” … the mega third phase of this bull market lies ahead. It may take into next year, but it’s a’comin’,” said an upbeat Richard Russell from an otherwise somber La Jolla in the aftermath of the landslide.
Before highlighting this and some other memorable quotes from market wizards during the past week, let’s briefly review the market’s action on the basis of a few performance charts.
Indications of easier conditions in credit markets calmed investors during the past week and resulted in the start of the fourth quarter seeing a number of stock markets recording record highs.
On the economic front the feature of the week was the release of as-expected jobs data in the US on Friday, indicating that the US economy was recovering from the recession fears that spooked financial markets since the whole credit debacle started in July.
US equities performed strongly, with some of the previous laggards such as the Russell 2000 Index (small caps) and REIT stocks (not shown on graph) advancing by 4.9% and 6.2% respectively. Whereas the Dow Jones Industrial Index (including a number of companies benefiting from the US dollar’s slide) has been leading the boards for a while, the past week was the S&P 500 Index’s turn to hit an all-time high.
Elsewhere in the world mature and emerging stock markets in all geographic reasons powered along and recorded new highs in many instances. The Chinese markets were closed for the mid-Autumn festival holiday last week.
Global bond yields were higher across the yield curve as investors re-assessed the fallout of the credit squeeze not having such dire consequences for economic growth as previously expected. The rate of the US 3-month Treasury Bill also moved higher as the realization dawned that a further reduction of the Fed funds rate at the FOMC’s meeting of October 30 and 31 was perhaps no longer on the cards.
The expectation of US interest rates remaining at current levels for longer helped the US dollar stage a recovery from a short-term oversold situation. However, talk of diversification out of US dollar assets by an ever-increasing list of central banks (the latest being Vietnam and Qatar) stemmed the rise.
With the exception of industrial metals (including a strong performance by copper), commodities retreated across the board during the past week. This is seen as a necessary breather for markets that have been surging at break-neck speed.
The debate is still on whether the credit crisis is over or not. The words from the investment wise below will hopefully assist to make sense of this and other pertinent investment issues.
Economy.com: Survey of business confidence for world
“Global business confidence appears to have stabilized, but at a low level that is consistent with a global economy that is just avoiding recession. US business confidence is weaker and suggests that the US economy contracted in September. European confidence is also very soft. Sentiment in Asia and South America are weathering the financial storm reasonably well.”
Source: Moody’s Economy.com, October 1, 2007.
Paul Kasriel and Asha Bangalore (Northern Trust): Rates likely on hold at October FOMC meeting
“The payroll tally for September, significant upward revisions of employment in July and August, the 0.6% inflation adjusted increase in consumer spending during August, and the nearly steady sales pace of autos in September (16.22 million units vs. 16.26 million units in August) are factors that have reduced the probability of a cut in the federal funds rate on October 31. That said, it is abundantly clear that a growth recession is underway. By cutting the federal funds rate by 50 bps in one fell swoop on September 18, the FOMC has bought itself some time to watch developments in the economy. We believe that further weakness in economic activity will appear in the weeks ahead, which will induce another cut in the federal funds rate at the December 11 FOMC meeting.”
Source: Paul Kasriel and Asha Bangalore, Northern Trust’s Daily Global Commentary, October 5, 2007.
MarketWatch: Fed’s Kohn says half-point rate cut may be enough
“The Federal Reserve’s half-a-percentage point rate cut on September 18 may be enough to keep the economy from sinking from the financial market turmoil, said Donald Kohn, the vice-chairman of the Fed Board on Friday. ‘But pending further evidence, a 50-basis-point easing was not an unreasonable first approximation of what might be required to keep the economy on a sustainable growth path,’ Kohn said in a speech to the Greater Philadelphia Chamber of Commerce. It would be better for the Fed to respond ‘too much or too rapidly’ to the turmoil in financial markets rather than acting ‘too little or too slowly,’ Kohn said. With recent favorable inflation news, Kohn said he believes the Fed could reverse the recent rate cut if it turned out to be larger than needed.”
Source: Greg Robb, MarketWatch, October 5, 2007.
Paul Kasriel and Asha Bangalore (Northern Trust): ECB and Bank of England policies
“The European Central Bank (ECB) left its policy interest rate unchanged at 4.00%. Trichet noted that the ‘outlook for price stability over the medium term is subject to upside risks. Against this background, and with money and credit growth vigorous in the euro area, our monetary policy stands ready to counter upside risks to price stability.’ But Trichet also mentioned that ‘on balance, risks to the outlook of growth are judged to lie on the downside,’ and the reference to monetary conditions being accommodative was eliminated. These features of the statement suggest that the ECB has moved to a neutral stance and there were no hints about policy tightening in the near term. The Bank of England also left the policy rate intact at 5.75%. It is widely held that the Bank of England’s next move is an easing of monetary policy, but the timing remains uncertain.”
Source: Paul Kasriel and Asha Bangalore, Northern Trust’s Week in Review, October 5, 2007.
David Fuller (Fullermoney): Outlook for GDP growth and interest rates
“I assume that slower growth in Euroland, the UK and USA will persist into 2008. This should lead to lower interest rates from the BoE and ECB at some point, preferably sooner rather than later, although this necessitates a reassessment at these two institutions which were still signalling higher rates in early August. I also expect further rate cuts from the Fed.
“While the US and Europe should avoid recessions, assuming the balance of monetary policy remains in favor of easing, slower economic growth almost certainly means lower corporate profits for many industries. This will be a headwind for Western stock markets. Consequently, a repeat of the gains for stock indices in the West, to which investors have become accustomed in recent years, will require valuation expansion in the form of higher P/Es. This is not guaranteed, although easier monetary policy will help. Companies which export to Asia should be among the better relative performers. Meanwhile, the stagflation risk is increasing.”
Source: David Fuller, Fullermoney, October 1, 2007.
Richard Russell (Dow Theory Letters): Grip of the debt monster
” … we’re caught in what I call the ‘grip of the debt monster’. The mountain of debt that has been built by the US is inherently deflationary. If we seriously attempt to cut back and pay off the debt through thrift or savings, the US will go into a recession so deep that you won’t believe it. We would experience a spiral of deflation comparable to what happened during the 1930s. It took the massive spending of World War II to bring us out of the Great Depression. It may take that kind of spending to ward off the current deflationary forces.
“Fed Chief Ben Bernanke is an expert on the Great Depression. He wrote his dissertation on the Great Depression. There is no way in the world that Bernanke would be willingly allow the US to sink into a deflationary depression. The choice, as I’ve warned about for the last number of years is – ‘inflate or die’. Clearly, Bernanke has already made his choice. The choice is to inflate.”
Source: Richard Russell, Dow Theory Letters, October 3, 2007.
Paul Kasriel and Asha Bangalore (Northern Trust): Inflationary impact of Fed’s action
“The bond market continues to view the Fed’s more-aggressive-than-expected action as having a potential inflationary impact, particularly after recent bullish economic reports. Inflation expectations (2.30% on October 3, 2007) are holding close to levels seen in the past two weeks and are marginally higher than the low of 2.19% seen on September 5 (see chart).”
Source: Paul Kasriel and Asha Bangalore, Northern Trust’s Week in Review, October 5, 2007.
Richard Russell (Dow Theory Letters): Mega third phase of bull market lies ahead
“I envision the housing mess slowly being resolved. I see the ‘cheap’ US dollar rendering US manufacturing very competitive (at last). I see world liquidity staying at high levels, and I see a period of coming extraordinary prosperity. In the meantime, with communication and computers increasingly available, the downtrodden populations of the world will see the benefits of freedom or at least the benefits of free enterprise.
“Note that the Dow is pushing subtly higher and higher. Where’s it going? It’s going ever closer to the ‘big show’, that’s where it’s going. Yes, the Big One, the mega third phase of this bull market lies ahead. It may take into next year, but it’s a’comin’. And you heard it here first.”
Source: Richard Russell, Dow Theory Letters, October 5, 2007.
John Hussman (Hussman Funds): Stocks – overvalued, overbought, overbullish
“The current price to forward operating earnings multiple is as high as it was at the 1987 peak, higher than it was before the 1990 bear market, and is in fact at the highest level that would have been observed in history except for the late 1990’s.
” … we’ve now reestablished the overvalued, overbought, overbullish combination of conditions that has historically been associated with average returns below Treasury bill yields, even when market action has been otherwise favorable on the basis of price trends. Importantly, these instances are not usually associated with immediate and persistent losses. Rather, they tend to be associated with further incremental gains and marginal new highs, followed by sudden losses that abruptly erase weeks or months of upside progress within a handful of trading sessions.”
Source: Dr John Hussman, Hussmann Funds, October 1, 2007.
BCA Research: Anti-US housing trades
“We remain bullish on the ‘go global’ theme, even though it is now widely embraced by investors. Global portfolio investment flows continue to move towards equities, commodities and currencies that are farthest from the US housing market, i.e. away from the epicenter of economic weakness.
” … emerging market equities have completely recovered, hitting a new high. Meanwhile, the dollar continues its steady downtrend, reflecting waning interest in US paper as a consequence of relatively unattractive economic and investment prospects. In sum, the environment is the opposite of the 1990s, when the dollar and US equities were king.”
Source: Daily Insights, BCA Research, September 28, 2007.
Telegraph: Dollar’s double blow from Vietnam and Qatar
“Vietnam is planning to cut its purchases of US Treasuries and other dollar bonds, raising fears that Asian central banks with control over two thirds of the world’s foreign reserves may soon join the flight from US assets. Together they hold $3 575bn of foreign reserves, over 65% of the world’s total. China leads with $1 340bn, but South Korea, Taiwan, Singapore, and even Thailand all built up massive holdings. The concern is that once one or two members of the region jump ship, it could set off a broader scramble. None of them want to be the last one left holding a devalued asset.
“Separately, the gas-rich Gulf state of Qatar announced that it had cut the dollar holdings of its $50bn sovereign wealth fund from 99% to 40%, switching into investments in China, Japan, and emerging Asia. The drastic shift by the Qatar Investment Authority is a warning that petro-dollar powers with some $3 500bn under management may pull the plug on the heavily endebted US economy – which needs to suck in the majority of the world’s savings just to stay afloat.
“Saudi Arabia set off jitters in the currency markets last month when it decided not to cut interest rates in lockstep with the US Federal Reserve, raising doubts about its commitment to the Saudi dollar peg. But it too has strong political reasons to stick with America. Kuwait has already abandoned its peg, fearing that its economy would overheat if it continued to import America’s loose monetary policies. Separately, Iran said it would soon refuse to accept dollars for its oil exports, preferring to be paid in a ‘more credible currency’.”
Source: Ambrose Evans-Pritchard, Telegraph.co.uk, October 4, 2007.
The Wall Street Journal Online: Historic surge in grain prices roils markets
“Rising prices and surging demand for the crops that supply half of the world’s calories are producing the biggest changes in global food markets in 30 years, altering the economic landscape for everyone from consumers and farmers to corporate giants and the world’s poor. ‘The days of cheap grain are gone,’ says Dan Basse, president of AgResource Co., a Chicago commodity forecasting concern.
“This year the prices of Illinois corn and soybeans are up 40 percent and 75 percent, respectively, from a year ago. Kansas wheat is up 70 percent or more. And a growing number of economists and agribusiness executives think the run-ups could last as long as a decade, raising the cost of all kinds of food.
” … powerful new sources of demand are emerging. In addition to US government incentives that encourage businesses to turn corn and soybeans into motor fuel, the growing economies of Asia and Latin America are enabling hundreds of millions of people to spend more on food. A growing middle class in these regions is eating more meat and milk, which in turn is increasing demand for grain to feed livestock.
“The reversal of a long-term trend toward lower grain prices could have profound effects on the world’s ability to feed its poor. Global grain stockpiles are being drawn down to their tightest levels in three decades, leaving the world vulnerable to shocks brought on by bad harvests.”
Source: Scott Kilman, The Wall Street Journal Online, October 5, 2007.
Eoin Treacy (Fullermoney): Chinese stocks – further room for upside
” … Chinese stocks are expensive when compared with their global counterparts however the 2000 P/E peak was at 63 while today’s levels are closer to 50. This indicates that the Shanghai A-Shares may still have further room to appreciate before they equate to valuations in 2000 and since this is a more broad-based move, valuations have the potential to become even move expensive going forward. If China’s stock market is to continue on its way to forming an investment bubble, as it appears to be doing, then there remains further room on the upside in terms of absolute prices and P/Es.”
Source: Eoin Treacy, Fullermoney, October 5, 2007.
Bill Gross (Pimco): “One size fits all” interest rates not appropriate
“Bernanke may face a problem with this elevator-based ease in monetary policy… globalization and financial innovation have enormously complicated the job of central bankers. Whereas in prior decades a ‘one size fits all’ policy rate move has coincidentally and democratically affected households and corporations alike, the 21st century has ushered in an innovation revolution favoring corporations with global investment opportunities as opposed to individuals with daily bills to pay. The same 4.75% rate is not and cannot be ‘neutral’ for both sides in today’s US economy. Whereas current yields are not restrictive for investment grade corporations with global opportunities, they are far too high for homeowner Jane Doe and two million of her neighbors facing higher and higher monthly payments on adjustable rate mortgages. Should Bernanke put on a brave face and freeze the elevator and rates in mid-descent, he risks exacerbating a housing crisis in the making. Yet, should he favor the homeowner over the corporation, he risks reigniting speculative equity market behavior, and – in addition – a run on the dollar.”
Source: Bill Gross, Pimco’s Investment Outlook, October 2007.