Words from the (Investment) Wise for the Week That Was (June 2 - 8, 2008): Part II
David Fuller (Fullermoney): Banks are a leading indicator
"Fullermoney has long maintained that banks are a leading indicator, more often than not. Therefore at a time when confidence in western banks and bankers is at a once-in-a-generation low, the accountancy nonsense ... will not help. However a key market-related question for investors is likely to be: To what extent has the bad news, current and anticipated, already been discounted?
"For several months we have maintained that while the credit crisis had passed its nadir, the convalescence for banks would be lengthy, not least because their most lucrative business model of the last decade also led to their downfall last year.
"While the prospect of banks returning to more prudent forms of banking should be reassuring for the long term, it does not answer investors' present concerns as to how the attractive dividends will be funded. Moreover, minority shareholders have often seen their equity diluted. Consequently they have been voting with their feet recently, as we can see with this weak performance by bank indices in the USA, UK and to a lesser extent, Continental Europe.
"The spectacle of US and UK bank indices testing their January and March lows is certainly not reassuring for equity investors, neither is the recent move beneath the April reaction low by the DJ Euro Bank Index. However, on a more positive note, these indices appear somewhat overstretched once again as a consequence of recent and persistent weakness.
"The catalyst for such a rebound is not immediately apparent to me, although contrarian thinkers may be encouraged by today's front-page headline for the UK's Evening Standard: 'Major Banks in New Crisis'. Personally, I regard the current spate of rights issues (secondary offerings) as a good sign in terms of the long term outlook for commercial banks."
Source: David Fuller, Fullermoney, June 2, 2008.
Richard Russell (Dow Theory Letters): US dollar not going out of business
"With a number of Mideast nations threatening to remove their currencies from the dollar peg, Treasury Secretary Paulson is getting worried, and again he's announcing that the US is in favor 'a strong dollar'.
"Is anyone listening? By this time, no one believes in a strong dollar, but now time may be on the dollar's side. Here's why I say that. Check out the chart of the dollar. Are you looking at the latest plunge to 71. That uncorrected decline is almost ridiculous. The dollar is not going out of business yet. In fact, the dollar is long overdue for a correction to the upside.
"The dollar's direct competition is the euro, and the euro is too expensive. Europe is as afraid of inflation as the US is afraid of deflation. And Europe's interest rates are too high. The high Euro interest rates are killing business. The pressure in Europe is for lower rates, and the pressure in the US is for higher rates to offset inflation. This, plus the oversold condition of the dollar, should send the dollar higher. Of course, if oil tops out, that too would help the dollar. At any rate, that's the way Richard Russell sees it - for now."
Source: Richard Russell, Dow Theory Letters, June 3, 2008.
David Fuller (Fullermoney): US dollar to remain in ranging pattern
"... I think the USA and its trade partners would like to see at least a quietly steady greenback over the medium term.
"The US government has achieved much of its unstated devaluation objectives and further near-term weakness for the USD would most likely be counterproductive, not least in terms of inflationary pressures. America's trade partners can live with the dollar at this level; creditors have no interest in a further devaluation of their USD holdings, and currency appreciation has mitigated inflationary pressures somewhat.
"Some commentators look at the USD's long slide and conclude that it should bottom out near current levels, not least because it is 'cheap' in terms of purchasing power parity. I have never been impressed by PPP as a currency forecasting tool but even if the USD has commenced a base building phase prior to a significant recovery, I think the process would be lengthy as we have seen before.
"After all, US short-term rates are hardly an incentive to buy the USD and likely to stay low for some time; everyone knows that the Fed will continue printing and the presidential candidates are promising even more big spending, and creditor nations probably feel that they already have too many US dollars.
"I maintain that the US Dollar Index will remain in a broadly ranging pattern for a while longer. Beyond that I think the prospect for a significant rally is at least matched by the possibility for another downward slide.
"The latter would probably have a whiff of crisis about it and therefore be a headwind for most stock markets. Conversely, a steady dollar should be a benign influence. ... it could pay to acquire precious metals during easing in this seasonally dull period for bullion and while the USD is temporarily firm."
Source: David Fuller, Fullermoney, June 4, 2008.
John Authers (Financial Times): Pound reflects increasing pessimism in UK
Source: John Authers, Financial Times, June 4, 2008.
MarketWatch: Soros says commodity bubble echoes '87 climate
"The investment flood into commodity indexes bears eerie similarities to the craze for portfolio insurance that led to the stock-market crash of 1987, according to hedge-fund investor George Soros, who warned that the rush into oil has created a 'bubble'.
"'In both cases, the institutions are piling in on one side of the market and they have sufficient weight to unbalance it,' said Soros in testimony prepared for a Senate panel on energy manipulation. 'If the trend were reversed and the institutions as a group headed for the exit as they did in 1987, there would be a crash.'
"Tuesday's hearing by the Senate Committee on Commerce, Science and Transportation aimed to determine what factors the Federal Trade Commission should consider when it makes rules on preventing manipulation in the wholesale oil and petroleum-distillates markets.
"It's the latest public forum focused on whether drivers besides supply and demand are responsible for the recent spike in oil, grains and other commodity prices.
"Soros, who made his fortune speculating on currencies, advised lawmakers to use caution when considering regulations designed to reduce speculation.
"Such rules could push investors further into unregulated markets, he said. Still, varying margin requirements can be used to more actively prevent asset bubbles from inflating, he added. 'That is one of the main lessons to be learned from the recent financial crisis.'
"He said there are fundamental factors behind the rise in oil prices. Namely, there are increasing costs of developing new reserves and waning oil production in countries like Russia and Venezuela, as well as domestic subsidies in countries such as China that keep prices artificially low."
Source: Laura Mandaro, MarketWatch, June 3, 2008.
BCA Research: Is a commodity correction approaching?
"Our global Leading Economic Indicator (LEI) is signaling that some contagion from the US slowdown is spreading beyond the G7 countries, which could finally trigger a shakeout in commodity prices.
"Since the end of 2006 there has been an unprecedented divergence between the G7 and non-G7 LEI. However, the steady decline of the non-G7 indicator warns that some contagion may soon develop. Though the worst of the US economic slide may be past, a long period of sluggishness seems probable, and there remain downside risks given the ongoing housing slump and relentless rise in energy prices.
"Bottom line: A slowing in non-G7 economic growth at a time when the US is still weak could be the catalyst for the long overdue correction in commodity prices. We would hold back from putting fresh funds to work until overbought conditions and sentiment ease."
Source: BCA Research, May 28, 2008.
Bloomberg: Jim Rogers says bull market in oil has "years to go"
Source: Bloomberg, June 5, 2008.
CNBC: Ed Schafer - Food inflation to hit 43%
"'Internationally we're looking at a 43% inflation rate in food this year,' Ed Schafer, US secretary of Agriculture, told CNBC on Tuesday. Schafer said the big driving factor was energy."
Source: CNBC, June 3, 2008.
Eoin Treacy (Fullermoney): Food production to lag demand significantly
"Food over-production was such a problem in Europe, that the infamous butter mountains and wine lakes were synonymous with bureaucratic incompetence and a Common Agricultural Policy which had outgrown its usefulness. However, now that production has decreased and the price of food has become an international cause celebre, set-aside policies are likely to be revisited. As one would expect, higher demand should result in an eventual corresponding move from the supply side.
"While there are a number of contributing factors surrounding the run up in commodity prices, there is a temptation to blame everything on biofuel. The bigger picture is just not that simple. Rising food demand from growing populations who can afford to have a more balanced diet is the key driver behind increased demand for food of all types. This is not something which is about to change anytime soon. In fact as global GDP growth continues to be led by the largest population centres, and millions more enter the middle classes, demand is only going to increase.
"Many crops have an annual cycle, which means that when prices rise, a bumper crop the following year is possible as farmers plant more of that commodity. However, this also leads to less of another crop being planted and sows the seeds of the next bull market. When one factors in weather, agricultural commodity prices are volatile. It will take a significant amount of time before global food production taken on aggregate can meet rising demand."
Source: Eoin Treacy, Fullermoney, June 3, 2008.
Victoria Marklew (Northern Trust): European Central Bank sounds hawkish
"As expected, the European Central Bank (ECB) left its refi rate at 4.0% again this morning. What was not expected was the hawkish tone of the subsequent statement and the press briefing from President Trichet. He noted that the Governing Council had a 'deep discussion' and remains 'in a state of heightened alertness'. Some members apparently wanted a rate hike this month but the consensus was to hold. The President then noted that the Council may decide to make 'a small hike' at the July 3 meeting in order to anchor inflation expectations. The euro promptly firmed anew.
"So, what are the odds of a July rate hike? The ECB's mandate is to keep inflation 'below but close to 2%' in the medium term. That qualifier allows some wriggle-room - the Council can say that current conditions are temporary and prices will come back toward target in the 'medium-term' and can define that however it sees fit. For now, our hunch is that the Council will continue to talk tough but the consensus to stand pat will prevail. As always, though, watch the data."
Source: Victoria Marklew, Northern Trust - Daily Global Commentary, June 5, 2008.
Reuters: UK house prices fall 2.4%
"House prices fell a larger-than-expected 2.4% in May, the country's biggest mortgage lender, Halifax, said on Thursday, providing further evidence the property market downturn is gathering pace.
"'The latest data on the housing market are undeniably alarming,' said Howard Archer, an economist at Global Insight. 'Clearly, the downward pressure on house prices coming from stretched buyer affordability and tight lending conditions is now biting hard.'
"Analysts polled by Reuters had expected only a 1.3% monthly decline.
"Figures from rival lender Nationwide last week were equally weak, showing house prices fell 2.5% in May, the sharpest monthly fall since its survey began in 1991.
"Halifax said the average cost of a house in May was 184,111 pounds, 6.4% lower than in the same month last year. The Halifax index shows house prices have fallen 7.8% from their peak in August 2007."
Source: Reuters, June 5, 2008.
BCA Research: BoE stubborn as economy melts
"The Bank of England (BoE) remains fixated on inflation risks and opted to leave the official Bank Rate unchanged at 5%, as expected.
"According to the BoE's May Inflation Report, the central bank sees the risks in the current macro environment as very asymmetric, with inflation posing a significant threat and weak but manageable downside for growth. We disagree with the central bank's assessment and hold a much more bearish outlook for growth. Indeed, the latest macro data suggests that the economy is deteriorating rapidly. Real estate prices are already plunging faster than our models had warned, with Nationwide house prices down 4.4% YoY and commercial real estate price inflation contracting at a double digit pace.
"Consumer confidence continues to drop to new cyclical lows and the PMI services index has slipped below its boom/bust line. While retail sales volume growth has held up reasonably well, this is largely due to aggressive price discounting and our models warn that dramatic headwinds are building. In turn, it is likely that consumer price pressures will ease in the coming months.
"Bottom line: Stay overweight gilts within a global hedged fixed income portfolio. The BoE is making a policy mistake by remaining hawkish and will be forced to play catch up later this year."
Source: BCA Research, June 6, 2008.
Business Day: China's growing inflation threat
"Six months after the People's Bank of China signaled a stepped-up battle against inflation, it has only fallen further behind in the fight.
"With inflation the highest in almost 12 years, central bank Governor Zhou Xiaochuan has lifted interest rates once, by just 0.18 percentage points, since the PBOC declared in December it was shifting to a 'tight' monetary stance. That means price increases are outpacing the return on loans and deposits, encouraging people to borrow and spend more.
"Inflation quickened to 8.5% in April, up two percentage points from December. The benchmark one-year lending rate is 7.47%, and the equivalent for deposits is 4.14%."
Source: Business Day, June 2, 2008.
GaveKal: CPIs spiraling up
Source: GaveKal - Checking the Boxes, June 2 & 5, 2008.
Ambrose Evans-Pritchard (Telegraph): Argentine alert as inflation spectre
stalks the world
"Argentina is defaulting on its sovereign debt yet again, this time by stealth.
"European and US pension funds that snapped up Argentina's peso bonds at the height of the credit bubble are discovering that it pays to probe the politics of Latin America - and indeed, Eastern Europe, and emerging Asia - before taking the plunge.
"It seems like only yesterday that Argentina halted payments on $95 billion of external debt. The 'Great Haircut' of 2001 was the biggest default in history. Investors are so forgiving.
"Argentina's trick this time, under the presidential double act of Nestor and Cristina Kirchner, has been to purge the National Statistics Office and appoint a friend to manage inflation data.
"The official Consumer Price Index (CPI) is 8.9%. This is the benchmark used to set payments on inflation-linked bonds, now 40% of the country's debt. The true inflation rate is more than 25%, according to union staff of the statistics office. They allege manipulation.
"'Argentina is engineering a partial default on its domestic debt,' said Professor Carmen Reinhart, from Maryland University.
"Vladimir Werning, from JP Morgan Chase, said the yield spread on inflation-linked peso debt has ballooned to 1,230 basis points. They are priced for the dustbin.
"On paper, Argentina looks safe. The world's biggest exporter of soybeans - and number two in corn - is riding the food boom, even if at war with its own farmers. The trade surplus is $12 billion. Foreign reserves are more than $50 billion. Yet the default premium is soaring anyway.
"Argentina is a warning of what can go wrong once inflation gets out of hand, as it has in roughly half the world.
"Among the CPI rates - if you believe them - are: Ukraine (30%), Venezuela (29%), Vietnam (25%), Kazakhstan (19%), Latvia (18%), Qatar (17%), Pakistan (17%), Egypt (16%), Bulgaria (15%), Russia (14%), the Emirates (11%), Estonia (11%), Turkey (9.7%), Indonesia (9%), Saudi Arabia (9.6%), Romania (8.6%), China (8.5%) and India (7.6%)."
Source: Ambrose Evans-Pritchard, Telegraph, June 3, 2008.