Volatility – no other word describes the past week’s market action more aptly. On the one hand investors were faced with a deteriorating housing market causing increasingly more subprime-related corporate write-offs, manufacturing growth losing momentum, a surging oil price and a plunging US dollar. But some good news also filtered through in the form of better-than-expected reports for October’s payrolls and Q3’s GDP.
Before highlighting some thought-provoking quotes from market commentators during the past week, let’s briefly review the markets’ actions on the basis of economic statistics and a performance chart.
Although the FOMC reduced the Fed funds rate by 25 basis points from 4.75% to 4.5% on Halloween Day, a worsening housing situation and perception that another round of credit losses lies ahead did not do much to temper investors’ uncertainty. The downside risks to economic growth caused highly-regarded BCA Research to say “the easing cycle is only part way through” and John Mauldin (Thoughts from the Frontline) to remark “the Fed will cut again and again”.
Richard Russell (Dow Theory Letters) referred to Bernanke’s “brutal problem” of having to inflate at all cost without “kissing the dollar goodbye”, tempting David Galland (Casey Research – The Room) to ask: “Death spiral? Too early to say, but maybe.”
WEEK’S ECONOMIC REPORTS
Source: Gold Seeker Weekly Wrap-Up, November 2, 2007.
This week’s economic highlights include ISM Services on Monday, Productivity, Wholesale Inventories, and Consumer Credit on Wednesday, Initial Jobless Claims on Thursday, and Export and Import Prices, the Trade Balance, and Michigan Sentiment on Friday.
The performance charts usually obtained from StockCharts were unfortunately not available this week, but the Wall Street Journal Online came to my rescue with the following chart indicating how different markets fared during the past week:
Source: Wall Street Journal Online, November 4, 2007.
Global stock markets experienced a rollercoaster ride over the week, with the prospect of fresh credit losses triggering particularly sharp falls on Thursday. Although all markets ended in the red for the week as a whole, emerging markets performed relatively better than mature markets. US REITs and financial stocks experienced a particularly torrid time, thereby extending their slide of the past few months.
Global bond yields were lower for the week as investors focused on slower economic growth and switched from stocks to bonds perceived to offer safe-haven status.
The US dollar had another dreadful week on fears that the Fed would need to cut interest rates more to ease the fall-out of the credit crunch. The dollar hit all-time lows against the euro and the Canadian dollar and a 26-year low against the British pound.
As far as commodities were concerned, the week again belonged to energy and precious metals, with crude oil approaching $100 and gold bullion breaching $800 – its highest level since January 1980. Concerns that oil supplies will fail to meet demand during the winter heating season and tensions in the Middle East propelled the oil price upwards.
The rise in the oil price, together with a declining dollar, boosted gold as investors focused on flight-to-quality issues.
Elsewhere, copper and zinc lost 5.1% and 4.6% respectively during the week under pressure from rising LME stocks as traders are starting to question the implications of slower economic growth for the demand of industrial metals.
Now for some words (and pictures) from the investment wise that will hopefully assist to make sense of the ramifications of the credit debacle and other pertinent investment issues.
Economy.com: Survey of business confidence for world
“Global business sentiment slipped last week and has shown no measurable improvement since falling sharply during this past summer’s subprime financial shock. Confidence remains consistent with an economy that is expanding very slowly. Businesses are particularly dour in the broad assessment of current conditions. Expectations regarding the six-month outlook also remain firmly negative. Confidence is weakest in the US, followed by Europe. Asian and South American confidence are notably stronger. Sentiment is weakest among those in housing and financial services, and strongest among high-tech firms.”
Source: Moody’s Economy.com, October 29, 2007.
Gavekal: Fed tends to follow long bonds (published prior to Fed funds rate cut)
“The Fed tends to follow long-bonds, as a smart-market indicator of future economic health. Having failed to rebound from their declines two weeks ago, the Fed may follow 10-year yields down.”
Source: Gavekal Checking the Boxes, GaveKal Research, October 29, 2007.
Asha Bangalore (Northern Trust): December rate cut is not certain
Source: Asha Bangalore, Northern Trust, October 31, 2007.
BCA Research: The Fed has more to do
“Yesterday’s rate cut still leaves the funds rate too high given the downside risks to economic growth. The Fed ratified market expectations with a 25 basis point rate cut, after what may have been an intense debate. Overall GDP growth is holding up despite the housing meltdown, policymakers are sensitive to criticism that they are bailing out imprudent borrowers and lenders, and some FOMC members still worry about inflation. Nevertheless, there are major economic uncertainties and risks in the outlook, and the level of rates still seems too high. By the Fed’s own calculations, a Taylor Rule approach, based on inflation and potential output, indicates that the funds rate should be between 3% and 4%. The Fed has shifted to a neutral bias, but the easing cycle is only part way through.”
Source: BCA Research, November 1, 2007.
John Mauldin (Thoughts from the Frontline): Round two of the credit crunch
“I think we should be getting ready for a second round of the credit crisis. And I would certainly be uncomfortable with owning any financial stock with exposure to the mortgage markets. We may not know the full exposure of many banks until the middle of next year.
“The asset-backed commercial paper market declined another $9 billion last week, down for the 12th straight week. It has dropped 26% since August 8, and there is no reason to think that trend will not continue for several months, as commercial paper linked to mortgage assets is simply not being rolled over. The Financial Times talks of one banker who is bartering his mortgage assets to avoid setting a price.
“Bottom line? With rising unemployment, a credit crisis, and a housing bubble imploding, this is not a market or an economy where the Fed will be able to sit tight. We are going to see a Fed funds rate below 4% in two more meetings, at a minimum.”
Source: John Mauldin, Thoughts from the Frontline, November 2, 2007.
Asha Bangalore (Northern Trust): Comment on Case-Shiller survey
“The large inventory of unsold homes calls for expectations of a further reduction in home prices.”
Source: Asha Bangalore, Northern Trust, October 30, 2007.
Richard Russell (Dow Theory Letters): Bernanke’s got a brutal problem
“The housing situation is deteriorating. The spectre of mass foreclosures next year is haunting the building and real estate industry and its workers. US consumers are growing increasingly pessimistic. US consumers are pessimistic about the war, they’re pessimistic about our President, they’re even more pessimistic about Congress, they’re pessimistic about their inability to keep up their standard of living because of rising prices, they’re pessimistic about their government’s debts – and their own debts.
“Where might all this pessimism lead to? It will lead to a cut-back in consumer spending. Consumer spending amounts to nearly 70% of the Gross Domestic Product of the United States. If consumers cut back substantially, the nation will sink into recession. The ramifications of a recession are international in scope. US consumer spending comprises 19.3% of the world’s GDP. If the US goes into recession, it will impact adversely on the world economy.
“Fed Chief Bernanke’s got a brutal problem. He’d probably like to go all-out on the path of inflation, knock deflation on its fanny. But to do that means we must kiss the dollar good bye. Already, Bernanke is hearing the hoots and the warnings. The world is sneering at the once all-powerful ‘Yankee dollar.’ And that’s not a good omen.
“What would happen if the US let the dollar fall, and I mean fall hard? We know that the Fed talks to central banks the world over. But the biggies, China, Russia, the Mideast, would they stand for a crashing dollar? After all, they hold billions in US securities. What would they do? What is Bernanke to do? Maybe Ben should come out with the truth. Maybe he should announce that if the US goes into recession, the whole world is going to feel the pain – and that will create political and social problems across the face of the globe. Therefore, the US must inflate.”
Source: Richard Russell, Dow Theory Letters, November 2, 2007.
Bill Gross (Pimco): Bernanke’s challenge
“An increasingly recessionary looking US economy will likely require 1% real short rates and 3½% Fed Funds in order to stabilize a potential growth contraction in lending not witnessed since the early 1970s or, to be honest, Roosevelt’s depressionary 1930s. We can only hope that Bernanke, Paulson, and their cohorts recognize the danger and that the music keeps playing with the lights still turned on.”
Source: Bill Gross, Pimco’s Investment Outlook, November 2007.
David Galland (Casey Research): What is the Fed going to do?
“… even the dumbest of the dumbest institutional investors are now strapping on the life jackets and sidling toward the lifeboat. In fact, on the news that unemployment was better than expected, gold has moved up and the dollar fell to yet another low against the euro and many other foreign currencies. So what is the Fed going to do? After all, they just stepped up to the plate with another rate cut while simultaneously trying to sound confident in their carefully prepared notes by stating that they would prefer not to cut any more.
“Nice try. Mr. Market isn’t buying it.
“So, seriously, what now? A further interest rate cut between Fed meetings (the next regularly scheduled meeting is December 11)? That would almost certainly send foreign holders of the US dollar scrambling for the exits even faster, and push gold even more quickly over the landmark $850 level. But if they leave things alone, hoping that the steady stream of bad news out of financial institutions will stop, they will almost certainly start to feel the earth rumble beneath them. That’s because the worst of the losses are still ahead, not behind, for the world’s financial institutions.
“Death spiral? Too early to say, but maybe.
Source: Doug Galland, Casey Research – The Room, November 2, 2007.
Richard Russell (Dow Theory Letters): Government BS statistics on inflation
“… the nation’s faith in the Fed is amazing. It’s even more amazing in view of the fact that our President (I’m referring to George Bush) is receiving the lowest approval rating of any president in history. The only thing lower is the current approval rating of today’s pathetic Congress.
“And yet, we continue to take the government BS statistics on inflation seriously. The latest Economist magazine puts the year-over-year dollar index of ‘all item’s’ up 16.7%. They put the price of food up 31.6% year-over-year. So our government tells us that ‘core inflation’ is running below 1%. And people take these figures seriously.”
Source: Richard Russell, Dow Theory Letters, October 30, 2007.
BCA Research: Duration call – investors should remain above-benchmark
“The US housing recession and its impact on US consumer spending and the other major countries will occur over an extended period. The bond rally will play out in waves, with sharp corrections along the way. However, we do not believe that the cyclical low in yields has been reached, because we have not yet seen much of a reaction to the housing contraction in consumer spending or employment. Meanwhile, rating downgrades of CDOs are in full swing and will likely generate more fireworks in financial markets in the coming months. We have indicated that the economy should be sufficiently weak to ensure that a protracted easing cycle unfolds.
“Still, even if one does not expect the Fed to ease policy by more than is currently discounted in the eurodollar market (about 105 basis points over the next year), a long duration position still makes sense. Expectations for Fed rate cuts always overshoot and bond rallies do not end so soon in an extended Fed easing cycle.”
Source: BCA Research, October 31, 2007.
The Telegraph: Credit Suisse – central bank sales ‘masked’ gold market deficit
“The gold price will soar to more than $1 000 per ounce over the next five years as dwindling supply of the precious metal combines with increased demand, Credit Suisse has forecast. ‘In the current environment, upward pressure on the price of gold is being driven by the economic environment surrounding the US economy, in particular the (weak) US dollar, the strength of oil and commodity prices, and a change in the dynamics surrounding gold supply and demand,’ Credit Suisse analyst David Davis said in a note yesterday.
“He wrote that global gold production will fall in the coming years, as the diminishing number of new reserves fails to compensate for dying mines. ‘We find that over the last 18 years, apart from on three occasions, the supply of gold has been in deficit,’ Davis said. ‘This primary deficit has been masked by the secondary supply of gold into the market mainly from central bank sales. We believe central bank sales will wither going forward and the banks could become net buyers of gold.’”
Source: David Litterick, The Telegraph, November 1, 2007.
Reuters: OPEC considers switching oil pricing from dollar to currency basket
“OPEC is likely to discuss creating a basket of currencies for oil pricing at its next summit due to the steady decline in the dollar, Venezuela’s Energy Minister Rafael Ramirez said on Friday. ‘The need to establish a basket of currencies … will probably be a point of discussion in the next OPEC summit,’ Ramirez told reporters during an evening event in the presidential palace. ‘The dollar as a benchmark currency has been weakening quite a lot and it creates distortions in oil markets.’
“Oil prices have soared in part because of a weakening dollar that tumbled in the wake of an interest rate cut by the US Federal Reserve.
“The cartel is slated to hold a summit of the heads of state of OPEC nations in November and a meeting of ministerial delegates in December.”
Source: Reuters (via Yahoo News), October 27, 2007.
Reuters: Dollar’s fall amid interest rate cuts distresses Arab countries
“Gulf Arab rulers will decide in December whether to delay monetary union among six oil producers that are divided over how to respond if more US interest rate cuts test currency pegs to the sliding dollar. Gulf finance ministers and central bankers met in Saudi Arabia to review the 2010 deadline for creating a single currency in the world’s top oil-exporting region – a timetable all six say will be difficult if not impossible to meet.
“With a widely-anticipated delay prompting investors to bet on the appreciation of dollar-pegged Gulf currencies, the six states agreed to keep foreign exchange policy unchanged, although each would steer its own course on interest rates.
“When the US Federal Reserve cut rates on September 18, Saudi Arabia, Oman, and Bahrain declined to follow, opting to ride out pressure on their currencies to appreciate rather than stoke inflation. Inflation hit a 16-year high of 6.47 percent in Oman and a seven-year peak of 4.4 percent Saudi Arabia in August. Qatar and the United Arab Emirates cut some key rates along with Kuwait, the only Gulf Arab state that does not peg its currency to the dollar. Inflation in the UAE hit a 19-year high of 9.3 percent in 2006 and price rises were 12.8 percent in Qatar in June.
“Analysts polled by Reuters last month were unanimous that the deadline would not be met. UAE Central Bank Governor Sultan Nasser al-Suweidi told a magazine this month that the timetable could slip beyond 2015.”
Source: Souhail Karam, Reuters (via Yahoo News) , October 27, 2007.
Associated Press: Hong Kong central bank gushes cash to prop up US dollar
“Hong Kong’s de-facto central bank stepped in four times Wednesday to defend the Hong Kong dollar’s peg to the US dollar, injecting about $800 million worth of local currency into the red-hot market. The Hong Kong Monetary Authority injected a total 6.2 billion Hong Kong dollars ($800 million) into the market, said Peggy Lo, spokeswoman for the authority.
“Under Hong Kong’s currency board system, the Hong Kong dollar is pegged at 7.80 to the US dollar but is allowed to trade between 7.75 and 7.85. When the Hong Kong dollar reaches the limits of its trading band, the monetary authority can be expected to intervene, Lo said.
“Analysts said they expect further interventions if the US Federal Reserve cuts its key interest rate later Wednesday. The Hong Kong dollar has been rising against the US dollar as investors pour money into the soaring Hong Kong stock market. The US dollar is also at multiple-decade lows against many major currencies. Another interest rate cut will weaken it further.
“Lo said the Hong Kong government is ‘totally committed’ to the linked exchange rate mechanism. Rumors that it’s lobbying Beijing to drop the peg are ‘unfounded,’ she said.”
Source: Cassie Biggs, Associated Press (via Yahoo News), October 31, 2007.
BCA Research: Stampede into China and India
“Global investors are rushing into Chinese and Indian equities, bidding up multiples in the process. The scarcity of available market capitalization relative to foreign investors’ demand for plays on growth in China and India is one reason behind the stampede into the Chinese and Indian stock markets. While the China/India growth story continues to draw heightened interest from global investors, the size of the investable market remains fairly limited for both bourses: China and India account for 15% and 7% of global GDP (adjusted for purchasing power), yet the market capitalization of the MSCI global equity index open to foreign investors represents only 1.6% and 0.7%, respectively. Bottom line: The excess demand associated with foreign investors’ desire to have a stake in China and India will continue to put upward pressure on Chinese and Indian stock prices.”
Source: BCA Research, October 26, 2007.
Reuters: China encourages its banks to look for overseas targets
“China will push its banks to forge deeper into overseas markets for acquisitions and a global profile, a top bank regulator said on Sunday. ‘We will encourage Chinese banks to go abroad to participate in international competition and overseas acquisitions to improve global competitiveness,’ Wang Zhaoxing, assistant chairman of the China Banking Regulatory Commission, told a financial forum in Xianghe, Hebei province.
“Flush with cash after blockbuster share flotations and their books cleaned up thanks to government-led billion-dollar rescue packages, Chinese banks are increasingly opening branches and buying into overseas banks. Last week China’s biggest lender ICBC agreed to buy a 20 percent stake in South Africa’s Standard Bank for $5.6 billion, the biggest foreign acquisition by a Chinese commercial bank yet.”
Source: Reuters, October 28, 2007.