Words from the (Investment) Wise for the Week That Was (March 9 - 15, 2009)

By: Prieur du Plessis | Sun, Mar 15, 2009
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Global stock markets surged over the past four days as investors adopted a more positive view of the prospects for the beleaguered financial sector and shrugged aside gloom about the economy. Citigroup (C) on Tuesday said it had turned a profit from operations for January and February (BUT did not mention credit losses, toxic paper, derivatives, etc.). JPMorgan (JPM) and Bank of America (BAC) later made similar comments.

A positive shift in investor sentiment, together with the possibility of the suspension of mark-to-market accounting and the reinstitution of the uptick rule, resulted in the best week for equities since November.

Arriving in time for my 54th birthday today, the reversal of fortune is illustrated by the strong gains of the MSCI World Index (+9.8%) and the MSCI Emerging Markets Index (+8.8%) since Tuesday. Although stashed (or "panic") cash was deployed, the top-performing stocks were the most pummeled ones of the past few months, indicating significant short-covering.

Extremely oversold markets bounced off levels last seen 12 years ago in the case of the S&P 500 Index and the FTSE Eurofirst 300 Index, and 26 years ago as far as the Nikkei 225 Average is concerned. Talking about being oversold, the Dow Jones Industrial Index has been down for 13 of the past 16 months.

As shown in the table below, the major US indices gained strongly during the week, recording only the second up-week out of ten in 2009.

As far as exchange-traded funds (ETF) are concerned, John Nyaradi (Wall Street Sector Selector) reports that the battered financial sector last week rose like the legendary Phoenix with the Financial Select Sector SPDR (XLF) surging by 32.5%. ETFs like iShares Regional Banks (IAT) (+31.1%) and SPDR S&P Homebuilders (XHB) (+19.8%) also recorded handsome gains. Interestingly, the broad financial sector was the only main US economic sector to beat the top-performing broad index ETF, the Russell 2000 (IWM), which added "only" 11.9% on the week.

Source: StockCharts.com

The fact that government bonds had not been sold off during the equity rally indicates that some "side-lined" cash was deployed to fund the buy orders. The amount of cash hoarded over the past few months as a result of precautionary savings and deleveraging is enormous, as seen from the fact that money-market and savings accounts constitute more than 90% of the market capitalization of the Wilshire 5000 Index. (Hat tip: Todd Sullivan, Value Plays.)

Still on the topic of government bonds, according to CEP News, Chinese Premier Wen Jiabao said on Friday that China was growing "worried" about the safety of US Treasuries and wanted assurances from the United States. "I request the US to maintain its good credit, to honour its promises and to guarantee the safety of China's assets," he said, voicing concerns over the state of the American economy. This is not good news for the massive issuance of US government bonds that lies ahead.

UK government bond prices surged to record levels as the Bank of England launched its £75 billion program of buying securities to expand the money supply. The yield of the ten-year Gilt plunged by 40 basis points to close at 2.95% after having touched 2.91% earlier - its lowest level ever.

The US dollar lost ground as the rally in global equities kept the greenback in check and was further undermined by Wen Jiabao's comments about China's dollar reserves. However, the announcement by the Swiss National Bank to intervene by devaluing the Swiss franc dominated news in the currency markets. This step was a strong signal of the severity of the global recession and knocked the Swiss franc back by 2.5% against the US dollar and 4.7% against the euro (see chart below) on the week.

Source: StockCharts.com

Commenting on the SNB's decision, Bill King (The King Report) said: "This is the dangerous aspect of the game - competitive currency debasement and 'beggar-thy-neighbor' trade policies. Tariffs and other trade barriers usually result. So trade diminishes but inflation jumps. Once the monetization card is played, the market must commence a watch for extraordinary inflation."

The SNB's move provided support for the gold price (although still down by 1.3% on the week) as more hedge funds are turning to the yellow metal. David Einhorn of hedge fund Greenlight Capital wrote in a recent letter to his investors (as quoted in the Financial Times): "Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself."

On the credit front, the TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) is showing renewed stress as it has widened by 20 basis points since February 10 (also see "Credit market conditions - an update"). However, a graph of the US Depository Institutions Aggregate Excess Reserves (shown below) makes for interesting reading. Although the level of reserves is still far in excess of the amount banks need to keep on deposit to meet their requirements, the decline in this measure could be indicating a turning point in the recovery of banks. But the speed of the recovery, needless to say, remains unknown.

Source: Fullermoney

Next, a quick textual analysis of my week's reading. No surprises here as the picture is almost identical to that of last week with key words such as "bank", "financial" and "market" still featuring prominently. "Gold" seems to be on the ascent.

The stock market "internals", or market breadth, like the up/down volume spread, the advance/decline spread and new highs/lows have improved dramatically over the past few days and auger well for the nascent rally. Yet, the market still needs to do a considerable amount of work before evidence of a primary bear market low will be demonstrated. As a first step, the indices must clear their respective 50-day moving averages, i.e. the S&P 500 and Dow Industrials need to rise by 7.4% and 8.3% respectively.

I will soon have the privilege to meet face-to-face with Richard Russell (Dow Theory Letters) again at the time of his Tribute Dinner in San Diego on April 4, when he will undoubtedly share his market wisdom. Meanwhile, he commented as follows yesterday: "So where are we now? Over the last few weeks the market has become drastically oversold - at the same time investors' sentiment has grown progressively more bearish. Furthermore, since September 2008 we have experienced an amazing twenty-one 90% down-days, which may have exhausted the urge by big investors to sell.

"By the way, yesterday [Thursday] was a 90% up-day, the second of this week. This action strengthens the thesis that this advance has further to go.

"... are we now in a new-born bull market, or is this an upward correction in an oversold bear market? ... on the basis of duration and values, I believe we are experiencing a significant upward correction in an ongoing bear market.

"How far might this rally carry? Every movement in the stock market, minor, secondary or primary, is eventually corrected. Upward corrections in bear markets tend to recoup one-third to two-thirds of the ground lost in the preceding down-leg. The bear market will do whatever it has to relieve its oversold condition and at the same time lure the greatest number of investors back into its folds."

On the topic of rally "targets", Adam Hewitson of INO.com prepared a few slides dealing specifically with key levels. Click here to access the presentation.

Not putting his faith in further upside potential, Bennet Sedacca (Atlantic Advisors) said on Friday: "We are taking profits after the recent 13% move in equities. The macro-economic view is just too negative for me. It never, ever hurts to take a profit. We are back to 0% equities." Sedacca's price target for the S&P 500 is in the 350-400 range, which is a decline of 47-54% from current levels. He sees the ultimate low only by October 2010.

Using rolling ten-year reported earnings, my research (based on Robert Shiller's CAPE methodology) shows that the "normalized" price-earnings ratio of the S&P 500 Index is currently 12.6. This compares with a long-term average of just more than 15. Based on the historical PE/return patterns, this would imply average ten-year real returns off these levels in the order of 8% (see graph below). Although, at index level, this may not grab one as bargain basement returns, it certainly is starting to point to a broad area within which opportunities should arise for the judicious stock picker.

The debate on whether stock markets are witnessing A bottom or THE bottom will take a while longer to resolve. Taking one step at a time, it is quite conceivable that the rally may last until the release of potentially ugly earnings and guidance announcements in April, by when a clearer picture should emerge on whether the bottom has been reached or yet lower levels are in store.

For more discussion about the direction of stock markets, also see my recent posts "Stock markets: Relief rally or new bull?", "Technical talk: S&P 500 up against resistance levels", "Video-o-rama: Stock markets - turnaround time" and "Jeremy Grantham: Reinvesting when terrified". (And do make a point of listening to Donald Coxe's webcast of Friday, which can be accessed from the sidebar of the Investment Postcards site.)

"Global business confidence ... remains very near the record low that has prevailed since last November. Sentiment is eerily weak across the entire globe and all industries. Oddly, US business confidence, while very poor, seems a bit better than anywhere else," said the latest Survey of Business Confidence of the World conducted by Moody's Economy.com. "Most worrisome is the recent collapse in pricing power; a record over one-third of respondents now say they are cutting prices for their goods and services."

Source: Moody's Economy.com, March 9, 2009.

European Central Bank member Jürgen Stark said the world economy is in its deepest slump since the Second World War and that it was difficult to predict when it would end, as reported by CEP News.

Also, analysts at JPMorgan note (via the Financial Times) that 30 out of the 35 countries they cover saw activity contracting at the end of last year, with those economies most linked to global trade flows, rather than those at the root of the financial crisis, hit hardest.

Grim trade data from China also spooked economists. The country's trade surplus plunged to $4.8 billion in February, about an eighth of the amount in the previous month, as exports tumbled by 25.7% from a year earlier and imports fell by 24.1%. According to CEP News, Premier Wen Jiabao was quick to add that China remained firm in its commitment to deliver an annual 8% growth rate for 2009 and had "adequate ammunition" to "introduce new stimulus policies".

A snapshot of the week's US economic data is provided below. (Click on the dates to see Northern Trust's assessment of the various data releases.)

March 13, 2009
• Despite impressive improvement in nominal terms, real trade deficit will be a drag on Q1 GDP

March 12, 2009
• Household net worth recorded historical plunge
• Consumer spending - less pronounced weakness in Q1
• Inventories-sales ratio holds steady in January
• Labor market remains mired in a recession

March 11, 2009
• Credit market conditions - renewed stress

March 10, 2009
• Bernanke sketched out financial reform agenda to "address systemic risk"
• Wholesale trade report - significant drop in demand
• NFIB Survey shows small business optimism at lowest point since 1980

Commenting on the better-than-expected retail sales data and the issue of whether the US consumer could prove more resilient than feared, Asha Bangalore (Northern Trust) said: "The important question is if this pace of gains in retail sales will prevail in an environment where employment conditions are abysmal. The dire employment situation persuades us to forecast weakness in consumer spending in the near term."

Also jeopardizing the consumer's firepower is a sharp decline in household net worth, falling by $5.1 trillion in the fourth quarter of 2008 for an annual decline of $11.2 trillion - slightly below the mark seen in 2004. "Net worth of households has declined and their debt levels have grown noticeably slowly in 2008. But, the sharp drop in net worth has led to a debt-to-net worth ratio for households that is alarming," said Bangalore.

Week's economic reports
Click here for the week's economy in pictures, courtesy of Jake of EconomPic Data.

Date Time (ET) Statistic For Actual Briefing Forecast Market Expects Prior
Mar 10 10:00 AM Wholesale Inventories Jan -0.7% -1.1% -1.0% -1.5%
Mar 11 10:30 AM Crude Inventories 03/06 +749K NA NA -757K
Mar 11 2:00 PM Treasury Budget Feb -$192.8B NA -$205B -$175.6B
Mar 12 8:30 AM Initial Claims 03/07 654K 640K 644K 645K
Mar 12 8:30 AM Retail Sales Feb -0.1% -0.3% -0.5% 1.8%
Mar 12 8:30 AM Retail Sales ex-auto Feb 0.7% -0.1% -0.1% 1.6%
Mar 12 10:00 AM Business Inventories Jan -1.1% -1.1% -1.0% -1.6%
Mar 13 8:30 AM Export Prices ex-agriculture Feb 0.1% NA NA 0.1%
Mar 13 8:30 AM Import Prices ex-oil Feb -0.6% NA NA -0.8%
Mar 13 8:30 AM Trade Balance Jan -$36.0B -$37.5B -$38.0B -$39.9B
Mar 13 10:00 AM Michigan Sentiment(prelim) Mar 56.6 56.5 55.0 56.3
Source: Yahoo Finance, March 13, 2009.

In addition to interest rate announcements by the Bank of Japan (Tuesday, March 17) and the Federal Open Market Committee (Wednesday, March 18), the US economic highlights for the week include the following:

Source: Northern Trust

Click the links below for the following reports:

Wachovia's Weekly US Economic & Financial Commentary (March 13, 2009)

Wachovia's Monthly Economic Outlook (March 2009)

Wachovia's Global Chartbook (March 2009)

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, March 13, 2009.

People calculate too much and think too little," said Charlie Munger (hat tip: Harry Newton). It is hoped the "Words from the Wise" reviews will provide Investment Postcards readers with the necessary material to stimulate the thinking process and add structure to their investment decisions.

That's the way it looks from Cape Town (where friends are arriving for my birthday celebrations).

Hat tip: Barry Ritholtz, The Big Picture, March 13, 2009.

Richard Russell (Dow Theory Letters): Amazing facts in the new world
"The true deficit of the federal government is a $65.5 trillion in total obligations. This exceeds the gross domestic product of the entire world.

"Empty houses in the US now number about 14 million or one in nine homes.

"At the forum in Davos, it was revealed the 40% of the world's wealth has been destroyed by the financial crisis so far.

"The International Labor Organization now estimates that global unemployment in 2009 could increase to 198 million or 230 million in the worst case scenario.

"In short, the biggest bubble of them all - that the US dollar is 'money' - is about to pop. The US dollar is on the path to the fiat currency graveyard, and will soon get there."

Source: Richard Russell, Dow Theory Letters, March 10, 2009.

CNBC: Warren Buffett - billionaire next door
"Thoughts on the steps needed for economic recovery, with Warren Buffett, Berkshire Hathaway chairman/CEO."

Source: CNBC, March 9, 2009.

CEP News: Buffett says "everything will be all right"
"Even though the US economy has 'fallen off a cliff', and unemployment is likely to climb higher, billionaire Warren Buffett remains optimistic about the long term, he told CNBC on Monday.

"'Everything will be all right', he said. 'We do have the greatest economic machine that man has ever created.'

"However, Buffett, who runs Berkshire Hathaway, said fear and uncertainty have taken hold of investor behaviour, which now requires strong leadership from President Barack Obama as the US fights an economic war.

'What is required is a commander in chief that's looked at like a commander in chief in a time of war,' Buffett said, adding that the President needs to restore faith in the financial system, letting American know their money is safe, even in the event of another bank failure.

"'If you don't trust where you have your money, the world stops,' he told CNBC.

"Buffett said that Americans need to accept that government actions aimed at helping the economy will inevitably help some people who made poor decisions that contributed to the problem in the first place. However, everyone is in the same boat now, he said.

"'The people that behaved well are no doubt going to find themselves taking care of the people who didn't behave well,' he said."

Source: CEP News, March 9, 2009.

CEP News: ECB's Stark says global economy in deepest slump since WWII
"European Central Bank member Jürgen Stark said the world economy is in its deepest slump since the Second World War and said that it is difficult to predict when it will end.

"'The year 2009 will be a very difficult year,' Stark said at the fifth German-Luxembourgish Economic Conference in Luxembourg on Monday. 'Policy makers need to prevent a further deterioration in economic and financial conditions.'

"However, central banks alone cannot solve the crisis, Stark said, adding that measures to restructure and recapitalize the banking sector are also needed. '(This year) will be the year of adjustments in the balance sheets of banks, firms and private households,' Stark said.

"Stark also said that rate reductions alone would not bring an end to the crisis and that rates at too low a level could be counterproductive.

"'(Low rates) have the potential to weaken the incentives for banks to clean up their balance sheet of troubled assets and monitor their credit risk carefully,' Stark said, echoing comments made previously to a Luxembourg newspaper over the weekend.

"He also said that while the ECB has room to cut its policy rate further, there is a limit to every policy and that the ECB's key policy rate at 1.50% is already 'very low'.

"Stark added that current measures taken by the central bank, including the expansion of its balance sheet and accepting corporate loans as collateral, are already unconventional and that there are limits regarding these measures as well."

Source: CEP News, March 9, 2009.

Financial Times: Economic outlook - fears for industrial output
"The worldwide crisis in financial markets and the deepening global economic recession are feeding off each other furiously in spite of governments slashing interest rates and ramping up public spending in their efforts to stave off a prolonged depression.

"Analysts at JPMorgan note that 30 out of the 35 countries they cover saw activity contracting at the end of last year, with those economies most linked to global trade flows, rather than those at the root of the financial crisis, hit hardest.

"Meanwhile, the threat to the health of the banking system from the credit crunch has not abated.

"While banks have been applying more stringent lending criteria to new loans, in the eurozone companies have been able to draw down on existing credit lines so year-on-year growth in corporate lending has remained 'strikingly robust', according to UBS.

"Nick Davey at UBS says corporate credit remains a major threat to the health of the eurozone banking sector. He says credit lines agreed pre-crisis are likely to have been inadequately priced for the current severe economic recession and that banks will face a significant rise in corporate defaults in 2009."

Source: Chris Flood, Financial Times, March 8, 2009.

The Wall Street Journal: New fears as credit markets tighten
"The credit markets are seizing up again amid new anxieties about the global financial system.

"The fear and uncertainty that sent stocks to 12-year lows is now roiling the market for corporate bonds and loans, which have given back much of the gains they chalked up earlier in the year.

"Short-term credit markets are still performing better than they did last year thanks to government programs to buy commercial paper and guarantee short-term debt. But Libor, the London interbank offered rate, a common benchmark interest rate, has crept up over the past weeks, from 1.1% in mid-January to 1.3% on Friday, reflecting banks' concerns about being paid back for even short-term loans. It is still well below its peak of 4.8% last October.

"This time around, the economy is slipping deeper into a recession, and bond investors worry the government's repeated modifications to its financial-rescue packages are undermining the very foundations of bond investing: the right of creditors to claim their assets first if a borrower defaults. Without this assurance, bonds of even the most stalwart institutions are much riskier to own.

"After what seemed like the beginning of a thawing of debt markets early in the year, sentiment has deteriorated, analysts say. The markets remain open only to the strongest companies. A rally in US Treasury bonds last week reflects another bout of flight-to-quality buying. Junk bonds now yield 19 percentage points more than safe Treasury bonds, up from a 16-point spread in February, according to Merrill Lynch. The spread is still narrower than the 21-percentage-point premium reached last December, but any widening shows investors are becoming more fearful.

"Part of the problem is that investors are still waiting for key details from the government about its plans to bolster US banks and unfreeze the credit markets. After launching a $1 trillion program to kick-start consumer lending last week, the Obama administration is considering creating multiple investment funds to purchase bad loans and other distressed assets. The intent of the funds is to stabilize the prices of good assets and restore investor confidence.

"Without more clarity from the government on its bailout plans, the market could continue to drop, say analysts. That would further harm the economy and the institutions the government hopes to help, compounding its task of shoring up the financial system."

Source: Liz Rappaport and Serena Ng, The Wall Street Journal, March 3, 2009.

BCA Research: A world of credit easing
"Quantitative or credit easing, coupled with dramatic fiscal support, may be the only viable option to prevent a debt-deflation spiral from taking hold.

"The depth of the economic recession and widespread deflation suggests that nominal policy rates need to drop into negative territory in order to provide adequate stimulus, which is impossible. Conceptually, at equilibrium, the cost of capital in the aggregate economy should roughly be equivalent to nominal GDP growth (a proxy for the rate of return in the aggregate economy). If the authorities push interest rates below GDP growth for a prolonged period, they subsidize growth and run the risk of overheating the economy.

"Conversely, keeping interest rates above economic growth restricts activity and creates recessionary pressures. Given that there will likely be a rare decline in nominal GDP in the developed world this year, there is also a need for nominal policy rates to drop into negative territory (i.e. close to zero and accompanied by aggressive quantitative or credit easing) in order to provide sufficient stimulus. The Taylor rule for the developed countries provides a similar reading.

"Bottom line: The world economy is still at risk of falling into a debt-deflation spiral and reflation efforts will need to be ramped up further. Policy rates are converging on zero and aggressive quantitative or credit easing measures in each of the major countries can be expected. Ultimately, this should benefit high quality spread product, but also government bonds given that central banks will buy these bonds outright or will buy private sector assets that could help push government yields lower via arbitrage."

Source: BCA Research, March 11, 2009.

Stuart Thomson (Ignis Asset Management): Quantitative easing should be global strategy
"Quantitative easing should help improve risk appetite in the markets and rebuild economic growth - but can only be a truly effective strategy if it is adopted globally, says Stuart Thomson, economist at Ignis Asset Management

"He argues that the Federal Reserve's current strategy isn't working. 'Financial conditions have deteriorated to their worst level since last October with bonds and equity prices lower and the dollar higher.'

"Mr Thomson says the consequences of this deterioration have been further weakening of US activity in the first quarter. 'Aggregate hours, which is an effective proxy for GDP assuming stable productivity, declined at an annualised rate of 8.2% during the first quarter,' he says. 'There is a clear incentive for full QE, but we fear that the Fed will delay its own nuclear response to the credit crunch until the last possible minute.'

"He believes the US central bank may wait until June before taking decisive action, and suggests that the European Central Bank - traditionally seen as a policy laggard - could begin quantitative easing before the Fed.

"'The ECB is expected to cut rates to 1% in either April, but most likely, May. This will force overnight rates to zero. However, the ECB staff's downgrades to growth forecasts implies rates should be below zero. This suggests the ECB will move to quantitative easing in either June or July.'"

Source: Stuart Thomson, Ignis Asset Management (via Financial Times), March 10, 2009.

Bloomberg: Chang sees civil unrest spreading from global recession
"Ha-Joon Chang, a professor at the University of Cambridge, and Frank Holmes, chief executive officer of US Global Investors, talk with Bloomberg's Pimm Fox about the outlook for the global economic crisis. Chang and Holmes also discuss the outlook for trade, the credit market and investment strategy."

Source: Bloomberg, March 9, 2009.

The Wall Street Journal: Obama, Geithner get low grades
"US President Barack Obama and Treasury Secretary Timothy Geithner received failing grades for their efforts to revive the economy from participants in the latest Wall Street Journal forecasting survey.

"The economists' assessment stands in stark contrast with Mr. Obama's popularity with the public, with a recent Wall Street Journal/NBC poll giving him a 60% approval rating. A majority of the 49 economists polled said they were dissatisfied with the administration's economic policies.

"On average, they gave the president a grade of 59 out of 100, and although there was a broad range of marks, 42% of respondents rated Mr. Obama below 60. Mr. Geithner received an average grade of 51. Federal Reserve Chairman Ben Bernanke scored better, with an average 71.

"The economists, many of whom have been continually surprised by the depth of the downturn, also pushed back yet again their forecasts for when a recovery would begin. On average, they expect the downturn to end in October. Last month, they said the bottom would arrive in August. They estimate that US gross domestic product will continue to contract in the first half of this year, with slow growth returning in the third quarter.

"Economists were divided over whether the $787 billion economic-stimulus package passed last month is enough. Some 43% said the US will need another stimulus package on the order of nearly $500 billion. Others were skeptical of the need for stimulus at all.

"However, economists' main criticism of the Obama team centered on delays in enacting key parts of plans to rescue banks. 'They overpromised and underdelivered,' said Stephen Stanley of RBS Greenwich Capital. 'Secretary Geithner scheduled a big speech and came out with just a vague blueprint. The uncertainty is hanging over everyone's head.'"

Source: Phil Izzo, The Wall Street Journal, March 11, 2009.

CNBC: Fed Chairman Bernanke on systemic risk
"Federal Reserve chairman Ben Bernanke says the Treasury and Fed will take any necessary steps to ensure banks have enough capital and liquidity."

Source: CNBC, March 10, 2009.

Asha Bangalore (Northern Trust): Bernanke sketches out financial reform agenda to "address systemic risk"
"In his speech to the Council on Foreign Relations, Chairman Bernanke voiced the contours of financial reform. More importantly, he stressed that 'until we stabilize the financial system, a sustainable economic recovery will remain out of reach. In particular, the continued viability of systemically important financial institutions is vital to this effort.'

"He went on to mention that 'the Federal Reserve, other federal regulators, and the Treasury Department have stated that they will take any necessary and appropriate steps to ensure that our banking institutions have the capital and liquidity necessary to function well in even a severe economic downturn. Moreover, we have reiterated the US government's determination to ensure that systemically important financial institutions continue to be able to meet their commitments.'

"There were five aspects of future financial reform addressed in today's speech:

(1) The main thrust of Bernanke's judgment regarding the large interconnected firms or firms that are 'too-big-to-fail' is that policymakers should concentrate on how to prevent these firms from excessive risk-taking and minimize the consequences of unwinding these 'critical firms'.

(2) He noted that the 'financial infrastructure' needs to be strengthened such that it will perform well under stress and indicated that gaps in the regulatory framework that allow a migration of firms to less-regulated from more-regulated forms should be eliminated.

(3) Bernanke stated that improved tools are necessary to addresses the unwinding of large non-bank financial institutions such that they are not a systemic risk and threaten public interest.

(4) He spoke about excessive procyclicality of capital standards and why they need to be changed because the current structure leads 'financial institutions to ease credit in booms and tighten credit in downturns more than is justified by changes in the creditworthiness of borrowers, thereby intensifying cyclical changes.'

(5) He was of the opinion that 'we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing.'"

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 10, 2009.

Bloomberg: JPMorgan's Dimon says US needs systemic risk regulator
"Jamie Dimon, chief executive officer of JPMorgan Chase, speaks about the need to establish a 'systemic risk regulator' and set up procedures to deal with potential failures of large financial institutions. Dimon, speaking at a conference hosted by the US Chamber of Commerce in Washington, also discusses his firm's use of aid from the Troubled Asset Relief Program and the outlook for the financial market crisis."

Source: Bloomberg, March 11, 2009.

Asha Bangalore (Northern Trust): Consumer spending - less pronounced weakness
"Retail sales dropped 0.1% in February after a 1.8% gain in the prior month. Excluding autos (-4.3%) and gasoline (+3.4%), retail sales moved up 0.5% in February versus a 1.4% jump in January. Most of the major components of retail sales excluding autos and gasoline advanced in February - apparel (+2.8%), general merchandise (+1.3%), furniture (+0.7%), electronics and appliances (+1.2%). The exceptions were the 0.2% decline in sales of building materials and a 0.7% drop in purchases of food.

"In addition to the strength implied by these numbers, retail sales in January were revised to a 1.8% increase from the earlier estimate of a 0.7% gain, which implies that real consumer spending in January will be raised from the current estimate of a 0.4% increase. Therefore, on a quarterly basis, real consumer spending is most likely to show a decline in the first quarter but it will be significantly smaller than the 3.8% and 4.3% drops recorded in the third and fourth quarters of 2008.

"The important question is if this pace of gains in retail sales will prevail in an environment where employment conditions are abysmal. The dire employment situation persuades us to forecast weakness in consumer spending in the near term."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 12, 2009.

CEP News: Unemployment rate tops 10% in four US states
"The unemployment rate rose to double digits in four US states in January, the Department of Labor reported on Wednesday.

"Unemployment is now above 10% in California, Michigan, South Carolina and Rhode Island, the Labor Department's report on state unemployment showed. Michigan's rate, at 11.6%, is the highest in the country, followed by 10.4% in Rhode Island.

"At the other end of the scale, Wyoming recorded the lowest jobless rate at 3.7%.

"The jobless rate rose in 49 states and the District of Columbia in January compared to a year earlier, causing the national unemployment rate to rise to 7.6% from 7.2%. Louisiana was the only state to see a monthly drop in unemployment, where it fell to 5.1% from 5.5%.

"February unemployment, which was released last week by the Bureau of Labor Statistics, rose to a 25-year high of 8.1%."

Source: Stephen Huebl, CEP News, March 11, 2009.

Bloomberg: Feldstein says US unemployment rate may rise above 10%
"Martin Feldstein, an economics professor at Harvard University, talks with Bloomberg's Kathleen Hays about the outlook for the US unemployment rate. Feldstein also discusses Citigroup's financial position, regulation of the banking industry, and the state of US and European economies."

Source: Bloomberg, March 10, 2009.

Asha Bangalore (Northern Trust): Real trade deficit will be a drag on Q1 GDP
"The trade deficit narrowed to $36.03 billion in January from $39.9 billion in the prior month. The nominal trade deficit has declined roughly 46% from a high of $66.97 billion in July 2006 - an impressive improvement in a very short period. In January, the price of imported oil dropped to $39.81 from $49.93 in the prior month and helped to narrow the trade deficit in addition to a reduction in the quantity of imported petroleum (-1.4%).

"More importantly, inflation adjusted trade data give a more accurate picture of the impact of the trade deficit on real GDP. The real trade deficit of goods widened in January to $44 billion from $42.9 billion in December, which is not a favorable factor for growth of real GDP in the first quarter, assuming the trade deficit fails to record a noteworthy improvement during February and March. Nonetheless, it is noteworthy, that the real trade deficit of goods has narrowed 28.4% from the widest trade gap in January 2006 ($61.4 billion)."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 13, 2009.

Asha Bangalore (Northern Trust): Household net worth records historic plunge
"Household net worth fell $5.1 trillion in the fourth quarter of 2008, putting the annual decline at $11.2 trillion. Net worth of households in 2008 is now slightly below the mark seen in 2004.

"The 2008 drop in net worth is the largest annual decline on record. During 2000-2002, households lost 3.8% of their net worth which was a record when it occurred. The 17.9% drop in net worth during 2008 is staggering and will have a significant impact on the future trajectory of household consumption and saving.

"Nearly 25% of the loss in net worth was from real estate, and equities and mutual fund shares made up 50% of the loss.

"Net worth of households has declined and their debt levels have grown noticeably slowly in 2008. But, the sharp drop in net worth has led to a debt-to-net worth ratio for households that is alarming."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 12, 2009.

The Wall Street Journal: Deleveraging - it's not over till it's over
"Deleveraging has more to go. Just how far could become clearer when the Federal Reserve releases fourth-quarter flow-of-funds data Thursday. The third quarter marked the first decline in household debt since recordkeeping began in 1952, fueled by a record 2.4% drop in mortgage debt.

"Debt likely shrank even faster in the fourth quarter. According to already-released Fed data, non-mortgage consumer credit fell at a 3.2% annual rate. Another decline in mortgage debt, which is four times as big as non-consumer debt, is almost certain, given the collapse in sales and home-equity extraction, as well as surging loan delinquencies and defaults.

"Shedding more debt would be a healthy thing, since household debt levels in the third quarter were equal to 96% of gross domestic product and 130% of disposable income.

"The trick is figuring out just how far this deleveraging should go. There is 'no magic number', suggests T. Rowe Price chief economist Alan Levenson, but one benchmark could be 1998, when foreign savings began to rise. Back then, the percentage of household income spent satisfying creditors was less than 12%, in line with the long-term average, compared with a near-record 14% now.

"Household debt was just 66% of GDP in 1998; and returning to that level would entail a 30% plunge in debt. That may be too extreme, particularly if the US homeownership rate keeps a floor under mortgage debt, despite declining from its 2005 peak.

"Suffice to say that consumer debt ratios will likely keep falling. An income boom would do the trick painlessly, but that seems unlikely. Otherwise, consumer spending will slow, keeping pressure on the financial sector, which is shedding debt much more slowly than households."

Source: Jeff D. Opdyke, The Wall Street Journal, March 11, 2009.

Meredith Whitney (The Wall Street Journal): Credit cards are the next credit crunch
"Few doubt the importance of consumer spending to the US economy and its multiplier effect on the global economy, but what is underappreciated is the role of credit-card availability in that spending. Currently, there is roughly $5 trillion in credit-card lines outstanding in the US, and a little more than $800 billion is currently drawn upon. While those numbers look small relative to total mortgage debt of over $10.5 trillion, credit-card debt is revolving and accordingly being paid off and drawn down over and over, creating a critical role in commerce in America.

"Just six months ago, I estimated that at least $2 trillion of available credit-card lines would be expunged from the system by the end of 2010. However, today, that estimate now looks optimistic, as available lines were reduced by nearly $500 billion in the fourth quarter of 2008 alone. My revised estimates are that over $2 trillion of credit-card lines will be cut inside of 2009, and $2.7 trillion by the end of 2010.

"Inevitably, credit lines will continue to be reduced across the system, but the velocity at which it is already occurring and will continue to occur will result in unintended consequences for consumer confidence, spending and the overall economy. Lenders, regulators and politicians need to show thoughtful leadership now on this issue in order to derail what I believe will be at least a 57% contraction in credit-card lines."

Click here for the full article.

Source: Meredith Whitney, The Wall Street Journal, March 10, 2009.

Dimitry Fleming (ING): Commercial property woes
"After the collapse in the US housing market, the non-residential property sector is now in trouble - posing a fresh threat to the banks, says Dimitry Fleming, economist at ING.

"He notes that US office vacancy rates have risen sharply as the service sector contracts and sheds jobs - and that plunging sales volumes have pushed retail vacancy rates to levels last seen in 1995.

"'An unprecedented gap has opened up between demand for and supply of commercial structures, putting prices under severe pressure,' Mr Fleming says.

"Commercial real estate construction contracted in the fourth quarter of 2008 - and this looks to be only the start, he adds.

"'Together with falling prices, the rise in loan defaults poses a big risk to bank loan portfolios. At the end of 2008, outstanding commercial property loans amounted to $2,500 billion, of which commercial banks and savings institutions held just over half.'

"Mr Fleming notes that Donald Kohn, the vice chairman of the Federal Reserve, has already stated that the banking sector is much more sensitive to a downturn in commercial real estate than in housing - and that exposure is high at some smaller banks.

"'So, while these banks were able to dodge the bullet when housing collapsed, they may not do so when commercial real estate implodes.'

"The US banking sector's exposure to commercial property opens up the prospect of a further wave of bad debt-related writedowns."

Source: Dimitry Fleming, ING (via Financial Times), March 11, 2009.

CEP News: China "worried" about safety of US Treasuries
"China is growing 'worried' about the safety of US Treasuries and wants assurances from the United States, according to Chinese Premier Wen Jiabao speaking at a press conference on Friday.

"'I request the US to maintain its good credit, to honour its promises and to guarantee the safety of China's assets,' he said voicing concerns over the state of the American economy.

"The lawmaker added that the country remained firm in its commitment to deliver an annual 8% growth rate for 2009 and has 'adequate ammunition' to 'introduce new stimulus policies'.

"He also noted that Chinese exports have come under pressure due to an appreciation in the Chinese Yuan against a broad basket of currencies, not just the US dollar.

"China will keep the value of the Yuan 'at a reasonable and balanced level', he promised, reiterating the country's intentions to diversify its foreign exchange holdings."

Source: Erik Kevin Franco, CEP News, March 13, 2009.

Barry Ritholtz (The Big Picture): US bear market losses - $11 trillion dollars
"Here is a mind blowing stat: Stocks have lost $11 trillion in market value since the October 2007 peak, according to Marketwatch.

"This is based on the Dow Jones Wilshire 5000 index, which includes nearly every US-listed stock. Losses since the start of 2009 are $2.6 trillion. Nearly half of all stocks in the index are now trading at less than $5 and 37% are under $3."

Source: Barry Ritholtz, The Big Picture, March 9, 2009.

John Authers (Financial Times): Silver lining for equities
"Perhaps the greatest reason for hope at present is that almost all hope seems to have been lost. The latest global self-off of stocks has been accompanied by commentary that no longer speculates on a rebound but instead tries to work out how much worse things could get, says John Authers."

Click here for the full article.

Source: John Authers, Financial Times, March 9, 2009.

Bespoke: Dow Jones Industrial - longest streaks below 200-day moving average
"As we noted yesterday, even after Tuesday's strong rally, the major averages remain well below their long-term 200-day moving averages (DMA). The last time the Dow closed above its 200-DMA was 204 trading days ago (5/19/08). This represents the eleventh longest streak of trading below the 200-DMA in the Dow's history and the longest since 1982.

"Looking ahead, given the large spread between the current level of the Dow and its 200-DMA, we have a ways to go before the index reaches that level (or the moving average catches up to the index). Therefore, even if we get a strong rally over the next two months, by the time the Dow closes above its 200-DMA, the current streak is likely to be at least the sixth strongest in history."

Source: Bespoke, March 11, 2009.


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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