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.
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
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.
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
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.
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.
"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."
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
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.)
• Despite impressive improvement in nominal terms, real trade deficit
will be a drag on Q1 GDP
• 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
• 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
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:
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
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."