July 11, 2009

Market Insights - 11 July 2009

Dear Friends & Fellow Investors

Weekly Snapshot
• The U.S. trade deficit in May unexpectedly shrank to $26.0 billion (Bloomberg)
• U.S. consumer sentiment fell more than 6 points to 64.6 for mid-month July (Bloomberg)
• Google to launch PC operating system directly competing with Microsoft Windows (Financial Times)
• Car sales in China up by 48% last month compared with a year ago (Economist.com)
• U.S. Retailers report weak June sales (AP)
• Initial jobless claims fell 52,000 to a seasonally adjusted 565,000 (Reuters)
• Continued claims of people still on jobless aid rose by 159,000 to a record 6.883 million (Reuters)
• Euro area GDP down by 2.5% in first Quarter 2009 (Eurostat)
• Bank of England leaves rates at a record-low of 0.5% for the fifth straight month (Economy.com)
• CFTC considers trading curbs on energy trades to minimize excessive speculation (Financial Times)
• The vacancy rate for U.S. apartments reached 7.5%, the highest level in more than 20 years (Reuters)
• U.S. office vacancy rate hits 15.9% in Q2 (Reuters)
• U.S. loan defaults hit new record - payments more than 30 days overdue rose to 3.23% (BBC)

From Previous Week
• U.S. unemployment rate rose to 9.5% in June (Bloomberg)
• U.S. employers slashed 467,000 jobs in June, worse than expected (Yahoo!Finance)
• Unemployment rate in the 16 euro countries climbed to a 10-year high of 9.5% (Reuters)
• European Central Bank keeps key interest rate at 1% (Reuters)

Chart of the Week
Those who read this newsletter regularly have learned that I'm generally more concerned with inflation rather than deflation. Ask various economists and you get a multitude of answers, often leaving you more confused than you were before asking the experts. The inflation/deflation debate continues but most of us are probably better off using our own personal definition as to what inflation or deflation means when we assess how personal income and standard of living are affected. The chart below perfectly illustrates how far apart the forecasts and views of some economic experts are in terms of inflation expectations. As David Altig in his macroblog notes:

In the latest survey of the Blue Chip panel, the difference between the 10 highest and the 10 lowest inflation predictions for the fourth quarter of 2010 was a gaping 3.7 percentage points (compared with an average of about 1.5 percentage points over the past decade and a half). This wide range of opinions about inflation prospects started to emerge last year as economic conditions deteriorated.

This also implies that there is still plenty of uncertainty as to the “when” and “how much” of an economic recovery…

From: http://macroblog.typepad.com/macroblog/

7/11 - Peak Oil Day
Exactly one year ago to this day, on July 11, 2008, crude oil futures reached an all-time high of $147.90. In that same month, world crude oil production achieved a record 74.8 million barrels per day. Much has happened since and in the wake of the financial crisis, crude oil prices tumbled to a low of $35 just before the end of the 2008. We will go into a more detailed analysis of oil price movements in an upcoming newsletter; in the meantime, please enjoy this remarkable example of boom/bust price action and celebrate the fact that we are far away from that peak-oil price.

The Fed and the US Dollar
The Wall Street Journal Blog had a nice visual presentation of the increasing Federal Reserve balance sheet. Interesting to note here that until the end of 2007, over 90% of the Fed’s balance sheet consisted of US treasury securities. Things have changed dramatically since and the Fed’s balance sheet almost tripled at some point. It is currently just below $2 trillion, still far above anything imaginable by proponents of “free” markets. One must also wonder exactly how some of these assets are valued: Marked to market, or marked to myth?

Source: http://blogs.wsj.com/economics/2009/07/06/a-look-inside-feds-balance-sheet-70609-update/  
Data sources: http://www.federalreserve.gov/releases/h41/Current/  

During this week’s G8 meeting, various voices have been heard about the current and future role of the US$ as a global reserve currency. While there are ongoing concerns, particularly from China (Reservations about the dollar & China attacks dollar’s dominance ) about the massive US government deficit and the Fed’s monetary policy, it has become increasingly clear that, in the short term, there is no real substitute for the Greenback’s status as the main reserve currency (Japan backs dollar as reserve currency). It should also be noted that both Japan and China have a vested interested in the Greenback’s future viability. The two countries are the largest holders of US treasuries.

Going back to the graph above, there is widespread concern about the Fed’s $2,000bn balance sheet and the Fed’s growing influence (manipulation) over the “free market economy”. But from a U.S. perspective, one should be equally concerned with China holding nearly $2,000bn in US Treasuries. One could argue that China, being the U.S. largest creditor, has some influence over certain U.S. policies. As the saying goes, you don’t bite the hand that feeds you…

Thoughts about Markets
Please consider the following articles: Follow the Herd? Or Reason? and Cash Best as Record Correlation Hints Herd Collapse.

Take note of the fact that correlation between various markets and asset classes has been increasing to levels not seen in decades. And, the tendency of the total aggregate of all investors (the herd) to have very similar investment preferences poses a potentially huge risk management dilemma. As Kieran Osborne notes “what happens when the herd gets it wrong?” We have seen what happens last year.

Asset allocation and diversification, long the supreme mantras of modern finance, call for diversified portfolios to balance risk and reward and to smoothen out returns; in simple terms: “Don’t put all your eggs in one basket”. I too have advocated the same on several occasions, and for smaller and less sophisticated investors, I suggested a simple but effective age-based asset allocation model (Market Insights 27-June-2009; Market Insights 10-Oct-2008) between equities and fixed income or cash-type-assets to mitigate some risk. I still believe that asset allocation and diversification are essential to long term investing and to a healthy and balanced portfolio. I also have very strong views that the cash or fixed income component in a portfolio needs to be diversified itself i.e. not purely in Bonds but spread among different cash-equivalent asset types including currencies other than the U.S. Dollar (no matter where you reside). We will come back to more extensive discussions on diversification and asset allocation in upcoming newsletters. Meanwhile, I would like to leave you with a question to ponder about possible future scenarios:

Given that everyone has (or soon will have) access to the same real-time information and given that capital can essentially flow freely to chase after any potential investment opportunity and, if everyone believes in the aforementioned investment mantras, consequentially, all portfolios should be nearly identical. But if, on aggregate, every single participant of the global market is fully diversified, in more or less the same way, is anyone? To help you ponder, here is a previous example used to show how ineffective diversification can be when “the herd” gets going.

Continue reading and get a free copy of our weekly newsletter here...

Good luck & good trading!

Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this email be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

No comments: