October 17, 2009

Market Insights - 17 October 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
▪   More On The US Dollar
▪   Higher Returns Elsewhere 
▪   FHA Loans Return To 0% Down 
▪   Back To Record Earnings 
▪   Fed Up With Banks

Weekly Snapshot
• Australian $ and New Zealand $ reach new 14 month high against US$ (eSignal)
• Crude Oil closed above $79 on Friday, highest level since October 2008 (Reuters)
• Euro area annual inflation down to -0.3% (Eurostat)
• US industrial production rose 0.7% in September (Economy.com)
• US consumer sentiment for October fell to 69.4, from September's 73.5 (Reuters)
• Gold hit new all-time high on Wednesday @ 1,070.50 (eSignal)
• US Consumer Price Index rose 0.2% in September (BLS.gov)
• US Jobless claims show 5th drop in 6 weeks (AP)
• The Fed kept interest rates near zero, disagreement on inflation among board members (MarketWatch)
• The Finnish government made broadband Internet access a guaranteed legal right of its citizens (PC World)
• US retail sales fell 1.5% in September but rose 0.5% excluding autos (Economy.com)
• Industrial production up by 0.9% in Euro area (Eurostat)

Chart Of The Week 
Most major market indices had a strong recovery since last October.  Emerging markets outperformed US and European markets in multiples.  From an international perspective, investment returns in US stocks were not all that impressive.  After accounting for the decrease in the value of the US$, net average returns were only about 6% for foreign investors in US stocks.


More On The US Dollar
Although regaining some ground in late trading on Friday, the US Dollar was again under pressure this week.  Australian $ and New Zealand $ were among the strongest currencies against the US Dollar as more and more investors shunned the greenback.  This week’s FOMC meeting resulted in no change in terms of the expected interest rate policy of the Federal Reserve Bank.  As the minutes of the board meeting revealed, there was some disagreement on inflation among the board members.  With practically everyone raising concerns about the future of the US Dollar, we could find one rare supporter in Mike (Mish) Shedlock who suggested that the only 3% of all traders are in support of the Dollar.  As a fervent deflationist, he argues that we are still in a period of credit stress and in his view, deflation is currently still a bigger threat than inflation.  He also takes the extremely bearish US$ sentiment as a signal to “temporarily” take the other side of the trade.

From a trading perspective, this “temporary” bullish Dollar position may be plausible.  However, it is a rather risky strategy particularly if one were to take leveraged positions e.g. via futures contracts.   Timing is everything and for a trader to go against the general trend can be profitable by taking quick trades in and out of the market.  I do not suggest these strategies for an average investor however.  It is also interesting to note that his “temporarily” taking a bullish US Dollar position suggests that he too would agree on a longer term depreciation of the US$. 

Unlike Mish, I believe it is questionable whether the US stock market and the Dollar will continue to be this negatively correlated.  Historically, there is no clear relationship of US$ versus US stocks. If indeed government stimulus was withdrawn, or if the stock market were to fall simply because of the poor underlying economic conditions, I can see little reason why this would be positive for the US Dollar.  As the graph below depicts, institutions and foreign investors have been increasingly crowding out private households in terms of share ownership.  If expectations of returns in US equities were to diminish one could make an even stronger case for institutions and foreign investors to get abandon the US Dollar and to seek higher returns elsewhere.

Ownership of US Shares

Source: www.ft.com

Higher Returns Elsewhere 
We discussed the notion of a carry trade before.  A carry trade is a strategy not commonly known by average investors but it has been a favored play among the institutional traders.  The Financial Times has an easy-to-understand visual guide explaining the basics of a carry trade. 


Click on graph to view the presentation

As long as US$ deposit rates are still practically zero it continues to put pressure on the US Dollar by enabling institutions to borrow in US$ converting them to e.g. Australian $ or New Zealand $ and enjoying gains from the interest rate differential.  As long as the US$ remains weak, this strategy will be one of the favorites among the smart money traders.  Oh, and in case you wondered where Goldman Sachs, JP Morgan et al. made their record earnings this quarter, look to strategies like carry trades, further enabled by the US government by allowing these institutions to borrow at 0% and investing them in higher yielding assets, including foreign currencies.  Still amazed why banks aren’t lending to US consumers and businesses?

FHA Loans Return To 0% Down
Please consider the recent Business Week article: FHA Loans: Return to 0% Down

Having just learned that the FHA is back to providing basically zero down mortgages again, I am flabbergasted.  Henry Blodget of Yahoo!techticker put it best by coining a new term:  “Be Glad To Help You Screw Yourself” Mortgages.  To think that this is all done under the watchful eye of our government...

Back To Record Earnings 
Please consider the Wall Street Journal report: Let the Good Times Roll, Again

It is difficult not to feel empathy for the growing public outrage over compensation at financial institutions.  The Wall Street Journal estimates that $140bn will be allocated towards employee compensation in 2009.   Transparency, often advocated by politicians and regulators, may have tilted public opinion in favor of something closer to an understanding of why financial executives are being compensated at the expense and at the risk of tax-payer funds.  But the scale and complexity of various compensation packages remains a mystery to most of us.  So here goes one example then: The graph below depicts the projected compensation of financial institutions as a percentage of revenue.  Topping the list is Blackstone, a private equity group, with stunning results compensating their own with almost 4 times the projected revenue.


Data Sources: WSJ, the companies, Thomson Reuters

Blackstone and a few other firms were not on the list of TARP fund recipients.  As long as they operate within the legal framework of a free capitalist system and entirely at their own risk, public outrage would be relatively tame.  However, at a time when the real economy is still in limbo, jobs are at the worst in decades and a recovery in the real economy is not yet in sight, any notion of excessive bonus packages would naturally anger the public.  How can banks get away with it?  Because they can...

Fed Up With Banks 
The outrage over banks’ bonuses continues and understandably so.  Elizabeth Warren, chair of the Congressional Oversight Panel,  gives her analysis of the status quo one year after the biggest financial crisis since the Great Depression.  To sum up what has changed since last October:

The large Banks today are even “Too Bigger to Fail”.
Toxic Assets, which were supposed to be removed by TARP, "are still there by and large."
Current economic situation is worse than the “worst-case scenario” in the stress tests conducted.

Enjoy these two important videos; highly recommend!


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 communication 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.

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