Before highlighting some memorable quotes from market commentators during the past week, let’s briefly review the week’s ups and downs on the basis of a few bar charts.
Worries of the recent credit market turmoil diminished during the week as weak economic news was interpreted as ammunition for further interest rate reductions. Emerging markets as a group surged by 4.3%, with a number of individual emerging markets advancing to new all-time highs, but mature markets also did not disappoint investors.
The past week brought to an end a turbulent and nerve-wrecking third quarter, the end result of which surprised many pundits. Contrary to expectations of just a few weeks ago, the Dow Jones Industrial Index (+3.6%), the Nasdaq Composite Index (+3.8%) and the S&P 500 Index (+1.5%), by means of example, all tallied useful gains.
GLOBAL STOCK MARKETS
Global bond yields were lower on the week as investors focused on slower economic growth rather than on the inflationary implications of easy monetary policy. The rate of the US 3-month Treasury Bill, however, edged higher in the aftermath of the Fed’s rate cut.
On the currency front the US dollar remained under intense pressure in anticipation of a slowing economy and further interest rate cuts, and recorded an all-time low against a basket of currencies (using the US Dollar Index as a measure). The US dollar plunged to a 30-year low against the Canadian dollar, or so-called loonie or Canuck (not shown on the graph), and an all-time low against the euro.
FIXED-INTEREST AND CURRENCY MARKETS
The declining US dollar encouraged further strong gains in gold (hitting a 28-year high), silver and platinum (not shown as a result of a data error). Crude oil recovered from a mid-week low to close almost unchanged, but in the light of storm concerns, persistent geo-political problems and the dollar’s weakness, a breach of the $100 level is no longer regarded as a far-fetched prospect.
Solid demand from China and other developing countries, as well as weather-related issues, boosted the prices of agricultural commodities to another strong weekly increase. Wheat soared to an all-time high, having more than doubled over the past year.
Now for some words from the investment wise to navigate through the markets’ cross-currents:
Economy.com: Survey of business confidence for world
“Global business confidence sagged again last week, despite the Federal Reserve’s aggressive cut in interest rates. Sentiment fell to a new record low in the US where it is now consistent with a contracting economy. Sales notably weakened last week and assessments of present conditions and expectations regarding the six-month outlook are very negative.”
Source: Moody’s Economy.com, September 24, 2007.
Richard Russell: “Inflate or die” – poison for US dollar
“The consumer is slowing down, and business is cutting back on its spending … it now falls on our government to keep up the spending. I’ve been warning about this all along. Richard Koo in his book, ‘The Balance Sheet Recession’, warned about this. With the massive amount of debt in this country hanging over us, with the monster current account deficits being run up every year, these are forces for deflation. To keep the US economy moving, there has to be BIG spending – and an expanding Gross Domestic Product. If the consumer isn’t going to do the spending, if business isn’t going to do the spending, then the government will have to do the spending. Yes, it’s ironic, but the US must now run bigger deficits than ever! It’s now truly a case of ‘inflate or die’.
“Unfortunately, this will play hell with the already weak dollar. Huge deficits, lower interest rates, a weakish economy, they’re all poison for any currency, and the dollar will be no exception. Who will benefit? The answer is that gold will benefit. When the dollar declines in value, it takes more dollars to buy an ounce of gold. In fact, it will take more dollars to buy diamonds, Picassos, top-grade collectibles, rare coins, objects of art, and so on. It will cost more dollars to buy anything of lasting tangible value.”
Source: Richard Russell, Dow Theory Letters, 28 September 2007.
Eric Fry (Rude Awakeing): Blame Bernanke
“Sooner or later – probably sooner – the dollar-holders of the world will realize that Bernanke will sacrifice the dollar to ‘save’ the economy. They will realize that he will sacrifice dollar-lenders in order to save dollar-debtors. But no one likes being a patsy. The abused dollar-holders of the world will not suffer abuse indefinitely. Instead, they will seek the comfort and sanctuary of non-dollar alternatives like euros or Swiss francs or gold or bushels of wheat.”
Source: Eric Fry, Rude Awakening, September 28, 2007.
Telegraph: Fears of dollar collapse as Saudis take fright
“Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signaling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.
“’This is a very dangerous situation for the dollar,’ said Hans Redeker, currency chief at BNP Paribas. ‘They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the US,’ he said.
“As a close ally of the US, Riyadh has so far tried to stick to the peg, but the link is now destabilising its own economy. Inflation has risen to 4% and the M3 broad money supply is surging at 22%. The pressures are even worse in other parts of the Gulf. The United Arab Emirates now faces inflation of 9.3%, a 20-year high. In Qatar it has reached 13%. Kuwait became the first of the oil sheikhdoms to break its dollar peg in May, a move that has begun to rein in rampant money supply growth.”
Source: Telegraph.co.uk, September 21, 2007.
The Times: Predicting record gold run
“It would be the biggest run on gold since the attempted French invasion of Britain of 1797 that sent prices through the roof. The precious metal … was predicted by a leading analyst to quadruple within three years as buyers seek shelter from prolonged turmoil in mainstream financial markets.
“According to Christopher Wood, chief strategist at CLSA, market ructions and a collapse of the dollar could send gold prices to more than $3 400 an ounce within the next three years. Gold futures last night hit a 28-year high at $733 an ounce, but are more than $100 short of the record.
“Mr Wood said that the sub-prime conflagration would be the catalyst for a wider breakdown in markets. However, Wood predicted that investors would soon realise that the sub-prime crisis is simply the catalyst of a much wider breakdown, arguing that it has been the ‘Archduke Ferdinand assassination event’ that sparks a bigger calamity. ‘This is not a sub-prime crisis. Sub-prime has merely exposed the bigger scam of structured finance; a scam that is about pretending that bad credit is good credit,’ he said.”
Source: Leo Lewis, The Times, September 19, 2007.
Peter Spina (Goldforecaster): Gold returns to centre stage
“Gold returned to the center stage Friday reaching fresh record levels. Gold is returning to its historical attribute as a monetary instrument. With the US dollar falling to new lows, capital is looking for a preservation of wealth asset. As foreign currencies become more expensive and suspect themselves, gold is quickly becoming an asset choice. A lack of faith in the US dollar’s ability to preserve purchasing power will continue to flood the gold market with investment demand. This is the key driver. I would expect in the coming months the process will continue, in waves, with gold surpassing the $800 level as investors begin to focus on the $1 000 level.”
Source: Peter Spina, Goldforecaster.com, September 28, 2007.
Bloomberg: Jim Rogers sees ‘skyrocketing’ prices for commodities
“The ‘clowns in Washington’ have ‘signaled to the world they don’t care about the US dollar,’ Jim Rogers said … The commodities rally, which Rogers correctly predicted in 1999, may last 15 more years, he said. Oil may reach $150 a barrel during that time, Rogers added. In 2005, he said the commodity bull market may last until 2022 because of a lack of investment during the past two decades.
“On July 2, Rogers said agricultural commodities were ‘the place to be,’ and that investors should buy them over stocks and bonds. Today, he advised against buying wheat, which has become the most expensive ever relative to corn, soybeans and cotton. ‘I wouldn’t buy it now,’ Rogers said. ‘If you’re going to buy something, buy coffee or cotton or sugar. Wheat has been going straight up for about a year. I don’t like to jump on a moving bus.’”
Source: Betty Liu and Eric Martin, Bloomberg.com, September 24, 2007.
Asha Bangalore (Northern Trust): Issues haunting the Fed
“The weak dollar and inflation require tighter monetary policy conditions, while weakening economic conditions argue for easing of monetary policy. The FOMC will need to make tough choices in the weeks ahead – whether to focus on the economy, the dollar, or inflation. Is there a historical episode the Fed can draw lessons from? Yes and no.
“Each financial market crisis has its own special features that demand some creative solutions. The Fed’s response to the LTCM crisis in 1998 by lowering the federal funds rate 75 basis points was less challenging because the root of the problem was outside the country, the US economy was growing at a robust pace of 4.2%, the trade weighted value of the dollar was rising (not declining as now), and core inflation was slightly lower compared with the situation today.
“At the present time, the root of the problem is at home, the spillover effects of the housing market meltdown have been visible prior to the crisis, and the US economy has posted sub-par growth for four out of the last five quarters. Weak economic conditions are most likely to trump all other considerations in the weeks ahead. A lower federal funds rate in the months ahead is nearly certain but the timing of the cuts in the federal funds rate is not certain.”
Source: Asha Bangalore, Northern Trust’s Daily Global Commentary, September 24 & 27, 2007.
GaveKal: Fed decisions dependent on data releases
“The market is already betting on another cut of Fed funds rate before the end of the year – as evidenced by the fact that two-year notes are now yielding 70bp less than the targeted 4.75%. And it is worth noting that, over the past 20 years, this level of confidence amongst bond traders has proved to be a very reliable harbinger of upcoming rate cuts. That said, we are not sure this is such a slam-dunk call … at least not yet. Consider the following:
The Fed follows the tailend of the yield curve. When long-bond yields fall, the Fed usually cuts; and when yields start rising again, the Fed usually holds or rises. … since September 10, long yields have risen +30bps.
|2.||The weakness of the dollar has to weigh on the Fed.|
Commodities, and other economically sensitive prices, are on the rise. … the Fed may not want to take the risk of monetizing any further commodity price increases.
Global growth is slowing, but it is not falling off a cliff. … while growth is certainly set to slow in the US, in no way do we expect a recession.
“Given the nature of the current investment environment … additional rate cuts are certainly possible. But given the above factors, we think it may be too early to be confident with that call. Instead, we think the outcomes of upcoming Fed meetings are going to be very dependent on data releases between now and then.”
Source: Checking the Boxes, GaveKal Research, September 24, 2007.
Asha Bangalore (Northern Trust): Existing home sales decline to 5-year low
In August, the median price of a single-family home was unchanged from a year ago at $223 900 and down 2.0% from July. The Case-Shiller Home Price Index for the 20 large metropolitan areas dropped 3.9% from a year ago in July, after establishing a peak year-to-year gain of 17.1% in August 2004 (see chart). Given the extension of time to sell existing single-family homes and bloated inventory of unsold homes, prices should fall more rapidly in the months ahead as homeowners take drastic measures to sell their homes.”
Source: Asha Bangalore, Northern Trust’s Daily Global Commentary, September 25, 2007.
BCA Research: Homebuilders – the downward spiral continues
“Homebuilding stocks have been stuck in a freefall and a turnaround in coming quarters is unlikely. Heightened concern about sub-prime loan defaults remains a key ingredient to the bear market in both sub-prime and housing stocks. Notably, sub-prime relative performance, has led homebuilding stocks in the past decade, and the current message is still negative.
“It will take a substantial drop in interest rates, house prices, or a combination of the two, to bolster affordability sufficiently to clear excess housing stock. The latter is unlikely with lenders still in the early stages of tightening standards on mortgage loans and a still high level of home sales relative to the housing stock. Thus, while the industry has already been through a dreadful year, it is too soon to attempt any bottom fishing.”
Source: Daily Insights, BCA Research, September 27, 2007.
John Hussman (Hussman Funds): Market’s performance following two consecutive rate cuts
“Investors will likely be reminded of how the market has historically performed following two consecutive cuts in the Discount Rate. We’ve observed 11 instances of this since 1950, with average total returns in the S&P 500 of 6.18% over the following 3 months, 12.48% over the following 6 months, and 21.05% over the following year. The difficulty with these averages is that the cuts almost invariably occurred well into bear markets, where valuations were already depressed. Specifically, the average P/E on the S&P 500 (based on trailing net earnings) was only 14 (with a median closer to 12), while the average dividend yield was 3.75% and the average price/revenue multiple was just 0.90. Presently, the trailing net P/E on the S&P 500 is 17.9, with a dividend yield of just 1.84 and a price/revenue multiple of 1.55.
“Indeed, only two of those “second Discount Rate cuts” occurred with the S&P 500 P/E above 15 and advisory bullishness running over 50%. Those instances were December 1971 and January 2001. The average subsequent performance of the S&P 500 following those cuts was -1.22 over 3 months, 0.92% over 6 months, and 3.17% over the following year.”
Richard Russell: Amazing two-tier market
“There are times when all you have in this business is your instinct. I’m going to use my instinct now. I think it’s time to be rather cautious toward this market. We’re in a very tricky area. I’ve said repeatedly that this is not an institutional market. It’s more of a trader’s market. And traders can reverse their opinion and actions at the drop of a hat.
“I’m getting a bit nervous about this market. It’s not one thing that I can put my finger on, but I’m watching those Lowry’s figures. I’m watching the rising number of new lows, and I keep waiting for volume to expand on the days when the market is higher. So let me put it gingerly. My instinct tells me that this is not a great time to be loaded with a broad spectrum of stocks. I think the best thing that could happen now would be the majority of stocks fluctuating within a trading range, while the Dow and maybe the ‘big’ stock averages tend to head higher. This has become a true two-tier market.”
Source: Richard Russell, Dow Theory Letters, September 26, 2007.
BCA Research: Reflation trades – thanks Ben
“The bold 50 bp rate cut by the FOMC reinforces our bullish cyclical stance on reflation trades. The economy will be weak through year-end, as a lower fed funds rate is not going to revive the housing market any time soon, and consumers will retrench further. Still, the odds of reversing the credit crunch have improved, which is positive for the economy, and is especially positive for economic-sensitive assets. Bottom line: while the road ahead will be bumpy as the economy struggles, Fed easing should help to revive risk-taking and is bullish for stock, commodity and energy prices, while capping the upside potential for Treasury prices.”
Source: Daily Insights, BCA Research, September 20, 2007.
John Mauldin: A Chinese tsunami of money
“You may not have read about it yet, but there is a tsunami of money getting ready to come from China into the world. And I am not talking about the large government balances or their new sovereign wealth fund. This week, the Chinese announced they are going to let one of their larger mutual funds invest outside of China. Local Chinese investors will be able to start to diversify and businesses will start to be able to take their capital and employ it abroad. This is just the start of the process.
“This will take off a lot of the market pressure for a stronger yuan, as the Chinese will need to buy dollars and euros and other currencies in order to make those investments. I think we will see the Chinese government open up the potential to invest and spend abroad before they float their currency.”
Source: John Mauldin: Thoughts from the Frontline, September 29, 2007.