WordWords from the (Investment) Wise for the Week That Was (Oct 27 - Nov 2, 2008): Part II

By: Prieur du Plessis | Sun, Nov 2, 2008
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Guy Stear (Société Générale): US needs aggressive fiscal package
"An aggressive fiscal expansionary plan in the US after the elections could be the safety-net that capital markets need, argues Guy Stear, credit analyst at Société Générale.

"'Equity markets continue to slide, while credit derivatives have come under significant pressure in the past week, even though the outlook for the financial sector has become marginally better over the past fortnight,' he points out. 'The problem now lies with the non-financial sector.'

"The markets, Mr Stear says, are counting on interest rate cuts to turn the situation around - although these cuts are expected to be relatively short-lived. 'US Fed funds futures are still pricing in hikes from the second half of next year,' he notes.

"'And while lower rates might help the banking system, they arguably might not do much for the non-financial sector, especially if the banks are still cagey about lending. Worries about defaults are mounting as liquidity is strained,' Mr Stear says.

"'So the real solution to this crisis is an aggressive expansionary fiscal package. This looks easier to achieve in the US than it does in Europe, although it will need to wait until after the Presidential elections."

Source: Guy Stear, Société Générale (via Financial Times), October 28, 2008.

Financial Times: Pension fund gap hits $100 billion
"US companies will need to inject more than $100 billion into their pension funds to cover market losses, putting them in a cash squeeze at a time when it is difficult to raise money.

"The cash payment, estimated by several pension industry executives, would be spread over this financial year and next year.

"Companies' pension fund losses - running at an estimated 20% in the year to date - also are expected to alter earnings this year, partly because of accounting changes.

"The 700 largest corporate plans were more than 100% funded at the end of last year, but as of last week that had fallen to about 83%, according to estimates by Mercer, a pension consultant.

"John Erhardt, a principal at Milliman, a consulting firm, said: 'To bring company funds back to 100% funding, companies would need to put in about $50 billion this year and that again next year, for the top 100 funds. You could add another 30% to 40% to that for the rest of the funds.'

"'Earnings will be impacted significantly. The 2008 year-end balance sheet will reflect that.'"

Source: Deborah Brewster, Financial Times, October 29, 2008.

Telegraph: Thousands of hedge funds on brink of failure
"Emmanuel Roman, of GLG Partners, said 25% to 30% of the world's 8,000 hedge funds would disappear 'in a Darwinian process', either going bust or deciding meagre profits are not worth their efforts.

"'This will go down in the history books as one of the greatest fiascos of banking in 100 years,' said Mr Roman, who with Noam Gottesman, co-runs GLG, a former division of Lehman Brothers Holdings with assets of $24 billion. 'There need to be some scapegoats, and the regulators are going to go hunt people. That will be good in the long run.'

"His views were echoed by Professor Nouriel Roubini, a former US Treasury and presidential adviser known for his accurate prediction of financial crises, who estimated that up to 500 hedge funds would fail within months.

"'It's the beginning of the decline of the US financial empire. The Great Depression ended in a massive war. I hope that's not going to happen but it's pretty ugly now,' Prof Roubini said."

Source: Rowena Mason, Telegraph, October 24, 2008.

Bloomberg: Levitt says derivatives necessary, should be regulated
"Former US Securities and Exchange Commission Chairman Arthur Levitt talks with Bloomberg about the importance of credit derivatives to the financial markets and the need for regulation and transparency, and the outlook for executive compensation at financial firms."

Source: Bloomberg, October 29, 2008.

Bespoke: Another double digit move higher
"Today's 10.88% gain in the Dow was the seventh largest one-day percentage gain in the index since 1900. It was also the second 10%+ gain in the last half month (15 days), a feat that has never happened once in the last 100+ years. Below we show the context in which each prior 10%+ gain occurred. While the move in 1987 led to a prolonged rally, the moves in the 1930s proved only to be an opportunity to sell.

"The fact that the Dow is still down 15% this month even with two 10% up days shows just how unhinged this market has become. Over the last fifty trading days, its average daily percentage move on an absolute basis has been 2.78%. The wild swings make the current period the most volatile in terms of one-day moves that we have seen since the early 1930s."

Source: Bespoke, October 28, 2008.

Bespoke: The lost quarter century
"Japan in the 1990s was the original 'lost decade', even though the current decade for the US is now considered the same. But now that the Nikkei 225 is currently trading at its lowest levels since October 1982, it really is the 'lost quarter century' for Japan."

Source: Bespoke, October 27, 2008.

CNBC: Is this the bottom and the turn?
"The Dow gained a massive 11% in Tuesday's trading session. Is this the bottom and the turn? Wilbur Ross, Chairman & CEO of WL Ross & Co., shares his views with CNBC.

Source: CNBC, October 28, 2008.

The New York Times: Forecasters race to call the bottom to the market
"Financial forecasters are in a race to call the bottom to the bear market. And just as on the way up, when analysts competed for attention with their forecasts of bigger and bigger gains, the financial pundit class now seems compelled to out-gloom the next guy.

"'To make a crazy forecast today is not crazy,' said Owen Lamont, a former professor at Yale who has studied economic forecasting. 'It's not crazy to predict the Dow is going to 2,000. That's in the realm of possibility.'

"Indeed, in an era of 1,000-point daily swings in the Dow and 30% losses in the stock market, prescience is at a premium - and the dividends of a high-profile correct call can be immense.

"In 1987, a little-known strategist named Elaine Garzarelli found herself a newly minted celebrity after predicting the market would crash just days before Black Monday. This time around, longtime doomsayers like Nouriel Roubini of New York University have become media staples since many of their most apocalyptic predictions started coming true.

"Even in normal times, forecasters have a strong incentive to make extreme predictions, which is why those 'Dow 1,000!' reports persist. 'It's eye-popping. It's relevant. It seems exciting,' Mr. Lamont said. Such predictions attract publicity, name recognition and a bigger client base in a business where investors pay thousands, if not millions, for stock advice and investment guidance.

"'Anyone that invests 10 cents on the basis of someone's forecast of the Dow is desirous of losing a good portion of their 10 cents,' said William A. Fleckenstein, president of Fleckenstein Capital, a money management firm in Issaquah, Wash. 'It is almost the height of arrogance to say this is where the Dow is going to trade.'

"'These types of forecasts are wildly off-base,' Mr. Fleckenstein said. 'What they're always about is extrapolation. People are always extrapolating recent trends. And you don't know how far the trend is going to really run.'"

Source: Michael M. Grynbaum, The New York Times, October 26, 2008.

David Fuller (Fullermoney): How to identify a stock market low
"How will we know that capitulation selling and deleveraging is mostly over? One sign would be a loss of downside momentum by stock markets beyond the brief pause that we have seen recently. However, I think we may also need to see some weakness in the two main carry trade currencies during recent years - the Japanese yen and US dollar. Their considerable strength since July is the inverse mirror image of asset deleveraging, as people scramble to repay their liabilities in JPY and USD.

"... for evidence of a stock market low, I would look for a loss of downside momentum by share indices, coinciding with a loss of upside momentum for the yen and US dollar. Meanwhile, the proximity of the 2002 bear market lows for the S&P, plus its current downside overextension relative to the moving average (MA), suggest that some mean reversion is overdue. If accompanied by weaker carry trade currencies, we should see a rally towards the declining MA. However if the yen and dollar remain firm, we may only see a ranging reversion towards the declining MA.

"Recently, the S&P paused in its decline following the October 10 low, but remains barely steady near that level. Moreover, stock market indices for most other countries have already broken downwards once again.

"... many people feel that the fundamentals are much worse today than in 2002. They certainly have a point. Therefore, a cautious investor may prefer to wait for evidence of new bull markets before significantly increasing equity exposure. The technical signals would be base formation development followed by breaks above the 200-day MAs, which also turn upwards. I do not know when that will occur but the charts will certainly show us."

Source: David Fuller, Fullermoney, October 28, 2008.

Ian Scott (Nomura): Stocks to bottom soon
"Stock markets should show signs of bottoming out soon, given the robust response of governments and central banks to the financial crisis, believes Ian Scott, equity strategist at Nomura.

"He says with markets behaving as they are, rationalising such extreme movements with economic or corporate fundamentals is virtually impossible.

"'While it is always theoretically possible to invent an economic scenario to justify current prices, the scenario that would now be required necessitates policy failure on a scale not seen since the 1930s.

"'Yet it is hard to imagine a more committed policy response than the one we have had, and there are now some tentative signs that it is having an impact. Stocks should bottom soon.'

"Mr Scott argues that with inflation absent, interest rates are set to come down sharply. 'Although we would bias away from leveraged companies, we would overweight rate-sensitive sectors.

"'Indeed, there is a stark contrast between early-cycle cyclicals - where earnings estimates have been cut, valuations are low and rate cuts will be a benefit - and late-cycle industrials where earnings estimates have barely budged and valuations are high, and which tend to underperform when rates come down.

"'We suggest biasing portfolios in favour of media, retail, real estate and technology and away from capital goods, construction and building materials, leisure, steel and consumer staples.'"

Source: Ian Scott, Nomura (via Financial Times), October 27, 2008.

Eoin Treacy (Fullermoney): Has dollar and yen turned into tailwind for equities
"This week has seen some extremely large moves in the currency markets. Over the last few months, two of the main beneficiaries of the liquidation of carry trades have been the US dollar and especially the Japanese yen. Both of these currencies have rallied in impressive fashion and their strength has been a considerable headwind for commodity and many equity markets. In fact there is a clear correlation between the rally in these currencies and the weakness of emerging market stock indices. The question now is whether this headwind is turning into a tailwind.

"The yen has gone from being one of the weakest currencies in the world to one of the strongest in a very short time. This has seen it advance considerably in a clearly accelerated move which is now under pressure. Although the Yen found a least short-term support today, it needs to sustain moves to significant new highs to question scope for a further retracement of recent gains.

"The dollar also rallied impressively over the last few months and encountered resistance this week. However, the commonality of this move is far less clear cut with the dollar than for the yen. The Dollar Index's rally broke its almost three-year downtrend and forced investors to reassess the medium-term prospects for the currency. It encountered resistance this week near 88, but this is so far an equal sized reaction to that posted in September. It needs to now encounter resistance below 88 and sustain a move below 84 to confirm that it has hit a medium-term peak."

Source: Eoin Treacy, Fullermoney, October 30, 2008.

The New York Times: Are stocks the bargain you think?
"Some of the country's most famous investors, including Warren Buffett and John Bogle, have started to make the case that it's time to dive back into the stock market.

"They are usually careful to add that they don't know what stocks will do in the short term. Yet their basic message is clear enough: stocks are now cheap, irrational fears have been driving the market down lately, and people who buy today will be glad that they did.

"After a day like Tuesday, when the market rose 11%, it's easy to see the merits of the argument.

" there is another argument that deserves more attention than it has gotten so far. It's the bearish argument that is based neither on fears that the country may be sliding into another depression nor on gut-level worries about the unknown. It is based on numbers and history, and it has at least as much claim on reason as the bullish argument does.

"It goes something like this: Stocks are truly cheap only relative to their values over the last 20 years, a period that will go down as one of the great bubbles in history. If you take a longer view, you see that the ratio of stock prices to corporate earnings is only slightly below its long-term average. And in past economic crises - during the 1930s and 1970s - stocks fell well below their long-run average before they turned around.

"To make matters worse, corporate earnings have now started to plunge, too. Assuming that they keep dropping, stocks would also need to fall to keep the price-earnings ratio at its current level.

"The 10-year price-to-earnings ratio tells an incredibly consistent story over the last century. It has averaged about 16 over that time. There have been long periods when it stayed above 16 and even shot above 20, like the 1920s, 1960s and recent years. As recently as last October, when other measures suggested the market was reasonably valued, the Graham-Dodd version of the ratio was a disturbing 27. But periods in which the ratio has jumped above 20 have always been followed by steep declines and at least a decade of poor returns.

"By 1932, the ratio had fallen to 6. In 1982, it was only 7. Then, of course, the market began to self-correct in the other direction, and stocks took off.

"After Tuesday's big rally, the ratio was just a shade below 16, or almost equal to its long-run average. This is a little difficult to swallow, I realize. Stocks are down 40 percent since last October, and every experience from the last 25 years suggests they now have to bounce back.

"But that's precisely the problem. Since the 1980s, stocks have always bounced back from a loss, usually reaching a high in relatively short order. As a result, the market became enormously overvalued.

"As Robert Shiller, the economist who specializes in bubbles, points out, human beings tend to put too much weight on recent experiences. We think the market snapbacks of 1987 and the current decade are more meaningful and more predictive than the long slumps of the 1930s, 1940s and 1970s. Of course, anyone who made the same assumption in 1930 or 1975 - this just has to turn around soon - would have had to wait years and years until the investment paid off."

Source: David Leonhardt, The New York Times, October 28, 2008.

Bespoke: S&P 500 earnings versus valuation matrix
"Even though we're in the midst of earnings season, most investors really have no idea where earnings are going to be in the future. While the consensus forecast for 2009 is currently around $95, there probably isn't a person on the planet who thinks earnings will be anywhere near that high. But how much further below $95 will earnings be, and what multiple do those earnings deserve?

"With that in mind, we created a matrix to show where the S&P 500 would trade based on different combinations of earnings and multiples. Boxes highlighted in red indicate levels within 5% of where the S&P 500 is currently trading. As shown, if (and we realize there is really no chance of this happening) the consensus for 2009 EPS forecasts proves to be accurate, the S&P would currently be trading at about 10 times next year's earnings.

"So where are earnings likely to come in next year? One of the more bearish forecasts making the rounds is that earnings for the S&P 500 will come in at $60 per share next year. If that forecast proves to be accurate, that would bring the current multiple of the S&P 500 to about 15.5 times next year's earnings. While a multiple of 15 is by no means extremely cheap on a historical basis, it is hardly expensive either."

Source: Bespoke, October 29, 2008.

Bespoke: Percentage of stocks above 50-day moving averages
"After this week's 9% rally in the S&P 500 so far, 6% of stocks in the index are trading above their 50-day moving averages. At least it's not at zero, right?

"On a sector basis, 15% of Consumer Staples stocks are trading above their 50-days. And that is the most positive sector. Financials and Utilities rank second at 10%, followed by Health Care at 8%. Materials and Telecom are still unfortunately stuck at zero."

Source: Bespoke, October 30, 2008.

US Global Investors: Investors underweight Chinese equities
"China remains one of the most underweight countries for Asia-focused funds this year. However, given China's solid fundamentals compared with its regional peers, valuation extremes caused by global deleveraging and a potential presidential election rally in the US, sentiment might undergo a short-term improvement."

Source: US Global Investors - Weekly Investor Alert, October 31, 2008.

Ambrose Evans-Pritchard (Telegraph): Europe on the brink of currency crisis meltdown
"The financial crisis spreading like wildfire across the former Soviet bloc threatens to set off a second and more dangerous banking crisis in Western Europe, tipping the whole Continent into a fully-fledged economic slump.

"Currency pegs are being tested to destruction on the fringes of Europe's monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.

"'This is the biggest currency crisis the world has ever seen,' said Neil Mellor, a strategist at Bank of New York Mellon.

"Experts fear the mayhem may soon trigger a chain reaction within the eurozone itself. The risk is a surge in capital flight from Austria - the country, as it happens, that set off the global banking collapse of May 1931 when Credit-Anstalt went down - and from a string of Club Med countries that rely on foreign funding to cover huge current account deficits.

"The latest data from the Bank for International Settlements shows that Western European banks hold almost all the exposure to the emerging market bubble, now busting with spectacular effect.

"They account for three-quarters of the total $4.7 trillion in cross-border bank loans to Eastern Europe, Latin America and emerging Asia extended during the global credit boom - a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles.

"Austria's bank exposure to emerging markets is equal to 85% of GDP - with a heavy concentration in Hungary, Ukraine, and Serbia - all now queuing up (with Belarus) for rescue packages from the International Monetary Fund.

"Exposure is 50% of GDP for Switzerland, 25% for Sweden, 24% for the UK, and 23% for Spain. The US figure is just 4%. America is the staid old lady in this drama."

Source: Ambrose Evans-Pritchard, Telegraph, October 26, 2008.

BCA Research: Currency strategy after panic subsides
"Given the extreme volatility in the market, it remains too early to make large currency bets. Once the panic subsides and financial stress eases, our strategy will have three pillars.

"First, the euro and pound will be 'trading buys' against the dollar and yen, but no more than that. The European economies and financial systems will be soggy for some time, and their central banks are still behind the curve.

"Second, the trade-weighted dollar is close to a three-year high, which will not make economic sense even after the US economy and banking system turn the corner. Most likely, the dollar will lose ground against emerging and commodity currencies with good fundamentals, but will hold its own against the euro.

"Finally, the yen is a tougher call and we recommend standing aside. On economic grounds, the currency is a sell the minute that investor risk aversion peaks. However, the Japanese balance of payments warns that policymakers would have to knock down the yen. The private sector has been burned on foreign investments too often, and any renewed Japanese 'stretch for yield' will be moderated by interest rate cuts around the globe."

Source: BCA Research, October 29, 2008.

BCA Research: Approval for yen intervention
"The G7 statement over the weekend gives Japan's Ministry of Finance the latitude to intervene and slow the yen's appreciation.

"The G7 made a rare unscheduled statement on currency market movements earlier. The statement comes as the trade-weighted Japanese yen rallied to an 8-year high last week. It has recently become clear that many leveraged trades were financed with borrowed yen, and unwinding of these positions has sent the currency surging. The yen is up over 22% since August, which effectively destroys exporters' profit forecasts and threatens to destabilize global markets.

"To that end, the G7 issued the following comments: "We reaffirm our shared interest in a strong and stable international financial system. We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability. We continue to monitor markets closely, and cooperate as appropriate."

"Bottom line: If this 'verbal intervention' does not slow the accent of the yen in the coming days, expect the Bank of Japan (acting as an agent of the Ministry of Finance) to intervene in markets and purchase yen. Still, while the medium-term effect may be positive, the immediate impact will be limited unless there are coordinated efforts on behalf of all G7 nations. For now, this outcome seems highly unlikely."

Source: BCA Research, October 28, 2008.

Bloomberg: Jim Rogers - commodities in a recession

Source: Bloomberg (via Clip Syndicate), October 24, 2008.

Richard Russell (Dow Theory Letters): Gold attempting to make a bottom
"Let's take a hard look at gold. It's severely oversold. From October 9 to 23 gold declined on a closing basis 8 out of 10 sessions or 80% of the time. That alone spelled oversold. Note the long 'stems' on the first red arrow. These stems denote rejection of the downside. The blue histograms are beginning to pull back towards zero. Finally, the full stochastics are in oversold territory and are now starting to turn up. Conclusion - gold may now be attempting to establish a bottom."

Source: Richard Russell, Dow Theory Letters, October 27, 2008.

Financial Times: Trichet says ECB may cut rates
"The European Central Bank could cut interest rates again at its next meeting on November 6, ECB president Jean-Claude Trichet said on Monday.

"'I consider possible that the governing council will decrease interest rates once again at its next meeting on November 6. It is not a certainty, it is a possibility,' Trichet said in a speech at a banking conference in Madrid.

"'New information is likely to indicate a further alleviation to upside risks to inflation in the medium term.'

"The ECB cut rates by 50 basis points in tandem with other central banks on October 8 and economists had already forecast further loosening by the end of the year as both growth and inflation cool.

"Mr Trichet said weakening economic growth was easing inflation fears but stressed that the ECB would only ease rates further from the current 3.75% if it felt the inflation outlook justified such a move.

"'Any new monetary policy stance that we could decide on at our next regular monetary policy meeting must continue to allow us to tell our 320 million fellow citizens: You can be confident. We will deliver price stability in line with our definition of less than but close to 2% in the medium term,' Mr Trichet said."

Source: Financial Times, October 27, 2008.

Reuters: Germany to spend and fight recession
"Germany say they may spend billions of dollars to bolster the economy in a bid to stave off a deep global recession."

Source: Reuters, October 30, 2008.

Victoria Marklew: (Northern Trust): Deteriorating outlook in Germany and the Eurozone
"Last week's PMI surveys for the Eurozone and for its various countries warned that the outlook for Q4 is deteriorating sharply. To date, the strongest of the major Eurozone economies clearly has been Germany, which may actually escape a technical recession if consumer demand keeps Q3 real GDP growth in positive territory. However, today's October Ifo business climate index for Germany - a poll of around 7,000 firms from this key exporting nation - deteriorated for the fifth consecutive month... Last week's PMI surveys from Germany also painted a very gloomy picture, with the manufacturing new orders index dropping to 39.3, the lowest since the series began in 1996, and business expectations in the services sector dropping to 34.3, the lowest since that series began in 1997."

Source: Victoria Marklew, Northern Trust - Daily Global Commentary, October 27, 2008 and Ifo, October 2008.

Nationwide: Twelve months of house price falls
"House prices in the UK fell for the twelfth consecutive month in October. The price of a typical house is now 14.6% lower than at this time last year, the peak of the market. The typical house price fell by 1.4% in October, around the same rate as the average monthly fall of 1.3% over the last year, but lower than the monthly falls recorded in each of the previous three months. The price of a typical house is now £158,872, almost £30,000 less than a year ago, but to put in context, still almost £30,000 more than five years ago."

Click here for the full report.

Source: Nationwide, October 30, 2008.

Financial Times: Japan unveils economic stimulus package
"Taro Aso, Japan's prime minister, on Thursday unveiled a $50.8 billion economic stimulus package, the second in two months, warning of the damaging impact the global credit crisis would have on the world's second largest economy.

"'A storm that comes once in 100 years is raging,' Mr Aso said of the global financial turmoil.

"While Japan's financial system remained sound, he said, there was no doubt that the global crisis would affect Japan's real economy. He promised to act quickly to implement bold measures to counter the downturn.

"The stimulus plan follows the passing of a supplementary budget earlier this month to fund Japan's first stimulus package this year."

Source: Michiyo Nakamoto, Financial Times, October 30, 2008.

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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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