Words from the (Investment) Wise for the Week That Was (April 6 - 12, 2009)

By: Prieur du Plessis | Sun, Apr 12, 2009
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Five in a row! Not withstanding sentiment for equities waxing and waning for most of the Easter-shortened week, bourses closed strongly on Friday and capped a five-week winning streak - the first since October 2007 for the major MSCI and US stock market indices.

An encouraging pre-announcement of first-quarter results by Wells Fargo (WFC) provided some confidence for the nascent earnings season and gave a healthy boost to the financial sector and overall market.

On a related note, the Treasury Department is expected to announce the expansion of the Troubled Asset Relief Program (TARP) to aid ailing life insurance companies within the next few days, adding a third industry to the banks and automakers that have already received bailouts from the government.

Not only did global stock markets extend their gains last week, but the US dollar reclaimed a stronger footing as a result of heightened risk aversion during the earlier part of the week. Holiday-thinned trading in commodities ended with a mixed performance among the 19 constituents of the Reuters/Jefferies CRB Index. Government bonds, under threat of large-scale issuance in the coming months, also had a relatively quiet period.

The performance of the major asset classes is summarized by the chart below, courtesy of StockCharts.com.

Stock markets, led by financials, added to the gains of the rally that commenced on March 10 (see table below). The MSCI World Index gained 0.8% (YTD -6.4%) and the MSCI Emerging Markets Index 2.5% (YTD +11.6%). These indices have risen by 25.1% and 30.4% respectively since the low of March 9.

Returns around the globe ranged from top-performers Ukraine (+19.4%), Egypt (+9.7%) and Russia (+8.5%) to Côte d'Ivoire (-4.3%), Macedonia (-4.1%), Norway (-3.9%) and the United Kingdom (-3.4%), which were languishing in the red. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

Among the major US indices, the Nasdaq Composite Index (+4.8%) is the only index in positive territory for the year to date. Although not yet claiming this feat, US small caps have also been running hard over the past few weeks, as can be seen from the rising trend line of the S&P 600 Small Cap Index relative to the S&P 500 Large Cap Index since the March 9 lows. The fact that small companies are now outperforming the larger ones is an indication that investors are becoming less risk averse - a positive sign for equities in general to improve further.

Source: StockCharts.com

As far as leadership since the start of the five-week old rally is concerned, the rebounding Financial SPDR (XLF) is by far the top performer among the economic sector exchange-traded funds (ETFs). Interestingly, cyclical sectors such as the Consumer Discretionary SPDR (XLY), Industrial SPDR (XLI), Materials SPDR (XLB) and Technology SPDR (XLK) all outperformed the S&P 500, whereas the traditional defensive sectors like the Utilities SPDR (XLU), Energy SPDR (XLE), Consumer Staples SPDR (XLP) and Health Care SPDR (XLV) were all lagging the broader market. This is the type of pattern one would typically expect to emerge during a market base formation development.

Source: StockCharts.com

John Nyaradi (Wall Street Sector Selector) reports that the strongest ETFs on the week were the Merrill Lynch Regional Bank Holders (RKH) (+16.2%), iShares Cohen & Steers Realty (ICF) (+15.8%) and Financial Select Sector SPDR (XLF) (+14.2%). On the other end of the performance scale the Market Vectors Gold Miners (GDX) (-10.9%), iShares Silver Trust (SLV) (-4.7%) and United States Natural Gas (UNG) (-4.6%) performed poorly - in tandem with natural gas and precious metals retreating.

Next, a quick textual analysis of my week's reading. No surprises here with key words such as "market", "prices", "economy", "financial" and "banks" featuring prominently.

On the question of whether the current rally has more steam left, Kevin Lane, technical analyst of Fusion IQ, said: "It is a very fine line between a rally extension call and a retest call, though we are leaning towards the former after a pullback/pause. However, since both calls - rally or retest - are plausible we continue to suggest investors tighten up stops and portfolio VAR (Value At Risk) until more evidence unfolds. Until more clarity occurs either technically or fundamentally, I can think of worse things in the world than locking in some gains or getting stopped out at a profit on trailing stops.

"So over the next few sessions watch the skew of decliners to advancers and down to up volume. As long as we don't get ratios of 5 to 1 or higher on both indicators the likelihood of a retest in the near term is lessened."

As shown in the table below, the 50-day moving averages have been cleared comfortably by all the major US indices and the early January highs are the next important targets. As a matter of fact, the Nasdaq Composite Index is already one point above this level and has to rise by a further 9.0% in order to reach the key 200-day moving average - an indicator often used to distinguish between primary bull and bear markets. On the downside, the levels from where the nascent rally commenced on March 9 should hold in order for the upward trend to endure.

Although he still maintains that stock markets are witnessing nothing more than a bear market rally, Richard Russell, doyen of newsletter writers and author of the 50-year old Dow Theory Letters, on Friday said. "I was wrong. It looks as though this rally has legs. Lowry's Selling Pressure Index has stopped rising and now appears to be topping out. At the same time, Lowry's Buying Power Index is in a rising trend. The look of the Lowry's chart suggests that the [short-term] direction of least resistance is up."

From London, David Fuller (Fullermoney) opined: "... consistent and persistent trends, such as we have seen over the last five weeks, are often important trends. This continues to look like the first psychological perception stage of a new bull market - lows are rising over time, indicating that demand has the upper hand, but most people do not believe in the market's recovery. Consequently, the perception is of high risk, while it is actually low, given all the cash available to fuel an additional advance.

"... Asian emerging and South American resources markets are currently carrying our preferred secular themes higher. The tech and telecom cyclical theme is also performing well. These look like new bull markets.

"Europe and the USA, T&T excepted, continue to underperform, not surprisingly given the economic problems. Wall Street still has the capacity to be a spoiler because we do not yet have confirmation that the early March lows will hold. Technical confirmation of a new bull market, as we have often said, comes later and requires a break above the 200-day moving average, which then also turns upwards."

The CBOE Volatility Index (VIX) (green line in the chart below) is another indicator heading in the right direction for equity bulls, having declined from the 80s in October and November to 36.5 on Friday - its lowest close since late September, just ahead of the stock market meltdown. This is comforting as the VIX is the market's main gauge of fear and usually moves in the opposite direction of the S&P 500 (red line).

Source: StockCharts.com

Bill Fleckenstein, well-known perma-bear who announced late last year that he was closing his short-only hedge fund as a result of the reduced number of attractive shorting targets, said: "Now that stocks have rebounded as far as they have, the upcoming earnings season will be particularly interesting - and potentially dangerous - but it will offer information as to the sustainability of the recent advance. If stock prices can shrug off the news, then the market may be headed higher still."

On the topic of earnings, in the coming week all eyes will be on announcements by Goldman Sachs (GS) (Tuesday), JPMorgan Chase (JPM) (Thursday) and Citigroup (C) (Friday), especially with Goldie mulling a multi-billion dollar equity offering.

For more discussion about the direction of stock markets, also see my recent posts "Video interview: 'The tide is turning,' says Prieur du Plessis", "Emerging-market equities show leadership", "Technical talk: Sentiment review", "Video-o-rama: Five in a row for stock markets", and "Picture du Jour: It's earnings, stupid!".

I regularly post short comments (maximum 140 characters) on topical economic and market issues on Twitter. For those not doing so already, you can follow my "tweets" by clicking here. The Twitter posts also appear on my Facebook page and in the sidebar of the Investment Postcards site.

"Business pessimism remains deep and widespread across all industries and regions of the globe," said the latest Survey of Business Confidence of the World conducted by Moody's Economy.com. "Sales remain extraordinarily soft and pricing power continues to weaken." However, it is encouraging that the Survey found that businesses were becoming steadily less negative about the economy's prospects later this year and that the index had inched up very recently, as shown in the graph below.

But although the rate of decline in a number of economic indicators seems to be moderating, the fallout of the financial crisis has clearly not been fully arrested as gleaned from the International Monetary Fund's (IFM) new forecast that toxic debt racked up by banks and insurers could spiral to $4 trillion. According to Times Online, the IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia.

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

April 9
• Significant improvement in trade balance a big plus for Q1 GDP
• Initial Jobless Claims - glimmer of hope?

April 8
• Minutes of March 2009 FOMC meeting - highlight concerns that led to further expansion of Fed's balance sheet
• Wholesale inventories - drop in inventories-sales ratio a positive signal

April 7
• Consumer credit - households are parsimonious, not a surprise

April 6
• Price-to-rent ratio - pace of decline in home prices to moderate

The minutes of the Federal Open Market Committee's (FOMC) March 17-18 meeting show that members downgraded forecasts for GDP growth in the second half of 2009 and into 2010, adding that they expect growth "to flatten out gradually over the second half of this year and then to expand slowly next year as the stresses in financial markets ease."

George Soros is more pessimistic on the outlook (as reported by CNBC), saying: "I don't expect the US economy to recover in the third or fourth quarter so I think we are in for a pretty lasting slowdown." He added that there might be "something" in terms of US growth in 2010. The recovery will look like 'an inverted square root sign', Soros said. "You hit bottom and you automatically rebound some, but then you don't come out of it in a V-shape recovery or anything like that."

On a more upbeat note, Bespoke highlights that the Investors Business Daily's survey of economic optimism has increased for the second month in a row and is now at its second highest level (49.1) since the start of the recession. Although the indicator has shown steady improvement since the July low, the current level of below 50 indicates that consumers remain pessimistic on a net basis.

Another glimmer of hope is the ECRI Weekly Leading Index that has leveled off since the beginning of the year. "Since 1970, a significant upturn in the index has preceded the end of a recession by an average of two months. While the Index has dropped more than during any other period on record (since peaking in June 2007), the Index has been relatively flat since early December and has been moving up over the past four weeks," said Chart of the Day. We'll be watching this space.

Pulling it all together, BCA Research commented: "Now the focus has shifted to whether or not positive second-half growth will provide the base for a solid recovery next year. There is plenty of fiscal and monetary stimulus in the pipeline, but the headwinds and risks highlight that the recovery will be fragile. Much will depend on the apparent success or failure of the bank stress tests and the Treasury's plan to relieve banks of their legacy assets. Both are wild cards that could reverse the recent improvement in investor sentiment. Moreover, consumer fundamentals remain grim due to high debt levels, falling home prices and massive payroll cuts.

"Bottom line: A bottoming in growth suggests that we have seen the lows in the equity market, but a sustainable uptrend may take time to develop and could be very choppy."

Back to the global economy, according to George Soros, China will be the first country to emerge from recession, probably this year, and will spearhead global growth in 2010. He said world policymakers are "actually beginning to catch up" with the crisis and efforts to fix structural problems in the financial system.

Meanwhile, China's passenger car sales increased by 10% year on year in March, thanks to sales tax cuts and other government subsidies. Also, as reported by US Global Investors, explosive new loan growth in China has prompted its banking regulator to review whether it is necessary to restrain lending practice. "According to the latest unofficial estimate, new bank loans may have reached 1.87 trillion yuan in March. This makes the first quarter's total lending almost as much as the government's full year target."

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
Apr 7 3:00 PM Consumer Credit Feb -$7.5B unch -$3.0B $8.1B
Apr 8 10:00 AM Wholesale Inventories Feb -1.5% -0.6% -0.7% -0.7%
Apr 8 10:30 AM Crude Inventories 04/03 +1645K NA NA +2840K
Apr 9 8:30 AM Export Prices ex-agriculture Mar -0.3% NA NA -0.1%
Apr 9 8:30 AM Import Prices ex-oil Mar -0.7% NA NA -0.7%
Apr 9 8:30 AM Initial Claims 04/04 654K 650k 660K 674K
Apr 9 8:30 AM Trade Balance Feb -$26.0B -$37.0B -$36.0B -$36.2B
Apr 10 2:00 PM Treasury Budget Mar - NA -$160.0B -$48.2B
Source: Yahoo Finance, April 10, 2009.

In addition to Fed Chairman Ben Bernanke speaking at the Fed Conference (Friday, April 17), the US economic highlights for the week include the following:

Source: Northern Trust

Click the links below for the following reports:

Wachovia's report on the "State of the Global Economy"

Wachovia's Monthly Economic Outlook (April 2009)

Wachovia's Global Chartbook (April 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, April 10, 2009.

Friend Kevin Lane said: "Hope is a slippery slope and greed is not a trustworthy steed (i.e. horse), so work on removing emotion and bias from your investing/trading as much as possible. Hopefully the "Words from the Wise" reviews will assist Investment Postcards readers with taking well-informed and unemotional investment decisions.

Wishing you and your families a pleasant time during what remains of the Easter weekend.

That's the way it looks from Cape Town (where I will be spending the next two weeks before heading back to America for a brief visit).

Cartoon from 1934 Chicago Tribune - looking familiar?

Hat tip: Charleston Voice

CNBC: El-Erian - investors be wary of stocks, Treasurys
"Investors can still lose a lot of money in the stock market, but US government bonds aren't the solution either for those seeking safe havens, Pimco's co-CEO and co-chief investment officer Mohammed El-Erian told CNBC. 'Certain bonds aren't worth owning, like government bonds for instance,' El-Erian said, adding that gaping deficits will force governments issue more debt.

"I am very underweight equities," he said, adding that he has cut his exposure to stocks to 30% compared with around 60% in normal market conditions. Pimco is the world's biggest bond fund.

"'Fundamentally we are in a volatile journey to what we call the new normal, the new destination. The world is changing,' El-Erian said.

"People have to adjust to the fact that wealth has been destroyed, and the fact that there are more than 5 million unemployed in the US shows how serious the situation is, he added.

"'The American consumer will return but will be a saner consumer ... worried about their savings, worried about their retirement. That is a good adjustment. The problem is that it doesn't happen overnight,' El-Erian said.

"Asked whether he believed the stock market can re-test the March lows, he said: 'The intellectually honest answer is we don't know. I have a fear right now that people are sucked into the equities market ... go in as long as you can afford to lose that money,' he added.

"Two out of four conditions need to be met for an economic recovery to begin, according to El-Erian: house prices need to stabilize, banks must start lending again, the consumer must start spending again and the rest of the world must pick up.

"For the moment, only the fourth condition is partly fulfilled, with timid signs of recovery in China emerging, he said.

"Asked about attractive areas of investment, El-Erian listed mortgages, municipal bonds and corporate bonds, especially instead of stocks.

Source: CNBC, April 7, 2009.

CNBC: Pimco's power player
"The markets are on a volatile journey to a 'new normal', says Mohamed El-Erian, Pimco CEO."

Source: CNBC, April 7, 2009.

Times Online: Toxic debts could reach $4 trillion, IMF to warn
"Toxic debts racked up by banks and insurers could spiral to $4 trillion, new forecasts from the International Monetary Fund (IMF) are set to suggest.

"The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia.

"Banks and insurers, which so far have owned up to $1.29 trillion in toxic assets, are facing increasing losses as the deepening recession takes a toll, adding to the debts racked up from sub-prime mortgages. The IMF's new forecast, which could be revised again before the end of the month, will come as a blow to governments that have already pumped billions into the banking system.

"Paul Ashworth, senior US economist at Capital Economics, said: 'The first losses were asset writedowns based on sub-prime mortgages and associated instruments. But now, banks are selling 'plain vanilla' losses from mortgages, commercial loans and credit cards. For this reason, the housing market will play a crucial part in how big the bad debt toll is over the next year or two.'

"The IMF's jump will come as little surprise to economists who have suggested that the bad debts will be much higher than anticipated. Nouriel Roubini, chairman of RGE Monitor, expects bad debts from US-originated assets to reach $3.6 trillion by the middle of next year. This figure is expected to rise when bad debts from assets elsewhere are calculated, he said."

Source: Gráinne Gilmore, Times Online, April 7, 2009.

Guardian: US watchdog calls for bank executives to be sacked
"Elizabeth Warren, chief watchdog of America's $700 billion bank bailout plan, will this week call for the removal of top executives from Citigroup, AIG and other institutions that have received government funds in a damning report that will question the administration's approach to saving the financial system from collapse.

"Warren, a Harvard law professor and chair of the congressional oversight committee monitoring the government's Troubled Asset Relief Program (Tarp), is also set to call for shareholders in those institutions to be 'wiped out'. 'It is crucial for these things to happen,' she said. 'Japan tried to avoid them and just offered subsidy with little or no consequences for management or equity investors, and this is why Japan suffered a lost decade.'

She declined to give more detail but confirmed that she would refer to insurance group AIG, which has received $173 billion in bailout money, and banking giant Citigroup, which has had $45 billion in funds and more than $316 billion of loan guarantees.

"She said she did not want to be too hard on Geithner but that he must address the issues in the report. 'The very notion that anyone would infuse money into a financially troubled entity without demanding changes in management is preposterous.'"

Source: James Doran, Guardian, April 5, 2009.

The Wall Street Journal: US to offer aid to life insurers
"The Treasury Department has decided to extend bailout funds to a number of struggling life-insurance companies, helping an industry that is a linchpin of the US financial system, people familiar with the matter said.

"The department is expected to announce the expansion of the Troubled Asset Relief Program to aid the ailing industry within the next several days, these people said.

"The news will come as a relief to a number of iconic American companies that have suffered big losses made worse by generous promises to buyers of some investment products. Shares of life insurers have fallen more than 40% this year. Their troubles led to a string of rating-agency downgrades that, in a vicious cycle, made it more difficult for some insurers to raise funds.

"The life-insurance industry is an important piece of the US financial system. Millions of Americans have entrusted their families' financial safety to these companies, so keeping them on solid footing is crucial to maintaining confidence. If massive numbers of customers sought to redeem their policies, it could cause a cash crunch for some companies. And because insurers invest the premiums they receive from customers into bonds, real estate and other investments, they are major holders of securities. If they needed to sell off holdings to raise cash, it could cause markets to tumble."

Source: Scott Patterson, Deborah Solomon and Leslie Scism, The Wall Street Journal, April 8, 2009.

Financial Times: Derivatives sector answers critics
"The financial industry will on Wednesday overhaul how it writes contracts in the credit derivatives world - an effort to rebuff criticism that the vast sector could pose a systemic threat.

"More than 1,400 banks and asset managers will adopt a new 'big bang' protocol, which will make it easier for investors to know what will happen to credit derivatives contracts if debt defaults occur.

"The US market will also introduce a standardised pricing system for CDS contracts, which have hitherto been run on an unregulated, freewheeling basis.

"The moves follow mounting criticism of the credit derivatives world, which some regulators claim contributed to problems at AIG. The pressure for change was underscored at last week's meeting of G20 leaders, which reiterated calls for more standardisation and transparency.

"Robert Pickel, head of the International Swaps and Derivatives Association, argued that the reforms showed the industry was responding to these calls. 'These measures provide a framework - it will bring more order. It is a significant step,' he said.

"Separately, TriOptima, a trade processing group, said it had removed $5,500 billion of redundant contracts from the market in the first three months of the year because banks had cancelled deals that offset each other. This process of 'tearing up' - or offsetting contracts - has already cut the estimated size of the sector to below $30,000 billion, less than half its level 18 months ago."

Source: Anousha Sakoui, Michael Mackenzie and Nicole Bullock, Financial Times, April 7, 2009.

Forbes: The recovery begins
"The Federal Reserve is following possibly the most accommodative monetary policy of its 96-year history. The economy and stock market are floating on a sea of liquidity. That's all that really matters right now.

"Through Friday, April 3, this sea of liquidity had lifted the Dow Jones Industrial Average by 22.5% in less than a month, with the NASDAQ up 27.8%, and the S&P 500 up 24.5%.

"For us, this is the real deal. But pessimism is so rampant that it is hard for many investors to believe that this rally can last. When it was reported on Friday that the US lost 663,000 jobs in March, it was almost too much for many investors to take. Since December 2007 the US has lost 5.1 million jobs. These job losses have pushed the unemployment rate up from 4.9% to 8.5% - the highest since 1983.

"The horrible jobs data have many asking: How can any kind of economic recovery take hold? How can stock prices continue to rise? The thinking is that with people losing jobs, spending will fall, which will lower production causing more layoffs, sending the economy down again.

"But this is not the way the economy works. If jobs were the catalyst for all economic change, then the economy would never stop expanding as jobs increased, nor would it ever stop contracting as jobs fell.

"Don't take this as a sign that we do not care about job losses - they hurt. They are personal. And when unemployment rises above 7% or so, just about everyone knows someone who has lost a job. But in the past the unemployment rate has been much higher than it is today, and yet the economy recovered and the stock market boomed anyway. Unemployment is a lagging indicator.

"In fact, the best historical precedent for what the US economy is living through today is the mid-1970s. Between December 1973 and May 1975, the unemployment rate jumped from 4.9% to 9%. This recession included a 43% drop in the S&P 500 during the bear market of 1973 to 1974.

"But the stock market bottomed in December 1974, and even though the unemployment rate increased from 7.2% to 9% in the first five months of 1975, the S&P 500 jumped 34%.

"The major factor behind all that volatility in the economy and the stock market was the Federal Reserve's monetary policy. The Fed hiked the federal funds rate from 3.3% in early 1972 to 12.9% in July 1974. Then the Fed reversed course and cut the funds rate to 5.2% by May 1975. This roller-coaster monetary policy caused a bust and then a boom."

Click here for the full article.

Source: Brian Wesbury and Robert Stein, Forbes, April 7, 2009.

CNBC: Soros - US recovery is far off, banks are "basically insolvent"
"The US economy is in for a 'lasting slowdown' and could face a Japan-style period of relatively low growth coupled with high inflation, billionaire investor George Soros said on Monday.

"Soros, speaking to Reuters Financial Television, also warned that rescuing US banks could turn them into 'zombies' that draw the lifeblood of the economy, prolonging the economic slowdown.

"'I don't expect the US economy to recover in the third or fourth quarter so I think we are in for a pretty lasting slowdown,' Soros said, adding that in 2010 there might be 'something' in terms of US growth.

"Soros' view contrasts with the majority of economists, who expect the US economy to stop contracting in the third quarter and resume growing in the fourth quarter, according to the latest monthly poll of forecasts conducted by Reuters.

"The recovery will look like 'an inverted square root sign,' Soros said. 'You hit bottom and you automatically rebound some, but then you don't come out of it in a V-shape recovery or anything like that. You settle down - step down.'

"The healing of the banking system and housing markets is crucial to recovery. 'The banking system, as a whole, is basically insolvent,' Soros said.

"What's more, the Treasury's Public-Private Investment Fund is going to work but it won't be enough to recapitalize the banks in a way that they are able to or willing to provide credit.

"'What we have created now is a situation where the banks who will be able to earn their way out of a hole, but by doing that, they are going to weigh on the economy,' he said. 'Instead of stimulating the economy, they will draw the lifeblood, so to speak, of profits away from the real economy in order to keep themselves alive. This is the zombie bank situation.'"

Click here for the full article.

Source: CNBC, April 6, 2009.

Asha Bangalore (Northern Trust): FOMC minutes highlight concerns that led to further expansion of Fed's balance sheet
"The March 17-18 FOMC meeting concluded with the federal funds rate left unchanged - no surprises there. However, the policy announcement indicated that the Fed would increase its balance sheet by another $1.15 trillion ($750 billion MBS + $100 billion agency debt + $300 billion Treasury securities) - this was the surprise.

"The minutes succinctly state the reason for the bold and outsized move: 'In light of the economic and financial conditions, meeting participants viewed the expansion of the Federal Reserve's balance sheet that might be associated with these and other programs as appropriate in order to foster the dual objectives of maximum employment and price stability. Several members felt that the significant deterioration in the economic outlook merited a very substantial increase in purchases of longer-term assets.'

"In addition, 'participants expressed concern about downside risks to an outlook for activity that was already weak.' The precise quantity and types of securities purchased appears to be a compromise because the minutes note that members had different preferences about both aspects.

"As part of the extensive discussion about the Fed's balance sheet, 'members agreed that the monetary base was likely to grow significantly as a consequence of additional asset purchases; one, in particular, stressed that sustained increases in the monetary base were important to ensure that policy was consistently expansionary."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, April 8, 2009.

Financial Times: Downbeat outlook prevails inside Fed
"The Federal Reserve sharply downgraded its economic outlook at its latest meeting only three weeks ago, minutes released on Wednesday revealed, challenging the view that green shoots of recovery are now plain to see.

"'The staff's projections for real GDP in the second half of 2009 and 2010 were revised down,' the minutes say. Fed staff no longer expected growth would recover this year, and instead forecast that output would 'flatten out gradually' in the second half and then 'expand slowly next year'.

"While Fed policymakers took note of some news that was better than expected on housing and consumer spending, they appeared reluctant to put much weight on this. Most 'viewed downside risks as predominating in the near term'.

"Officials worried about 'adverse feedback effects as reduced employment and production weighed on consumer spending' and a 'weakening economy boosted the prospective losses of financial institutions, leading to a further tightening of credit conditions'.

"While there has been better news since the March 18 meeting, the tenor of the Fed discussion suggests most policymakers will treat this data with scepticism."

Source: Krishna Guha, Financial Times, April 8, 2009.

Barry Ritholtz (The Big Picture): Getting worse more slowly
"Ever since Ben Bernanke's 60 Minutes interview where he used the phrase 'Green Shoots', many of the key data releases have been misinterpreted. This has led to a robust debate as to whether the worst is behind us.

"In recent weeks, I have keyed in on four data points that the mainstream has spun positively, despite the actual data being horrific. These four factors include ISM data, New Home Sales, Existing Home Sales, and Non Farm Payroll.

"Coming off historical lows (and in some cases, all time lows) many data-points feels like things are getting better. In reality, things are getting worse, but more slowly. What is happening in the real world is the change in the rate of fall. The direction is still negative - the economy is still contracting - but it is doing so at a slower pace.

"You may have heard the phrase 'second derivative' bandied about; most users of the term fail to define it in plain English. Here's my attempt: Imagine you jump from a airplane - for a while, you are free falling - accelerating downwards at increasing speeds. After a few thousand feet, you pull the rip cord and your parachute opens up. In terms of direction, you are still heading down; in terms of speed, however, even though you are falling, you are falling at a much slower rate. As the parachute deploys, you are decelerating - the rate of your fall is slowing.

"That pretty much sums up the economy lately - still contracting, but at a slower rate than the panic period from September to February. But this does not mean we are yet on the ground. And the economy is certainly not expanding. That is likely several quarters (or longer) away.

"And those investors who made recent bets that Green Shoots are a great entry for investing - well, they may be somewhat disappointed ..."

Source: Barry Ritholtz, The Big Picture, April 8, 2009.

Asha Bangalore (Northern Trust): Significant improvement in trade balance a big plus for Q1 GDP
"The trade balance narrowed to $25.97 billion in February from $36.2 billion in January. The trade deficit has fallen $32.3 billion in a six-month period, the largest six-month change on record. The trade deficit in February is the smallest since December 2001!

"Exports of goods and services increased 1.6% after a string of six monthly declines. After adjusting for inflation, the 3.1% increase in exports of goods in February is the first monthly increase since August 2008. The 5.1% drop in imports of goods and services in February is a continuation of a declining trend which began in August 2008. Inflation adjusted imports of goods fell 5.3% in February.

"The sharp improvement in the trade deficit is a big plus for first quarter GDP. We are working on the revision of our forecast of first quarter real GDP."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, April 9, 2009.

The Wall Street Journal: V or L?: Economists debate recovery's shape
"Two former chief economists of the International Monetary Fund disagreed Tuesday on whether the eventual global recovery will take the shape of a solid 'V' or weak 'L'.

"Simon Johnson and Michael Mussa, both senior fellows at the Peterson Institute for International Economics, agreed that the world economic recession is likely to be the worst since World War II. However, they differed not just on the outlook for the economy - but on the fundamental nature of the crisis itself.

"Mussa, who served as chief economist for the IMF from 1991 to 2001, expects the world economy to remain true to the historical trend that when there is a steep downturn in growth, it is followed by a sharp upturn. Such recoveries are referred to as V-shaped due to how they look on a graph.

"Mussa foresees a 0.8% contraction in the world economy this year. But a recovery will likely be underway by year-end, he says, with global growth bouncing back at a pace of 3.7% next year.

"While the exact timing of the recovery may be debated, 'when it starts, I think it is far more likely than not that the US economy and the world economy will see the V for victory,' Mussa said at a Peterson Institute conference.

"But whereas Mussa sees the current downturn in the more traditional vein in which global demand snaps back from a negative shock, Johnson views the crisis as part of a more sinister story in which the power of international banks has distorted the business cycle.

"Johnson, who was the IMF's chief economist in 2007 and 2008, argued that the amount of economic and political power the financial sector has amassed in the US is a 'dangerous' development that has put the global economy in uncharted waters.

"'The industrial countries, particularly the US, have become a lot more like emerging markets than we've ever seen before,' said Johnson.

"Thus, he sees the world economy struggling to recover over the next couple of years. For 2009, he foresees a 1% contraction, fourth quarter versus fourth quarter, with the economy remaining essentially flat in 2010."

Source: Tom Barkley, The Wall Street Journal, April 7, 2009.

Reuters: CEO confidence hits record low
"Two-thirds of US chief executives plan additional layoffs and expect sales to decline in the next six months as their confidence in the economy continues to fall, according to a survey released on Tuesday.

"The Business Roundtable's quarterly CEO Economic Outlook Index fell to negative 5 - the first negative reading in the survey's six-year history - and down from a fourth-quarter reading of 16.5. A reading below 50 means CEOs expect economic contraction rather than growth.

"The poll of 100 US CEOs found they now expect real US gross domestic product to decline 1.9% this year. That is below their December forecast, which anticipated flat GDP.

"The group's head held out hope that the Obama administration's efforts to shore up the financial system and buoy the economy with a stimulus program may be beginning to pay off. But other economists argued that it was too early to call a turnaround.

"'While recently implemented policies need time to make an impact, they have already begun to restore confidence in our markets, which is obviously a critical first step,' said Harold McGraw, who serves as Roundtable chairman and is also chief executive of publisher McGraw-Hill Cos.

"'We are very close to a bottom, and the fourth quarter of last year and the first quarter of this year will probably be the most disappointing,' McGraw said.

"Michael Goodman, an economist at the University of Massachusetts' Donahue Institute, took issue with that view. 'I don't really see accumulating evidence that we've hit the bottom just yet,' Goodman said. 'The pace of the decline may slow in the future, but I think all the evidence is still clear that we can expect continued decline.'"

Source: Scott Malone, Reuters and Business Roundtable, April 7, 2009.

Bloomberg: Manhattan office rents fall most in quarter century
"Manhattan office rents fell the most in at least 25 years in the first quarter as financial companies slashed jobs and relinquished space in the US recession.

"Rents dropped 6% from the fourth quarter to $65.01 a square foot, commercial property broker Cushman & Wakefield said in a report today. The decline is the most in records dating back to 1984, Cushman said, and shows how much the fallout from the September bankruptcy of Lehman Brothers Holdings hurt the New York property market.

"'It's gone beyond the financial firms,' Joseph Harbert, Cushman & Wakefield's chief operating officer for the New York region, said in a telephone interview. 'It's broad across a lot of industries. Everybody has the same way of thinking, which is low confidence in job growth, consolidation, cutting expenses, not hiring unless you really have to.'

"The recession has eroded demand for commercial property as companies fire workers and consumers rein in spending. The Bloomberg REIT Office Property Index of 14 companies is down 28% this year. In New York, the amount of space available for sublease approached a five-year high in the first quarter, Cushman said.

"Space for sublease helped push the overall vacancy rate in Manhattan to 9.6% from 6.1% a year earlier, the highest since the third quarter of 2005, the report said.

"Rents are 'falling faster than they did in the last two recessions,' Harbert said."

Source: David Levitt, Bloomberg, April 7, 2009.

Asha Bangalore (Northern Trust): Consumer credit - households are parsimonious, not a surprise
"Consumer credit fell at an annual rate of 3.5% in February, after a 3.8% increase in January. This is not a surprise because households are financially strapped and employment conditions are bleak. With the exception of a decline in January 1998, consumer credit has risen every month from April 1993-July 2008. In other words, a fifteen-year stretch of consumer borrowing that has stopped abruptly.

"The jobless rate was 8.5% in March 2009 and an unemployment rate of 10% is the projected high for the current downturn. Therefore, it should not be surprising to see a further contraction in consumer credit. The parsimonious behavior of households needs an offset to rejuvenate consumer spending. This is another aspect that justifies the fiscal stimulus put in place."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, April 7, 2009.

Asha Bangalore (Northern Trust): Price-to-rent ratio - pace of decline in home prices to moderate
"At the end of 2008, the price-to-rent ratio (i.e. ratio of the Case-Shiller Home Price Index and the Owners' Equivalent Rent of the Consumer Price Index) showed a noticeable improvement, with the ratio in the fourth quarter of 2008 (107.97) closer to the long-term average of 98.05.

"The fourth quarter price-to-rent ratio is well within the range of the mean (109.77) of the entire historical period (1987-2008) which includes the go-go years of 2001-2008. The main take-away from this chart is that home prices are most likely to decline in the months ahead, given the elevated level of inventories; but the pace of decline will be assuredly small."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, April 6, 2009.

Bloomberg: Soros sees "signs" US housing market is hitting bottom
"Billionaire investor George Soros talks with Bloomberg's Kathleen Hays about the outlook for the US housing market. Soros also discusses the US government's efforts to rescue the US banking system and the Financial Accounting Standards Board's decision to relax fair-value accounting rules."

Source: Bloomberg, April 6, 2009.

Floyd Norris (The New York Times): Will job numbers keep being revised down?
"Here are the total job losses reported for recent months, as originally reported and as shown in the latest revisions.

August 2008: Initially 84,000, revised to 175,000
September 2008: Initially 159,000, revised to 321,000
October 2008: Initially 240,000, revised to 380,000
November 2008: Initially 533,000, revised to 597,000
December 2008: Initially 524,000, revised to 681,000
January 2009: Initially 598,000, revised to 655,000
February 2009: Initially 651,000, as released today.
"On average, from August through January, the first estimate was too optimistic by 112,000 jobs."

Source: Floyd Norris, The New York Times, April 6, 2009.

BCA Research: ISM Manufacturing - bottomed, but what next?
"With more evidence of a bottoming in global growth, investor attention has shifted to the strength of the recovery.

"Evidence continues to accumulate that the worst of the recession is over. The US leading economic indicator and a few of our global leading indicators appear to have bottomed. Even some global coincident economic data have bounced off of their respective lows.

"In the US, the ISM new orders index rose above 40 for the first time in seven months, although this has not fed through to production as firms struggle to get inventories under control.

"The S&P 500 celebrated the shift in tone in the economic data, posting a solid 8.5% gain in March (its best monthly performance since an 8.6% gain in October 2002).

"Now the focus has shifted to whether or not positive second-half growth will provide the base for a solid recovery next year. There is plenty of fiscal and monetary stimulus in the pipeline, but the headwinds and risks highlight that the recovery will be fragile. Much will depend on the apparent success or failure of the bank stress tests and the Treasury's plan to relieve banks of their legacy assets. Both are wild cards that could reverse the recent improvement in investor sentiment. Moreover, consumer fundamentals remain grim due to high debt levels, falling home prices and massive payroll cuts.

"Bottom line: A bottoming in growth suggests that we have seen the lows in the equity market, but a sustainable uptrend may take time to develop and could be very choppy."

Source: BCA Research, April 3, 2009.

News N Economics: Federal mortgage relief programs - troubling statistics
"Delinquency rates are surging, up 7.88% in the fourth quarter of 2008 (Q4 2008) according to the Mortgage Bankers Association (MBA). Both the quarterly change and the share of delinquencies are the highest since the series was first measured in 1972. Furthermore, troubling statistics at the Office of Thrift Supervision show that government interventions through Q4 2008 have failed to halt mortgage default rates.

"Delinquency rates are making records across all loan types, with prime delinquencies hitting 5.1% in Q4 2008. The delinquency data include loans that are at least one payment overdue and not yet in the foreclosure process; clearly some of these loans will enter the foreclosure process soon.

"Foreclosures in 2008 were up 225% since 2006, and according to the delinquency rates, that number is set to worsen in 2009."

Source: Rebecca Wilder, News N Economics, April 6, 2009.

News N Economics: Failed bank list surprises - consolidation?
"The number of (or lack of) bank failures in 2008 and 2009, 46 total, is shocking: world bank losses near $1.3 trillion; the US economy enters its 16th month of recession; default rates surges (from student loans and credit cards to mortgages and corporations); and the G-20 Leaders move forward on tightening global financial regulation.

"In shoring up the banking system, the Fed and the Treasury likely enabled the economy to skirt a depression-sized disaster. However, since there are so many banks left standing - in a perfectly efficient situation more would have fallen by now - there is probably still a long way to go on the road to recovery. Consolidation is likely inevitable. This is inefficient, and government intervention is using resources to push aside a natural market response: the consolidation of the banking industry.

"The chart below illustrates the number of bank failures and the magnitude of bank failures, as measured by the population. In the Great Depression, the number of bank failures peaked at 112 in 1938; and during the saving and loan crisis, the number of failures hit 211 in 1987 and 1988. However, according to the size of the population, the magnitudes of the bank failures in 1934 and 1988 were similar in size (clearly, the economic response was not).

"In 2008 and 2009, the banking system has averted mass closure with the various government intervention efforts, where only 46 banks total have failed - minuscule compared to the previous two crises. Massive government interventions are pushing back banking reform; and in its effort to preserve the financial system, the consolidation of the banking system is inhibited by allowing weak banks to survive.

"The market response requires consolidation - wonder when that is going to happen."

Source: Rebecca Wilder, News N Economics, April 3, 2009.

Casey's Charts: Cross-border investment shrinking
"The latest US Treasury International Capital (TIC) report shows the January outflow of foreign private investments was $158 billion. Since June of 2007, there has been a massive flight of foreign capital from the United States, though the impact has been mitigated by a collapse in US investments abroad.

"Nonetheless, the exodus reveals increasing unease by foreign capital holders about the US's economic future, especially troubling at a time when the government needs to finance a $3 trillion budget. The outlook for the dollar is not so good."

Source: Casey's Charts, April 7, 2009.

Vicktor Capitalist: High-yield default rate to reach 53% over five years
"About 53% of US companies that issued high-risk, high-yield bonds will default over the next five years, according to Jim Reid at Deutsche Bank.

"The figure compares with a 31% five-year rate in the early 1990s and 2000s, and as much as 45% 'in a very, very different market in the Great Depression', Reid, the London-based head of fundamental credit strategy, wrote in a note to clients today. The estimate is based on the premium investors demand to hold the notes and assumes recoveries from the defaults will be zero, Reid wrote."

Source: Vicktor Capitalist, April 7, 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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