January 09, 2010

Market Insights - 9 January 2010

Dear Friends & Fellow Investors

Here  is our first issue of Market Insights for 2010.
As always, please email any questions to: . 

Wishing everyone a healthy and prosperous New Year!

In This Week's Issue
• Weekly Snapshot
• Chart Of The Decade
• Cautious Optimism 
• The Decade In A Nutshell
• A Decade In Graphs
• More Of The Same?
• Some Things Never Change

Weekly Snapshot
• U.S. employers unexpectedly cut 85,000 jobs in December (Reuters)
• US unemployment rate remains at 10.0% in December (Briefing.com)
• Euro area unemployment rate up to 10.0% in November (Eurostat)
• Euro area GDP up by 0.4% and EU27 GDP up by 0.3% (Eurostat)
• UK interest rates remain unchanged at 0.5% (Economy.com)
• Cold weather helped push the price of oil to $83.52 on Wed, a 15-month high (Economist)
• FOMC left rates unchanged in a range of zero to 0.25% (WSJ)
• Fed still plans to buy $1.43 trillion of housing-finance debt through March (Business Week)
• Industrial new orders down by 2.2% in euro area (Eurostat)
• Euro area inflation at 0.9% (Eurointelligence)
• Google revealed their own smart phone "Nexus One" competing with Apple’s iPhone (WSJ)
• US pending home sales plunged 16% in November (Bloomberg)
• Spanish unemployment nears 4m, nearly 20% of workforce (FT)
• Dubai opened the $1.5 billion Burj Khalifa tower, the world’s tallest building at 828 meters (FT)

Chart Of The Decade
Some of the events of the past decade as compared with the chart of the S&P500 during the period.  


    Click on chart for larger image

Cautious Optimism
So here we are at the dawn of a new decade wondering what the next ten years might bring while looking back at a period that has left many with deep financial scars.  Turbulent would be an understatement when describing the events of the first decade of the 21st century.  But despite of it all, we’re still around and, realizing that the world has not fallen of a cliff just yet, a fair amount of optimism should be in order when locking at the challenges ahead of us. 

Particularly the US which, most would agree, was the cause and epicenter of the financial crisis of 2008/09, is looking comparatively untarnished considering the extent of the deleveraging that took place.  Look no further than Japan, which recently completed the 2nd decade of its mega-bear market, to feel comparatively fortunate.  At the end of 1989, the Japanese Stock Index Nikkei peaked at almost 39,000; today, 20 years later, it is still hovering just above 10,000, a little more than a quarter of its peak value then.  


Looking ahead then, the rest of the world should be cautiously optimistic but also be mindful of the fact that two decades of near zero interest rates and various other measures similar to quantitative easing haven’t helped the Japanese Stock Market rebound. Instead, it left the country with a record deficit.

The Decade In A Nutshell
Essentially a continuation of the dotcom bubble, housing was the new investment fad of the rather volatile “Noughties” (00’s).  In continuation with the 90’s, a large part of the world's demand for goods was created by the US consumer who became the locomotive for global production of goods and the main engine of the world economy as a whole.  A slight problem was the fact that all this consumption was mainly created through credit and not through production and savings, the traditional way of generating wealth.

For a long while the scheme worked like this: China  (to a lesser extent India and other developing nations too)  supplied the US consumers with all the goods they wanted and even provided the financing for a near two-decade spending spree.  This symbiotic relationship created a fairly stable equilibrium which was beneficial to everyone.  The US enjoyed a long period of extremely high standard of living - much greater than it should have been given the underlying GDP.  Meanwhile, China created lots of jobs and Chinese citizens saved money.  The country modernized its infrastructure, gave birth to potentially the largest ever middle class, and it is now on the verge of being the dominant economic super power in the world.   The US, once the largest creditor in the world has become the largest debtor.  In September 2008, China took over Japan as the number one creditor to the US and it is currently holding nearly $1 trillion in US Treasuries in addition to some $2 trillion in Foreign Currency Reserves, the majority of which are also in US Dollars. 

 US Creditors
Source: Department of the Treasury/Federal Reserve Board

As a result of the financial crises this symbiotic creditor/debtor relationship broke down when the credit stopped flowing.   Central Bankers and world leaders, spearheaded by the US administration, have done a good job in pumping massive amounts of money into the system.  “QE” (Quantitative Easing), “Government Bailouts” and “Too Big To Fail” became the most uttered phrases of the past two years.  Things have stabilized since and the global economy is breathing again.  However, huge amounts of additional debt has been created (at the expense of future generations) in order to “save” some of the largest institutions which are now “Too Larger To Fail”.

A Decade In Graphs 
Please consider these graphs as reminder of some of the developments during the past decade.

Nominal_returns  Real_returns


Gold  Oil

 US_China Brazil-India

More Of The Same? 
Taking a glimpse ahead, a sustainable solution cannot be a continuation of the cheap credit environment.  This will invariable result in the same bubbles that caused the crisis to begin with. The basis of this odd symbiosis of American Über-Consumer and the tremendous growth of the BRIC (Brazil, Russia, India, China) countries was a "drugged" system with the drug being "cheap credit".   As we learned, that was not sustainable.  The system has failed and cannot serve as a model for the future.

To kick-start another period of extended world growth, demand has to come from somewhere.  The world is waiting for China and India to create this vast new middle class and to act as the new engine for consumption and economic growth.  That might take time however. 

Europe has its own economic struggles and surplus nations like Germany and France are extremely reluctant to spend.  Don’t expect them to spend more than they have...

The US consumer is cash strapped and banks are still very reluctant to lend.  Friday’s employment data are less than encouraging, particularly if one digs a little deeper into the reports.  The official unemployment rate is unchanged at 10% but the "real" unemployment rate (U6 includes: discouraged, marginally attached and non-voluntary part-timers) rose to 17.3%.  Worse yet, long-term and permanently unemployed are at an all-time high.  The previous and current US administration believe in continued stimulus but it remains questionable how much of that stimulus is going to find its way into the real economy.  Conceptually, the renewed deficit spending is like trying to get a drug user (US economy/US consumer) off the drugs by injection them with more drugs – Nice!  Not very effective though in the long term.  To make matters worse, at some time in the future governments cannot afford to pump endless money into the system. Unless the US and Europe can create substantially more jobs, consumers will simply have to save more and consume less.  As a result, companies will have a hard time achieving the projected earnings at which current valuations are based on.

2010 will be a difficult year for the real economy and real people. Despite further possible stock market gains, we don’t expect a true recovery until more people are back at work.  Having said all that, global interdependencies have become increasingly complex and no one can truly fathom how much would be at risk if the US and/or Europe would fall back into a protracted recession.   The developing countries, most of all China, are not yet able to support their current economy from domestic demand.   Therefore it is in everyone’s interest to strive for economic improvement in the  US.  With regard to the two-decade stock market misery in Japan, one should hope that the US markets will not fall into the same hole.  If nothing else, one can never under-estimate the entrepreneurial spirit, drive and conviction of the American people.  Being an underdog for a change might bring out the best of innovations and new businesses that can make a sustainable recovery happen.  Here’s to a brighter decade!

Some Things Never Change 
The year has barely started and we’re back to revelations about the (mis)management of dealing with the credit crisis.  Once again the target of the controversies is Mr. Geithner.  Please consider this Bloomberg story Geithner’s Fed Told AIG to Limit Swaps Disclosure (Update3) along with the video below:

Good luck and best wishes for a 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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