FXIS Market Insights

As the Wall Street Journal reported today:

Greece continued to pay a stiff premium Monday to raise €5 billion ($6.71 billion) in its third syndicated bond offering of the year, a demonstration that the announcement last week of a possible European Union rescue package has done little to lower the troubled country's high cost of borrowing.

Compared with Greece's two previous bond issues in 2010, demand was relatively subdued. The seven-year bond attracted around €7 billion in bids. Greece's two earlier bond offerings this year had seen bids totaling three times what was eventually sold. Greece is paying a coupon of 5.9% on the new bond, 3.34 percentage points above what Germany pays to borrow money. The new €5 billion bond issue means Greece has now sold about €20 billion of bonds, or 43% of its 2010 target.

Call me naïve, ignorant or cynical but I have a hard time justifying this rate as adequate risk premium over what is still considered “risk-free” i.e. US government securities.  Yes, the Greek debt crisis has subsided since the Euro Member countries pledged some support for Greece last week.  But Greece still has to sell another €26 billion of bonds until the end of this year, the outcome of which is far from certain. Hence, the market still wants more than a 3% premium over equivalent German Bonds.

I don’t know anyone personally who bought Greek government debt in the past and I fail to see why an institution or an international investor would want to do so now.  Why should one lend money to the Greek government at 5.9% for 7 years when for instance the equivalent Bond from Australia, which from this vantage point appears in better economic shape than most European member countries, is yielding 5.68% –that’s just a fraction below those of Greece.  Granted, a European investor might fear the currency exposure against the Australian Dollar.  However, a non-Euro denominated investor such as an American institution would have a similar currency risk either via the Euro or via the Australian Dollar.  Is Greece’s tiny premium of 0.22% over Australian Bonds really worth the seemingly higher proportionate risk?

Apparently, the market rates indicate that the chances of an Australian default are still lower than the possibility of European Union members letting Greece default.  As time goes on and as the dust about Greece sovereign debt settles, Greek Bond yields should subside as well.  At that point the Australian yield would probably be higher than those of Greece and would make my choice towards Australian over Greek debt an even more compelling one.   For a US investor, there is of course still the question about currency risk which needs to be assessed no matter what.  However, that is a risk I personally feel much more comfortable with and am willing to take anytime over the uncertainty of Greek government finances sustaining for the next 7 years.

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 
• Taking on Krugman
• Katrina Quality Rescue Skills
• The Euro Weakness In A Different Light

Weekly Snapshot
• China will introduce its long-awaited stock-index futures on April 16 (WSJ)
• US Michigan Consumer Sentiment Index Held at 73.6 in March (Bloomberg)
• US GDP increased 5.6% in Q4 of 2009, 0.3% less than the second estimate (ESA)
• Mortgage delinquencies in the US rise to nearly 14% (Washington Post)
• US Government unveils $14bn plan to help troubled homeowners (AP)
• Euro-zone member countries agree to Greek rescue deal (FT)
• Fitch cut its rating on Portugal by one notch to AA- (AP)
• Industrial new orders down by 2.0% in Euro area, down by 0.2% in EU27 (Eurostat)
• New orders for manufactured durable goods in February increased 0.5% to $178.1 billion (NBER)
• Germany's IFO business climate index climbed in March to its highest since mid-2008 (Economy.com)
• Sales of new single-family homes in the US fell 2.2% to a 308,000 unit annual rate (Reuters)
• China likely to see a "record trade deficit" in March thanks to surging imports (China Daily)

Chart Of The Week
Our colleague from Political Calculations came up with a wonderful chart indicating the doubling rates of US Imports from China.  We will examine the relationship of international trade and currency exchange rates in great detail further down.
 

Weekly Barometers  (click on chart for larger image)

Taking on Krugman
China has been the favored target of some politicians and an increasing number of high profile economists in recent months.  Talk of Chinese currency manipulation has become more widespread in the main-stream media too.  Ask someone about the name of the Norwegian currency for instance and you might get a blank stare. But the Chinese Renminbi a.k.a. Yuan has been part of the talk on the street these days.  And so is the common perception that it is the “artificially” low exchange rate which is to blame for the massive trade deficit between the US and China; better yet, blame China for every other challenge facing the US and global economy these days.

In his recent NY Times article Taking On China, Paul Krugman does some of that finger-pointing towards the East.  Call it a fool’s privilege, but I would like to “take on” the Nobel Laureate in Economics by reviewing the actual impact of currency exchange rates on international trade.  But first, let me clarify that I have the utmost respect for Mr. Krugman and that I am not out here to join the increasingly popular crowd bashing Keynesian economics, however convenient that may be at this time.  Keeping within the length restrictions of this short article, we have to simplify a few things. Realizing the limitations of a brief analysis, we cannot get into the complex historic circumstances that ended the Bretton Woods agreement which then lead to the current system of freely floating exchange rates among the major global currencies.  I simply question whether Mr. Krugman’s suggestion of a 25% tariff on Chinese Goods would convince the Chinese government to revalue their currency and I like to demonstrate that a stronger Chinese Yuan may not lead to an improvement of the US trade deficit with China.

To help us out here, let us examine some historic charts.  The two charts below show how the US Dollar traded against the Japanese Yen and the Deutsche Mark since 1971 (Ed. Note: The Deutsche Mark has been the legal tender of Germany until it was abandoned in favor of the Euro in 2002.   From Jan-2002 onward, we used the official conversion rate of  DM 1.95583 = 1 Euro to establish a hypothetical Deutsche Mark value for the purpose of charting this currency trend).

Although we did not have access to trade data of 1971, we were able to chart the US imports from Japan and Germany since 1985 and super-imposed those with the currency exchange rates.  To illustrate the fallacy in Mr. Krugman’s proposition, we can point to numerous periods when the US Dollar weakened and conversely the foreign currency appreciated while imports to the US had grown rather than decreased.

 

Take for instance the period between 1985 and 1995 when the US Dollar depreciated from ¥254 = $1 to about ¥100 = $1, that’s a 60% decrease in the value of the US$.  Meanwhile imports from Japan grew over 54% in the same time period.  A similar case could be made for the data from Germany.

In the same time period between 1985 and 1995, German imports to the US grew 46% while the US$ lost over 50% against the German Mark.  From 2000 until summer 2008, German imports to the US grew by nearly 120% while the greenback lost another 35% in value.  Having examined the actual data side by side, there is simply no correlation between these two sets of data (send me an email if you like a copy of our spreadsheet and data analysis). 

I realize that by not examining the other side of the trade equation (we shall examine that in a future article), we might run short of a more substantial proof that Mr. Krugman’s suggestion is flawed. However, it is commonly understood that the US has not been a leading exporter for several decades now and irrespective of where the US Dollar may have traded.  Moreover, it is often forgotten that that the demand for high quality products (i.e. Japanese consumer electronics, cars or German machinery/cars), even at a higher price, may still lead to higher sales figures through increased profit margins.  In simplified terms, I only need to sell half as many goods at double the price to achieve the same revenues.  Granted that the suggested taxes might take the biggest chunk out of the price increases temporarily but they would also create a new price benchmark and once repealed, the new price levels would be an immediate windfall for the exporters – overall, not a good solution.

When Japan entered the US market, initially gaining market share by supplying the cheapest products available and when the Japan bashing and calls for import duties entered the popular press, Japan countered with better products eventually selling at higher prices. Japanese car makers also responded by adding substantial manufacturing capacity directly inside the US.  They effectively circumvented trade or import duties that may have been in place. 

China is a slightly different animal but they have come very far in a short period of time and they will not forego the biggest global consumer market that easily.  Import Duties of 25% may put a damper on the massive US trade deficit with China, but it is unlikely that it will be an effective way to stop imports from China or from any other country for that matter. It is also questionable whether China would revalue its currency in response to trade barriers.  It is rather more likely that China will revalue its currency only when it serves its own economic and political purpose.  More probable still, China will increasingly focus on producing higher quality products which will be less sensitive to potential price changes i.e. via a stronger or eventually floating currency.  Finally, let’s not forget that a stronger Chinese Yuan has numerous positive effects on producers in China as well.  The price of commodities and raw materials which China has an increasing appetite for, would also fall for the Chinese manufacturers, offsetting at least some of the losses from Chinese exports via stronger currency.

When the Chinese Yuan might appreciate is anyone’s guess.  However, it is widely accepted that China will have to revalue its currency at some point anyway, making Mr. Krugman’s call for a 25% import tax seem rather desperate.  As history has shown time and again, prices can only be manipulated for so long, eventually the economic imbalances will become so great that price adjustments will have to be made, either through gradual and manipulated adjustments or via the natural forces of supply and demand.   Instead of blaming China for the economic misery of the world, one should consider what can be done to steer consumer demand away from cheap consumption goods to high quality and durable products that add value to society. Sometimes less is more.

Katrina Quality Rescue Skills  
Gerald Celente of the Trends Research Institute is known for making rather gloomy but often quite accurate and certainly entertaining predictions by following major global trends.  As you might have guessed, he is not exactly bullish on the economy and predicts another crash looming upon us. 

His confidence in the US government to have any positive effect on the long-term economy is obviously not the highest when he says:

“Everything they touch, they turn into a disaster.  They have Katrina Quality Rescue Skills...”

But instead of chiming in with the blame game, I would like to refer to the second part of the interview where he talks about the US-China financial relations and makes some interesting remarks about the exchange rates which are not dissimilar from our commentary above.  Enjoy!

The Euro Weakness In A Different Light
On the back of continued wrangling over a possible Greek bailout by Germany (or the IMF), currency players have been shorting the Euro with renewed rigor throughout the week.  When the 16 member countries of the Euro-zone put aside their differences and agreed on a pledge of financial support for Greece, the single currency reversed some of the losses and ended the week on a slightly less pessimistic note.
Throughout the week, European equities appeared relatively insulated from the Greek struggles; the German DAX was trading higher throughout the week and closed only 0.3% below its 52-week high.  Traders favored quality and safety over risk which was evident by the over 3 point spread of Greek treasury yields over German 10-year Bonds.  That same need for quality and safety has recently not been associated with the single European currency which was all to apparent in the decline of the Euro versus the US Dollar in recent weeks.

A little less publicized but much more vehement was the decline of the Euro versus other major currencies.  Topping the list are the cross-currency trades Euro versus Australian Dollar and Euro versus Swiss Franc, both of which may have emanated from a different rationale.

Let's examine the Euro versus Australian Dollar first.  The Euro hit a 13 year low of 1.4605 versus the Australian Dollar on Thursday. The single currency has now lost over 26% in the past 12 months and the speed and intensity of the decline has been rather troubling. 

 

Australia still enjoys a healthy 3% spread over European deposit rates making it a preferred target for a carry trade against the Euro as a funding currency.   But the Australian Dollar has now gained so much against the Euro that one might hesitate to put on a trade that may have already run most of its course.  There has been no significant technical correction to speak of since this dramatic currency slide began last February, which posed the question as to when the major net sellers of the Euro would cover their short positions.  Some short covering happened on Friday when, on the back of positive news about Greece, the Euro retraced upwards by over 200 points and closed the week at 1.4827. 

 

Any renewed doubts about the fiscal conditions in Greece or other countries such as Portugal, which saw its triple A rating reduced this week, will turn the pressure on the Euro again.  Political wrangling and fundamental factors aside, the technical elements continue to favor the downside so far.  Possible targets are a retest of the technical support at 1.4605 (previous low of September ‘97 and Thursday this week) as well as the all-time low of 1.4025.

Turning our attention to the Swiss cross trade now, the Euro fell to a 25 year low of 1.4232 on Wednesday. In the absence of previous reference points (our charts only go back to 1984), we are entering somewhat new territory here.

The Euro’s slide against the Swiss Franc by contrast to the Aussie, has not been quite as fast or as drastic and the rationale for favoring the Swissie over the Euro is slightly different from that of the Aussie $.  For starters, the Swiss currency has even lower deposit rates (0.25%) than the Euro (1%), so the carry trade is out.  Further, the Swissie is not exactly a commodity type currency and it is not nearly as important in terms of international trade.  However, it has historically been considered a safe-haven currency, perhaps a bit tainted after some heavy arm twisting by the US government that led to a partial lift of the Swiss banking secrecy laws, but nevertheless, it is a “neutral” country.  That neutrality would play well and as long as the Euro member countries are trying to sort out their sovereign debt issues.

Although the Euro gained back some of the losses on the positive Greek rescue deal, a true reversal of these two cross trades has not happened just yet.   In the absence of a deterioration of the Greek debt crisis and a possible spill over towards other Southern European member nations, fundamental reasons should outweigh neutrality.  As time passes, the Aussie Dollar might be the better fundamental trade via its favorable deposit rates over a much more neutral stance via the Swissie.  Much of the Euro-woes may have already been priced in by now, bearing in mind the severity of the decline thus far.  A pull-back from recent lows could happen fast and lift the Euro back to levels seen earlier this year. But as long as serious doubts about the continued existence of the Euro remain, one should consider expressing that opinion via the cross currency trade rather than the more commonly known Euro versus US Dollar trade.
Good luck and good investing!

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

China has been the favored target of some politicians and an increasing number of high profile economists in recent months.  Talk of Chinese currency manipulation has become more widespread in the main-stream media too.  Ask someone about the name of the Norwegian currency for instance and you might get a blank stare. But the Chinese Renminbi a.k.a. Yuan has been part of the talk on the street these days.  And so is the common perception that it is the “artificially” low exchange rate which is to blame for the massive trade deficit between the US and China; better yet, blame China for every other challenge facing the US and global economy these days.

In his recent NY Times article Taking On China, Paul Krugman does some of that finger-pointing towards the East.  Call it a fool’s privilege, but I would like to “take on” the Nobel Laureate in Economics by reviewing the actual impact of currency exchange rates on international trade.  But first, let me clarify that I have the utmost respect for Mr. Krugman and that I am not out here to join the increasingly popular crowd bashing Keynesian economics, however convenient that may be at this time.  Keeping within the length restrictions of this short article, we have to simplify a few things. Realizing the limitations of a brief analysis, we cannot get into the complex historic circumstances that ended the Bretton Woods agreement which then lead to the current system of freely floating exchange rates among the major global currencies.  I simply question whether Mr. Krugman’s suggestion of a 25% tariff on Chinese Goods would convince the Chinese government to revalue their currency and I like to demonstrate that a stronger Chinese Yuan may not lead to an improvement of the US trade deficit with China.

To help us out here, let us examine some historic charts.  The two charts below show how the US Dollar traded against the Japanese Yen and the Deutsche Mark since 1971 (Ed. Note: The Deutsche Mark has been the legal tender of Germany until it was abandoned in favor of the Euro in 2002.   From Jan-2002 onward, we used the official conversion rate of  DM 1.95583 = 1 Euro to establish a hypothetical Deutsche Mark value for the purpose of charting this currency trend).

Although we did not have access to trade data of 1971, we were able to chart the US imports from Japan and Germany since 1985 and super-imposed those with the currency exchange rates.  To illustrate the fallacy in Mr. Krugman’s proposition, we can point to numerous periods when the US Dollar weakened and conversely the foreign currency appreciated while imports to the US had grown rather than decreased.

Take for instance the period between 1985 and 1995 when the US Dollar depreciated from ¥254 = $1 to about ¥100 = $1, that’s a 60% decrease in the value of the US$.  Meanwhile imports from Japan grew over 54% in the same time period.  A similar case could be made for the data from Germany.

In the same time period between 1985 and 1995, German imports to the US grew 46% while the US$ lost over 50% against the German Mark.  From 2000 until summer 2008, German imports to the US grew by nearly 120% while the greenback lost another 35% in value.  Having examined the actual data side by side, there is simply no correlation between these two sets of data (send me an email if you like a copy of our spreadsheet and data analysis). 

I realize that by not examining the other side of the trade equation (we shall examine that in a future article), we might run short of a more substantial proof that Mr. Krugman’s suggestion is flawed. However, it is commonly understood that the US has not been a leading exporter for several decades now and irrespective of where the US Dollar may have traded.  Moreover, it is often forgotten that that the demand for high quality products (i.e. Japanese consumer electronics, cars or German machinery/cars), even at a higher price, may still lead to higher sales figures through increased profit margins.  In simplified terms, I only need to sell half as many goods at double the price to achieve the same net profit.  Granted that the suggested taxes might take the biggest chunk out of the price increases temporarily but they would also create a new price benchmark and once repealed, the new price levels would be an immediate windfall for the exporters – overall, not a good solution.

When Japan entered the US market, initially gaining market share by supplying the cheapest products available and when the Japan bashing and calls for import duties entered the popular press, Japan countered with better products eventually selling at higher prices. Japanese car makers responded by adding substantial manufacturing capacity directly inside the US.  They effectively circumvented trade or import duties that may have been in place. 

China is a slightly different animal but they have come very far in a short period of time and they will not forego the biggest consumer market that easily.  Import Duties of 25% may put a damper on the massive US trade deficit with China, but it is unlikely that it will be an effective way to stop imports from China or from any other country for that matter. It is also questionable whether China would revalue its currency in response to trade barriers.  It is rather more likely that China will revalue its currency only when it serves its own economic or political purpose.  More probable still, China will increasingly focus on producing higher quality products which will be less sensitive to potential price changes i.e. via a stronger or eventually floating currency.  Finally, let’s not forget that a stronger Chinese Yuan has numerous positive effects on producers in China as well.  The price of commodities and raw materials which China has an increasing appetite for, would also fall for the Chinese manufacturers, offsetting at least some of the losses from Chinese exports via stronger currency.

When the Chinese Yuan might appreciate is anyone’s guess.  However, it is widely accepted that China will have to revalue its currency at some point anyway, making Mr. Krugman’s call for a 25% import tax seem rather desperate.  As history has shown time and again, prices can only be manipulated for so long, eventually the economic imbalances will become so great that price adjustments will have to be made, either through gradual and manipulated adjustments or via the natural forces of supply and demand.   Instead of blaming China for the economic misery of the world, one should consider what can be done to steer consumer demand away from cheap consumption goods to high quality and durable products that add value to society. Sometimes less is more.

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

On the back of continued wrangling over a possible Greek bailout by Germany (or the IMF), currency players have been shorting the Euro with renewed rigor.  European equities remain fairly upbeat so far with the German DAX only 1.3% below its 52-week high at present. The fact that Greek 10-year Bonds are still yielding 6.34%, about a 3 1/4 point spread over German 10-year Bonds, clearly shows the current investors’ tendency towards quality and safety over risk.  That same need for quality and safety is currently not associated with the single European currency which is all to apparent in the renewed decline of the Euro versus the US Dollar.

A little less publicized but much more vehement was the decline of the Euro versus other major currencies.  Topping the list are the cross-currency trades Euro versus Australian Dollar and Euro versus Swiss Franc, both of which may have emanated from a different rationale.

Let's examine the Euro versus Australian Dollar first.  The Euro hit a 13 year low of 1.4665 versus the Australian Dollar in early Australian markets today. The single currency has now lost over 26% in the past 12 months and the speed and intensity of the decline has been rather troubling.  Australia still enjoys a healthy 3% spread over European deposit rates making it a preferred target for a carry trade against the Euro as a funding currency.   But the Australian Dollar has now gained so much against the Euro that one might hesitate to put on a trade that may have already run most of its course.  There has been no significant technical correction to speak of since this dramatic currency slide began last February, which poses the question as to when the major net sellers of the Euro would cover their short positions. 

One could equally assume that possible deflationary pressures on commodity prices may weigh on the Australian Dollar, which typically correlates closer to the commodities than any other currencies. However, that has not happened yet either. Moreover, technical factors continue to favor the downside with possible targets at technical support of 1.4605 and at the all-time low of 1.4025 which looks increasingly likely now. 

Turning our attention to the Swiss cross trade, in the overnight Australian markets the Euro fell to a 25 year low of 1.4232. In the absence of previous reference points (our charts only go back to 1984), we are entering somewhat new territory here. 

The Euro’s slide against the Swiss Franc by contrast to the Aussie, has not been quite as fast or as drastic and the rationale for favoring the Swissie over the Euro is slightly different from that of the Aussie $.  For starters, the Swiss currency has even lower deposit rates (0.25%) than the Euro (1%), so the carry trade is out.  Further, the Swissie is not exactly a commodity type currency and it is not nearly as important in terms of international trade.  However, it has historically been considered a safe-haven currency, perhaps a bit tainted after some heavy arm twisting by the US government that led to a partial lift of the Swiss banking secrecy laws, but nevertheless, it is a “neutral” country.  That neutrality would play well and as long as the Euro member countries are trying to sort out their issues. 

In the meantime, there is not much that speaks for a reversal of these two cross trades just yet.  The market sentiment is clearly against the Euro at the moment.  Although one might be concerned about a possible reversal of the speculative shorts against the Euro, until the Greek debt crisis is settled the Euro will have a hard time slowing down or even reversing the trend.  In times of trouble, stay neutral which means continue favoring the most neutral of all countries.  In the absence of a deterioration of the Greek debt crisis and a possible spill over towards other Southern European member nations, one should consider favoring fundamental reasons over neutrality.  As time passes, the Aussie Dollar might be the better fundamental trade via its favorable deposit rates over a much more neutral stance via the Swissie.

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 
• Lehman Brothers - The Fall Of A Sith Lord? 
• Naïve Expectations Versus Actual Performance
• Fed Maintains Ultra-low Rate Policy
• Are We Still In A Bear Market?
• In Dodd We Trust

Weekly Snapshot
• Renewed concerns about Greece strengthen US$, pressure on Euro and commodities (Reuters)
• SEC, Fed were warned of Lehman's liquidity problems prior to collapse (FT)
• German producer prices fell 2.9% an annual basis in February (Economist)
• Leading Economic Index (LEI) for the US increased 0.1% in February (Conference Board)
• US consumer prices unchanged in February on a seasonally adjusted basis (BLS)
• US current account deficit increased to $115.6 billion (3.2% of GDP Q4 of 2009 (ESA)
• Euro area annual inflation was 0.9% in February, down from 1.0% in January (Eurostat)
• US producer prices declined 0.6% in February, seasonally adjusted (BLS)
• Fed maintains the target range for the federal funds rate at 0 to 1/4% (AP)
• US Housing construction drops 5.9% and building permits fell 1.6% in February (ESA)
• China's holdings dipped by $5.8 billion to $889 billion in January compared with December (AP)
• US industrial production edged up 0.1% in February following a gain of 0.9% in January (FRB)

Chart Of The Week
Oil prices had an interesting week reaching a high of $83.36 but then retreating to a test of the $80 level.  $80 per barrel seemed unreachable just a year ago when crude prices were just moving above $40 again.  In historic perspective including inflation adjusted prices, oil is not all that expensive.

Weekly Barometers  (click on chart for larger image)

Lehman Brothers - The Fall Of A Sith Lord?
It took about a year and a half and a 2200 page report by the court-appointed examiner, Anton R. Valukas, to explain what most of us instinctively knew: Lehman Brothers used some rather creative accounting enabling them to "keep on dancing while the music was still playing".  One of the most popular catch phrases this week has been "Repo 105", an inside term for an accounting practice enabling Lehman to have as much as $50bn vanish from its balance sheet and temporarily reduce its debt levels.

The Financial Times has a nice explanation of how this Repo 105 worked: http://www.ft.com/cms/s/0/f0581674-2df0-11df-b85c-00144feabdc0.html

With these new revelations, finger-pointing has already begun.  Apparently, US regulators (SEC and New York Fed) were warned about potential liquidity problems at Lehman prior to their collapse.  The New York Fed was not able to confirm this and the senior staff at the SEC overseeing Lehman Brothers are no longer working with the SEC - how convenient.

While these revelations are yet another indication of how horribly wrong everything went within the financial services industry, what is much more concerning is the unsettling feeling - correction - the implicit knowledge that this was only the tip of an iceberg and that there is more to come.  As they say, it always takes two to Tango...

Moreover, if Lehman engaged in this practice, others must have done the same.  This seems like a perfect time to quote Jedi Masters from the Movie Star Wars...

Mace Windu: There's no doubt that the mysterious warrior was a Sith.
Master Yoda: Always two there are. No more, no less. A master... and an apprentice.
Mace Windu: But which was destroyed? The master or the apprentice? 

Naïve Expectations Versus Actual Performance 
Oil futures were up again this week reaching an intra-day high of $83.36 before closing just above $8o on Friday.  This year’s high at $84 was within arm’s length and could be tested again within the next trading week if bullish momentum re-ignites.  These price levels also bring back memories of the summer of 2007 when oil started its ascent all the way to the all-time high of $147 in July 2008.   Looking at the trend development so far, it is rather tempting to jump on the band wagon in the hope of catching a possible repeat of the triple digit prices.

Without making any prediction as to the near-term price targets at this time, I am taking this opportunity to highlight a peculiarity of certain instruments that the average investor may not be aware of.  With the growing popularity of ETFs, there are now various ways to express an opinion and create exposure to various asset classes which not too long ago had been outside the realm of an average investor.  These days, it has  become seemingly as “easy” as buying a stock.  One must caution however, that some of the recent ETFs tracking specific asset classes are not meant to be long-term instruments.  Examining the United States Oil Fund (USO) as an illustration, the fund sponsors note that:

The United States Oil Fund, LP ("USO") is a domestic exchange traded security designed to track the movements of light, sweet crude oil ("West Texas Intermediate").

As always, it pays to understand the true nature of the investments you are engaging in and the prospectus along with all disclosures should be read prior to considering any investment in ETFs.  In reality though, very few people take the time to read a complicated 128 page document such as the Prospectus for the USO.  In this case, it is critical to understand that the fund only seeks to match “daily returns”, a slight nuance in the terminology which can have a significant impact when comparing the returns with the underlying asset over a longer period of time.  Instead of examining some boring formulas, please consider the charts below comparing the returns of USO with the underlying oil price, that of West Texas Intermediate Futures.  In the near term, the USO seems to match the returns of oil futures close enough, albeit certainly not perfect.  Yet, with a longer time period, the performance turns significantly lower.  In the 12 months up to March 17, the oil price is up 65% whereas USO is up only 35%. 

Oil vs. USO -YTD		Oil vs. USO - Past 12 months

This illustrates how vast the difference can be between perception, what some industry professionals call the “naïve expectation”, and actual performance.  USO and similar ETFs may be perfectly suitable investments for some investors.  However, one should be fully aware of the true nature of an ETF’s holdings and should carefully consider the cost of holding the investment for an extended period of time.

Fed Maintains Ultra-low Rate Policy 
As expected by the majority of market participants, the Federal Open Market Committee issued a statement earlier this week maintaining the target range for the federal funds rate at 0 to 1/4%  for an extended period of time.

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, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, 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 has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are nearing completion, and the remaining transactions will be executed by the end of this month. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

The complete FOMC statement is available here: http://www.federalreserve.gov/newsevents/press/monetary/20100316a.htm

While this has been widely anticipated, the more important issue will be how the economy will fair when the remaining special liquidity facilities, most of which will end this month, are no longer in place.  Without the massive federal support, can mortgage rates and other commercial loans remain at current levels? 

Are We Still In A Bear Market?
US Equities have shrugged off many of the gloom and doom forecasts so far this year.  The S&P 500 reached a new 18 month high at 1169.84 this week.  Dshort.com published a nice chart this week referencing the current price level to previous iterations in his words, the 1150 congestion area. 

More compelling than the chart is his rationale for using technical analysis when one of his blog readers challenged the very existence of using TA to predict price trends:

I like to include some technical analysis on dshort.com for a couple of reasons:

1) Strict mathematical indicators, for example, moving averages, can show that the market is susceptible to trends of various durations — up, down, sideways. Technical analysis offers some strategies for making conjectures about continuations and reversals.

2) There's a significant behavioral factor in markets and the economy — irrational exuberance, dismal despair, and everything in between. Technical analysis, with its trend lines of support and resistance, may provide some clues about the underlying market psychology.

As for the predictive power of TA? Not exactly a crystal ball. Same for fundamental analysis. However, a long-term trend, horizontal consolidation, or even an inverted head-and-shoulders formation is probably a better indicator of next week's S&P 500 than an inch of rain in Massachusetts tomorrow.

Ultimately technical analysis, like its fundamental counterpart, is a search for evidence to make educated guesses.

Actually, there's a third reason I like to post some technical charts: Sheer entertainment value. I look at a market bumping and grinding against a couple of trend lines, and I love the suspense. Take that 1150 resistance in the chart linked above. Will it break out? Break down? Or consolidate sideways?

For some of us, these charts are almost as much fun as NCAA basketball!

So there you have it.  And since enough market players are using technical analysis these days, there is a fair amount self-fulfilling prophecy at play too.  Enough people seeing the same pattern will cause traders to tilt to either the Buy or  the Sell button.  Are we still in a bear market?  The medium term technicians will point towards a break-out of the bearish trend line as it developed this week.  The educated guess for a technician would suggest a favoritism towards the upside – that is to say based on just one basic technical trending tool.

But as you might have guessed, it’s not nearly as clear-cut in the real world.  Stock prices have traditionally been a forward looking indicator of the economy in that stocks typically move about 6 months ahead of the real economy.  And the real economy is exactly what may cause some concern and put a reign on further price advances unless there will be some major improvements in jobs and consumer spending going forward.  The economic picture at present does not look nearly as rosy as market advances might suggest. Looking beyond just pure economic growth indicators there are some additional caveats to note:

• Bank lending and credit is still contracting
• About 15% of all residential housing units are vacant
• A significant amount of manufacturing capacity is sitting idle
• 43% of Americans have less than $10,000 saved for retirement
• More than five million homeowners are behind on their mortgages
• Commercial real estate values are down about 30% in the past 12 months
• More than six million Americans have been unemployed for at least six months

These are massive challenges for the all-important American consumer making it less likely that the economic recovery will be as fast and as strong as the stock market recovered in the past 12 months.

In Dodd We Trust 
This was just too funny to pass up.  Enjoy and have a lovely week-end.

Good luck and good investing!

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

It took about a year and a half and a 2200 page report by the court-appointed examiner, Anton R. Valukas, to explain what most of us instinctively knew: Lehman Brothers used some rather creative accounting enabling them to "keep on dancing while the music was still playing".  One of the most popular catch phrases this week has been "Repo 105", an inside term for an accounting practice enabling Lehman to have as much as $50bn vanish from its balance sheet and temporarily reduce its debt levels.

The Financial Times has a nice explanation of how this Repo 105 worked: http://www.ft.com/cms/s/0/f0581674-2df0-11df-b85c-00144feabdc0.html

With these new revelations, finger-pointing has already begun.  Apparently, US regulators (SEC and New York Fed) were warned about potential liquidity problems at Lehman prior to their collapse.  The New York Fed was not able to confirm this and the senior staff at the SEC overseeing Lehman Brothers are no longer working with the SEC - how convenient.

While these revelations are yet another indication of how horribly wrong everything went within the financial services industry, what is much more concerning is the unsettling feeling - correction - the implicit knowledge that this was only the tip of an iceberg and that there is more to come.  As they say, it always takes two to Tango...

Moreover, if Lehman engaged in this practice, others must have done the same.  This seems like a perfect time to quote Jedi Masters from the Movie Star Wars...

Mace Windu: There's no doubt that the mysterious warrior was a Sith.
Master Yoda: Always two there are. No more, no less. A master... and an apprentice.
Mace Windu: But which was destroyed? The master or the apprentice?

Oil futures were up again today reaching an intra-day high of $83.36 before closing just below $83.  This year’s high at $84 is now within arm’s length and could be tested within the next trading session.  These price levels also bring back memories of the summer of 2007 when oil started its ascent all the way to the all-time high of $147 in July 2008.   Looking at the trend development so far, it is rather tempting to jump on the band wagon in the hope of catching a possible repeat of the triple digit prices.

Without making any prediction as to the near-term price targets at this time, I am taking this opportunity to highlight a peculiarity of certain instruments that the average investor may not be aware of.  With the growing popularity of ETFs, there are now various ways to express an opinion and create exposure to various assets classes, which not too long ago, had been outside the realm of an average investor.  These days, it has  become seemingly as “easy” as buying a stock.  One must caution however, that some of the recent ETFs tracking specific asset classes are not meant to be long-term instruments.  Examining the United States Oil Fund (USO) as an illustration, the fund sponsors note that:

The United States Oil Fund, LP ("USO") is a domestic exchange traded security designed to track the movements of light, sweet crude oil ("West Texas Intermediate").

As always, it pays to understand the true nature of the investments you are engaging in and the prospectus along with all disclosures should be read prior to considering any investment in ETFs.  In reality though, very few people take the time to read a complicated 128 page document such as the Prospectus for the USO.  In this case, it is critical to understand that the fund only seeks to match “daily returns”, a slight nuance in the terminology which can have a significant impact when comparing the returns with the underlying asset over a longer period of time.  Instead of examining some boring formulas, please consider the charts below comparing the returns of USO with the underlying oil price, that of West Texas Intermediate Futures.  In the near term, the USO seems to match the returns of oil futures close enough, albeit certainly not perfect.  Yet, with a longer time period, the performance turns significantly lower.  In the 12 months up to March 17, the oil price is up 65% whereas USO is up only 35%. 

Oil vs. USO -YTD		Oil vs. USO - Past 12 months

This illustrates how vast the difference can be between perception, what some industry professionals call the “naïve expectation”, and actual performance.  USO and similar ETFs may be perfectly suitable investments for some investors.  However, one should be fully aware of the true nature of an ETF’s holdings and should carefully consider the cost of holding the investment for an extended period of time.

As expected by the majority of market participants, the Federal Open Market Committee issued a statement maintaining the target range for the federal funds rate at 0 to 1/4%  for an extended period of time.

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, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, 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 has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are nearing completion, and the remaining transactions will be executed by the end of this month. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

The complete FOMC statement is available here: http://www.federalreserve.gov/newsevents/press/monetary/20100316a.htm

While this has been widely anticipated, the more important issue will be how the economy will fair when the remaining special liquidity facilities, most of which will end this month, are no longer in place.  Without the massive federal support, can mortgage rates and other commercial loans remain at current levels?

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)

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:  http://investwithanedge.com/totally-obscene-umm-dmm-expense-ratio

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!

Disclaimer
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. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

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...

The Euro hit a new multi-year low of 1.4809 versus the Australian Dollar yesterday reaching the lowest level since August 1997. The single currency has now lost 25% in the past 12 months and it has done so in a troubling one-way move to the down-side (click on historic chart below). 

Today, the Euro recovered somewhat but still closed the day below 1.5000  an important technical and psychological support level. 

There has been no significant technical correction to speak of since this dramatic currency slide began last February. One should think that net sellers of the Euro would eventually take some profits and cover enough of their short positions for the Euro to regain some ground.  But it doesn’t appear to have happened just yet. 

In addition to the technical rationale for further downside pressure, ongoing concerns over Greek and other European Sovereign Debt will continue weigh heavy on the Euro going forward.  Furthermore, after the Australian 0.25% rate hike last week, Australia now enjoys a healthy 3% spread over European deposit rates making it a preferred target for a carry trade.  In the absence of significant negative factors for Australia’s economy, and unless there are deflationary pressures on commodities, one is tempted to follow the crowd and push the Euro lower still.  Next significant technical supports are at 1.4755, 1.4605 and 1.4375.  If this downward pressure continues, all-time low is at 1.4025.

Yesterday was the one-year anniversary of the market trough when the major global stock markets had the bleakest day of the great recession. Today is 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.  Today, the same index closed at 2358.95, 53% below it's peak of March 2000. The chart below is just a gentle reminder of where we came from...

Exactly one 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.