June 13, 2009

Market Insights 13 June 2009

Weekly Snapshot
• BlackRock buys Barclays Global Investors for $13.5bn - now managing almost $3 trillion in assets
• US Consumer sentiment at 69.0 - highest level in 9 months
• Oil hit a year high of $73 on Thursday before closing the week at $72
• 10 Year T-Note yield hit 4% this week
• Rates on US 30-year fixed mortgages highest in 7 months
• Latvia faces a currency and financial crisis, possible default
• US retail sales show a modest increase of 0.5% in May compared to April
• Japan's Nikkei Index above 10,000 - first time since Oct-08
• Fiat closes Chrysler deal - new management team is chosen
• Federal Reserve's "Beige Book" shows that economic conditions remained weak
• US trade deficit increased to -$29.2 billion in April

Chart of the Week
The Nikkei 225 Index, Japan's benchmark stock index closed the week above 10,000 for the first time in 9 months. Japanese equities have now "risen" back to the prices of 1984. So much for equity returns of a quarter century.

Nikkei versus NASDAQ
Examining the chart of the Nikkei this week prompted me to turn back my internal clock about 10 years to a time when I wrote a paper entitled: "Has Japan Learned From The Economic Mistakes Of The Past?"
I would like to share some excerpts of this paper to emphasize some daunting similarities with regard to the economic conditions we are facing today.

Japan's economy had an unprecedented performance during the 1980's. Japanese products flushed the US market dominating such industries as consumer electronics and cars. Meanwhile the trade balance between the US and Japan worsened with every year. With the surplus of cash, Japanese investors and institutions began to buy American assets primarily in the form of real estate and US Government Bonds. The $-Yen exchange rate at the time was generally above 200.00 while Japanese Stocks showed performances similar to the US equity market of the late 1990's. In fact, the similarities are striking.
One other major problem in Japan is the bear market of the last nine years. Apart from some short term improvements and despite historic low interest rates and massive economic stimulus packages by their government, the domestic equity market never came close to the highs of the 1980's. There were some temporary corrections in the overall bear market since 1990 when the economy performed slightly better. However, Hashimoto's government has been blamed to have completely miscalculated the business cycle when he raised the consumption tax from 3% to 5% in 1997 just after the economy peaked in early 1997. Then in summer 1997, the Asian financial crisis took a further beating at Japan's economy.

The growth prospects for the next two years look bad. Interest rates are effectively zero and growth rates for GDP are expected to contract further in 1999 leaving essentially no room for monetary stimuli. At the moment, the US and Europe seem to be the preferred exporting target as the demand in Asia, licking the wounds of the aftermath of their financial crisis, is expected to be weak. The value of the Yen against the Dollar and the Euro will have a profound impact on their exports. Currently the medium term volatility of the Yen remains high (~20%). If the Yen were to appreciate further to the levels of below 100, it would have further negative impacts on Japanese exports.

More importantly, I believe that as long as the structural problems (banking sector) and cultural inability to deal with disclosure of financial dealings are not resolved, prospects for economic improvement will be bad even in the long term.

Sounds familiar? Certainly when it comes to stock market performance as an indicator of economic success, these predictions were depressingly accurate. Taking a pessimistic view of the current economic conditions and super-imposing NASDAQ over Nikkei with about a 10 year time adjustment, one would recognize the trend lines as all-too similar. If NASDAQ were indeed to play out like the Nikkei Index did, we would currently be at the red dot indicated in the Nikkei chart above. I sure hope this is not the case, otherwise we would be looking at another decade of flat to negative equity returns.

Must See
I highly recommend watching Mike Shedlock's presentation at Google Tech Talk May 6, 2009 http://www.youtube.com/watch?v=1YKc0UolTqE

That's about as good as it gets in explaining current economic conditions.

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Good luck & good trading!

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