Words from the (Investment) Wise for the Week That Was (Aug 4 - 10, 2008)

By: Prieur du Plessis | Sun, Aug 10, 2008
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The Olympic Games kicked off at 8:08:08 pm on Friday night, the eighth day of the eighth month of 2008. Coincidence? Not at all. The number eight is considered lucky by the Chinese, because in Cantonese (the language of South China) the word for prosperity is "fa", which sounds like "ba" (eight).

Let the gains begin. Fortune also smiled upon stock markets, with the S&P 500 Index scoring its first back-to-back weekly gain since April as the US dollar rallied strongly and oil and commodities plummeted. The S&P 500's gain since the low of July 15 has been 6.7%, with the Financial SPDR up by 27.8%.

Hat tip: Phil's Stock World

As expected, the Federal Open Market Committee held the Fed funds target rate steady at 2.0%. This is the second straight meeting with no change in the rate. The committee's statement discussed high inflation; although the FOMC expected inflation to decline in the months ahead, the members said "the inflation outlook remains highly uncertain". The statement acknowledged both downside risks to growth and upside risks to inflation, indicating no near-term change in monetary policy. Click here for a comparison of the content of last week's communiqué with that of the previous one (June 25), courtesy of Bill King ( The King Report).

Casting light on the market situation, David Fuller (The King Report) said: "The obvious beneficiaries of weaker oil and a firmer US dollar are global stock markets. As the US has been The Rocky Horror Show in terms of concerns, it is now one of the more obvious candidates for a relief (short covering?) rally."

To which GaveKal added: "Policy responses to the credit crunch have helped. To successfully get out of a financial squeeze you need three things: 1) a cheap currency, 2) a positive yield curve, and 3) the recapitalization of bank balance sheets. With surprising speed, all three of these conditions are now being met in the US."

Next, 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. "Prices", understandably, remained a key concern of commentators.

I believe there is still no confirmation that stock markets have bottomed and maintain that the convalescence period will be an extended affair. From a short-term perspective, however, I would give the upside the benefit of the doubt unless the lows established on 1) July 28 and 2) July 15 are broken.

Interestingly, assets in US money market funds have increased by 1.8% to $3.56 trillion since the mid-July stock market lows. Mulling through my head are the words of the late Sir John Templeton: "Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria." It's best to keep an open mind about matters.

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.

"Global business sentiment remains weak and fragile," according to the Survey of Business Confidence of the World conducted by Moody's Economy.com. The survey results suggest that the global economy is skirting recession, but just barely.

Economic reports released in the US during the past week were mixed and included the following:

• Personal income inched up 0.1% in June after soaring 1.8% in May. Excluding the tax rebate effect, personal income rose by 0.3% in June, up from 0.4% in May. Spending growth slipped to 0.6% from 0.8% the prior month. Real spending fell by 0.2% as prices soared. The core PCE deflator rose by 0.3%, the fastest since September, while the top-line deflator jumped 0.8%.

• The ISM non-manufacturing index came in slightly better than expected in July. However, a decline in new orders and new export orders signaled weaker activity in the non-manufacturing economy in the months ahead.

• Initial claims for unemployment insurance benefits increased 7,000 to 455,000 for the week ended August 2. Although expectations had been for claims to remain high, this figure exceeded them.

• Friday's productivity and costs numbers came in worse than expected on the productivity side but better than expected on the cost side.

On Thursday, the European Central Bank (ECB) left interest rates on hold at 4.25% and stated that risks to economic growth were starting to materialize. Victoria Marklew (Northern Trust) commented: "Eurozone GDP almost certainly contracted in Q2 - Eurostat will release its flash estimate on August 14, the same day that Germany and France release their own first estimates. If the numbers surprise on the downside, the markets will start anticipating a rate cut by the ECB on September 4."

"Europe has moved further along the road towards a recession than the US. The economic data of the past two weeks make that conclusion hard to avoid," reported John Authers in the Financial Times.

In line with market expectations, the Bank of England also decided to keep its key repo rate steady at 5.0% at its August monetary policy meeting last week. August marks the fifth consecutive month with no change in the repo rate. UK house prices fell by almost 11% in the year to July - one of the biggest year-on-year falls recorded in the UK - prompting BCA Research to say: "The BoE will cut aggressively before year end."

Further afield, according to the Financial Times, the Japanese government conceded on Wednesday that the country's longest postwar period of economic expansion might be over as it reported a drop in its key measure of underlying economic conditions for June.


Date Time (ET) Statistic For Actual Briefing Forecast Market Expects Prior
Aug 4 8:30 AM Personal Income Jun 0.1% 0.0% -0.2% 1.8%
Aug 4 8:30 AM Personal Spending Jun 0.6% 0.4% 0.4% 0.8%
Aug 4 10:00 AM Factory Orders Jun 1.7% 0.5% 0.7% 0.9%
Aug 5 10:00 AM ISM Services Jul 49.5 51.0 48.7 48.2
Aug 5 2:15 PM FOMC Policy Statement - - - - -
Aug 6 10:35 AM Crude Inventories 08/02 1614K NA NA -81K
Aug 6 3:00 PM Consumer Credit Jun - $7.0B $6.0B $7.8B
Aug 7 8:30 AM Initial Claims 08/02 455K 420K 420K 448K
Aug 7 10:00 AM Pending Home Sales Jun 5.3% - -1.0% -4.9%
Aug 7 3:00 PM Consumer Credit Jun $14.3B $7.0B $6.4B $7.8B
Aug 8 8:30 AM Productivity-Prel Q2 2.2% 2.5% 2.5% 2.6%
Aug 8 10:00 AM Wholesale Inventories Jun 1.1% 0.6% 0.6% 0.9%
Source: Yahoo Finance, August 8, 2008.

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

1. International Trade (August 12): The trade deficit is predicted to have widened to $61.5 billion in June from $59.7 billion in May, with the oil import bill showing a noticeable increase. Consensus: $59.5 billion.

2. Retail Sales (August 13): Auto sales fell sharply to 12.55 million units in July. Non-auto retail sales were soft. The decline in gasoline prices in July should trim back the headline reading. Consensus: 0.0% versus 0.1% in June; non-auto retail sales: 0.5% versus 0.8% in June.

3. Consumer Price Index (August 14): A 0.4% increase in the CPI is predicted for July after a 1.1% jump in June. The core CPI is expected to have moved up 0.2% versus a 0.3% increase in June. Consensus: +0.3%; core CPI +0.2%.

4. Industrial production (August 15): The 0.1% drop in the manufacturing man-hours index in July points to a drop in industrial production. The operating rate is projected to have declined to 79.8% in July, the lowest since September 2005, excluding the 79.6% rate in May 2008. Factory production had declined for three straight quarters, with the 3.7% annualized drop in the second quarter the largest since the fourth quarter of 2001. Consensus: -0.1%; Capacity Utilization 79.8% versus 79.9% in June.

5. Other reports: NFIB Survey (August 12), Inventories (August 13), Consumer Sentiment Index (August 15).

Click here for a summary of Merrill Lynch's US economic and interest rate forecasts.

A summary of the release dates of economic reports in the UK, Eurozone, Japan and China is provided here. It is important to keep an eye on growth trends in these economies for clues on, among others, which way the US dollar is going to move and how strongly.

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, August 10, 2008.

Developed stock markets, in general, soared during the past week, with gains in excess of 2.5% being the order of the day. As was the case during the previous week, the Japanese Nikkei 225 Average was the worst performer among mature markets, rising by a relatively modest 0.6%.

The emerging markets category, as a group, underperformed developed markets, with Russia (-11.3%), China (-7.0% - a 19-month low) Turkey ( 4.7%) and Hong Kong (-4.32%) leading the declines. On the other side of the scale, the Indian BSE 30 Sensex Index (+3.5%) scored a fifth successive weekly gain. The Philippines (+4.2%) and Taiwan (+3.0%) also delivered solid returns.

Interestingly, the MSCI World Index has been outperforming the MSCI Emerging Markets Index since the stock market peaks of the middle of May, gaining 4.0% in relative performance on the back of perceived increased risks in developing markets.

The US stock markets moved strongly higher, especially on Wednesday and Friday when the Dow Jones Industrial Index recorded gains in excess of 300 points. The major index movements were: Dow Jones +3.6% (YTD -11.5%), S&P 500 Index +2.9% (YTD -11.7%), Nasdaq Composite Index +4.5% (YTD 9.0%) and Russell 2000 Index +2.5% (YTD -4.1%).

It is noteworthy that the Dow Jones, Nasdaq Composite and Russell 2000 have all crept back to above their 50-day moving averages, with the S&P 500 closing the week a mere 1 point below. The Russell 2000 also managed to penetrate the key 200-day line - often used as an indicator of the primary trend.

Click here or on the thumbnail below for a 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 apparel & accessory group outperformed last week, gaining 16%. Polo Ralph Lauren (RL) and Jones Apparel (JNY) reported earnings that handsomely beat the consensus estimates. Coach (COH), the largest member of the group, rose by 20% on the back of Coach's CEO increasing his holdings in the company's stock.

The casino & gaming group (+14%) was also among the top performers. Its single member, International Game Technology (IGT), reported that it had repurchased 3% of the company's outstanding shares since the end of June.

Stocks related to the energy sector (-4.6%) and materials sector (-3.0%) were at the bottom end of the week's performance table.

The thrifts & mortgage finance group was the worst-performing group for the week, down by 12%. The two largest members of the group, Fannie Mae (FNM) and Freddie Mac (FRE), both reported losses in excess of the analyst consensus estimates as they continue to be negatively affected by the housing decline and mortgage-related credit problems.

In other corporate news, Citigroup (C) and UBS (UBS) agreed to settle allegations of misrepresentation in the marketing of auction-rate securities. Separately, Moody's indicated that it had placed American Express' (AXP) A1 rating on review for a downgrade.

Fixed-interest instruments
UK, Eurozone and Japanese government bond yields declined during the past week as the economic outlook for those parts of the world worsened.

The UK ten-year Gilt yield declined by 17 basis points to 4.68%, the German ten-year Bund yield by 7 basis points to 4.26% and the Japanese ten-year bond yield by 4 basis points to 1.47%. The ten-year US Treasury Note, however, was almost unchanged at 1 basis point higher, closing at 3.95%.

US mortgage rates rose, with the 15-year fixed rate and the 5-year ARM both 7 basis points higher at 6.08% and 6.06% respectively.

Credit market stress was almost unchanged in the US, but worsened in Europe as reflected by the spread of the Markit iTraxx Europe Crossover Index widening from 531 to 563.

Source: Markit/Creditex

The US dollar surged following an acknowledgment of weakening growth in the Eurozone by ECB President Trichet, prompting traders to think the ECB would not be hiking rates further to fight inflation.

The US Dollar Index now trades above its 50-day and 200-day moving averages, signaling a breakout from its five-month trading range.

The greenback rose against the euro (+3.2% - a five-month high), the British pound (+2.9% - a 20-month peak), the Swiss franc (+3.0%), the Japanese yen (+2.2%) and the Canadian dollar (+3.7%).

The Australian dollar (-3.9%) and New Zealand dollar (-3.1%) also lost badly against their US namesake as a result of slowing economic growth pointing to interest rate cuts.

The dollar's rally and growing concerns of slowing demand knocked down dollar-denominated commodity prices as seen in the Reuters/Jeffries CRB Index plunging by 7.4%.

Crude oil, understandably, received the most attention in the commodity sell-off given its strong link to the economy. The price of West Texas Intermediate crude dropped by 7.9% for the week to $115.20 a barrel, i.e. a decline of 20.9% since its high on July 11.

Precious metals remained out of favor, with silver down 12.5%, platinum 5.9% and gold bullion 5.6%. The yellow metal dropped to a three-month low, falling below its 200-day moving average. Among base metals, copper declined by 6.9%.

As far as agricultural commodities were concerned, an expected reassurance from the US Department of Agriculture on the outlook for this year's harvest caused corn to nosedive 11.8%, soyabeans 12.0% and wheat 2.8%.

The chart below shows the past week's damage for the various commodities.

Source: StockCharts.com

Now for a few news items and some words and charts from the investment wise that will hopefully assist with our preparation to achieve investment success. It is a prerequisite for success at the Beijing Olympics that athletes be extraordinarily well prepared. Likewise with managing our investments.

Source: Slate

Financial Times: Beijing Olympics in perspective
John Authers discusses the market implications of the Beijing Olympics.

Source: John Authers, Financial Times, August 8, 2008.

Financial Times: A year in a tin hat - one-year anniversary of the credit crunch
FT Alphaville's Paul Murphy narrates a short guide to the 12 months of the credit crunch.

Source: Financial Times, August 5, 2008.

CNBC: Faber says US economy in recession; "long" on dollar
"Investor Marc Faber, publisher of the Gloom, Boom & Doom Report, talks with Bloomberg about the euro's performance against the US dollar, the commodities market and the global economy. The euro fell the most in almost eight years against the dollar as traders pared bets the European Central Bank will raise interest rates as the economy slows."

Source: CNBC, August 8, 2008.

CNBC: Hugh Hendry (Eclectica Asset Management) - the state of the market and opportunities

Source: CNBC, August 1, 2008.

GaveKal: Investment environment is starting to improve
"... is this simply a bounce from the extreme levels that we highlighted three weeks ago? Or is the investment environment starting to improve? ... we argue the following:

• Oil prices are rolling over. From their highs in July, crude prices are now down more than -18%. As we see it, this is a sign that the ongoing demand destruction is finally impacting price movements. Most importantly, the short-term pressures of Chinese demand - the biggest driver of the oil rally - are now rapidly abating.

• Policy responses to the credit crunch have helped. To successfully get out of a financial squeeze you need three things: 1) a cheap currency, 2) a positive yield curve, and 3) the recapitalization of bank balance sheets. With surprising speed, all three of these conditions are now being met in the US. Yesterday, the Fed decided to keep rates at 2%, giving no outright signal for imminent hikes. As such, the yield curve is poised to stay positive, giving banks more time to rebuild their balance sheets. While we believe the Fed's next move will be a hike, this will not happen for a while.

• OECD inflationary pressures are abating. Given that a) the Fed has kept monetary aggregates in check, b) banks have severely curtailed their lending, and c) the US current account deficit - an important source of global liquidity is now narrowing, rising inflationary pressures around the world seem unlikely.

• Parts of the US economy are being boosted by the weak US$. Even though the US$ has gained some footing in recent weeks, it is still down some -12% since December 31, 2006. As can be expected, this has sparked record exports, which, in turn, have boosted US manufacturing activity. This development is likely to keep the US from falling into a recession.

"So the investment environment is not that dire. In fact, away from the massive volatility prevalent in the financials and commodity space (which together seem to account for almost 50% or more of most indices, and volumes traded), other sectors (technology, healthcare, staples ...) are holding their own. At this juncture, we reiterate our belief that it makes more sense to focus on these forgotten parts of the market and resist the urges to call tops, or bottoms, in the overcrowded financial and commodity spaces."

Source: GaveKal - Checking the Boxes, August 6, 2008.

Bloomberg: Global economy "close" to recession in 2009, UBS says
"The world economy is 'precariously close' to a recession in 2009, UBS said as it cut next year's global growth forecast due to a US slowdown.

"Global gross domestic product will expand 2.9% next year, from an earlier prediction of 3.1%, UBS chief economist Larry Hatheway wrote in a report published yesterday. UBS considers a 2.5% global growth rate as one that is consistent with a recession.

"A global recession would be the first since 2001-2002, and may ease inflation that's already projected by the International Monetary Fund to be the fastest in nine years.

"'Softer global economic activity for longer suggests peaking and then declining inflation,' Hatheway said. 'A sustainable recovery of 'risk' assets probably requires policy recognition that the primary macroeconomic challenge remains weak growth, not temporarily high inflation.'

"The Fed will cut interest rates by a further half percentage point this year, from the current 2% rate, UBS predicts. The ECB and the Bank of England will probably lower borrowing costs next year, Hatheway said."

Source: Shamim Adam, Bloomberg, August 7, 2008.

Financial Times: UBS's George Magnus - downturn could hit developing countries
"George Magnus, senior economic advisor of UBS, talks about the impact of the credit crunch on companies and nations. He believes there will be low growth up to and beyond 2010 and the slowdown will hit emerging markets as well as rich nations."

Source: Financial Times, August 8, 2008.

CNBC: The frugal future
Thoughts on the future of the economy, with David Rosenberg, Merrill Lynch North American economist.

Source: CNBC, August 6, 2008.

Bloomberg: Mobius says Fed should cut rates to 1% to boost economy
Mark Mobius, executive chairman of Templeton Asset Management, talks with Bloomberg about Federal Reserve monetary policy, oil prices and investment opportunities in emerging markets.

Source: Bloomberg, August 5, 2008.

BCA Research: US Manufacturing - global weakness adds to domestic drag
"The July ISM manufacturing survey showed further softening in already weak domestic demand, while a slowing in overseas growth presents a new headwind.

"Global leading economic indicators have rolled over, implying that slower overseas growth will diminish one of the key sources of support for US manufacturers. The July ISM manufacturing survey reported a drop in export orders (albeit the index is still well above its boom/bust line). A slowdown in exports is worrisome because this sector had been the primary source of growth for manufacturers in the past year, as the domestic economy is mired in recession.

"The only silver lining is that energy prices have finally begun to recede. Although oil prices will have to move substantially lower before having a significant economic impact, energy price relief will help to ease pressure on profit margins and lower inflation expectations.

"Bottom line: The overall manufacturing sector will continue to grow at a sub-par pace, and the risks will stay on the downside until the consumer retrenchment is further advanced and/or much more relief from commodity prices arrives."

Source: BCA Research, August 5, 2008.

Asha Bangalore (Northern Trust): Fed policy statement is marginally dovish
"The Fed left the Federal funds rate unchanged at 2.0%, no surprises here. President Fisher dissented; he would have preferred a higher Federal funds rate. The committee included one new member, Governor Elizabeth Duke, who voted in favor of holding the federal funds rate unchanged.

"The Fed retained most of the June 25 statement but rearranged the order of sentences and made subtle but important changes. First, the phrase 'downside risks to economic growth remain but they appear to have diminished somewhat' is missing. Also, in place of 'economic activity continues to expand,' the latest statement notes that 'economic activity expanded in the second quarter'. These changes with regard to growth suggest that the FOMC is less optimistic about economic growth.

"Second, the more hawkish part of the June 25 statement - 'the upside risks to inflation and inflation expectations have increased' is eliminated entirely. The recent reduction in energy and commodity prices is captured by the phrase 'earlier increases in prices of energy and some other commodities' as opposed to 'continued increases in prices of energy and some other commodities', which suggest that the FOMC views recent downward movements in energy prices as meaningful."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 5, 2008.

Bill King (The King Report): Adjusted Monetary Base continues surge
"The 'Adjusted Monetary Base' as calculated by the St. Louis Fed continues its near-vertical surge."

Source: Bill King, The King Report, August 8, 2008.

Asha Bangalore (Northern Trust): Pending Home Sales Index moves up
"The Pending Home Sales Index (PHSI) of the National Association of Realtors increased 5.3 points to 89.0 in June. According to the National Association of Realtors, the PHSI leads sales of existing home sales by one or two months. Based on this, sales of existing homes should show gains in the July-August period."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 7, 2008.

Asha Bangalore (Northern Trust): Credit crunch and weak employment conditions continue to weigh on housing market
"The Mortgage Bankers Association's Mortgage Purchase Index rose to 315.2 during the week ended August 2 from 309.5 in the prior week. According to the Mortgage Bankers Association, FHA loans accounted for a large part of the increase in the index, while applications for conventional mortgage loans declined.

"Sales reports of existing and new home for June contained faint signs of a housing market mending but additional support from a pickup in hiring and willingness of banks to lend money will be necessary for stability in the housing market."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 6, 2008.

Asha Bangalore (Northern Trust): Outlook for consumer spending remains gloomy
"Nominal consumer spending increased 0.6% in June, following a 0.8% jump in May. These headlines overstate the strength in consumer spending. After adjusting for inflation, consumer spending fell 0.2% in June after a 0.3% increase in May. On a year-to-year basis, consumer spending showed to a 1.2% increase in June, the smallest gain since October 2002.

"Given the weakness in labor market conditions and the absence of the one-off tax rebate check, consumer spending will most likely decline in the third quarter.

"Personal income increased 0.1% in June after a 1.8% gain in May. The difference in growth of personal income reflects the impact of the Economic Stimulus Act of 2008. Excluding the impact of tax rebates, personal income increased 0.3% in June, following a 0.4% jump in May.

"The overall personal consumption expenditure price index moved up 0.8% in June, putting the year-to-year increase at 4.1%."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 4, 2008.

CNBC: Freddie's forecast seems a little too bright
"I came away from the Freddie Mac conference call feeling a little, shall we say nicely, confused.

"The CEO, Richard Syron, warned of the troubled times in housing, even revised his forecast for home price drops, peak to trough, from 15% to 18-20%. He said we're only halfway through the correction.

"But then one of his underlings went on to assure everyone that Freddie would be able to withstand $40 billion worth of credit pain through 2009 (if it finishes raising that $5.5 billion it promised). He also talked about how they may reverse some of the previously estimated losses as the portfolio does better than expected.

"Here's the issue: write-downs. Unless you've been trapped under something heavy for the past year, you probably know that this is the crux of the credit crash. Wall Street has been writing down the value of all these mortgage-backed securities, as foreclosures and defaults rise on home loans and prices continue to fall. That has taken billions and billions of dollars off the nation's corporate balance sheets and caused the collapse of the likes of Bear Stearns and many many others.

"Freddie, in the second quarter, wrote down the value of its subprime and Alt-A portfolio by $1 billion. Freddie is claiming that they can hold these securities to maturity and not have to take a loss, because over time, the dire predictions of defaults on these loans just won't come to pass. Freddie's subprime and Alt-A portfolio is about $130 billion. Think of that. Just $1 billion in writedowns.

"I think Armando Falcon, a former head of OFHEO, said it best when I interviewed him yesterday:

"'They've only written them down by let's say five or 6% total over the past few quarters. If those were sold on the market they would get maybe 50 cents on the dollar for these securities. At some point they can't delay the inevitable about having to mark these assets down to their true market value. They are now holding them close to book value, based on the theory that these are temporary impairments. As the market continues to decline into next year, it will be clear that these aren't just temporary impairments. Then the government will not be able to allow this forbearance on recognizing losses much longer.'"

Source: Diana Olick, CNBC, August 6, 2008.

The Wall Street Journal: S&P email - "We should not be rating it"
"Some of the most strongly worded emails from analysts questioning their own ratings came from S&P, according to a draft version of the 38-page report, which includes the firms and was reviewed by The Wall Street Journal. The unit of McGraw-Hill is the largest bond-rating firm by revenue.

"In one email, an S&P analytical staffer emailed another that a mortgage or structured-finance deal was 'ridiculous' and that 'we should not be rating it'. The other S&P staffer replied that 'we rate every deal', adding that 'it could be structured by cows and we would rate it'.

"Meanwhile, an analytical manager in the collateralized debt obligations group at S&P told a senior analytical manager in a separate email that 'rating agencies continue to create' an 'even bigger monster - the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters. ;O)'"

Source: Aaron Lucchetti, The Wall Street Journal, August 2, 2008.

Bloomberg: Morgan Stanley said to freeze client home-equity credit lines
"Morgan Stanley, the second-biggest US securities firm, told several thousand clients this week that they won't be allowed to withdraw money on their home- equity credit lines, said a person familiar with the situation.

"The action mostly affected clients with properties that have lost value, according to the person, who declined to be identified because the information isn't public. The New York-based investment bank will review home equity lines of credit, or HELOCS, monthly from now on, the person said.

"Wall Street firms including Morgan Stanley are ratcheting back on risks after the collapse of the subprime mortgage market and ensuing credit contraction saddled banks and brokerages with almost $500 billion of writedowns and losses. Consumers fell behind on home-equity credit lines at the fastest pace in two decades in the first quarter, the American Bankers Association reported last month.

"'Consistent with the terms of the HELOC, or home-equity line of credit, Morgan Stanley periodically reassesses client property values and risk profiles,' said Christine Pollak, a Morgan Stanley spokeswoman in New York. 'A segment of clients was recently notified of a change in the status of their home equity line of credit or HELOC due to a change in the value of their property and/or their credit profile.'"

Source: Christine Harper, Bloomberg, August 5, 2008.

The New York Times: Housing lenders fear bigger wave of loan defaults
"The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is quickly building.

"Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults.

"The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12% in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7% in that time.

"While it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two, analysts said."

Source: Vikas Bajaj, The New York Times, August 4, 2008.

John Authers (Financial Times): Emerging market carry trade - unburst bubble?

Click here for the full article.

Source: John Authers, Financial Times, August 6, 2008.

David Fuller (Fullermoney): Stock markets - give the upside benefit of the doubt
"The obviously beneficiaries of weaker oil and a firmer USD are global stock markets. As the USA has been The Rocky Horror Show in terms of concerns, it is now one of the more obvious candidates for a relief (short covering?) rally. Actually, I maintain that the rally commenced in mid-July, but it has struggled recently due to bad economic news and the proximity of technical resistance from the January-March trading band.

"I think it is now getting a second wind and will recover further, provided that banks hold above their initial support levels established by the higher reaction low on 28th and 29th July. A breach of that level would not confirm a resumption of the bear trend but it would be a warning. The banks' performance today is muted, as they have already had a substantial short covering rally.

"Elsewhere, Wall Street shows the steady performance of Transports, where you can see higher reaction lows since January, and the Nasdaq which never broke beneath its January-March lows. The S&P 500 and Dow have bigger mountains to climb but demand has marginally held the upper hand over supply since the climactic low on 15th July. I will give the upside the benefit of the doubt while the 28th and 29th July lows hold.

"A steady to rising Wall Street would represent a tailwind for other stock markets - remember the influential leash-effect. Most of Europe's indices are quite similar, as can see from the DAX, SMI and FTSE 100. Here also, watch the late-July lows. These indices are a long way from breaking their overall downtrends, I know, but these modest recoveries to date should be extended. Remember, that last down leg from mid-May to mid-July was heavily influenced by oil's spike.

"Asian stock markets should get some traction from a positive Wall Street leash effect and lower oil prices. However, the China leash has yet to turn favourable. India has shown the best form recently. Resources markets are currently among the most subdued, as Brazil and Canada were among the last to peak, but they have some of the best long-term fundamentals, despite the correction underway in commodities. Australia is one of the more oversold markets currently and having seen a downside failure this week, should now at least take out the July rally high."

Note - charts in this report were prepared before markets in the US, Canada and Brazil had closed.

Source: David Fuller, Fullermoney, August 8, 2008.

Richard Russell (Dow Theory Letters): A big picture Q&A
"The following is what's haunting me. Please follow my line of reasoning. Lowry's studies over many decades show that bear markets end this way. There's a series of 90% (panic) down-days. In due time there is a final 90% down day, and this indicates total seller-exhaustion. This final 90% down day is quickly followed by a 90% up-day. The 90% up-day indicates that big money believes the selling is finally exhausted. The 90% up-day indicates that money, probably institutional money, has come roaring back into the market to load up on what they believe are bargains.

"So far, we've seen only two 90% downside days since the March high. There should be more, how many more nobody knows.

"Question - Wait, Russell, can't we have a market bottom without any more 90% down-days?

"Answer - The market can do anything. And with the Transports closing yesterday 1075 points above their January 17 low, I'm still not convinced that this a classic, primary bear market. The stubborn refusal by the Transports to confirm the weaker Industrials keeps me wondering.

"Question - If, for the sake of argument, we've been in a severe and deceptive correction rather than a true primary bear market, would the 90% down-days and then a 90% up-day have to occur?

"Answer - Ah, that's the question I've been asking myself all year! I'll repeat - the action of the Transports has me thinking all along that this might not be a true bear market.

"Question - How do you explain the recent strength in the bonds?

"Answer - With the dollar turning stronger and today breaking out powerfully from its base, this could bring in foreign buying of US bonds. Up to now with the steadily weakening dollar, foreigners were worried about buying US bonds. But now the "dollar fear" has evaporated. So maybe we're going back to the old formula of stocks and bonds going up together. And with gold and commodities breaking, there's even more incentive to buy bonds."

Source: Richard Russell, Dow Theory Letters, August 8, 2008.

Barron's: Stocks are cooking on low heat
"Given weak technicals, the durability of the bear-market rally is now in question.

"Investors often ask how we can tell the difference between a bull market and a rally in a bear market. Charting experts will argue many points from choppiness in price action to limited participation in the rally by various sectors of the market.

"I argue that it is all of the above. This confirms that the current rally is of the bear-market variety. And while it can move higher in its current condition, its days are starting to become numbered.

"The phrase 'fits and starts' is a good one to apply to today's market. Each time traditional technical signals fire off short-term buys, the following few days are spent declining. Joy turns to gloom, and then, when it seems really dark, the market kicks into high gear for a super day or two of gains.

"Followers of Elliott Wave analysis are familiar with the term 'impulse wave', which is just a strong price move in the direction of the major trend. It is marked by strong momentum and heavy volume as investors act with conviction. Even in a bear market, investors can sell with conviction - heavy volume and urgency to trade - to create downside impulses.

"In contrast, corrections are marked by lower activity and technical indicators that do not confirm the action. For a bear market, the correction is, of course, to the upside. And we should see diminishing volume as the fuel for the rally - bottom-fishers scooping up cheap stocks and short-sellers covering their bets - is used up.

"That is what is happening in the current marketplace.

"Price action since the July low has certainly not been in a strong trend by any definition. A market in a strong bullish trend does not take two steps forward and one step back to allow weak bulls to buy comfortably at what are seen as reasonable prices. Strong markets take five or 10 steps forward, and that can leave the timid in the dust."

Source: Michael Kahn, Barron's, August 6, 2008.

Bill King (The King Report): Will relief rally last?
"Here's the really big problem for all investors and traders in today's markets: Unless one was operating in 1931, he or she has NEVER experienced what is occurring now.

"As we have noted in past missives, since WWII the Fed instigated recessions when it feared inflation (mostly wages) or excess inventories. The Fed tightened credit and/or increased the cost of credit. When the Fed wanted the recession to end, it cut rates and increased credit. On the fiscal side taxes were cut.

"However, the current situation, recession and the worst financial conditions since The Great Depression, have occurred while the Fed was not only pumping record amounts of credit but was also creating a record number of credit facilities (TAF, TSLF, PBDC).

"Fiscally tax cuts have already been enacted and the deficit is at a record level BEFORE recession has intensified. AND there has been an inordinate amount of socialization and de facto nationalization.

"That's why we asked a couple weeks ago: How do we get out of this mess and get the economy growing given all the fixes, maneuvers and gambits enacted to PREVENT recession and debt contraction?

"The record amount of fixes have rendered the concepts of 'freely traded markets', 'moral hazard' and 'market capitalism' as fantasies. Solons are fighting for the life of the political and financial systems.

"A very astute executive recently informed us that equity prices are extremely important in pricing and garnering credit. You can be sure than solons are keenly aware of this and are acting accordingly.

"Ergo stocks are likely to continue their manic/depressive volatility until an event induces a critical mass of investors and traders to act in a concerted manner.

"The last thing that the Fed should want is for stocks to surge. A large stock market rally will present huge problems later because the Fed, Treasury and solons know that they must administer severe discipline to the markets when they can do so without precipitating an implosion ... PS - A big rally could incite inflation and asset bubbles. And the record US budget deficit and dollar must be addressed at some point.

"Ergo stock market returns are likely to be below trend in the coming quarters, if not years. Bill Gross obliquely addressed this issue yesterday on CNBC when he stated that the Fed cannot worry about 'moral hazard' right now - 'because in a monsoon you have to provide umbrellas'. Mr. Gross didn't get a chance to elaborate on what this means in the future, so we did.

"Several money managers are calling for the Fed to cut rates now that commodities have declined. Of course these managers are getting killed and cling to a hope that another rate cut or two will matter. It won't. When one ex-Bubblevision commentator turned money manager was challenged that rates have little room to be cut, he retorted, 'They can cut to zero.' This is so misguided you have to wonder ...

"The question for stocks becomes 'how long will this relief rally (on the latest crisis and 'fix') last. The post-Bear Stearns crisis relief rally on record Fed credit creation (and vehicles) lasted two months. The ensuing decline on the recessing economy and further bank and GSE woes lasted two months. Will this rally last one or two months? Stay tuned."

Source: Bill King, The King Report, August 6, 2008.

David Rosenberg (Merrill Lynch): Up-days of 300 points are typical of bear markets
"The Dow surged 331 points - moves like that typically take place in bear markets. There have been six of these sessions since the bear market began a year ago; there were absolutely none in the 2002-07 bull market. Keep in mind that there have been 10 days this down-cycle when the Dow closed down 300 points or more. In other words, volatility gains momentum in bear markets.

"Go back to the 2000-02 bear market and you will see much the same thing - there were actually nearly twice as many 300 up-days in that down-phase as there were 300-point losses! And this was in the context of a 38% peak-to trough decline in the DJIA. So, think of what happened yesterday as a characteristic of a bear market, even if the shorts got painfully squeezed - that should not be lost on investors as we go through this oversold technical rally (that has seen the financials soar 30% from the mid-July lows)."

Source: David Rosenberg, Merrill Lynch, August 6, 2008.

Richard Russell (Dow Theory Letters): Dow is running at a net loss
"Some items to be noted. According to this week's Barron's, earnings on the Dow are now a negative 81.34. The Dow is running at a net loss! This means that the price/earnings ratio for the Dow is infinity. Nothing times nothing = nothing.

"It's happened before. For instance, in July 1932 the earnings on the Dow were negative and the P/E for the Dow went to infinity. The Dow in July 1932 sold to a low of 41.22. The Dow started up in July 1932 and continued to 194 in 1937. That was an advance of 373% beginning from a level at which Dow earnings were actually negative or below zero. Could we be there again?

"I'm not saying that we're in for a repeat of the 1932-37 bull market. I'm just saying that occasionally great buying areas occur during times of seemingly disastrous statistics."

Source: Richard Russell, Dow Theory Letters, August 4, 2008.

Richard Russell (Dow Theory Letters): Real estate ETF turning up
"Here's a chart that every home owner (and Wall Streeters) should like. And it's a chart that I haven't seen anywhere else. What you see here is IYR (the exchange traded fund for real estate shares) relative to the S&P 500 Composite.

"First, note that relative strength for IYR turned up in January. Then a dip with a higher low, and most recently a rally toward the April high. If the current rise in relative strength breaks out above the upper horizontal line, the market will be saying 'something GOOD' about real estate and housing. It's getting interesting here, even while most analysts continue to moan and groan about real estate and housing!"

Source: Richard Russell, Dow Theory Letters, August 6, 2008.

John Authers (Financial Times): Impact of falling oil on stocks and currencies
"The slick from the sudden fall in oil prices is spreading. Cheaper oil is good for the economy but investors face a risk of accidents as traders retreat from the expectation that the oil price would continue rising.

"The most obvious casualties are energy stocks. Their share prices indicated that the stock market never believed the highest crude prices were sustainable. From crude's brief dip below $50 a barrel in January last year, until its peak last month, it gained 183.5%. Meanwhile, the S&P 500 energy index of US stocks gained only 43.9%, and the MSCI World energy index rose only 29.7%.

"Yet energy stocks have still fallen more than the underlying oil price. Indeed, they are now in a bear market; S&P's energy index is down 20.5% since it peaked in May, almost two months before the top of the crude market. The MSCI index is off almost 19.7%. The crude price is down only 16.3% from its peak.

"With energy stocks one of the most popular vehicles for hedge funds playing the oil boom, they have sold off disproportionately.

"Another casualty: the big oil-exporting emerging markets that were viewed as a geared play on the commodity boom. Both Brazil's and Russia's stock markets peaked at the same time as global energy stocks. Since then, Brazil's Bovespa is down 24.3%, while the dollar-denominated Russian RTS index has shed 27.3%.

"There is one asset class that conspicuously has not yet joined the list of casualties: oil exporters' currencies.

"Brazil's real has appreciated 4.2% against the dollar since energy stocks peaked in May; and by an astonishing 35.6% since oil was last at $50 a barrel. The rouble has also gained slightly since May, and is up 12.8% against the dollar since January last year. How long can this last?"

Source: John Authers, Financial Times, August 5, 2008.

GaveKal: Standing in way of improving dollar is likely to be painful
"As more investors realize that the US economy may not be in such dire straits after all, we expect the current positive momentum of the US$ to persist. This is all the more true since the US$ remains very cheap on a purchasing parity basis, especially against the euro, and that the US trade balance is now improving rapidly. Standing in the way of this US$ is likely to be very painful ..."

Source: GaveKal - Checking the Boxes, August 8, 2008.

GaveKal: CRB index declining rapidly

Source: GaveKal - Checking the Boxes, August 5, 2008.


Continue to Part II



Prieur du Plessis

Author: Prieur du Plessis

Dr Prieur du Plessis

Dr Prieur du Plessis

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.

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