September 26, 2009

Market Insights - 26 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
▪   Signposts Of Things To Come
▪   The Good Stuff
▪   Interesting Read
▪   Are (US) Equities Overvalued?
▪   Fed's Balance Sheet
▪   Taxpayer Funds At Work
▪   Recommended Video

Weekly Snapshot
• New U.S. home sales rise 0.7% in August (AP)
• US consumer sentiment rose more than 3 points from mid-month to 73.5 (Bloomberg)
• US Durable goods in August decreased $4.0 billion or 2.4% to $164.4 billion (U.S. Census)
• Germany’s IFO Index rises for the sixth month in a row to 91.3 (Eurointelligence)
• The SEC promised to “vigorously pursue” its case against BofA (Economist)
• US existing home sales declined 2.7% in August compared with a 7.2% rise in July (AP)
• Muammar Gaddafi delivers 100 minute speech to UN general assembly (
• New jobless claims in the US drop unexpectedly to 530,000 (AP)
• Industrial new orders up by 2.6% in euro area (Eurostat)
• FOMC Meeting: US fed funds rate was left unchanged in its range from 0.00% to 0.25% (
• US Leading Economic Index increased 0.6% in August, following a 0.9% gain in July (Conference Board)

Chart Of The Week
A reminder of where we stand... 

Major Foreign Holder of US Debt

Data as of July-2009. Source:

Signposts Of Things To Come
Please consider:  HSBC finally gets its way about Hong Kong and HSBC chief to be based in Hong Kong

Every now and then, there are little markers giving us a glimpse of where the global economy might be heading 10, 20 or 30 years from now.  The above chart is a good indicator and so is the seemingly benign move by HSBC to relocate its chief executive (back) to Hong Kong.  You may recall that HSBC bought Midland Bank, one of the largest UK banks, in the early 90s.  The move raised some eye brows then particularly because Hong Kong was going to revert to Chinese control after 1997.  Regulators, encouraged by public fears over the safety of their deposits, urged HSBC to move its headquarters from Hong Kong to the UK, where they still are at the moment.  Now that the chief executive is back in Hong Kong, it shows that one must look East to get a glimpse of the future. Capital certainly seems to be looking eastward.

And, as John Gapper somewhat amusingly adds:

"the notion of ringfencing UK deposits to make sure they are not used for risky lending in far-off places is back in fashion as a way of handling future bank collapses. The difference is that the country from which UK depositors are supposed to be protected is the US, not China."

As a reminder, take a look at the graphic below from our previous newsletter in March.  In reality, HSBC has never really been a UK bank but rather a Chinese one, as the name Hongkong Shanghai Banking Corporation suggests.  This now gives China the 4 largest banks, by market cap.


Source: Complete data and additional yearly charts available at:

The Good Stuff
Please consider:  Congress Takes On Credit Ratings

I have long advocated that the inherent conflicts of interests at credit ratings agencies have been a major factor contributing to the financial crisis.  Sadly, the regulators only seem to come to this conclusion after most of the damage has been done.  Inertia, complacency, dis-incentives are perhaps some of the reasons why it takes bureaucratic organizations forever to make a move.  It takes determination and a lot of courage to make a difference, this is another example.  An individual can make a difference and greater public awareness is needed to support individuals who are willing to go against the grains. Speaking of conflicts of interest...

Interesting Read
Please consider: F.D.I.C. May Borrow Funds From Banks

As the New York Times reported, the F.D.I.C., experiencing its own version of a possible cash-flow bottleneck, is considering plans that to borrow funds from some of the Banks it regulates. While this may be somewhat of a relief for tax payers, lets cut through the clutter for a second here and consider what this really means: Massive potential conflicts of interest!

Can a regulator objectively regulate when it owes money to an institution it needs to oversee? What happened to: Never bite the hand that feeds you?


Are (US) Equities Overvalued?
Please consider the recent FT article: Equities are overvalued and carrying too much risk

The S&P 500 peaked at 1,080.15 midweek before drifting lower and closing the week at 1044.38.  This gives the US benchmark Index a year-to-date return of just over 16%, a great return by any standard.  Further, the Index is up over 57% compared to its low 666.79 in early March.  A consequence of this sudden rise from the ashes (the eerie 666 low of the S&P500), the market has now returned to risk levels of 2007. 

As David Rosenberg notes:
Six months and 60 per cent later, there is yet again, in 2007 style, tremendous risk in this market. Never before has the stock market surged this far, this fast, between the time of the low and the time the recession (supposedly) ended. What is "normal" is that the rally ahead of the recovery is 20 per cent. This market is now trading as if we were in the second half of a recovery phase, yet it has not even been fully ascertained the downturn is over.

The author continues in his analysis and projects, "based on the same 2 per cent growth rate the corporate bond market is discounting", a level of 842 as a possible target for the S&P500. 

David Rosenberg’s assessment makes sense. The relatively high multiples in the S&P need to be justified by the real economy eventually.  This week's subdued durable goods orders would suggest that at least some sectors in the economy might not be showing the kind of growth rates (i.e. 4% real economic growth in the coming year) that could justify these high price levels relative to earnings. 

In addition to the fundamentals urging us to be cautious, Technical Analysis can make an equally plausible case for retracements to the same 842 level of the S&P.  If 1,080.15 holds on the upside, Fibonacci retracement levels would indicate a range of 922 all the way down to 824 as possible targets on the downside.  There are of course several support level in between and a good test will be if the 1,000 level holds.


Fed’s Balance Sheet
We have expressed concerns about the size of the Fed’s balance sheet on a number of occasions.  They’re still at it, throwing billions and trillions at the problem.

From the FOMC Statement September 23, 2009:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.  To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt.  The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010.  As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009.

What’s more concerning than those twelve-figure numbers is the fact that we don’t know exactly where the money is being thrown at. Correction, some of it is known…

Taxpayer Funds At Work
I came across an excellent Blog doing remarkable investigative work to promote greater public awareness.  Please consider:  Taxpayer funded signing bonus at Freddie Mac?

As Michelle Leder reports, Freddie Mac’s newly named CFO, Ross J. Kari, gets the following package:

▪ annual compensation of $3.5 million (this includes $675K in salary, $1.6 million in something called “additional annual salary” and $1.1 million in a target incentive)
▪ a $1.95 million signing bonus
▪ immediate buyout of Kari’s house (or perhaps houses)
▪ reimbursement for travel between Washington D.C. and Kari’s residences in Ohio, Washington and Oregon

Granted, this compensation package seems relatively tame compared with those of major financial institutions.  However, I have problems with signing bonuses in general.  No disrespect to Mr. Kari, but nobody deserves to be paid just to show up for work.  Compensation at the executive level should always be tied to performance.  I firmly believe in giving the right incentives.  But if someone can get substantially more money working for a quasi government institution instead of working in the private sector AND gets paid in advance, sometthing is wrong.  More to the point, what possible incentives will he have to perform?

Give Mr. Kari the benefit of a doubt and let him get to work for a few years.  If he manages to de-lever the bloated mortgage lender and bring some form of reasonable competitiveness back to this institution, then he can have his millions; but not before we see some of Mr. Kari’s talents at work.

Recommended Video
Controversial as he may seem, Peter Schiff has made some very good calls in the past.  Most recently, he called for an end to the US rally and predicted that Gold would rise to $5,000 per ounce.  

Discounting his recent political ambitions here, lets put some of his seemingly outrageous predictions into perspective. Take a look at Peter Schiff's Mortgage Bankers Speech from Nov. 13th 2006.  The entire speech is almost an hour, but it is highly recommended including some very remarkable comments which all make sense in hindsight.

Good luck & good trading!

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