Words from the (Investment) Wise for the Week That Was (March 8-14, 2010)

By: Prieur du Plessis | Sun, Mar 14, 2010
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Shrugging off some lingering reminders of the credit crisis and recession, investors last week marked the one-year anniversary of the bear market low by pushing many benchmark equity indices to cycle highs.

Wall Street scaled 17-month highs on the back of easing concerns of sovereign debt defaults and increased hopes for a global economic recovery as the US dollar pulled back and the CBOE Volatility (VIX) Index approached 22-month lows. The Index is also referred to as the "fear gauge" of US stock markets and is used as a contrary indicator that moves inversely to equity prices, as seen in the chart below where it is plotted against the S&P 500 Index.

Source: StockCharts.com

Meanwhile, US Senate Banking Committee chairman Christopher Dodd plans to introduce a revised version of a financial regulatory reform bill on Monday. Dodd had hoped to release a bipartisan bill but has been unable to do so. Not a moment too soon, as a 2,200-page report by Anton Valukas, appointed by a US court to probe the reasons for Lehman's failure in September 2008, raised serious questions about the bank's top management, including former CEO Dick Fuld, and auditors Ernst & Young, reported the Financial Times.

Source: Doonesbury, SlateV.com, March 1, 2010. (Hat tip: The Big Picture)

The past week's performance of the major asset classes is summarized in the chart below - a set of numbers indicating that a degree of risk taking has crept back into financial markets. Interestingly, similar to a number of stock market indices, investment-grade corporate bonds also scaled fresh cycle peaks, whereas high-yield bonds are testing their January highs. Although yields on US government bonds did not change much on the week, the bond market was actually quite strong in light of the US Treasury being able to sell $74 billion in 3-, 10- and 30-year Notes and Bonds at lower-than-expected yields. Fears of further monetary tightening in China weighed on the Shanghai Composite Index (shown in the table of global stock market performance lower down) and commodities. Gold and silver were also out of favor. (Click here for Adam Hewison's (INO.com) latest technical analysis of the outlook for gold bullion.)


Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The cyclical bull market that commenced on March 9, 2009 celebrated its first anniversary with gains across a broad front. The MSCI World Index and the MSCI Emerging Markets Index gained 1.4% and 1.8% respectively. Among mature markets, Japan (+3.7%) reached its highest close in seven weeks in expectation that further easing of monetary policy by the Bank of Japan (BoJ) on Wednesday will weaken the yen and boost exporters. The only weak spots were a few emerging markets such as China (-0.6%), Russia (-0.3%) and Venezuela (-0.1%).

Notwithstanding the huge rally since the March lows, only the Chile Stock Market General Index has been able to reclaim its 2007 pre-crisis peak and is now trading 9.3% higher. Mexico and Israel could be the next countries to eliminate the bear market losses. The Dow Jones Industrial Index and the S&P 500 Index are still 25.0% and 26.5% respectively down on their October 2007 bull market peaks.

All the major US indices are back in the black for 2010 to date. The small-cap Russell 2000 Index, a clear leader among the indices, has registered 20 out of 23 up-days since the low of February 8.

Top performers among the entire spectrum of stock markets this week were Kenya (+8.3%), Jamaica (+6.5%), Sweden (+5.4%), Nigeria (+5.3%) and Hungary (+4.6%). Debt-burdened Greece's austerity plans gained favor with investors, pushing the Athex Composite Share Price Index up by +3.7 for the week. At the bottom end of the performance rankings, countries included Nepal (?3.4%), Bangladesh (-2.3%), Macedonia (-1.6%), Peru (-1.5%) and Botswana (-1.4%).

Of the 94 stock markets I keep on my radar screen, 74% recorded gains, 21% showed losses and 5% remained unchanged. The performance map below tells the past week's mostly bullish story.

Emerginvest world markets heat map

Source: Emerginvest (Click here to access a complete list of global stock market movements.)

Seven of the ten economic sectors of the S&P 500 Index closed higher for the week, with defensive sectors Health Care, Consumer Staples and Utilities the only ones under water.

Source: US Global Investors - Weekly Investor Alert, March 12, 2010.

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the winners for the week included iShares MSCI Sweden (EWD) (+5.3), Claymore/Delta Global Shipping (SEA) (+5.0%), Market Vectors Indonesia (IDX) (+5.0%), First Trust Amex Biotech (FBT) (+4.5%), Claymore/NYSE Arca Airline (FAA) (+3.9%) and iShares Cohen & Steers Realty Majors (ICF) (+3.9%).

At the bottom end of the performance rankings, ETFs included iPath DJ AIG Sugar (SGG) (-12.2%), United States Natural Gas (UNG) (-4.7%), iPath DJ AIG Natural Gas (GAZ) (-4.5%), ProShares Short Financials (SEF) (-4.1%) and ProShares Short Emerging Markets (EUM) (-2.8%).

The table below, courtesy of Bespoke, highlights the performance of key ETFs across all asset classes over the last month, six months and year.

"Over the last year, just three ETFs shown are down - Natural Gas (UNG) at ?48%, 7-10 Year Treasuries (IEF) at -4%, and 20+ Year Treasuries (TLT) at ?13%. The best-performing ETF shown over the last year has been Russia (RSX) with a gain of 175%. India (INP) ranks second with a gain of 165%, and the Financial sector ETF (XLF) third with a gain of 144%," said the report.

Source: Bespoke, March 9, 2010.

Referring to the ballooning US budget deficit, the quote du jour this week comes from 85-year-old Richard Russell, La Jolla-based author of the Dow Theory Letters. He said: "The estimates of budget deficits are so huge that they defy the ability of the average citizen to comprehend them. As the US continues to create more dollars, at some point our foreign creditors are going to want higher returns (rate) before they are willing to make loans to the US. Rising rates would be an extreme danger to the US. Not only would they hurt business. Rising interest rates mean a rising cost of carrying the national debt. The process of compounding the cost of the national debt would send US finances into a death spiral'.

"I think institutional investors are holding off on buying stocks because they don't see stocks as safe long-term holdings. Big money investors are looking ahead to higher interest rates. That combined with current high valuations for stocks constitutes a red flag for seasoned investors. The key here is probably the action of the bond market, and particularly long-dated Treasury bonds. The 30-year T-bonds would be particularly sensitive to Treasury financing looking years ahead.

"It is still not clear how the US is going to finance its enormous national debt. Reneging on the debt is unthinkable. To raise taxes and at the same time cut down on spending is almost an impossibility. That leaves inflation as the most probable answer. As soon as our creditors realize our way out' is inflation, they will halt their process of lending to the US, or at least halt lending at current low, low rates."

Elsewhere, The New York Times reported that "the White House and Congressional leaders put Democrats on notice on Friday that they would push ahead next week toward climactic votes on the health care legislation."

Next, a quick textual analysis of my week's reading. This is a way of visualizing word frequencies at a glance. The usual suspects such as "bank", "China", "debt", "economy", "Fed", "market", "policy" and "rates" featured prominently, with "Greece" taking a back seat after its prominence over the past few weeks.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town when not traveling) are given in the table below. With the exception of the Shanghai Composite Index, the indices in the table are all trading above their 50- and 200-day moving averages.

The table provides the February lows for the various indices as these must hold in order for the cyclical bull market to remain intact. Importantly, although the Shanghai Composite Index is trading a little below its key moving averages, it is still above the February low. On the upside, a break above 3,097 is required to again put the Index on a bullish path.

The Dow Jones Transportation Index, the Nasdaq Composite Index and the Russell 2000 Index all made new cycle highs during the week, with the S&P 500 closing at exactly the same level as its January high and the Dow Jones Industrial Index still 100 points short. (The fact that the Transports recorded a new high but not the Industrials represents a so-called Dow Theory non-confirmation.) However, the indices still have more work to do in order to reach pre-Lehman levels - 1,250 in the case of the S&P 500 (i.e. a gain of 8.7% from here).

Using Fibonacci retracement lines, the S&P 500 is now testing the 62% retracement line drawn from the May 2008 peak to the March 2009 bottom (see purple lines). According to John Murphy (StockCharts.com), a break of this key upside target raises the possibility that the Index could retrace 62% of the entire bear market that started in the fourth quarter of 2007, in which case the potential upside target is 1,232 (see green lines).

Source: StockCharts.com

Also commenting on the technical picture of the S&P 500, Kevin Lane (Fusion IQ) said: "Currently individual investor allocations towards equities are slightly below the mean, which puts us in a zone where, though reduced, buying power is still ample. With buying power relatively strong and the AAII Bull Sentiment Survey still at a relatively neutral reading, it's hard to see a big correction here. What may be a likely scenario is as follows: the market continues to move up and investors, even the non-believers, start chasing stocks, putting their last bit of buying power into the market."

Bill King (The King Report) believes the stock market could make some kind of top in the next 3-6 weeks. "The recovery rally is stretched, the Fed is scheduled to end its monetization this month, volume is contracting, the usual small cap-tech rally has accelerated and April 30 is the end of the best seasonal rally period; expiration is next week and Q1 performance gaming looms," he said. "But most importantly, March and April often contain important reversals or significant declines for stocks. Curfew hour is approaching."

From London, David Fuller (Fullermoney) adds the following perspective: "All technical evidence to date suggests we have seen a normal correction to the cyclical bull market's trend mean represented by rising 200-day moving averages. The only minor negative is that persistent rallies have replaced short-term oversold conditions with short-term overbought readings. If this matters beyond brief pauses, we would see it in the form of downward dynamics and failed upside breaks from trading ranges. However, a more important factor is likely to be the months spent by most equity indices in ranging consolidations, as they gradually worked their way over to their rising moving average mean. In the absence of downward dynamics, perhaps caused by some currently unexpected fright, stock markets remain capable of running on the upside."

On a somewhat longer-term horizon, Fuller identifies a number of possible warning signals to look out for: "1) Strong economic growth competes for capital and invites monetary tightening by central banks; 2) strong growth and too much speculation would lift oil prices over the low $80s highs for this cycle to date, towards headwind levels of $100 or more; 3) US 10-year Treasury yields above 4% would be an advance warning but the real danger area is above 5%; 4) a very weak USD could undermine confidence but this is clearly not a threat today."

Although the fat lady has not yet made her appearance to signal the end of the bull cycle, the steepness of the nascent rally, together with resistance in the area of the January highs, could result in stock markets consolidating in order to work off a short-term overbought condition. On the fundamental front, tighter money does not necessarily spell a declining stock market, but turning off the "juice" will certainly remove a tailwind, making earnings growth the key determinant for generating further gains (especially in light of stretched valuations).

For more discussion on the economy and financial markets, see my recent posts "Video feast: Make Markets Be Markets", "Stock market is overvalued, overbought and overbullish, according to Hussman", "Technical talk: Hard to see a big correction here", "Interview: James Montier on value investing", "Interview: James Montier on behavioral investing", "Stock markets - celebrating one year of gains, but only Chile above 2007 peak" and "Q&A on emerging markets with Mark Mobuis". (And do make a point of listening to Donald Coxe's webcast of March 12, which can be accessed from the sidebar of the Investment Postcards site.)

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"There has been little change in global business confidence since the beginning of this year. Sentiment remains consistent with only a modest global economic recovery. Businesses are upbeat when broadly assessing current conditions and the outlook through this summer, but remain stubbornly cautious in their assessment of sales strength, hiring and inventories," according to the results of the latest Survey of Business Confidence of the World by Moody's Economy.com. South Americans are the most upbeat and North Americans the most nervous. Confidence is strongest among financial and business services firms and weakest among those working in real estate and government. Manufacturing firms are in between.

Source: Moody's Economy.com

Referring to the precarious debt situation of many countries, Mohamed El-Erian, co-chief investment officer of Pimco, said on the company's website: "Every once in a while, the world is faced with a major economic development that is ill-understood at first and dismissed as of limited relevance, and which then catches governments, companies and households unawares."

As seen in the chart below (courtesy of US Global Investors), the sovereign debt-to-GDP ratio is much worse for the G-20 largest developed economies (about 100%) than for the 20 most important emerging markets (approximately 40%). The G-20 ratio is forecast to increase by another 20% over the next few years, while the emerging countries' ratio is expected to decline as a result of smaller budget deficits.

Source: US Global Investors - Investor Alert, March 12, 2010.

Although developed markets still have higher sovereign credit ratings (left axis) than emerging markets (right axis), the ratings of emerging markets are improving, while those of developed markets are worsening significantly.

Source: US Global Investors - Investor Alert, March 12, 2010.

Back to El-Erian who said: "Governments naturally aspire to overcome bad debt dynamics through the orderly (and relatively painless) combination of growth and a willingness on the part of the private sector to maintain and extend holdings of government debt. Such an outcome, however, faces considerable headwinds in a world of unusually high unemployment, muted growth dynamics, persistently large deficits and regulatory uncertainty.

"Countries will thus be forced to make difficult decisions relating to higher taxation and lower spending. If these do not materialize on a timely basis, the universe of likely outcomes will expand to include inflating out of excessive debt and, in the extreme, default and confiscation."

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

Friday, March 12, 2010
• Strength of February retail sales impressive, but Q1 consumer spending could show only tepid gain
• Rebound in business inventory accumulation in store for 2010?
• University of Michigan Consumer Sentiment Index again edges down

Thursday, March 11, 2010
• Flow of funds: Net worth of households grew, household debt reduction continues, net lending remains a challenge
• International trade: Decline in oil and auto imports account for narrowing of trade gap
• Total continuing claims holding at elevated level

Wednesday, March 10, 2010
• Budget deficits: The challenge ahead in a picture
• Wholesale inventories: Inventory-sales ratio at record low

Considering the Fed's Beige Book (released the week before last), David Rosenberg (Gluskin Sheff & Associates) said: "The Beige Book is very useful in terms of its timeliness and granularity to the sector level. I always make a note to check and see which industries are seeing positive and negative momentum. In the latest Beige Book the list of positives was longer than I have seen in at least the last two years (twice as many positive sectors as there were negatives).

"The positive mentions are: steel, natural gas, tech (especially semiconductors), software/information services, housing (entry level), tourism, staffing firms, chemical manufacturing, rail transports, airlines (fares stabilizing, leisure and business demand improving), heavy machinery (especially mining and agriculture equipment), plastic products, health care services, negative mentions, commercial real estate, banking, commercial aircraft, automotive, coal and petrochemicals."

A majority of economists in the National Association of Business Economists' semi-annual survey expressed the opinion, as reported by MoneyNews, that a rise in interest rates was both likely and appropriate in the next several months. "I'm a little worried that the extended period language [used in the Fed's statements] is conveying too much of a particular date to markets about interest rates," added St. Louis Federal Reserve Bank President James Bullard.

Pimco's co-chief investment officer and founder, Bill Gross, on the other hand, said he was skeptical of the economy's ability to grow without the government programs and that it was possible for "some of the Fed's liquidity programs to come back" if recovery was uncertain, according to CNBC reports (via MoneyNews). "When debt to GDP reaches 90%, as it looks like it will, growth slows and bad things happen. That's the potential going forward, not a default," he said.

Bill King is of the opinion that "the FOMC meeting next Tuesday will certify or annul the scheduled termination of quantitative easing (QE) - the monetization of mortgage-backed securities (MBS) and agencies - on March 31. The bubble meisters must also address the issue of keeping interest rates low for an extended period of time'. This rhetoric is causing internecine fighting within the Fed. The financial center districts want to keep the juice flowing. Non-financial district presidents are more hawkish and concerned about inflation."

Moving across the pond, amidst debt concerns regarding the PIIGS countries (Portugal, Ireland, Iceland, Greece and Spain), the European Union released a report on Friday showing Eurozone industrial production had increased in January at the highest rate since the start of records in 1990.

Further afield, Chinese exports increased by 45.7% in February on a year-ago basis, eclipsing forecasts and providing evidence of a strong economy. However, China's inflation rate also rose significantly in February, registering a 2.5% increase from a year before - the highest in 16 months.

According to US Global Investors, the latest inflation figure surpassed the one-year deposit rate of 2.25%. Negative real interest rates may provide an additional incentive to drive asset prices higher, increasing the likelihood of the Chinese central bank raising interest rates from a five-year low.

Source: US Global Investors - Investor Alert, March 12, 2010.

On the question of exiting from monetary stimulus, the chart below shows Citi's estimates (via US Global Investors) of upcoming rate increases in emerging countries in 2010. Higher rates are on the cards for countries where inflation pressures are building, notably Brazil and Turkey.

Source: US Global Investors - Investor Alert, March 12, 2010.

Week's economic reports

Date Time (ET) Statistic For Actual Briefing
Mar 10 10:00 AM Wholesale Inventories Jan -0.2% -0.1% 0.2% -1.0%
Mar 10 10:30 AM Crude Inventories 03/06 1.43M NA NA 4.03M
Mar 10 02:00 PM Treasury Budget Feb -$220.9B -$223.0B -$222.0B -$42.6B
Mar 11 08:30 AM Continuing Claims 2/27 4558K 4550K 4500K 4521K
Mar 11 08:30 AM Initial Claims 03/06 462K 445K 460K 468K
Mar 11 08:30 AM Trade Balance Jan -$37.3B -$42.5B -$41.0B -$39.9B
Mar 11 12:00 PM Flow of Funds Q4 - - - -
Mar 12 08:30 AM Retail Sales Feb 0.3% -0.2% -0.2% 0.1%
Mar 12 08:30 AM Retail Sales ex auto Feb 0.8% 0.2% 0.1% 0.5%
Mar 12 09:55 AM Michigan Sentiment Mar 72.5 74.6 74.0 73.6
Mar 12 10:00 AM Business Inventories Jan 0.0% 0.0% 0.1% -0.2%
Source: Yahoo Finance, March 12, 2010.

Click the links below for Wells Fargo Securities' research reports.
Weekly Economic & Financial Commentary (March 12)
Global Chart Book (March 2010)
Monthly Economic Outlook (March 2010)

Next week sees interest rate announcements by the Federal Open Market Committee (FOMC) (Tuesday, March 16) and Bank of Japan (BoJ) (Wednesday, March 17). In addition, US economic data reports for the week include the following:

Monday, March 15
• Empire Manufacturing Survey
• Net long-term TIC flows
• Capacity utilization
• Industrial production

Tuesday, March 16
• Building permits
• Housing starts
• Import and export prices

Wednesday, March 17

Thursday, March 18
• Jobless claims
• Current account balance
• Leading indicators
• Philadelphia Fed

The performance chart obtained from the Wall Street Journal Online shows how different global financial markets performed during the past week.

Source:Wall Street Journal Online, February 26, 2010.

Final words
Warren Buffett said: "The person that turns over the most rocks wins the game. And that's always been my philosophy." (Hat tip: Charles Kirk.) Let's hope the news items and quotes from market commentators included in the "Words from the Wise" review will assist readers of Investment Postcards to "turn over many rocks", i.e. research matters properly in order to take prudent investment decisions.

That's the way it looks from Cape Town (where a blogger is finishing off this post in order to celebrate his birthday for the rest of Sunday, while Lance Armstrong and over 40,000 cyclists are battling a stiff wind in the 2010 Cape Argus cycle race).

Source: John Darkow, Comics.com, March 5, 2010.

The Wall Street Journal: What was Lehman hiding?
A 2,200-page report on pre-collapse Lehman Brothers raises serious questions about Enron-style accounting, Peter Lattman reports on the News Hub panel.

Source: The Wall Street Journal, March 12, 2010.

Financial Times: New York ties with London for finance crown
"London has lost its crown as the pre-eminent home of banking and finance, as it tied for the first time with New York in the latest ranking of financial centres.

"Fears about a regulatory backlash and new taxes drove down London's score by 14 points to tie with New York at 775 points, in the Global Financial Centres Index compiled by Z/Yen for the City of London Corporation.

"London was one of only four cities to lose points in the semi-annual ranking, which combines a survey of financial professionals with factors such as office rental rates, airport satisfaction and transport. New York's score rose by only one point.

"Asian cities continue to rise in the ranking of 75 global centres. Hong Kong and Singapore posted double-digit gains in third and fourth place and the gap between London and New York and the rest of the world is at its narrowest since the survey began in 2007.

"This research is a wake-up call for decision-makers,' said Stuart Fraser, policy chairman for the City of London Corporation, which promotes the UK financial services sector and provides local services. You can't take this route [of bashing banks and bankers] without endangering the competitiveness of London.'

"New York fared better than London for business environment, availability of people and infrastructure, even though those participating in the survey agreed that New York had taken the bigger hit from the financial crisis.

"The most recent rankings were based on surveys taken from July to December 2009, when discussion of tougher regulation and higher taxes in the UK was at fever pitch."

Source: Brooke Masters, Financial Times, March 12, 2010.

David Rosenberg (Gluskin Sheff & Associates): What's beige and what isn't
"The Fed's Beige Book is very useful in terms of its timeliness (information taken from mid-January to February 22) and granularity to the sector level. I always make a note to check and see which industries are seeing positive and negative momentum. In the latest Beige Book the list of positives was longer than I have seen in at least the last two years (twice as many positive sectors as there were negatives). Although, the number of Districts reporting improved economic conditions did fall to 9 from 10 in the prior report published on January 13th.

"In the latest Fed Beige Book, looking at the industry breakdown, we see that the list of positive outweighed the negatives. The positive mentions are:

Natural gas
Tech (especially semiconductors)
Software/Information services
Housing (entry level)
Staffing firms
Chemical manufacturing
Rail transports
Airlines (fares stabilizing, leisure and business demand improving)
Heavy machinery (especially mining and agriculture equipment)
Plastic products
Health care services
Negative mentions
Commercial real estate
Commercial aircraft

Source: David Rosenberg, Gluskin Sheff & Associates, March 5, 2010.

MoneyNews: Fed's Bullard impatient about low rate pledge for "extended period"
"A second senior Federal Reserve official has joined the ranks of those doubting whether the Fed should continue to commit to hold rates exceptionally low for an extended period, a sign pressures are building to drop the wording.

"I'm a little worried that the extended period language is conveying too much of a particular date to markets about … interest rates," St. Louis Federal Reserve Bank President James Bullard recently told reporters before speaking on a panel organized by St. Cloud State University.

"I think the extended period language, to the extent it's dictating a particular time horizon, is not what the committee wants to do," said Bullard, a voter on the Fed's interest-rate setting panel. And that's making me a little less patient with the extended period language.'

"Bullard's stance allies him with Kansas City Fed Bank President Thomas Hoenig, who dissented at the central bank's January meeting, saying economic conditions have improved sufficiently to drop the promise. Both are voters this year on the 10-strong policy-setting Federal Open Market Committee.

"Most policymakers want to maintain the pledge and the Fed is expected to renew it at its meeting this month. Discarding it would signal that the Fed could be within several months of raising borrowing costs."

Source: MoneyNews, March 8, 2010.

MoneyNews: Gross - Fed will have to support economy if weakness remains
"The Federal Reserve might continue to buy mortgage-backed securities and take other measures to inject liquidity into a still ailing economy, says Bill Gross, co-chief investment officer and founder of Pimco and manager of the world's largest bond fund.

"Many of the Fed's liquidity programs are set to expire at the end of March, but monetary authorities might consider renewing such measures because growth won't be strong enough without them.

"These things have all been very critical but let's face it - they're expiring at the end of March,' Gross says. The critical question … is do we really need Uncle Sam and the check writing to continue?'

"Gross says he is skeptical of the economy's ability to grow without the government programs and adds it's possible for 'some of these programs to come back' if recovery is uncertain, CNBC reports.

"He said sees economic struggles continuing over a three- to five-year period - and even as long as 10 years, depending on circumstances."

Source: Forrest Jones, MoneyNews, March 8, 2010.

MoneyNews: Former Fed Gov. Heller - double dip recession in cards
"The economy is headed back down, thanks to the exploding budget deficit, which will send interest rates soaring, says former Federal Reserve Gov. Robert Heller.

"A double dip recession is still very much in the cards,' the now retired he says.

"The big elephant in the room that nobody talks about is the huge federal deficit, and that will eventually force up interest rates,' Heller told CNBC.

"The deficit totaled $1.4 trillion last year and is expected to register about the same amount this year.

"As interest rates go up, it will kill both the business and consumer recovery,' Heller said.

"Therefore, the economy is likely to go down again. Sooner or later we'll see a spike in interest rates, and that's the danger awaiting investors.'"

Source: Dan Weil, MoneyNews, March 5, 2010.

Bloomberg: Pimco's El-Erian says public finance shock may deepen
"Mohamed El-Erian, whose company runs the world's biggest mutual fund, said deteriorating public finances may affect the global economy more than is currently realized.

"The importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood,' El-Erian, co-chief investment officer at Pacific Investment Management Co., wrote in an article on the Financial Times website. The potential damage from increased government borrowings is at present being viewed primarily - and excessively - through the narrow prism of Greece.'

"Governments may have to raise taxes and slash spending to cope with swelling deficits after borrowing unprecedented amounts to stave off the global financial crisis, said El-Erian, who shares his job title with Bill Gross. A failure to carry out fiscal measures in time would raise the possibility of governments seeking to eliminate excessive debt through inflation or default, he said.

"Pimco has said debt strains in Greece, Portugal and Spain underscore its view that 2010 will be a year of slower-than- average growth, and predicts there will be a shrinking global role for the US economy."

Click here for the full article.

Source: Garfield Reynolds, Bloomberg, March 11, 2010.

Bloomberg: Obama spending plan underestimates deficits, budget office says
"President Barack Obama's budget proposal would create bigger deficits than advertised every year of the next decade, with the shortfalls totaling $1.2 trillion more than the administration projected, according to the Congressional Budget Office.

"The nonpartisan agency said yesterday the deficit will remain above 4 percent of the nation's gross domestic product for the foreseeable future while the publicly held debt will zoom to $20.3 trillion, amounting to 90 percent of GDP by 2020. By then, interest payments on the debt will have quadrupled to more than $900 billion annually, the report said.

"Deficits between 2011 and 2020 would total $9.76 trillion, the CBO said.

"Economists generally consider deficits topping 3 percent of GDP to be unsustainable because that means government debt is growing faster than the ability to pay back the money.

"The news today from CBO is clear: The president's budget will continue to lead our nation into a fiscal catastrophe - an ever worse one than the president's own numbers suggest,' Representative Paul Ryan of Wisconsin, the top Republican on the House Budget Committee, said yesterday.

"White House Office of Management and Budget spokesman Kenneth Baer said the report highlights how sensitive and uncertain budget projections are'.

"Baer also said, What is certain is that the irresponsibility of the past put the country on an unsustainable fiscal trajectory.'

"The CBO report is designed to give Congress an independent assessment of the administration's budget request. The difference between the two outlooks is largely attributable to varying economic assumptions that affect projections of how quickly tax revenues will pour into the Treasury.

"Revenues will be about $2 trillion less than the administration projects, while spending will be lower by about $600 billion, according to the CBO report."

Source: Brian Faler, Bloomberg, March 6, 2010.

Bespoke: The deficit blob
"Yesterday's release of the monthly budget statement showed that the Federal government took in $108 billion and spent $328 billion, for a total monthly deficit of $221 billion. This marks the single largest monthly deficit reading in the history of the United States. The charts below show Federal Government revenues, spending, and deficits on a twelve month rolling basis. Not surprisingly, at a level of $1.48 trillion, this level is also at a record.

"With the stock market bottom more than a year in the past, and the economy showing clear signs of recovery, there is now widespread agreement that the US economy is emerging from crisis and no longer on the brink of collapse. For nearly two years now, Americans have been told by both Administrations that increased government spending was needed medicine to take the economy off of life support. Now that the economy is no longer on the brink, how much longer will Americans, and more importantly, the markets, accept this line of reasoning?"

Source: Bespoke, March 11, 2010.

MoneyNews: Romer - deficit a problem but don't stop spending
"The gaping US budget deficit is cause for concern but clamping down on spending immediately would be pound foolish' and derail the recovery, a top White House economic adviser said Tuesday.

"Christina Romer, who heads the Council of Economic Advisers, said cutting back now would inevitably nip the nascent economic recovery in the bud - just as fiscal and monetary contraction in 1936 and 1937 led to a second severe recession before the recovery from the Great Depression was complete.'

"Romer, in a speech to the National Association for Business Economics, also said President Barack Obama's $787 billion stimulus package had been successful in pulling the economy out of a deep recession.

"However, she said additional measures were necessary to bring the jobless rate down from the current level of 9.7 percent, which she called a terrible number by any metric'.

"Romer said Obama's job creation proposals - a hiring tax credit, additional aid for cash-strapped states, and providing capital to small banks - would help to bring down the jobless rate although she acknowledged that the economy probably would not grow fast enough to quickly close the labor gap."

Source: MoneyNews, March 9, 2010.

Richard Russell (Dow Theory Letters): Heading for inflation or deflation?
"It's hard to believe, but there's no consensus opinion on whether we're headed for inflation or deflation. The fact is that the US national debt is now over $12 trillion. If the Treasury and the Fed just stare at this figure and don't do anything the compounding interest on $12 trillion will eat us up alive'. That's the deflation part of the story. If the Fed and the administration cut back on the bail-out and stimulus programs, the US will probably sink back into an even more severe recession.

"The number one problem on the administration's collective minds is the chronic unemployment that seems to be imbedded in the guts of the nation. The main ambition of every politician is to get reelected. Nobody's going to get reelected while almost 20% of the voters in his district can't find a job. So the problem for the Obama crowd is - how to create jobs. I believe their prescription for job-creation is more inflation'. More printing of Federal Reserve Notes means that the banks will have even more money that they don't want to lend. Thus, small business can't get loans, and unemployment remains high.

"The reckless creation of fiat money is basically inflationary, but the trade-off is that the National Debt increases. Is there any painless way out of this predicament? None that I can figure out. With $12 trillion in national debt, the US must try to inflate the debt away or renege on it. Reneging on the debt is unthinkable, which leaves the inflation strategy. The problem must be addressed, since if it is not, the compounding factor will simply make the problem that much more intractable.

"The question becomes, will inflation produce more jobs? It was tried before during the Carter years, and the answer is that increased inflation does not guarantee more jobs.

"What about a lower dollar? A lower dollar helps US exports, but a lower dollar presents other problems. In the old days it was said that we owe the debt to ourselves, so that it's not a problem'. But today a large portion of our debt is owed to our friends overseas, and a lower dollar is the last thing they want to see.

"So what's the argument for coming deflation? In my opinion, a collapse in the stock market and a severe consumer strike. A cutback on dollar production and a halt to the bail-out and stimulus strategy would also be very deflationary.

"The bottom line is that nothing has been decided yet, which is why the stock market has been acting so 'spooky'. In the meantime, unemployment continues to be the main headache for the administration and with unemployment comes a consumer strike on spending. As Oliver Hardy would say to Stan Laurel, A fine mess you got us in.' Yes, indeed.

"Inflation or deflation or both. We'll know when it hits. And we will survive.

"Meanwhile, the so-called Greatest Generation' is passing on into history. There aren't a lot of the old guys and gals left. Maybe it's time for a new Greatest Generation'."

Source: Richard Russell, Dow Theory Letters, March 5, 2010.

Asha Bangalore (Northern Trust): Flow of funds - net worth of households grew, household debt reduction continues
"Net worth of households increased $682 billion to $54 trillion in the fourth quarter of 2009. In 2009, net worth of households moved up $2.8 trillion following a $13.1 trillion loss on 2008. The gains in equity prices in 2009 more than offset the losses of real estate holdings (-$905 billion) of households. There has been an 11.7% increase in household net worth from the trough in the first quarter of 2009.

"Although households experienced an increase in their wealth during 2009, they have significantly cut back on borrowing. In the fourth quarter of 2009, household net borrowing fell $54.4 billion, putting the annual decline at nearly $237 billion. The significant pace of debt reduction is a big negative for consumer spending.

"At the same time, net lending in the economy continues to be problematic. Net lending fell at annual rate of $577 billion in the fourth quarter vs. $361 billion drop in the third quarter. Self-sustaining economic growth is unlikely to occur if this situation persists in 2010."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 11, 2010.

Asha Bangalore (Northern Trust): International trade - decline in oil and auto imports account for narrowing of trade gap
"The trade deficit narrowed to $37.29 billion in January from a revised $39.9 billion deficit in December 2009. Exports and imports of goods and services dropped in January. Inflation adjusted exports of goods declined 1.6% and that of imports fell 3.1%.

"Exports of food (-2.3%), autos (-5.6%0, and capital goods excluding autos (-2.6%) accounted for a large part of the weakness in exports. On the imports side, autos (-8.0%), petroleum (-3.1%), and consumer goods excluding autos (-2.6%) posted the significant declines. The real trade deficit of goods narrowed to $41.0 billion in January from $43.8 billion in December. However, the January reading of the real trade deficit nearly matches the fourth quarter average, implying that international trade will have a positive effect on real GDP in the first quarter if the trade gap narrows noticeably in February and March."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 11, 2010.


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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