September 13, 2009

Market Insights - 13 September 2009

Dear Friends & Fellow Investors

Here is our new issue of market insights.
In case of questions, please email: . Enjoy reading!

In This Week's Issue
▪ Weekly Snapshot
▪ Chart of the Week
▪ One Year after Lehman's Collapse
▪ Interesting Read
▪ Signposts of Things to Come - Greater Transparency?
▪ Currency Markets
▪ All that glitters is Gold

Weekly Snapshot
• China recorded a $15.7 billion trade surplus in August, up from $10.6 billion in July (
• Russia's GDP fell 10.9% y/y in the second quarter, after falling 9.8% in the first quarter (
• US$ Index falls to 76.46 on Friday, the lowest level in 2009 (eSignal)
• US consumer confidence index for September rose to 70.2, higher than expected (Reuters)
• Switzerland is world’s most competitive economy, based on index of the World Economic Forum (Economist)
• WEF's ranking of the “soundness” of banks shows America at 108th position, behind Tanzania (Economist)
• US Census Bureau said the poverty rate jumped to 13.2%, the highest level since 1997 (Reuters)
• Brazil's GDP up 1.9% from previous quarter (Economist)
• Bank of England holds rates at 0.5% (FT)
• US mortgage rates dip to 3-month low (Reuters)
• September 9 marks six months, since the low of equity markets in this recession (FT)
• US trade gap expanded 16.3% in July, the biggest month-to-month increase since February 1999 (Reuters)
• China car sales up 90% year-on-year in August (FT)

Chart of the Week
The World Economic Form published their annual index of global competitiveness. Interesting to see that none of the BRIC countries (Brazil, Russia, India, China) are in the top 20. China is ranked 29th, India 49th, Brazil 56th and Russia in 63rd place. As always, rankings depend on the parameters and the validity of data where available. In my humble opinion however, it is rather questionable whether these WEF rankings reflect reality from a business perspective. Judging from my own experience, I would not place the US nor the Western European countries anywhere near the Top Ten since I feel they have lost their competitive edge many years ago.

I am curious to get some feedback from the readers as to which countries you would rank in the Top Ten. You can download the complete list at:; the full report is available at:

Data Source:

One Year after Lehman's Collapse...
One year ago, on September 15, 2008, Lehman Brothers, one of the premier global financial institutions, collapsed. There is ample coverage everywhere as to the impact this event had on the financial crisis.

To name a few: How Lehman's Collapse Changed Wall Street, History will judge Lehman mistake harshly, Lehman Had to Die So Global Finance Could Live

The discussion continues as to whether it was a mistake to let Lehman's collapse while rescuing Bear Sterns, Fannie Mae, Freddie Mac, AIG as well as pumping enough money into many other financial institutions. That decision remains as controversial as the funds that went into the massive bail out efforts and the decision making process as to how bailout funds were allocated. Many, including Professor Elisabeth Warren, chair of the congressional oversight panel, still question the US policy responses to the financial crisis (see Market Insights - 22 August 2009 and Prof. Warren's Interview).

To put things into perspective, let's look at how the markets faired since then. Below is a comparative chart of the major global stock market indices. Most markets except for China reached a low point in early March. Since then, equities showed a strong up-trend. The emerging markets are in positive territory since then, with China leading the way gaining over 40% since September 11, 2008. Interesting side note here, China, India and Brazil have all turned positive, while the major Western developed countries are still on their way to reach the levels of one year ago. If stock prices were the main indicator of "competitiveness", the chart above would be practically turned upside down. By comparison, the worst performers were US Markets (-17%) and Swiss Market Index (-15%) while China (+40%) Brazil (+14%) and India (+14%) weren't even in the Top 20.

Interesting Read
Please consider: Goldman chief says banks lost control

I don't know if it's a sign of the times that public figures and high profile executives can make a mockery out of facts and get away with it, or whether the general public is just at a point of complete disillusionment and ambivalence to simply not care anymore. Or maybe we are all just too stupid to comprehend the complexities of markets, valuations and compensation.

I have no quarrels with rewarding brilliance, hard work and the all the qualities that drive innovation, progress and improvements of society as a whole. But for someone like Lloyd Blankfein, CEO of Goldman Sachs, to come out in public and admit that "banks lost control of the exotic products they sold in the run-up to the financial crisis, and that some of the instruments lacked social or economic value" or to say that "multi-year bonuses should be outlawed and that senior staff should receive large proportions of pay in stock, rather than cash" is beyond my comprehension. Let's not forget that Goldman Sachs had bonus accruals amounting to $11.4bn in the first half of 2009, profits quite possibly derived, at least in part, from some of the instruments that "lacked social or economic value"...

What's worse, a brief glimpse at Mr. Blankfein's compensation is rather revealing in this context.

In 2007, Mr.Blankfein received $73.7M total pay.


In 2008, Mr.Blankfein received considerably less but still a respectable $25.8M total compensation.


Between 2003-2008, Mr. Blankfein received a total of $136.7M while the company's stock went down 20%.

Ironically, Goldman Sachs has been one of the better performing financial institutions and who knows, Mr. Blankfein may be one of the most brilliant CEO's on Wall Street. Without going into detail of competing banks' CEO compensation, figuring an average decline of financial stocks of about 60% in the same time period, we can assume that their track record must be worse. Is anyone of you aware of Mr. Blankfein or other big time CEO's paying back their compensation for 2007 or 2008? That would be something worth considering a "social and economic value" for tax payers. Anyone interested to dig deeper?

Signposts of Things to Come - Greater Transparency?
Please consider: BlackRock to launch trading platform

BlackRock, after its acquisition of Barclays Global Investors, is soon to be the largest money management firm with $3 trillion under management. The firm is now planning to launch its own global trading platform that will allow them to effectively cross-sell securities internally.

"The plan is still in its early stages, but its outlines are already clear. If some BlackRock clients are selling a security and others are buying, the group can “cross” those trades internally without going through Wall Street. BlackRock does not intend to take any fees for this service, since the whole point is to save its clients money, according to people familiar with the plan."

What does this mean?

If the plan is implemented, BlackRock would effectively "make markets" in traditional securities such as stocks and bonds but more likely in various sorts of derivatives - that's where most of the financial gravy is. In fact, most investment banks have been doing that, but this plan would enable them to do so on a much bigger and global scale, across any kind of asset class and presumable out of the reach of effective regulatory oversight. Making a market in a security and doing an over the counter trade is nothing new. Foreign Exchange Markets trade several trillion dollars each day "over the counter". Nothing wrong with that, it provides immense liquidity in securities and assets where price discovery is easily obtained. Where it does make life difficult for clients is in the area of certain derivatives, particularly the more complex derivatives which are often sold in bundles similar to insurance products and derived from complex mathematical models.

Perhaps the more important question is whether this move creates another "too big to fail" scenario. When securities and derivatives are traded off-exchange, the clients bear the counter-party risk of the transactions. In other words, if a large enough client of of BlackRock fails, or worse even, if BlackRock were to face a liquidity crunch, you could see events unfolding similar to those of last year. Perfect timing, one year after Lehman's collapse and amidst calls for greater transparency, this move is effectively creating the opposite.

The only sensible way to provide greater transparency is to trade derivatives on a centralized exchange. Of course there are downsides to exchange trading, particularly the need to standardize financial instruments and somewhat less choices for customers. However, as investors painfully realized, less complex financial instruments and less choice may have been exactly what could have prevented the massive financial implosion when the underlying asset prices of these obscure derivatives started to fall.

There are lots of other concerns, not least of which include conflicts of interest - how would you feel if your mutual fund was also making markets and effectively establishing prices in the investments they took? Going back to transparency, it does provide transparency, incredibly valuable transparency from an internal risk management and business perspective as such; but only for BlackRock not for its customers and certainly not for regulators.

We previously discussed the poor record of some US regulators most recently examining the SEC blunders in the Madoff case. Imagine 10 regulators from 10 different jurisdictions trying to regulate transactions and financial instruments that are many times more complex...

I am hopeful that this move by BlackRock will come under intense legal and regulatory scrutiny. However, with $3 trillion in assets, this firm can afford the best lawyers and lobbyists to push this through. Perhaps the best we can do is to raise public awareness, particularly among those who may be doing business with this giant money manager. This much concentration of assets within one global player is frightening.

Talk about too big to fail...

Currency Markets
The US Dollar has come under increased pressure this week falling to a new low for the year and closing the week at 76.68. The next technical support level would be just above 75. Failing that support, the Dollar Index could retest the low points of last year.

Last week, we examined the Australian Dollar which continued to move upwards, reaching another high for the year and closing Friday at 0.8633. The Aussie is now just 14% away from its all-time high versus the US$. The technical hurdle at the 0.85 level from last week was clearly not strong enough and we are now looking at new resistance levels around 0.8858 and the psychological level of 0.9000 as next stops. Perhaps more relevant than technical considerations are two major fundamental factors impacting the way forward. As a commodity currency, the Australian Dollar continues to benefit from a strong demand in commodities and metals all of which are available in this natural resource-rich country. Furthermore, at an almost 3% interest rate differential over the US$, the Aussie is looking increasingly attractive for international investors hoping to lock in some gains from the more advantageous deposit rates. As financial markets continue to stabilize, this rate differential may provide further impetus towards a retest of the highs during 2008.

All that glitters is Gold
Gold continues to shine reaching a new high for the year at $1,011.90 on Friday. The precious metal is now up almost two-fold within a two-year time frame. It is also closing in on last year's all-time high of $1,033.90.

The discussion on whether or not to own gold continues especially at these levels. Supporters of a continued price rise in Gold include those who believe that Gold is an ideal hedge against inflation, a protection against general market risk as well as a protection against a possible decline in the value of the US Dollar. There are also some supporters who argue that the price of Gold, adjusted for inflation, is currently where it was 26 years ago in today's money. Put differently, the previous peak of Gold in 1980, after adjusting for inflation, would be over $2,000 today indicating plenty of room for further upside.

On the other hand, you can appreciate the arguments of supporters of deflationist views indicating that price pressures at these levels may not be sufficient to drive Gold much higher. Another view was eloquently expressed by Edward Morse, head of economic research for LCM Commodities during a recent interview on techticker when he argued that despite the unusual place Gold has as a safe-haven commodity, it is also an industrial commodity. As such, the industrial demand for Gold at $1000 an ounce would diminish and keep prices in check. He then forecasted that Gold would continue trading range bound with $1,000 being the upper band of the range.

Gold at these levels also continues to attract retail investors and another discussion entails the question as to what would the best way to buy and own Gold - physical Gold, Gold certificates, Gold futures, Gold ETFs, Gold mining stocks etc. All have pros and cons but please remember that there is a cost associated with most of these Gold investments; despite the current low interest rates, making it more affordable to hold Gold, the opportunity cost of owning the precious metal makes it less attractive in the long run. Please carefully consider those costs when assessing possible investments in Gold or Gold related instruments.

Good luck & good trading!

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Saoirse said...

I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Patricia said...

Thanks Patricia. Let us know if you have any questions on any of our posts. FXIS Team