March 13, 2010

Market Insights - 13 March 2010

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

In This Week's Issue
• Weekly Snapshot
• Chart Of The Week
• Weekly Barometers 
• The Inflation/Deflation Debate 
• What A Difference A Year Makes
• The Lost Decade In Technology
• What Happens When An ETF Closes?
• What About The US Dollar?

Weekly Snapshot
• US consumer sentiment slipped back in mid-March to 72.5 vs. February's 73.6 (Bloomberg)
• US retail sales in February 2010 increased 0.3% from January, to $355.5 billion (ESA)
• German exports dropped 6.3% in January compared to December 2009 (MarketWatch)
• Eurozone industrial production up by 1.7% (Eurostat)
• Japan's Q4 GDP growth was revised down to +0.9% from +1.1% (MarketWatch)
• Chinese inflation hits 16-month high; consumer prices rose by 2.7% last month (AP)
• China’s exports grew at the fastest pace in three years in February, up 46% year on year (Economist)
• The U.S. trade deficit in January 2010 decreased 6.6% to $37.3 billion (ESA)
• Barack Obama asks China to institute a “more market-oriented” exchange rate (Reuters)
• Wholesale inventories in January 2010 decreased 0.2% to $382.2 billion from December (Reuters)
• US median CEO bonus payments fell 21.9% to $689,000 in 2009 from $882,000 in 2008 (Equilar)
• 43% of Americans have less than $10,000 saved for retirement (CNN Money)
• Brazil to raise tariffs on 102 U.S. exports, including wheat, cars, boats and chewing gum (Bloomberg)
• World equities up 73 percent a year after crisis low on March 9, 2009 (Reuters)

Chart Of The Week
Discussions about China’s currency peg have been surfacing every so often in recent years.  When convenient, US politicians have been pointing a finger at a manipulated currency rate, as if all economic troubles could resolve, were it not for the “artificially undervalued” currency.  This week, the US president himself called on China to institute a “more market-oriented” exchange rate. 

The issue is of course very complex and considering China’s multi-trillion Dollar US holdings, any change in its currency policy could have massive repercussions for their domestic economy.  In 1994, China initiated a gradual appreciation of their currency which came to a halt during the financial crisis.  China must now balance its need to keep domestic inflation under control with an equally challenging task to manage its huge US Dollar exposure.  Take your pick as to what would be the lesser of two evils.  The market seems to favor a gradual and managed appreciation of the Yuan against the Dollar.  As the Financial Times reported this week, Trading in forward CNY contracts factor in an appreciation of about 2.8% over the coming year.  Given the recent Chinese inflation numbers of +2.7%, that figure seems to correlate closely with the implied currency adjustment sometime later this year. 

Putting a possible revaluation into context however, the roughly 15% adjustment to values prior to 1994, which appears closer to the true value of the Chinese Yuan, seems far and elusive at this point.  If estimates are correct that China is holding over $2 trillion in US assets, we are looking at an implied loss of about $300bn, an amount big enough to raise more than a few eye brows...


Weekly Barometers  (click on chart for larger image)

Stock-2010-0312   FX-2010-0312

The Inflation/Deflation Debate
Inflation versus deflation - the subject has been discussed at length and it doesn’t seem to go away.  In previous commentaries, most recently in our Market Insights of 27 February, I tried to play devil’s advocate for and against both passionately divided camps.  Granted one assumes inflation as a general measure of price levels, I concluded that , a scenario-based personal inflation barometer similar to the Cost of Living Index could be the most realistic measure of inflation; it would presumably be closest to a “felt-inflation” number.

Please consider the following video interviews with Mike Shedlock and Mark Faber, both known for their gloom and doom forecasts, but also sitting on opposite sides of the inflation/deflation camp.  Interestingly, both arguments seem plausible, certainly when one considers slightly different definitions of what inflation constitutes.  Despite their gloomy forecasts, I find it heart-warming that they can both sit at the same table and have a laugh together.  Whether one agrees with Mr. Shedlock or sides with Mr. Faber instead, both forecasts are no laughing matter.


P.S.  In case you have trouble understanding Mark Faber’s Swiss accent, please do contact me.  Those of you who know me personally can attest that I know his accent all too well... I’ll be happy to help translate

What A Difference A Year Makes 
Only a year ago, it seemed like the financial world would fall into the abyss.  One trading session after the S&P 500 hit the eerie low of 666.79, the MSCI's all-country world stock index hit its low on March 9, 2009.  That painful day must still be fresh in everybody’s mind.  But since then, the world index is up about 73% and the S&P500 gained almost 70%.  The performance of the remaining major global stock indices since then has been equally impressive with returns ranging from 43% (China) to almost 110% (India) - see chart below.


Given these unusually high returns, it raises the question as to whether these types of returns can continue given rather difficult underlying economic conditions in most countries.  High unemployment rates in the US and in Europe, on average about 10%, put a damper on the all-important consumer spending.  Without a cash strapped US consumer for instance, it remains to be seen if companies can achieve the projected earnings at which current valuations are based upon.

Putting the above into perspective, the hoorays are not nearly as loud anymore.  We need to remember that current stock prices are still far below the levels of the pre-crisis highs which most of these indices reached in 2007 (India in Jan-08 Brazil in May-08).  Long-term investors are painfully aware of that when comparing their current net-worth with the amounts of 2007.  In terms of individual country performances, Brazil is nearly back to pre-crisis levels.  Others, in particular China, still have ways to catch up.


It remains to be seen whether global equities can continue generating double-digit returns in 2010.  But those are necessary for the majority of countries if stock prices are to go back to pre-crisis values anytime soon.  Both charts also remind us that portfolio diversification to mitigate a specific country risk is not easily achieved.  Although some countries performed slightly better than others, they all still went in the same direction during and after the crisis making international diversification rather questionable.

The Lost Decade In Technology 
This week was also another ominous anniversary.  Exactly 10 years ago, the Nasdaq Composite Index, a largely technology-focused stock index, closed at an all-time high of 5048.62.  This week, the same index closed at 2367.66, about 53% below it's peak of March 2000. The chart below is just a gentle reminder of where we came from...


In view of this 10 year anniversary, the interview with Henry Blodget, seems particularly relevant today. Blodget, a widely known tech analyst who, at the height of the tech-bubble, made some controversial recommendations that landed him in trouble with the SEC.  It is somewhat refreshing to see that such a high profile analyst appears humbled by his experiences.  Decide for yourself whether to like or to scapegoat Mr. Blodget.  What I find concerning is the fact that someone in his early 30s at the time, with not much experience to speak of, could have been in such a powerful and potentially market moving position with Merril Lynch.

What Happens When An ETF Closes?
ETFs have become the new mutual funds, finding wider acceptance among the average investors.  Yahoo! Finance currently lists 847 ETFs, many of which have begun charging higher fees close to the standard 1% fee of Mutual Funds. As discussed last week, some rather obscure ones appear every now and then too.  Not all of these ETFs turn out to be successful and some of them are closed after a period of unsuccessful trading or due to lackluster demand.  What happens then, when an ETF closes?  I asked the question to Ron Rowland, an expert when it comes to ETF investing.  Here is his answer:"

Typically, when an ETF closes it is announced 2-3 weeks ahead of time. I believe it is best to sell your shares as soon as the announcement is made. There have been cases where the sponsor has stated they were going to start liquidating immediately and it would therefore no longer track its index.  If you do go through the redemption process, then you should get the cash back in your account within a week after the redemption/closure. 

As far as investor protection from excessive fees - good luck. MacroShares recently assessed its shareholders about 3% as a closure fee. See:

Please also consider Mr. Rowland’s rather interesting ETF Deathwatch.  The ETF Death Toll for 2009 was 56 and as of this month, there are currently 104 ETFs on his Deathwatch.

What About The US Dollar? 
The US Dollar retraced somewhat this week loosing about 1% against the major currencies.  The Index which had a nice rally gaining over 7% since the beginning of December 2009 has been continuing along the same trend line so far.  Trend watchers will point to a test of the bullish trend going forward.  As you can see in the chart below, Friday’s price pierced through the (blue) trend line.  The coming week could be an interesting battle ground between the technical bulls and bears.  Moreover, some important economic data including Producer Prices (PPI) and Consumer Price Index (CPI) in the U.S. may decide whether the markets favor of the ongoing trend. 


Good luck and good investing!

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