below depicts inflation adjusted residential investment expenditures and growth in real GDP from 1954 onwards. The main conclusion from here is that sharp declines in residential investment expenditures are associated with recessions with exception of two periods – 1966-67, 1995. During both these time periods, the Fed eased monetary policy and stimulated economic growth.”
“ … the declines in residential investment expenditures come in different sizes but when they occur they are almost always associated with a downswing in real GDP growth. Without doubt there are several factors accounting for any given recession. As a reminder, the weakness in residential investment expenditures began long before the current financial market turmoil.”
Source: Asha Bangalore, Northern Trust’s Daily Global Commentary, September 10, 2007.
Paul McCulley (Pimco): Teton reflections
“There is a connection between Wall Street’s woes and cuts in the Fed funds rate, but the connection is through the impact of Wall Street tightening of credit provision to Main Street, opening downside risk to Main Street growth, not losses on Wall Street per se. Put differently, if the Wall Street tree fell but nobody on Main Street heard it, the Fed wouldn’t give a hoot. But, of course, that isn’t realistic and the Fed knows it.
“Wall Street’s falling tree is being heard very loudly on Main Street in the form of tightening terms, conditions and rates for all but conforming mortgages. And this tree is falling in the middle of a forest of homes for sale, many unoccupied, a sure sign of preceding speculative activity.
“Thus, the Fed needs to ease and will ease, substantially I firmly believe, not to bail out Wall Street but to make certain that weaker growth on Main Street does not morph into recession, which would carry serious debt-deflation consequences. It’s a risk management world: recession may be a low risk (though not as low as only a few months ago), but the consequences would be very severe. It’s a fat macroeconomic tail that the Fed must, and will, cut off.
“And that’s a much bigger, and more important, job than running a roto rooter snake through the financial system’s plumbing. Here’s saying a prayer that 100 basis points of Fed funds cuts, by the end of 2007, will not be too late for the sky.”
Source: Paul McCulley, Pimco’s Global Central Bank Focus, September 5, 2007.
David Fuller (Fullermoney): Rate cut will help to restore confidence
“ … sentiment is what has defined the extent to which markets have moved as a result of the credit crunch. There is still plenty of money in the system, what is lacking is the willingness to take risk because sentiment is at a bearish extreme. A 50 basis point cut is not going to fix the problems in the housing market and it certainly won’t bailout the millions of people at risk of losing their homes. However it will help to restore confidence in a market which has been rocked by uncertainty over the last month. It is for this reason I believe the Fed will cut rates in the upcoming meeting.”
Source, David Fuller, Fullermoney, September 10, 2007.
Eoin Treacy (Fullermoney): China
“Surging long dated government bond yields often result in an ending for stock market rallies. This was certainly the case last year when US yields were rising prior to the May/June correction. China’s 10-year yield has jumped from 3% in October 2006 to 4.33% today. While yields have consolidated somewhat around this area, higher interest rates could easily push them higher. Interest rates have risen from 5.56% in April 2006 to 7.02%, following six rate hikes. Rates are higher now than at any time since July 1998 because China has been trying to cool the economy and is also trying to keep inflation under control.
“The A-Share market has performed in spectacular fashion for much of the last two years but rising interest rates may act to cool it in the coming months, which could lead to another multi-month consolidation.”
Source: Eoin Treacy, Fullermoney, September 10, 2007.