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July 27, 2008

Words from the (Investment) Wise for the Week That Was (July 21 - 27, 2008)
by Prieur du Plessis

Financial markets witnessed another roller-coaster week as renewed concerns about the global economy and the health of the financial sector surfaced, resulting in a mixed week for world stock and bond markets, an improved US dollar and continued weakness in oil and commodities.

Source: Lisa Benson, Slate

US stocks plummeted on Thursday after two days of gains as investors' recent optimism was dented by renewed doubts about financials stocks, manifesting in the sector dropping 6.8% - its largest one-day decline in more than eight years.

In a rare Saturday session, the US Senate passed housing rescue legislation aimed at helping struggling homeowners avoid foreclosure and providing financial support to troubled mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), reported TheStreet.com. The bill, which cleared the House on Wednesday, now goes to President Bush.

Reuters highlighted that US banks' direct primary credit borrowing from the Federal Reserve rose to the highest level ever in the latest week, reflecting the growing need of the banking sector to rely on the central bank for cheap funding. On the day of July 23, banks' primary credit borrowings rose to $17.68 billion, the highest borrowing since September 12, 2001 when banks borrowed $45.5 billion in a single day.

No wonder John Paulson, who recorded what was thought to be the single biggest profit in the history of the hedge fund industry last year by betting on a financial collapse, is planning a new fund to provide capital to cash-strapped banks.

President George W. Bush, as reported in the Financial Times, also had his take (albeit unofficial) on matters: "There's no question about it. Wall Street got drunk ... it got drunk and now it's got a hangover. The question is how long will it sober up and not try to do all these fancy financial instruments."

Given all the shenanigans, Richard Russell (Dow Theory Letters) thought there was too much complacency. "... I guess everybody thinks the Fed or the Treasury is going to bail the whole economy out. Why worry, if you're in trouble, call Mr. Bernanke, and he'll drop a bundle of Federal Reserve notes in your mail box. Be sure the box is big enough," said Russell a day after turning a youthful 84.

Now for a new feature of this report: A tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. It is quite obvious that the key areas last week were "bank", "prices", "inflation", "oil" and "economy". As the saying goes: A picture paints a thousand words ...

Key to mapping out the intermediate stock market cycle is whether the July 15 levels for the S&P 500 Index (1,215) and Dow Jones Industrial Index (10,963) will hold. Specifically, the extent to which bank shares can sustain their moves above recent lows will be a vital determinant as to how well stock markets in general can rally from these levels. Short-term movements aside, do not expect a quick convalescence period.

Before highlighting some thought-provoking news items and quotes from market commentators, let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.

Economy
The Federal Reserve's Beige Book, released on Wednesday, noted slower growth since the last report issued on June 11. Weakness in consumer industries, housing and finance offset strength in IT and healthcare. Retail and wholesale price pressures were mounting, although there was little concern yet about wage inflation.

More specifically, the past week's economic reports in the US included the following notable releases:

• The Index of Leading Economic Indicators (LEI) fell by 0.1% in June, following a revised 0.2% drop in May. The quarterly average of LEI is down 2.0% from a year ago, the largest decline in the current business cycle. Historically, such large year-on-year declines of the quarterly average of the Index were associated with recessions.

• Weakness continues to characterize the housing market. Existing Home Sales declined by 2.6% month on month in June, according to the National Association of Realtors. Sales declined to 4.86 million annualized units. Inventories are rising and the months of inventory are about flat at 11. The median existing home price is declining, with a year-on-year drop of 6.2%, but not as severely as earlier this year.

• The Census Bureau reported a -0.6% month-on-month decrease in New Home Sales in June. However, the Bureau revised the monthly sales figures upward back to March, and thus June sales were stronger than expected at 530,000 annualized units. The median new home price declined slightly in June, as did months of inventory. Months on the market, however, are rising.

Furthermore, US foreclosure filings more than doubled in the second quarter compared to a year ago, representing an increase of 121% from a year earlier and 14% from the first quarter, according to RealtyTrac.

Summarizing the economic situation, David Rosenberg, North American economist of Merrill Lynch, said in a research report: "Though fiscal stimulus will provide a lingering boost to 3Q, we expect GDP to plummet 2.5% in 4Q and see a similar decline in 1Q. In all, we have shaved our 2009 GDP forecast to -0.5%, a full percentage point lower than where it was previously, while 2008 is broadly unchanged at 1.5%."

As far as interest rate policy is concerned, Asha Bangalore (Northern Trust) remarked: "It is ... important to recognize that the Fed is not in a position to raise rates until there is financial market stability, the housing market crisis improves, and firms decide to expand their payrolls. Concerns about economic growth will prevail over inflation, for now. In other words, tough talk about inflation will continue but it cannot be translated into action in the near term."

Across the pond, the UK was faced with a relentless stream of negative economic news. The minutes of the Bank of England's (BoE) monetary policy committee meeting in June showed that the BoE was struggling to balance the downward price pressures of slowing economic growth against the upward price pressures of strong oil and food price growth.

A slew of weak data also came from the Eurozone, with the RBS/Markit composite PMI dropping from 49.3 in June to 47.8 in July, the lowest since November 2001 and clearly indicating a contracting economy. It appears unlikely that the European Central Bank (ECB) will hike rates any further in the second half of this year.

Elsewhere, Japan's trade surplus was nearly 90% lower than last year's surplus, and core inflation ballooned to a fresh decade high of 1.9% year on year in June.

WEEK'S ECONOMIC REPORTS

Next week's economic highlights, courtesy of Northern Trust, include the following:

1. Real GDP (July 31): Real GDP is predicted to have advanced at an annual rate of 1.5% in the second quarter, supported by consumer spending. The fiscal stimulus package accounted for the strength in consumer spending, a one-off event. Real GDP grew by 0.6% in the fourth of 2007 and by 1.0% in the first quarter of 2008. The forecast range for growth in GDP in the second quarter is 1.4% to 3.0%. This report will contain revisions for the period 2005:Q1 to 2008:Q1. Consensus: 2.4%.

2. Employment Situation (August 1): Payroll employment in July is predicted to have declined by 75,000 after a loss of 62,000 jobs in June. The forecast range is -150,000 to -10,000. The unemployment rate is projected to have risen to 5.6% in July from 5.5% in June. Consensus: Payrolls: -72,000 versus -62,000 in June, unemployment rate: 5.6% versus 5.5% in June.

3. ISM Manufacturing Survey (August 1): The consensus for the manufacturing ISM composite index is 49.2 versus 50.2 in June.

4. Other reports: Consumer Confidence (July 29), Construction Spending, Auto Sales (August 1).

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global markets performed during the past week.

Source: Wall Street Journal Online, July 27, 2008.

Equities

Global stock markets, in general, maintained their positive tone during the past week after the strong recovery of the previous week, with the Dow Jones World Index registering an increase of 0.9%.

The Japanese Nikkei 225 Average was the strongest performer among developed markets, rising by 4.2% - its biggest weekly gain for five months.

The real stars, however, were among the emerging markets, including Pakistan (+7.8%), Taiwan (+6.1%), South Korea (+5.8%), the Philippines (+5.2%), Indonesia (+4.8%) and India (+4.7%). On the other side of the scale, previous strong performers Russia (-8.6%) and Brazil (-4.7%) suffered as oil and commodities fell further.

The US stock markets were mixed, with smaller and technology stocks outperforming their larger counterparts, as shown by the major index movements: Dow Jones Industrial Index -1.1% (YTD -14.3%), S&P 500 Index -0.2% (YTD -14.3%), Nasdaq Composite Index +1.2% (YTD 12.9%) and Russell 2000 Index +2.5% (YTD -7.3%).

Market map, courtesy of Finviz.com, providing a quick overview of the performance of the various segments of the S&P 500 Index over the week.

The managed healthcare group was the best performer for the week, rising by 13%. The Internet retail group was the second-best performer (+9%), led by Amazon.com (AMZN), its largest member, with better-than-expected earnings and guidance.

The thrifts and mortgage finance group was the worst-performing group, down by 14%. Washington Mutual (WM) was down 35% after it reported second-quarter losses in excess of expectations. Fannie Mae (FNM) and Freddie Mac (FRE), the two largest members of the group, were each down by more than 10%.

The consumer finance group was the second-worst performer, declining by 12%. The largest group member, American Express (AXP), reported second-quarter earnings below analysts' consensus estimate.

Halfway through the second-quarter earnings reporting season in the US, the numbers have generally been better than feared. Of the 248 S&P 500 companies that have reported results, 72.2% have registered positive surprises, 4.8% have been in line, and 23.0% have missed expectations, according to Bloomberg.

Data from Thomson Reuters show that S&P 500 earnings so far are down by 17.9% versus a year ago, but 7.7% higher when excluding financials.

Fixed-interest instruments
Government bonds experienced a mixed week, with yields declining in countries/regions with poor economic data (Eurozone, UK, Japan) and rising where the economic numbers exceeded expectations (US - consumer sentiment, durable goods orders and new home sales).

For example, the two-year US Treasury Note increased by 6 basis points during the week to close at 2.72%, whereas the UK two-year Gilt yield declined by 11 basis points to 5.05% and the German two-year Schatz yield dropped by 10 basis points to 4.44%.

US mortgage rates also increased, with the 15-year fixed rate rising by 7 basis points to 6.05% and the 5-year ARM 16 basis points higher at 6.04%.

The three-month US Treasury Bill jumped by 35 basis points during the week to close at 1.69% as investors' risk appetite recovered.

Credit markets eased somewhat as shown by the slightly narrower spreads of both the CDX (North American, investment grade) Index and the Markit iTraxx Europe Crossover Index.

Currencies

Currency traders' benign view of the US economic situation, together with lower oil and commodities prices, caused the US Dollar Index to rise by 0.9%.

Individually, the greenback gained against the euro (-0.9%), the British pound (-0.3%), the Swiss franc (-1.3%), the Japanese yen (-0.9%) and the Australian dollar (-1.6%).

Commodities
Oil prices declined further during the week under review, with West Texas Intermediate sinking by 4.8% to $123.26 by Friday's close. The crude price has declined by 16.3% since reaching a record high of $147.27 on July 11.

The correction in oil prices again weighed heavily on the entire commodities complex (especially precious metals), with traders reducing their commodities exposure on the back of mounting global growth concerns. The chart below shows the past week's negative performance of the various commodities.

Now for a few news items and some words and charts from the investment wise that will hopefully assist in preserving our capital in these demanding times.

Source: Ken Catalino, Slate

Bloomberg: Faber says Fannie, Freddie should split up, not get aid
"Marc Faber talks about the future of Fannie Mae and Freddie Mac, the global economy, and the outlook for stocks and commodities."

Source: Bloomberg, July 23, 2008.

David Fuller (Fullermoney): Predicting the markets
"Predicting is among the most hazardous of professions, as you know, because we can only guess. Nevertheless we need to focus on these challenging questions, so here are my guesses:

"US 30-Year Treasury Bond futures - I think Bill Gross' deficit forecast is probably right, and I also maintain that the US government will err on the side of inflation, as debtor nations invariably do. Therefore increased government borrowing is likely to face a buyers' strike at some point, turning US 30-year T-Bonds into one of the better shorts of the decade. Tactically, I will look to short the rallies as they lose momentum.

"The US Dollar Index - While the US government does not want a currency freefall, it can ill afford a strong dollar because it needs an export led recovery. Moreover, while the dollar remains the world's main reserve currency, the US is unlikely to kick its addictive habit of printing too many greenbacks. This will also lead to a buyers' strike, eventually forcing the US Dollar Index lower, with an even bigger decline occurring against the Chinese renminbi and the currencies of other high-growth economies. Tactically, I will look to short rallies as they lose momentum.

"Gold - In a fiat currency world, with the main reserve unit enfeebled, and resources inflation continuing when global GDP growth increases, people everywhere will continue to regard gold as real money for investment purposes. This will eventually support an extension of bullion's secular uptrend, once the current medium-term consolidation has been completed. Tactically, I will continue to buy following setbacks within the overall upward trend.

"Crude oil - Assuming and very much hoping that there will not be a military strike against Iran's nuclear installations, I maintain that oil has peaked for the medium term, defined as anything from a few months to two years and occasionally even longer. However as with gold and many other resources, there is a scarcity factor for oil resulting from increasing costs of production and finite supplies of light crude. Also, demand will rise following any significant correction in prices, not least because cheaper oil will boost GDP growth. Therefore crude oil will eventually resume its secular uptrend following what I suspect will be a lengthy correction. Tactically, I would consider longs in petroleum futures and also oil drillers and equipment stocks on evidence of renewed support building following a significant setback."

Source: David Fuller, Fullermoney, July 23, 2008.

Financial Times: Bob Parker, Credit Suisse - a softer landing?
"Credit conditions remain fraught as reflected in equity falls, but outright recession may be avoided in the US and UK, according to Bob Parker, vice chairman Credit Suisse Asset Management. He tells FT markets editor, Chris Brown-Humes, that fiscal stimulus and currency devaluation are positive factors, but a continuing high oil price could lead to recession."

Source: Chris Brown-Humes, Financial Times, July 21, 2008.

David Rosenberg (Merrill Lynch): Adjusting to the new economic reality
"Just like consumers, who are insulating their windows and making fewer trips to the malls, we are adjusting our economic forecast to the new high-oil price reality not to mention the latest round of trauma in the mortgage markets.

"Though fiscal stimulus will provide a lingering boost to 3Q we expect GDP to plummet 2.5% in 4Q and see a similar decline in 1Q. In all, we have shaved our 2009 GDP forecast to -0.5% a full percentage point lower that where it was previously, while 2008 is broadly unchanged at 1.5%."

Click here for the full report.

Source: David Rosenberg, Merrill Lynch, July 18, 2008 and Mark Gilbert, Bloomberg, July 22, 2008.

Bill King (The King Report): Jamie Dimon - dire economic forecast
"Why did so many people ignore Jamie Dimon's dire economic and industry forecast when JP Morgan issued its earnings last week? Mr. Dimon: 'Our expectation is for the economic environment to continue to be weak - and to likely get weaker - and for the capital markets to remain under stress ... We remain conscious that since substantial risks still remain on our balance sheet, these factors will likely affect our business for the remainder of the year or longer.'"

Source: Bill King, The King Report, July 23, 2008.

BCA Research: US FOMC - Bernanke against the hawks
"Some FOMC members continue to voice concerns about inflation, undermining the effectiveness of low rates and non-conventional policies aimed at aiding the hobbled financial system.

"Regional Fed President Stern was the latest hawk at the FOMC to voice his concern about inflation. This may be a valid concern AFTER the economy gains a head of steam, but deflation will continue to be the greater threat so long as the credit crisis and economic weakness persist. Private sector borrowing rates have failed to decline alongside the fed funds rate, and hawkish comments tend to put upward pressure on interest rate expectations, to the detriment of the economy (and the stock market).

"So far, Chairman Bernanke has been able to keep the hawks under control, and the Fed has maintained an accommodative policy stance. Bottom line: Inflation angst at the Fed risks prolonging the economic slowdown, and will make investors both wary of the Fed's commitment to 'open-ended' policy easing and worried that banking problems will persist."

Source: BCA Research, July 22, 2008.

Bloomberg: Fed's Plosser says housing slump no bar to rate rise
"Federal Reserve Bank of Philadelphia Charles Plosser said higher mortgage costs and continued declines in house prices pose no bar to raising interest rates.

"Policy makers must increase borrowing costs before inflation expectations become 'unhinged', Plosser said in an interview with Bloomberg Television today at his bank's headquarters.

"The Philadelphia Fed chief joins Gary Stern, head of the central bank's Minneapolis branch, in judging that policy makers shouldn't wait for an end to the housing recession before acting. Plosser spoke after the central bank's Beige Book survey of regional business conditions showed all 12 districts reported 'elevated or increasing' price pressures.

"'The question becomes how long are we willing to allow the pressure from a fairly accommodative monetary policy stance' to last 'before it begins to feed broad-based inflation', Plosser said in a separate interview with Bloomberg News today.

"Plosser and Stern have said raising rates before the housing slump ends isn't out of the question, while Dallas Fed President Richard Fisher dissented from the Fed's June 25 decision to leave the benchmark rate at 2%. Asked whether three dissents at the next Federal Open Market Committee meeting would be a concern, Plosser said 'no'.

"'Dissents serve a purpose,' he said today. 'They help communicate the sense of the committee. They help communicate where the hard choices are, where the uncertainty lies.'

"'Interest rates are low, I don't think there is any debate about that,' Plosser said today. 'At some time these rates are likely to go up. Challenge is determining when.'

"Asked if the Fed can act even as home prices are still falling, Plosser said: 'I wouldn't rule that out.' On whether the rise in home-mortgage rates this year would stand in the way of increases by the Fed in the benchmark interest rate, Plosser said, 'I don't think so.'"

Click here to view the video clip.

Source: Anthony Massucci and Kathleen Hays, Bloomberg, July 23, 2008.

Bloomberg: Pimco's Paul McCulley - Plosser "wrong" on rate hikes
"Paul McCulley talks about US deflation and property values, and the outlook for Federal Reserve policy. McCulley said Philadelphia Fed President Charles Plosser was wrong in saying that the central bank should raise interest rates 'sooner rather than later' to keep inflation from accelerating."

Source: Bloomberg, July 24, 2008.

Financial Times: Bush says Wall Street "got drunk"
"President George W. Bush said Wall Street had 'got drunk' and was experiencing a hangover at a recent closed-door fundraiser in Houston in which he also made light of the US housing crisis.

"In a video recording that emerged on Tuesday, Mr Bush questioned how long Wall Street banks would remain sober and 'not try to do all these fancy financial instruments'.

"The recording was obtained by an ABC outlet in Houston and filmed even after the president apparently asked for cameras to be turned off.

"When asked at a press conference last week whether the US banking system was 'in trouble', Mr Bush said: 'I think the system basically is sound. I truly do. And I understand there's a lot of nervousness ... but the economy's growing.'

"In the video obtained by ABC, Mr Bush had a tougher view of Wall Street.

"'There's no question about it. Wall Street got drunk - that's one of the reasons I asked you to turn off the TV cameras - it got drunk and now it's got a hangover. The question is how long will it sober up and not try to do all these fancy financial instruments.'

"Mr Bush then shifts attention to the housing crisis, pointing out to a laughing audience that the cities of Houston and Dallas had not been hit by the downturn in the housing market.

"'And then we got a housing issue ... not in Houston, and evidently not in Dallas, because Laura's over there trying to buy a house. I like Crawford [where Mr Bush owns a ranch] but unfortunately after eight years of sacrifice, I am apparently no longer the decision maker.'"

Source: Stephanie Kirchgaessner, Financial Times, July 23, 2008.

Bill Gross (Pimco): Dear President Obama
"Anyway, so you're gonna do the tax thing, Mr. President, and throw in some form of universal healthcare to boot, that your buddy Hillary will help spearhead. You hope you can get a lot of this passed despite a potentially long string of filibusters from a Senate that won't quite have sixty Democrats. In addition, you'll need to provide some immediate relief to homeowners in the form of FHA (Federal Housing Administration) subsidies and low mortgage rate loans that somehow have been studied and studied in Congress for the past six months yet still haven't been passed into law.

"By January, home prices will be down another 10% or so and our Japanese-style property deflation will be in full stride. Congress will have had its summer recess though and spent September and October on the campaign trail. They had to get re-elected you know, so those homeowners just had to wait.

"But you'll have your tax bill and your healthcare bill and your housing fix, and somehow it'll all be paid for by wealthy hedge fund managers, oil companies or, pray tell, a robust economy that's creating good jobs at home instead of exporting them abroad. Uh, I don't think so, Mr. President. That's where the 'yes we can' morphs into 'no we can't'.

"Not that you won't accomplish most of that - the robust economy and the good jobs notwithstanding. It's just that you won't be able to pay for it and it's better to admit it now as opposed to later. No David Stockman confessions in your administration. You're smarter than Ronald Reagan and too nice a guy to distort reality like King George. So let's start out by dropping all of that 'budget neutral' rhetoric and admit where we're headed. Your administration will produce this nation's first trillion dollar deficit!

"While the Republicans will blame you for years and label you 'Trillion Dollar Obama' in future campaigns, there is in fact not much that you or any other President can do. You've inherited an asset-based economy whose well has been pumped nearly dry with lower and lower interest rates and lender of last resort liquidity provisions that have managed to support Ponzi-style prosperity in recent years.

"Foreign lenders have cooperated by purchasing Treasuries at yields which when combined with dollar depreciation have resulted in negative returns on their money. Even if these charades continue (and they may not), their stimulative effects - their magical powers to transform a 110-pound weakling into a Charles Atlas/Arnold Schwarzenegger mensch of an economy - are gone.

"What you need now is fiscal spending and lots of it. No ordinary Starbucks will do, Mr. President, you need to step up for a six-pack of Red Bull."

Click here for the full report.

Source: Bill Gross, Pimco, July 2008.

Bloomberg: Paulson says GSE rescue needed to stabilize markets
"US Treasury Secretary Henry Paulson talks with Bloomberg's Kathleen Hays about the need for Congress to pass a bill to shore up confidence in Fannie Mae and Freddie Mac, the mortgage lenders' capital position, bank failures, and international perception of US markets."

Source: Bloomberg, July 22, 2008.

Bloomberg: Pimco's Gross says Fannie, Freddie mortgages "excellent"
"Bill Gross talks with Bloomberg's Kathleen Hays about Treasury Secretary Henry Paulson's plan to rescue Fannie Mae and Freddie Mac, the outlook for US home prices, Federal Reserve monetary policy and the bond market."

Click here for the full article.

Source: Bloomberg, July 21, 2008.

Financial Times: Blackrock's Larry Fink on the credit crunch
"Larry Fink, chairman and CEO of BlackRock, talks about the credit crunch and why the US government's interference in the markets has gone too far."

Source: Financial Times, July 23, 2008.

BCA Research: Fannie And Freddie debt is secure
"Agency debt should outperform Treasury securities in light of the recent strengthening of the government's implicit guarantee.

"CDS spreads for US Treasury debt jumped following Treasury Secretary Paulson's pledge to provide backstop capital for Fannie Mae and Freddie Mac (F&F). Meanwhile, debt issued by F&F has taken a big step closer to being backed by the US government. Thus, the cost of F&F credit protection is converging with the cost of credit protection on US Treasury securities, in much the same way that Bear Stearns spreads tightened to JP Morgan levels following that takeover.

"A heightened risk premium in Treasury-issued securities and the possible increase in supply created by the GSE bailout have contributed to the recent selloff in the Treasury market. Accelerating Treasury issuance has also emerged as an important factor placing downward pressure on swap spreads and Treasury issuance could increase if F&F in turn decide to draw down on the (increased) Treasury credit line. However, counterparty risk remains the most important factor driving swap spreads and all spreads remain at risk until concerns about financial systemic risk begin to ease."

Source: BCA Research, July 24, 2008.

Asha Bangalore (Northern Trust): Leading index confirms expectations of contraction in economic activity
"The Index of Leading Economic Indicators (LEI) fell 0.1% in June, following a revised 0.2% drop in May (previously estimated as a 0.1% increase). The quarterly average of LEI is down 2.0% from a year ago, the largest decline in the current business cycle. Historically, such large year-to-year declines of the quarterly average of the index are associated with recessions, with the exception of 1967.

"The National Bureau of Economic Research announces the dates of peaks and troughs of business cycles long after they occur because they need to wait for revisions of economic data. The main message from today's LEI data is that it confirms the severely weak status of the economy in the near term. LEI data have been sending warning signals for several months but they have been largely ignored."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, July 21, 2008.

Asha Bangalore (Northern Trust): New homes - hints of market recovery are visible
"Putting the latest sales data of new homes in a historical perspective, sales of new single-family homes are down 61.8% from the peak in July 2005 (1.389 million units). The bottom appears to have occurred in March 2008 when sales were down 63.1% from the peak. The median decline in sales of new-single family homes from the peak to the trough is 46.9% during 1969-2001.

"The median price of a new single-family home rose to $230,900 versus $227,700 in May. Home prices appear to have bottomed in May 2008, putting the peak-to-trough decline at 13.3%. The median decline in prices of new single-family homes from the peak to the trough is 8.6% during 1969-2001. In sum, the market of new homes is mending gradually."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, July 25, 2008.

Asha Bangalore (Northern Trust): Existing homes - weak conditions remain intact
"Sales of existing homes declined 2.6% to an annual rate of 4.86 million units in June. Purchases of single family homes declined 3.2% to an annual rate of 4.27 million units, the lowest sales pace since January 1998. Sales of existing single-family homes are now down nearly 33% from their peak in September 2005.

"Overall, the inventory of existing homes rose to an 11.1 month supply, up from a 10.8 month supply in May. The median price of an existing single-family home ($213,800) in June fell 6.7% from a year ago. Given the number of unsold homes in the market, home prices would have to fall further to clear the inventory."

=

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, July 24, 2008.

Asha Bangalore (Northern Trust): Jobless Claims - weakness in hiring prevails
"Initial jobless claims rose to 406,000 during the week ended July 19 from 372,000 in the prior week. The sharp increase is partly due to auto industry related shutdowns in the summer. Continuing claims, which lag initial jobless claims, stood at 3.107 million, down slightly from 3.116 million in the prior week. The four-week moving averages of both initial and continuing jobless claims continue to send a message of significant weakness in hiring."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, July 24, 2008.

Reuters: US banks primary borrowings from Fed biggest ever
"US banks' direct primary credit borrowing from the Federal Reserve rose to the highest level ever in the latest week, reflecting the growing need of the banking sector to rely on the central bank for cheap funding, analysts said.

"Banks primary credit borrowings averaged $16.38 billion per day in the latest week, a record high and up from $13.92 billion the previous week, Federal Reserve data showed on Thursday.

"On the day of July 23, banks' primary credit borrowings rose to $17.68 billion, the highest borrowing since September 12, 2001 when banks borrowed $45.5 billion in a single day."

Source: John Parry, Reuters, July 24, 2008.

Bill King (The King Report): Home equity loans weighing on banks
"Mr. Mortgage: Our nation's largest banks are being weighed down by second mortgage liens (home equity lines/loans). You have heard this in many of their earnings calls recently. The home equity market is thought to be as large as $1.3 trillion.

"For many banks this is their largest residential mortgage exposure. For example, Wells Fargo still carries $84 billion and Bank of America and Chase about $100 billion a piece. The banks were very touchy in their recent earnings reports on this topic. Wells Fargo actually changed the definition of 'default' from 120 days to 180 days to push out defaults further and hide losses ... Now, it looks as though the tax payers will shoulder the risks for the bank's irresponsible home equity lending as well. They added this last minute to the Fannie/Freddie, Wall St, Foreign Gov't, Washington DC, bank and investment bank bailout.

Source: Bill King, The King Report, July 24, 2008.

Bloomberg: US foreclosures double as house prices decline
"US foreclosure filings more than doubled in the second quarter from a year earlier as falling home prices left borrowers owing more on mortgages than their properties were worth.

"One in every 171 households was foreclosed on, received a default notice or was warned of a pending auction. That was an increase of 121% from a year earlier and 14% from the first quarter, RealtyTrac Inc. said today in a statement. Almost 740,000 properties were in some stage of foreclosure, the most since the Irvine, California-based data company began reporting in January 2005.

"'Rising foreclosures are putting downward pressure on prices, increasing the possibility that homeowners will go upside-down on their mortgages,' said Sheryl King, chief US economist at Merrill Lynch & Co. in New York. 'That will cause more losses in mortgage portfolios and less willingness from investors to securitize mortgages and therefore fewer mortgages.'

"About 25 million US homeowners risk owing more than the value of their homes, according to Bill Gross, manager of the world's biggest bond fund at Pimco. That would make it impossible for them to negotiate better loan terms or sell their property without contributing cash to the transaction."

Sources: Bob Ivry, Bloomberg and ForeclosurePulse, July 25, 2008.

Financial Times: John Paulson looks at cash-strapped banks
"John Paulson, who recorded what was thought to be the single biggest profit in the history of the hedge fund industry last year by betting on a financial collapse, is planning a new fund to provide capital to cash-strapped banks.

"Mr Paulson's New York-based Paulson & Co plans to open a new hedge fund by the end of the year to buy into financial institutions raising cash, although the plans have not yet been finalised. Investors said they expected to see documentation for the new fund next month, assuming it went ahead.

"The move suggests Mr Paulson is preparing to call the bottom of the market for financials, a shift likely to be closely watched by other investors. Mr Paulson was the flag-carrier last year for a group of hedge funds that made enormous profits - estimated by investors at more than $12 billion for Paulson's funds - by shorting, or betting against, subprime mortgages."

Source: James Mackintosh, Financial Times, July 23, 2008.

David Fuller (Fullermoney): Equities - is fundamental background deteriorating or improving?
"Is the fundamental background still deteriorating or is it now improving? People could debate this question all day, every day, without necessarily reaching agreement. Therefore, I will focus on four obvious concerns - the price of crude oil, the performance of bank shares which we have always regarded as lead indicators, central bank policy, and what I often refer to as the Wall Street leash effect.

"Crude oil has broken its medium-term uptrend, which is an improvement in terms of investor concerns, but it needs to fall considerably further to reverse its shock effect on stock markets and GDP growth.

"Western bank indices have bounced sharply after clear evidence of capitulation selling in the west, which is a recent improvement, but will need to demonstrate further evidence that the overall trend is reversing. Bank indices in other regions have often fared considerably better in recent months, not least in Japan.

"Central banks are still hawkish on inflation although there is some tentative evidence of a softening in this stance.

"The Wall Street leash effect had been very negative before providing some respite commencing last week, although it hit a speed bump today as the rally reached initial resistance from the January and March lows.

"Net it all out and we have some improvement. However to revive animal spirits among bulls, the technical rallies which commenced last week will have to be larger and more durable than what we saw following the January and March lows."

Source: David Fuller, Fullermoney, July 24, 2008.

Jeffrey Saut (Raymond James): Attempting to catch a bottom
"If the decline in crude oil continues to play, it should be bullish for stocks. Indeed, just as in horseshoes and hand-grenades, all you have to be is 'close' when attempting to 'catch' a bottom in the stock market to make a lot of money if you adopt a scale-in buying approach, which is what we have attempted to do over the past few weeks! As stated two weeks ago, 'What a great time to be an investor' for if you are a well prepared investor, volatility breeds opportunity."

Source: Jeffrey Saut, Raymond James, July 21, 2008.

David Rosenberg (Merrill Lynch): EPS to see 35% correction
"The decline in domestic economic activity, steadily climbing input costs and diminished support from currency translation is likely to result in a sharp downturn in EPS, in our view. We see EPS operating earnings at 68.0 in 2008 (down 17.7% from 2007) and 63.0 in 2009 (down 7.2%). That translates into a 35% decline in EPS from the peak in 2006.

"We have been saying all along that the slowdown in the economy is not about the business sector. Balance sheets, outside the financial sector and the perennially restructuring auto sector are relatively healthy. However, the toxic combination of declining revenues and soaring costs mean that few sectors will escape this downturn with profit margins intact."

Click here for the full report.

Source: David Rosenberg, Merrill Lynch, July 18, 2008.

John Authers (Financial Times): Why US financials have staged a recovery

Click here for the full article.

Source: John Authers, Financial Times, July 22, 2008.

Gareth Williams (ING): European profits under pressure
"The number of profit warnings from large-cap European companies this year looks set to hit the highest level since 2003, warns Gareth Williams, equity strategist at ING.

"He notes there were 25 warnings in the first half of 2008, the most for five years, and that there have been a further five so far in the second half.

"'Since 1996, 48% of profit warnings have come in the first half and 52% in the second half. Using the average to project forward suggests 52 profits warnings for the year as a whole; in other words, there might be another 22 to come.'

"However, Mr Williams warns that it is far more likely that the second half will see profit warnings coming through at a faster rate than in the first six months of the year.

"'Bottom-up forecasts remain dangerously optimistic and our top-down models suggest that euro strength, high oil prices and consumer fragility will start to hit home in the coming quarters,' he says.

"Mr Williams says that, unsurprisingly, the banking, retail and technology sectors have dominated the list of warnings so far this year. 'Our top-down work on margins and earnings suggests that technology, industrials, autos and food & beverages may be the sectors that deliver unwelcome surprises in the second half.'"

Source: Gareth Williams, ING (via Financial Times), July 22, 2008.

Lex (Financial Times): Cyclical stocks collapse in UK
Since the middle of May - roughly marking the top of the last rally - the FTSE 100 index has been hit hardest by a collapse in cyclical stocks. Investors have not just given up on the UK. It seems that belief in the resilience of the global economy is draining away as well.

"Over the past two months the transportation, retail, property and media sectors have all fallen further than bank stocks. If some now think the economy is following the US into oblivion, the very institutions charged with trying to avoid this fate have hardly reassured. Last week, speeches from the chancellor of the exchequer and the governor of the Bank of England only just stopped short of telling people to pack their bags and move to France.

"But more worrying is the slump in resources stocks, which reflects the health of the global, rather than the domestic, economy. The share prices of mega-miners BHP Billiton and Rio Tinto have lost more than a quarter of their value in the past two months, underperforming the broader market by 15%. In that period both companies have announced a near doubling of their iron ore contract prices and other metals are trading near record highs. Nor was either stock screamingly expensive.

"The mining sell-off suggests the global growth story is over. Fears of a slowdown across the developed world are being realised. But now the robustness of some developing economies is being questioned. The rate of growth in China is slowing, as last week's second-quarter numbers - albeit still an impressive 10% - showed. UK investors may soon look back fondly to a time when they just had to worry about banks."

Source: Lex, Financial Times, July 21, 2008.

Bloomberg: Mobius sees "good bargains" in China and India
"Stocks in China and India offer 'good bargains' after benchmark indexes in the nations declined more than any other major market this year, Templeton Asset Management's Mark Mobius said.

"'We've been rearranging the portfolio based on valuations, which have come down pretty dramatically in places like India and China,' Mobius, who oversees about $47 billion of emerging-market equities, said in an interview from Toronto. 'There've been big declines.'

"Mobius joins investor Jim Rogers in favoring Chinese stocks after they plunged 46% this year. China and India, the two most populous nations, are the worst performers among the world's 20 largest stock markets as soaring raw material prices and slowing economic growth weigh on profits. Last year, China's main index surged 162% and India's advanced 47%.

"China's CSI 300 Index is valued at 21 times reported earnings, near the lowest in more than two years, and down from a peak of 53 times in October 2007. In India, the Sensex Index is trading at 14 times reported earnings, down from a high of 31 earlier this year. That compares to a multiple of about 22 times for the S&P 500 Index in the US.

"Rogers, who said he hasn't sold any of the Chinese equities he started buying 1999, told investors on June 28 not to 'give up' on the nation's stock markets.

"Marc Faber, publisher of the Gloom, Boom & Doom Report, disagrees. The investor ... said on July 4 that investors betting on a rebound in China's tumbling stocks are setting themselves up for more losses.

"Mobius added that he favors shares in Brazil and Russia because the two markets can still benefit from the demand for energy and other raw materials. 'Russia and Brazil are pretty much in the same position,' Mobius said. 'Both of those areas are swimming in excess liquidity, which will drive consumer prices as well.'"

Source: Catherine Yang and Chen Shiyin, Bloomberg, July 22, 2008.

BCA Research: Euro - a tense anniversary
"Since its lows in late 2000, the euro has risen over 83% against the US dollar and 51% in trade-weighted terms. While we do not rule out one last spike in the currency, the climb has left the euro extremely overvalued and vulnerable to a correction. We suspect the latter will begin in 2009, as the domestic economy slows sharply and the US begins to recover.

"Another precondition would be a further setback or consolidation in crude prices, given that the ECB is more sensitive to headline inflation than the Fed.

"However, we are not expecting a collapse in the euro. The currency will continue to enjoy a positive interest rate differential with the US and the PIGS (Portugal, Italy, Greece and Spain) will not withdraw from the euro zone. Technically, there is strong resistance in the $1.38 to $1.41 range, established when the synthetic rate twice tested those levels in the early 1990s. Should it break these floors, the next support would be around $1.30."

Source: BCA Research, July 21, 2008.

Financial Times: Renminbi fall fuels talk of policy shift
"The Chinese renminbi fell for the third consecutive day on Monday, sparking speculation that its continued appreciation might not be a foregone conclusion.

"The renminbi has risen more than 6% against the dollar this year as the Chinese authorities have used the currency as a tool to dampen inflationary pressures in the country's overheating economy.

"By midday in New York, the renminbi dropped 0.2% to Rmb6.8290 against the dollar after the People's Bank of China fixed the currency's daily mid-point lower for a third successive day.

"Gabriel Stein, of Lombard Street Research, said that, while the move could just be put down to 'normal daily fluctuations', the Chinese ministry of commerce had called for a slower pace of renminbi appreciation.

"Wen Jiabao, the Chinese premier, has talked about helping China's exporters.

"'It could be the beginning of a policy shift,' said Mr Stein. 'It could also be an attempt to stave off speculative capital inflows by showing that renminbi appreciation is not a one-way bet.'"

Source: Peter Garnham, Financial Times, July 21, 2008.

David Fuller (Fullermoney): Oil prices by far the biggest global problem
"I have previously said that this year's spike in crude oil prices had become by far the biggest global problem. Spikes in the price of oil have proved to be much more damaging economically than slow, steady rises. ... spikes certainly contributed to recessions in 1990-1991 and 2001-2002. I also recall the oil shock recessions of 1973-1975 and 1980-1982, as will many veteran subscribers.

"Today, I feel increasingly confident that crude oil established an important medium-term peak last week. However it remains to be seen whether or not oil continues to fall back even more quickly than it rose, as it could, or ranges in a phase of top extension before declining to what I suspect will be at least $100. The difference in timing is important because it will be a crucial factor for central banks, which continue to express more concern over inflation than slowing economic growth. It will also influence the level of speculative activity in other commodities.

"Meanwhile, I think Mark Mobius is right to be interested in China and India at these levels, and given the size of the funds that Templeton manages, he cannot really afford to hold out for historically low valuations. Circumstances may not produce them and they probably would not stay there very long in any event.

"The main reservation most strategists have about China, India or any other promising market today, is inflation. That is why oil really is everything. At $100 a barrel, investors would obviously be a lot less concerned about inflation, and able to refocus on all the attractive aspects of emerging (progressing) markets. If we see $100 oil later this year, which I think is a real possibility, I suspect most stock market indices will be higher than they are today, led by those with the best combinations of sound governance and economic growth.

"To those who might ask: would we not then see oil move back up and renew its uptrend, my answer is not immediately. Lower demand for oil in the USA, due to more efficient usage, could easily offset rising demand in China for a while. Also, it is only a matter of time before Iraq's oil production increases dramatically."

Source: David Fuller, Fullermoney, July 22, 2008.

Financial Times: Arctic has 90 billion barrels of crudeM
"The Arctic holds as much as 90 billion barrels of undiscovered oil and has as much undiscovered gas as all the reserves known to exist in Russia, US government scientists have said in the first governmental assessment of the region's resources.

"The report is likely to add impetus to the race among polar nations, such as Russia, the US, Denmark, Norway and Canada, for control of the region.

"The US Geological Survey (USGS) believes the Arctic holds 13% of the world's undiscovered oil, while 1,669,000 billion cubic feet of natural gas is equivalent to 30% of the world's undiscovered gas reserves.

"'The extensive Arctic continental shelves may constitute the geographically largest unexplored prospective area for petroleum remaining on earth,' the USGS said."

Source: Carola Hoyos, Financial Times, July 23, 2008.

Continue to Part II

Dr Prieur du Plessis
investmentpostcards.com

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

Copyright © 2008-2009 Dr Prieur du Plessis

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