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HomeRevisiting the Weakest Link
Posted by Larry Doyle on October 7th, 2009 12:44 PM |
Are all regions of the world improving? Will Asia lead the globe to greener pastures and brighter days? Well, if so, the trek through the fields will not be easy and we will encounter many storms along the way.
While Australia’s raising rates yesterday is an indication of an improving economy in that country, as one moves out of Asia into eastern Europe we encounter a decidedly different dynamic. Let’s revisit the ‘weakest link,’ that being Eastern Europe in general and the Baltic nation of Latvia specifically.
I initially addressed the economic weakness in this part of the world last February in writing, “The Weakest Link.” Today, we learn that Latvian Currency Scare Rattles Markets:
The Swedish krona and a range of eastern European currencies have tumbled as Latvia appears to edge closer to devaluing its currency.
In a re-run of the last major devaluation scare, Latvia failed to attract any bids for one of its treasury bill auctions earlier Wednesday. The country’s treasury received no bids for its offer to sell eight million lats ($16.7 million) of paper maturing in April 2010.
The poor auction results are the latest sign of economic stress in the Baltic nation, where the government is struggling to meet budget cuts required by the International Monetary Fund, the European Union and other bilateral lenders in return for aid.
The Swedish krona, linked to Latvia through Sweden’s large banking exposure to the country, tumbled as news of the failed auction emerged. The euro extended earlier gains to reach a peak at SEK10.3670 against the krona.
Meanwhile, Europe’s emerging market currencies, which often suffer from nerves over risk when Latvia’s problems intensify, also fell.
The euro soared to over HUF269 against the highly risk-sensitive Hungarian forint, from under HUF267 at the start of the day. The euro also swept to over PLN4.24 against the Polish zloty, from a low of PLN4.18.
The Turkish lira and, to a lesser degree, the Czech koruna, also weakened. The failed bond auction was “not good news,” said Nigel Rendell, a European emerging markets strategist at RBC Capital Markets in London.
“It has all the makings of the final chapter in the Latvian story,” he added. In credit markets, the cost of insuring Latvian sovereign debt against default continued to climb from recent levels, in a sign that investors are increasingly uncomfortable with the outlook for the country. Regional peers Lithuania and Estonia, which also peg their currencies to the euro, saw their swaps spreads widen.
Still, the debt and currency markets shouldn’t be overly troubled by Latvian devaluation risk, as the threat has been building for some time, and the global financial markets are now much more robust than they were several months ago.
“If they did devalue, there would be a selloff [in eastern European assets], but the impact would not be as severe as it would have been six to nine months ago,” said Mr. Rendell at RBC. “If we had big currency moves, I think people would buy them back,” he added.
Devaluation is also unlikely to catch the Swedish banks off guard. To brace for the potential onslaught of defaulting customers, both Swedbank AB and Skandinaviska Enskilda Banken AB have set up Baltic units to deal with problem loans and seized collateral.
While officials may care to discount the impact of a full blown devaluation of the Latvian currency, the interconnectedness of the global markets has proven to be more of a risk propellant rather than a risk mitigant. How so? The use of derivatives across currency and credit markets has been shown to be as much speculative in nature as pure hedging. In fact, there certainly are market participants who will benefit by a Latvian devaluation.
Can that devaluation, if it does occur, be well contained?
I’ll be watching.
LD
Related Sense on Cents Commentary
Let’s Cross the Pond and Revist the Weakest Link (May 23, 2009)
U.S. Markets Play “Follow the Leader”
Posted by Larry Doyle on October 7th, 2009 9:40 AM |
Yesterday’s rise in rates by the Australian central bank is a bellweather sign of the global shift in the balance of economic power. While the rise in rates by the Aussies is the first central bank move, it certainly will not be the last. Why did the Aussies raise rates and what does it mean both in the short term and for the long haul? Let’s navigate.
The Australian economy did not have near the level of debt that burdens the U.S. and Europe and thus they did not need near the amount of monetary stimulus to weather this global recession. Additionally, Australia has benefited from extensive trade in the Asian hemisphere.
The knee jerk reaction in the markets was focused primarily on a selloff in the greenback which supported a move higher in commodities and global equities via the ‘positive carry trade.’ The commodity which garnered the greatest focus was gold, which moved toward $1040/ounce.
What do these moves mean? I see cross currents on the economic landscape, including:
1. The dollar may not necessarily continue to weaken, but given its current weakness it will support those companies which garner a greater degree of sales overseas.
2. A weak dollar is usually affiliated with inflation. I do not think we are in a position to look at prices in terms of one overall index. Why? Given the technical and fundamental factors in our economy, certain price components will likely project increased inflation while others will not.
To be more specific, given the labor situation in our country, I do not see any appreciable increase in wages anytime soon. In fact, I think it is likely wages will trend lower.
Given the glut of supply and vacancies in both the residential and commercial real estate markets, I have a tough time believing these prices will move appreciably higher anytime soon.
Commodities may very well move higher. Why? High five to MC for sharing with me that there is increased dialogue in the international trade community to move oil away from trading in dollars. In fact, that story likely had a big impact in yesterday’s trading. Even if there is not an immediate shift in this market dynamic, the mere fact that it is being discussed will support oil specifically, oil-based products broadly, and other commodities as well.
Given that these commodities are primarily inputs, the prices for the outputs will likely move higher. This development is clearly inflationary.
3. What happens to interest rates here in the United States? While on one hand we have some deflationary forces at work which would keep rates low, we have the tug of other factors pushing them higher. How does it play out? My gut instinct tells me that overall pools of capital will be flowing away from the United States and, as such, people and private corporations will have to pay more to attract capital here in our country. I think those entities which focus the bulk of their economic activity here in the United States will be forced to pay higher rates to attract funding.
4. What about our equity markets and the Fed? While the Fed will want to keep our rates low for an ‘extended period,’ they may not have that luxury. If other nations follow Australia in raising rates, the U.S. may need to withdraw some liquidity sooner rather than later. Kansas City Fed chair Thomas Hoenig made this very assertion yesterday.
What would higher rates mean or even the thought of higher rates mean? Slower growth and a tough road for equities going forward.
Thoughts, comments, questions always appreciated.
LD
Related Sense on Cents Commentary
Dollar Carry Trade Drives Global Equities (September 16, 2009)
Beware of Money Managers ‘Talking Their Book’
Posted by Larry Doyle on October 5th, 2009 9:02 AM |
“Oh, come on, Larry, you are just ‘talking your book.'”
I can hear those sentiments ringing in my ears from many Wall Street salespeople with whom I dealt over the years. What trader doesn’t talk his book? For those unfamiliar with this phrase, it is used when a trader or money manager offers a heavily biased view of the market and economy. While it would be naive to think that individuals aren’t biased by their business in developing their opinions, the challenge for investors is to weigh the opinion in light of the bias. To do otherwise would be the equivalent of flying blind.
I see evidence of ‘talking one’s book’ in commentary provided by Bloomberg, Stock Seers Say Gross 5% May Only Be Normal In Debt,
Wall Street projections for the fastest U.S. profit growth in two decades are putting some of the biggest equity investors at odds with Bill Gross.
Money managers are betting that more than two years of declining earnings, the longest stretch since the Great Depression, will end in 2010 when net income rises 26 percent before expanding 22 percent in 2011, according to data compiled by Bloomberg. Gross, who oversees the world’s biggest bond fund at Pacific Investment Management Co., says the economy won’t grow fast enough to sustain the steepest rally since the 1930s and equity returns will be limited to 5 percent a year.
Both Gross and the equity managers are in a perpetual battle for investor assets, the lifeblood of any money management operation.
One would be ill advised not to study the opinions of those involved in managing the largest equity and bond funds in the markets. These funds can move markets given their very size. That said, we need to weigh the manager’s opinions in the context of a wide array of other vastly more important variables. What are these variables and how do they impact my thought process in making investment decisions?
I initially develop an opinion about the economy. From there, I think about respective weightings I would like to allocate to different segments of the market (equities, bonds, cash, real estate, alternative assets). At that point, I review money managers to select those whom I deem to be the best. Only at that juncture would I seriously consider the thoughts and opinions of the money manager so I can most effectively make investment decisions.
I will often immediately dismiss money managers who have never offered opinions which run counter to their business.
Talking one’s book is not necessarily a bad thing. In fact, I would seriously discount a money manager who is not able to make a compelling case for his business. That said, as investors we need to be able to minimize the static and eliminate the noise that comes from managers ‘talking their book.’
LD
September 2009 Market Review
Posted by Larry Doyle on October 1st, 2009 9:31 AM |
I could wax poetic about the ebbs and flows of the various segments of the markets along with a variety of developments on and off Wall Street; however, in doing so I may detract from purely reading what the numbers are telling us. What do the numbers say? Much like last month, with the exception of the U.S. Dollar Index, every market segment once again increased in value. Wow!!
The dollar is clearly the ‘juice’ which is being used to drive an inordinate number of positive carry trades.
Are we merely supposed to enjoy the positive returns and assume they are a precursor to a brighter tomorrow? Not in my opinion. As I have been referencing, I believe we are not even a third of the way into running our ‘economic marathon,’ and thus prudence dictates we maintain our discipline and pace. Why do I feel this way? Our global banking system remains under pressure and has unrealized losses of $1.8 trillion. To this point, I wrote yesterday “When Is a $3.4 Trillion Loss Supposed to Be Good News?”:
A $3.4 trillion loss may be perceived as good news when it was previously projected to be $4 trillion. That said, when losses of this magnitude are buried in a mix of financial chicanery and accounting charades, the impact is not lessened but only extended.
How did the Financial Times characterize this IMF report and the state of global banking? The FT writes this morning:
The International Monetary Fund’s financial stability reports are losing their capacity to shock. This is a shame. . . . The shock factor may be gone, but sustaining a recovery will be no cakewalk.
Active traders may be excessively ebullient or despondent, depending on the daily swings in their profits or losses. I will enjoy the higher values in my monthly statements as they come in, but I am not changing my approach to increased discipline across all parts of my personal balance sheet. A balanced and well diversified portfolio with excess liquidity still strikes me as the best approach at this time.
Now, take a look at the numbers. Comments, questions always appreciated.
LD
Will Deflationary Forces Overwhelm Global Fiscal Stimulus?
Posted by Larry Doyle on September 28th, 2009 3:12 PM |
While Uncle Sam and his international brethren are doing everything they can to reflate the global economy, will the deflationary forces deeply embedded in the deleveraging process carry the day and the future? In doing so, will these deflationary forces usher in an economic dynamic not seen since the 1930s?
The analysis and review by market savants, media mavens, and government pundits is ultimately mere noise relative to the denouement of the question proffered above. Jeff Gundlach, of Trust Company of the West, has spoken his mind and believes deflation will ultimately weigh upon our economy and markets. Today I share with you Deflation Rising: Making the Case for a Lasting Deflationary Environment recently produced by Black Swan Trading. High five to loyal Sense on Cents reader Ben for sharing this report.
The professionals at Black Swan produce a thoroughly superb and comprehensive review of this critically important topic. I strongly encourage you to put this post in your “Save” box for further review as we navigate the economic landscape. The report is launched as follows:
“If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless”
Thomas JeffersonUncle Sam, whom we’ve dubbed the “stimulator of last resort”, is doing all it can to create some inflation. Inflation creation, through the debasement of money, is one thing governments have proven historically they do quite well.
Inflation bails out creditors because it allows them to repay debt more cheaply in the future, paying back the nominal value of debt with currency that loses a substantial amount of real value.
There is no bigger creditor than government.
But that said, at the moment it seems governments are losing the battle of inflation, to deflation, despite pumping money into the market around the clock.
This report makes the case for deflation. In it we examine the powerful deflationary headwinds that could lock the US and global economy into years of deflationary pressures that are reminiscent of the lost years in Japan when they became locked in a deflationary bear hug.
The report puts forth a wealth of compelling evidence for the deflationary case. The evidence covers the following topics, complete with numerous graphs and analytics:
1. Relationship between gold and the U.S. Dollar
2. Growth in money supply
3. Review of decline in the Consumer Price Index
4. Lack of Velocity of Money
5. Increase in bank reserves
6. Decline in outstanding consumer credit
7. Decline in nonfinancial corporate business credit
8. Discretionary spending reaches 50-year low >>>the writers posit that consumption will be much more dependent on income than credit
9. Decline in personal income
10. Structural headwinds in global economy including:
— U.S. economic policies
— likelihood of asset bubble in China
— dynamics in the oil and food markets
After an exhaustive, but not exhausting, 22-page review, the writers make a compelling case that the lessons of The Lost Decade in Japan will now very likely be played out here in the United States. What plagued Japan during that decade and to a great extent even today….deflation.
Additionally, the buildup of leverage within our economy took place over a 20 year time frame with a few significant hiccups. To think that our economy will be able to delever and recover within a year or two is beyond naive. I would project this delevering, adaptation, and recovery process will take at least five years if not longer.
Whether you place yourself in the deflationary camp, the hyperinflationary camp, or somewhere in between, do yourself the favor of reviewing this report. In the process, you will be more educated and qualified to navigate the global economic landscape.
LD
Auctions Across America
Posted by Larry Doyle on August 28th, 2009 4:07 PM |
How does an entity sell a massive amount of assets? Individual sales are too time consuming. Personal negotiations would be too onerous. How about utilizing the internet and engaging a wider audience? That is, in fact, exactly what is happening as America goes on sale via auctions. That’s right, folks.
From the state of California to small banks and all points in between, there are and will be ongoing liquidations via auctions for the foreseeable future.
How does one receive a list of items for sale? Check out the following to start:
>> Great California Garage Sale held by the California Department of General Services.
I have two rhetorical questions:
1. What will these auctions mean for consumer spending and retail sales going forward?
2. What will these auctions mean for the pace of inventory buildup?
All part of the new dynamic within the Uncle Sam economy.
Have fun shopping.
LD
Would You be Confident?
Posted by Larry Doyle on August 14th, 2009 3:33 PM |
I am an eternal optimist. I would also like to think I understand the fundamentals of the economy, and that I present a balanced approach here at Sense on Cents. So let’s pursue the truth.
The market is being hit 1-1.5% today on a retracement in the Consumer Confidence report this morning. While the equity markets have had an enormous rebound over the last few months, there is little doubt that the divide between Wall Street and Main Street has never been wider.
What impacts the consumer? In my opinion, the noise on Wall Street does not impact most Americans. What does? Job status, home value, and access to credit. How are Americans feeling on these fronts?
1. Jobs: the underemployment rate of 16.3% is forecasted to move higher and stay high. A little disconcerting, you think?
2. Home Value: foreclosures are continuing to surge, home prices are continuing to trend lower, and no reason for slowing on either front. Not generating lots of confidence here.
3. Credit: hat tip to MC from Investor Rebellion for sharing a story put out the other day by The Wall Street Journal which highlights how consumers’ credit cards are being discontinued indiscriminately without notice. This report, Cardholders Get Rude Surprise at the Register, is a true sign of the times.
Think about this scenario for a second. How humiliating and unsettling would it be to experience having your card rejected without notice. Do you think these people are going to rush out to do more shopping? Do you think their confidence may take a hit just a little?
Why is Wall Street, which is making all this “supposed” money and handing out enormous guarantees to certain employees, cutting credit lines? What do these banks see on the economic landscape?
Wall Street economists and analysts may be confident about future prospects, but I have yet to see one of them effectively address any of these three concerns which most impact Main Street.
LD
Are We in the Early Stages of a Depression?
Posted by Larry Doyle on July 23rd, 2009 8:48 AM |
At the request of a reader (hat tip to kbdabear), I have been asked to comment on a report produced by Sprott Asset Management of Toronto, Ontario entitled It’s the Real Economy, Stupid. The writers, Eric Sprott and David Franklin, believe:
We are now in the early stages of a depression. The economic indicators we follow to track real economic activity are all signaling a slowdown of massive proportions. You wouldn’t know it reading the mainstream papers of course – they all focus on the relative decline in the slowdown’s intensity. Reading about the slowdown ‘slowing down’ is not the same as growth however, and does not warrant excitement in our opinion.
Are we in the early stages of a depression or are we merely experiencing the worst recession since the 1930s? Let’s define these two economic terms.
Recession? Depression? What’s the Difference?
The standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.This definition is unpopular with most economists for two main reasons. First, this definition does not take into consideration changes in other variables. For example this definition ignores any changes in the unemployment rate or consumer confidence. Second, by using quarterly data this definition makes it difficult to pinpoint when a recession begins or ends. This means that a recession that lasts ten months or less may go undetected.
Recession: The BCDC Definition
The Business Cycle Dating Committee at the National Bureau of Economic Research (NBER) provides a better way to find out if there is a recession is taking place. This committee determines the amount of business activity in the economy by looking at things like employment, industrial production, real income and wholesale-retail sales. They define a recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out. When the business activity starts to rise again it is called an expansionary period. By this definition, the average recession lasts about a year.
And how is a widely feared depression defined?
Before the Great Depression of the 1930s any downturn in economic activity was referred to as a depression. The term recession was developed in this period to differentiate periods like the 1930s from smaller economic declines that occurred in 1910 and 1913. This leads to the simple definition of a depression as a recession that lasts longer and has a larger decline in business activity.
The Difference
So how can we tell the difference between a recession and a depression? A good rule of thumb for determining the difference between a recession and a depression is to look at the changes in GNP. A depression is any economic downturn where real GDP declines by more than 10 percent. A recession is an economic downturn that is less severe.
By this yardstick, the last depression in the United States was from May 1937 to June 1938, where real GDP declined by 18.2 percent. If we use this method then the Great Depression of the 1930s can be seen as two separate events: an incredibly severe depression lasting from August 1929 to March 1933 where real GDP declined by almost 33 percent, a period of recovery, then another less severe depression of 1937-38. The United States hasn’t had anything even close to a depression in the post-war period. The worst recession in the last 60 years was from November 1973 to March 1975, where real GDP fell by 4.9 percent. Countries such as Finland and Indonesia have suffered depressions in recent memory using this definition.
In reading Sprott’s and Franklin’s review, they focus on the negative assessments of the following economic data: (more…)
Bernanke Promises to Keep ‘Punch Bowl’ Filled
Posted by Larry Doyle on July 21st, 2009 1:59 PM |
Everybody back in the pool!!! Turn that music up and let’s rock!!
Why so ebullient and energized to ‘party?’ Well, our host, Ben Bernanke, has promised to keep the ‘punch bowl’ filled. As the Wall Street Journal highlights in writing Bernanke Sheds Light on Exit Strategy:
Mr. Bernanke reiterated that despite recent improvements in the economy and financial markets, the federal-funds rate will likely remain near zero for an extended period of time.
That statement by the ‘grand and wonderful wizard’ Ben Bernanke is the equivalent of turning up the volume to some music by the J. Geils Band. How are the partygoers reacting? Filling up their cups, that being, buying bonds like there is no tomorrow.
On the day, the Treasury market has rallied by 10 to 15 basis points (recall lower rates means higher bond prices) as all the partygoers (market participants) reenter into a variety of ‘positive carry’ trades. In layman’s terms, positive carry trades very simply are a vehicle to use cheap dollars (i.e Fed Funds borrowed between 0 and .25) to purchase higher yielding assets. Another commonly used term for this form of investing is utilizing increased ‘leverage.’ Yes, we have previously partied with increased leverage. That did not end well…
Why would traders or others utilize this approach in the midst of such economic uncertainty? Very simply, when the host tells you that the ‘punch bowl’ is going to remain filled for an extended period, he is compelling you to get involved. In fact, he is effectively forcing you into the pool. How so? The returns on the safest, shortest, and most liquid assets (T-bills, CDs, money markets) will also be kept low for an extended period.
As an investor, the Fed chair is literally forcing you to take greater risks in your investments. Those funds will be utilized by financial institutions to generate increased earnings and thus write off the loans on their books which are defaulting at an ever increasing rate.
What are the risks of keeping the ‘punch bowl’ filled too long?
> inflation, as too much “liquid”ity enters the system
> asset bubbles, as too many cheap dollars chase returns
> mispricing of risk, as market participants focus on the technical rally rather than fundamental analysis
The challenge for Bernanke is knowing when and how to pull that punch bowl away.
The last wizard, Alan Greenspan, badly miscalculated in his assessment which led to our current economic turmoil.
While it is nice to see positive returns in 401K statements and other monthly investment statements, be mindful of another tried and true piece of Wall Street wisdom . . . ‘the road to hell is paved with positive carry.’
In the meantime, as long as we understand the parameters of this situation, let’s enjoy Ain’t Nothing Like a House Party by the J. Geils Band!!
LD
‘Cash for Clunkers’ Comments and Questions
Posted by Larry Doyle on July 31st, 2009 2:51 PM |
Uncle Sam just spent $1 billion via the “Cash for Clunkers” program over a 4 day time frame. Given the speed of that burn rate, The Wall Street Journal reports, House Votes to Extend ‘Clunkers’ Program.
A few questions and comments:
1. The National Highway Traffic Safety Administration is overseeing the disbursement of these funds. Think there may be a chance of some kickbacks or fraud going on here? Who is checking?
2. Assuming the average list price of the fuel efficient vehicles being sold is $20k, the subsidy of upwards of $4500 is approximately a 20% discount. Is this a true reflection of latent demand or partially a reflection of consumers responding to a gift?
3. What does this program do to the used car market? If I am in the market for a used car, my bid just went down at least 10% if not more.
4. How does this program affect the less fuel efficient car market? Does it strip demand away from that segment?
5. If there is such demand for the Cash for Clunkers program, should there be further restrictions on who may be able to benefit from this program going forward?
6. Given the speed with which the initial $1 billion was utilized, do you think there is a chance car dealers are working other deals with customers?
Not to be overly cynical, but as an industry car dealers do not exactly enjoy the best reputation. As such, while Congress can approve more funds, I would like to see a thorough audit of this program prior to the actual allocation of those funds.
Thoughts and comments welcome.
LD
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