August 2008 COP Report

9/11/2008

Investment Gang

I used to think that somewhere in the world there would be something to invest in at all times.  If that is so how come every APA momentum in all of the countries that are available for me to track are negative at the same time. The only two things worth investing in are shorts, if you are very aggressive, and the dollar. This was exactly the state of the market for most of the day (Thursday 9/11).  At the onset all 21 of the country ETFs in my watch list were in the red.  By the end of the day six had moved into green. So there is not much to comment on.

Below are several notes from recent readings that I found most interesting.

“Former Federal Reserve Chairman Paul Volcker said the US financial system, dependent upon securitization rather than traditional bank loans, is broken, and may contribute to the weakest expansion since the 1930s.

“‘This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down,’ Volcker said today at a banking conference in Calgary. ‘Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.’

“‘It is the most complicated financial crisis I have ever experienced, and I have experienced a few,’ said Volcker.

“‘Changes are going to have to be made’ to the global financial system, Volcker said. Banks three decades ago accounted for about 60% of US credit; that later declined to about 30% as securitization – where financial firms package assets into bonds and other instruments and sell them on to investors and other companies – spread.”

“But if you had watched the just-completed Democratic and Republican National Conventions, you wouldn’t have known the US is stumbling through the worst financial crisis since the Great Depression. Nor would you have known, of course, that we’re queuing up for a bill that could exceed total Iraq War expenditures.” --- Paul Kedrosky (Infectious Greed)

Nouriel Roubini (Economist who forecast the financial markets breakdown) believes that Federal expenditures to support the mortgage markets and financial industry will actually double the size of the national debt by the end of next year -- and he has been right on about everything so far.  Wow!

Note above that the last recession started after unemployment started to rise and lasted only until unemployment was still about eight tenths below its peak (about 5.5 versus 6.3).  Almost regardless of who you listen to there seems to be agreement that this recession will be a much longer even if shallower one.  So where does unemployment rise to this time?  How can the recession remain shallow?

GaveKal: Ten-year US bond yields too low

“--with yields at 3.7% it seems to us that US Treasuries are increasingly becoming a ‘limited upside and large possible downside’ asset class. As the new investment environment unfolds, and as investors realize that, outside of financials and materials/energy, the rest of the OECD equity markets are holding up decently, we would expect equities to once again start outperforming bonds, and this especially in the US and in Japan.”  [Note: “real” yields (after inflation) are at their lowest since 1987 and we have been in a low interest environment for the last five years.]

[If the rates were “too low” it would mean that they were causing inflation and excessive debt accumulation – otherwise they are not too low.  We are clearly in a deleveraging period of debt reduction and a period of dropping inflation and recession.  I do not buy the too low story.]

Bill King (The King Report

--- the present combination of 5.6% headline inflation and S&P 500 trailing PE of roughly 25 has NEVER before occurred in the 44-year history of our data …

“Inflation expectations are literally imploding, and that is good for equities. Unfortunately, earnings estimates have yet to react, and that is worrisome. Thus, unless one believes in an immense productivity miracle, the S&P 500’s PE multiple must substantially decrease because of rising inflation and nominal growth or earnings are likely to be very disappointing because of disinflation/deflation.”

Bloomberg: US stocks at 25.8 times profit means rally may end

“The best may already be over for the US stock market this year. Shares in the benchmark index for American equity climbed to an average 25.8 times reported profits, the highest valuation in five years. The last time that happened, the S&P 500 fell 38%.

Very interesting chart --- The following chart is courtesy of Tom McClellan. [Via Mebane Faber]  He writes a daily report as well as a twice monthly newsletter, and they come highly recommended! You can find more info on his website www.msoscillator.com (as well as his older guest post here).

The chart below shows inflation (as measured by the CPI-U) as a leading indicator for unemployment. The CPI time series is shifted forward two years on the chart.

The simple take away is that with inflationary pressures rising, unemployment rates are likely to be going up for the next few years. . . [Even though inflation starts dropping now --tough for a new president]