December 19, 2009

Market Insights - 19 December 2009

Dear Friends & Fellow Investors

Here  is the last issue of Market Insights for 2009.
As always, please email any questions to: . 

Wishing everyone a Merry Christmas and a healthy and prosperous New Year!

In This Week's Issue
▪  Weekly Snapshot
▪  Chart Of The Week
▪  Mini Review Of 2009 
▪  More On The US Dollar 
▪  Bored With Gold

Weekly Snapshot
• US$ at highest level since September, Euro fell below 1.43 on Friday (eSignal)
• German business confidence rose to 94.7 points, the highest level since July-08 (Reuters)
• US Leading Economic Index increased 0.9% to 104.9 in November (Conference Board)
• US consumer price index rose by 0.4% in November (FT)
• Euro area annual inflation increased slightly to 0.5% (Eurostat)
• US current-account deficit increased to $108.0 billion, or 3.0% of GDP (ESA)
• Japan's Tankan survey showed small improvement in business sentiment Q4-09 (
• US Housing starts rose 8.9% from the prior month and fell 12.4% from the prior year, to 574,000 (ESA)
• US Industrial production increased 0.8% in November after having been unchanged in October (NBER)
• CME Group launches Credit Default Swaps and begins clearing trades on the exchange (CME)
• US Producer Price Index for Finished Goods rose 1.8% in November, seasonally adjusted (BLS)
• Industrial production down by 0.6% in euro area (Eurostat)

Chart Of The Week 
Last week, we looked at the disparity in US pay rises and noticed that the average pay increase of federal employees was nearly twice the increment of state/local and private employees since the beginning of the recession.  Here is another way of looking at how government outranks private enterprise these days.  Capitalism seems to have gotten the short end of the straw...

employer costs per hour


Mini Review Of 2009  
The major markets had an incredible rally since the lows in March and the world economy did not fall of the proverbial cliff as some might have feared when the S&P 500 hit 666.79.  But for most of us, 2009 was a challenging year of many ups and downs with the fear of downsizing and higher unemployment looming darkly above everything else.  We will do a more extensive review along with an outlook for 2010 in early January.

In the meantime, let’s re-examine our Predictions for 2009 issued in Mid-January:

• U.S. Housing will hit bottom during summer/fall 2009.
• U.S. 30 year mortgage rates as low as 4.5% - 4.75% sometime in 2009.
• Cont. volatility in energy markets. Oil will eventually trend higher above $50 per barrel at year end.
• Continued volatility in equity markets. S&P will close above 1,000 at year end.
• U.S. budget deficit is a major concern – I predict a deficit of $2 trillion in 2009.
• Onset of a decline in the value of the US Dollar against other major currencies

Although the year has not finished yet, it is probably fair to assume that there won’t be massive changes from current price levels and the majority of the predictions may hit right on target. 

Re: Housing/    This week, Moody's declared that US housing has bottomed but other analysts, including those of Deutsche Bank, predict that house prices may have another 10% to fall.  Based on the Case-Schiller Index, our prediction was quite on target as the Index saw the lowest prices in April and May of this year.   It remains to be seen whether 2010 will see another test of that bottom in house prices.

US Home Prices 

Re: 30 Year Mortgages/   Average 30-year mortgage rates fluctuated slightly above and below the 5% mark for the most part of the year but with a bit of shopping around, one could get really excellent terms in line with the upper band of our prediction.  I personally refinanced a conventional 30 year mortgage under 4.75%.  Something that was not reflected in the low rates was the immense scrutiny and red-tape one had to go through in order to actually get a loan this year.  Even borrowers with excellent credit ratings were seen as potential sub-prime customers as most lenders tightened their mortgage application screws.  Despite the massive bailout money from the tax payers, Banks were not lending, unless the borrowers had substantial down payments and/or above average credit ratings.  Makes me wonder how on earth sub-prime borrowers were ever allowed to purchase homes with no money down...


Re: Oil/  Crude Oil markets were choppy in 2009 but nothing like the volatility we have seen during 2008.  From our initial vantage point back in January, prices dropped to a low of $37.12 but increased steadily from thereon.  Since May, the oil price traded above $50 reaching a high of $82 in October.   Taking into account last year’s price movements, $90 would be about 50% of the price decline from $147 to $35.  While a $25 price of oil is highly unlike even for the die-hard deflationists, one also has to question whether a return to prices above $100 will be sustainable.  In either case, oil should be trading above $50 for quite some time.


Re: Equity Markets/  US stocks had an unprecedented rally ever since the eerie low of 666.79 back in March.  The S&P 500 is up about 65% since then and about 21% since the beginning of the year.  A remarkable performance given this particular time frame.  The fact that this rally bypassed the majority of average investors is not mentioned all too often and whether current valuations are sustainable is yet another question.  But unless something dramatic ensues, the US benchmark should stay above 1000 for the remainder of 2009.  Looking back a bit further, a level of 1,200 is about 50% of the decline from peak to through and that is the major resistance area that needs to be cleared for prices to go higher.  This year’s rally is impressive indeed but the average investor who bought in 2007 has still ways to go before breaking even.


Re: US Budget Deficit/  Depending on the sources, the current budget deficit is expected to be somewhere between $1.5 trillion to $1.8 trillion.  However, the projections from May of this year to reach a deficit of $1.841 trillion are going to be revised upward since the House of Representatives just passed a new $1.1 trillion spending bill and  the US government's debt ceiling may be increased by as much as 16% from its current $12.1 trillion limit.  Sadly, our original prediction will come true as well.

Re: The US Dollar/   The decline of the US Dollar was in the making all throughout 2009.  Just about everyone and their mother was bearish on the Dollar making it a rather crowded place for selling it further. More recently therefore, the US Dollar gained some strength back and appears to be on course to chase back some of the losses incurred during the year.  While the US did not fair too badly against the major currencies after all, emerging markets and commodity driven currencies had bumper years;  the more notable performers were Australian Dollar (+27%), New Zealand Dollars (+23%) and  Brazilian Real (+22%).

FX versus USD  

More On The US Dollar
The US Dollar Index reached 78.14 on Friday, the highest level since early September. 


The US$ Index itself is a good indicator of current overall US Dollar strength/weakness but, as we alluded to last week, it is probably not an ideal way of examining the trend going forward.  To get a better assessment we have to examine each currency pair individually.  For the sake of getting a general picture though, let’s examine some fundamentals anyway.   There are several reasons why continued US$ strength may be the ongoing theme in the coming months: 

• Expectations that the Fed will tighten earlier than expected (see recent PPI and CPI data)
• Better than expected growth in the US and a rebound in global trade 
• US$ is relatively cheap on a purchasing power parity basis 
• Growing concerns about sovereign debt in Europe and Middle East

Assuming the Fed will tighten relatively early and that the US will continue to gain strength, a lot of the funds flowing into relatively risky assets will return home in expectation of future rate hikes.  A logical looser for such a scenario would be “the carry-trade of 2009” the Australian Dollar and, to a lesser extent, other emerging market currencies with current yield advantages over the US$.  

Commodity-rich countries and their currencies may also loose some of their appeal if commodities fall in line with a stronger US$ (assuming that the inverse correlation continues going forward).   As we have seen with Gold, losing some of its shine in recent weeks, this may very well be the case . 

A stronger US$ is also very much desired by export driven countries who don’t have a Dollar peg (i.e. Japan, Brazil, Germany etc.), and who have experienced massive set-backs from a weakening Dollar in addition to the vanishing US consumer demand.  A stronger US$ gives these exporting nations some room to price their goods more competitively.  China, which maintains a fixed exchange rate, does not directly benefit from the outset; however, indirectly it relieves some pressure on the Chinese Central Bank to maintain artificially lower exchange rates. Further, let’s not forget the approximately $2 trillion in currency reserves and the massive amounts of US Debt they are holding.  An increase in the value of the Dollar means that their investments in US assets are regaining in strength as well. 

Another factor benefitting the US Dollar and weighing heavily on the euro were the peripheral downgrades for Greece, Spain and Ireland. Anytime sovereign debt is called into question, take the example of Dubai, a sudden shift into a safe haven currency or commodity occurs.  And, as in the case of last years credit crunch, the de-facto safe haven still appears to be the US Dollar.

An ongoing Dollar rally would also mean that the investor rationale since March is about to change.  Reversals of carry-trades, profit taking and/or reversals of positions in commodities, emerging market stocks as well as US stocks may ensue.  Hence, even in a bullish Dollar scenario, the investment climate remains challenging when trying to achieve a balanced portfolio.  Short of putting all your eggs in one basket (i.e. US Cash or Bonds), a stronger Dollar may bring about some additional portfolio challenges. 

Looking at the other side of the coin now:  Let’s assume that the recent Dollar strength is just a brief episode, a retracement or a pause in the underlying trend.  Several analysts including reporters of the Financial Times commented that the reason for the current US Dollar strength had little to do with the factors noted above.  Instead, the main reason was that investors who had accumulated short positions in the Dollar since the beginning of the year have recently begun to square those position ahead of the year-end.   This means it is just a technical correction in the underlying trend. 

The chart below illustrates how the Euro versus US$ had a retracement since it’s recent peak and it has been approaching the 38.2% Fibonacci retracement area.  To see an actual trend reversal in favor of the Dollar, substantially lower technical levels below 1.38 and just under 1.35 need to be reached.


During this week’s FOMC meeting, the Fed hinted that it might discontinue quantitative easing (QE) earlier than expected.  In view of the recent increase in the producer price index and the fact that inflation is being recognized as a possible side-effect of QE (who would have thought...), one must consider rates creeping up at some point.  The setting of higher benchmark rates by the Fed though bears the risk of a double dip recession, politically an untenable proposition.  Anyone still believing in the independence of the Fed, think again!  Those days are long gone. Today, we have a Fed led by Ben Bernanke who is continuing with the tradition of Alan Greenspan in being much more politically accommodating than Paul Volker ever could have tolerated.   Whether QE will continue or rates may creep up by 25 basis points at some time next year, overall benchmark rates will remain extremely low for the foreseeable future. 

To make one more point absolutely clear, it is our conviction that the Fed will be accommodative irrespective of any inflationary pressures (CPI and PPI numbers have a history of being massaged anyway) until such time that it finds it difficult to finance the $12.1 trillion (and counting) deficit .  From the US government’s perspective, there is no easier way to dilute the debt burden.  Keep rates artificially low and let the public believe that inflation does not exist.  As long as it can find buyers for its IOU’s, the US government will go on with its charade for quite some time.  But the ever mounting debt burden, combined with low interest rates does have this negative effect on the Dollar.  The exchange rate is effectively the economic valve allowing this Ponzi Scheme to function in the first place.  The more pressure (debt) builds up internally, the more the valve has to adjust in order to keep things somewhat in balance.   Consequently, it is hard to imagine a true build up in US Dollar strength without fundamental improvements in the US government’s finances. 

How these scenarios will play is not clear at this point – it’s complicated... 

However, we firmly believe that the US Dollar is still in a cyclical long-term down trend and that the only way to get back to the glory days of a strong Dollar and to maintain its status as a true reserve currency is via sound fiscal and economic policies and via a strong and sustainable economy.   No predictions in terms of prices at this point, but rest assured that 2010 will not be a quiet year.

Bored With Gold
Gold closed the week at 1,112.50 more than $100 below it’s all-time peak of $1,226.40.  The inverse correlation to the US$ worked like a charm and in line with the recent Dollar strength, Gold lost some of its luster.  Similar to the fate of the US$ is the question as to whether Gold’s rally is now over and done.   While you may ponder on this question over the holidays  I would like to end the year on a positive note and recommend a refreshingly simple even humorous way of looking at an investment.

James Altucher, ever so funny, has an intriguing way of assessing investments in gold.  "I'm So Bored of Gold," he notes.   So next time you wonder when it’s time to sell an investment, follow your heart and if you’re bored with the investment, just look for alternatives.  Who knows, it may be the best money making proposition.

Once again, best wishes for the holidays and have a happy and prosperous New Year!

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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