November 28, 2009

Market Insights - 28 November 2009

Dear Friends & Fellow Investors

Due to the US Thanksgiving Holiday, market insights comes in an abbreviated format.  As always,  please email any questions to: info@fxistrategies.com.  Enjoy reading!

Weekly Snapshot
• Gold prices reached a new high on at $1,195 on Thursday (eSignal)
• US new home sales in October 2009 increased 6.2% to 430,000 (Bloomberg)
• US durable goods orders in October 2009 decreased 0.6%, to $166.2 billion (ESA)
• Industrial new orders up by 1.5% in the Euro area (Eurostat)
• US Consumer Confidence increased to 49.5, up from 48.7 in October (Conference Board)
• Second estimate for US GDP saw an increased 2.8% in Q3 2009 (ESA)
• Driven by the first-time buyer tax credit, existing-home sales surged 10.1% in October (Realtor.org)

Charts Of The Week  
The US Volatility Index a.k.a. the fear index has been on a relatively steady path down back to pre-crisis levels indicating that a recovery has been in the making, at least as far as stocks are concerned.  We recall the insane volatility levels reaching almost 90 in October of last year.  In terms of market jitteriness, we are certainly better off today than a year ago. VIX-2009-1127-W

However, on Thursday world markets rattled again when Dubai World, the state holding company of Dubai, announced that it is seeking a standstill on repayment of part of its debt.  Dubai World said it seeks a six-month delay in paying creditors about $60 billion in debt.  Worries about exposure of mostly European banks triggered a wave of selling across the globe.  Volatility jumped almost 6 points on Friday and financials came under intense pressure closing Friday almost 3% down. Considering the relatively small exposure, the market sell-off is a stark reminder of how frail the recent market recovery really is.

VIX-2009-1127

Source: http://www.stockcharts.com

Recommended Video 
Barry Ritzholtz gives an excellent overview of the US property market.

Happy Thanksgiving!

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.

November 22, 2009

Market Insights - 22 November 2009

Dear Friends & Fellow Investors

Here is the latest issue of market insights.  For any questions, please email: info@fxistrategies.com.  Enjoy reading!

In This Week's Issue
▪   Weekly Snapshot
▪   Chart Of The Week
▪   US Economy Versus US Markets 
▪   More On The Dollar 
▪   More On Currencies
▪   Fed Balance Sheet
▪   A Different Approach To Financial Regulation

Weekly Snapshot
• US house of representatives approved Ron Paul's bill to "audit the Fed" (Marketplace)
• Euro area unemployment up to 9.7% (Eurostat)
• Germany's new finance minister Wolfgang SchĂ€uble warns US on market bubbles (FT)
• Some Treasury bill rates were negative again Friday after falling below zero Thursday (WSJ)
• The euro zone exited recession in the third quarter when its economy grew by 0.4% (Economist)
• US Housing starts declined 10.6% from last month and fell 30.7% from the prior year to 529,000 (ESA)
• OECD doubled its growth forecast for 2010 to 1.9% for 30 leading economies (Economist)
• US Leading Economic Index up 0.3% in October following a 1.0% gain in September (Conference Board)
• Gold reached a new all-time high of $1,152.80 on Wednesday (eSignal)
• US Consumer Prices up 0.3% in October after rising 0.2% in September (Bloomberg)
• US Producer Price Index advanced 0.3% in October (BLS)

Chart Of The Week  
Economic sentiment and leading economic indicators throughout numerous developed countries have been rising in line with the appreciation of most major asset classes.

Intl-LEI

Data Source: http://www.conference-board.org/economics/indicators.cfm

US Economy Versus US Markets
The US benchmark Index S&P500 reached a new yearly high just above 1,113 early in the week. Despite a drop off on Thursday and Friday, US markets are now up over 20% for the year and over 63% higher than the low in March-09.  The S&P 500 chart has now reached a critical technical inflection point, it’s almost a field day for technical analysts.  The major bear market trend line (purple) is now within arms reach and could potentially be broken if sentiment and momentum continues on a positive note.  At the same time, the market has been approaching the 50% Fibonacci retracement level (blue lines) as marked from the highest to the lowest points in the current bear market.  These points are critical because system traders and technical trend followers are placing their orders around these type of inflection points.  Failure to break above these trend lines typically cause markets to retrace.  A failure to break above this major trend line will trigger sell orders and protective trading strategies.

SPX-2009-1120 

In addition to the technical signals indicating a hurdle for US stocks, we have to revisit the underlying economic conditions which, despite the recent positive GDP numbers, are showing a much less favorable picture in terms of feeding the projected earnings at which stocks are currently valued at.  By some estimates, the S&P 500 is about 20% above fair value.   Officials are pinning much of their hopes on a recovery in the housing market.  But as last month’s housing starts numbers suggest, it is still an uphill struggle which may get worse when the $8,000 tax credit for new home purchases ends.  As we noted before, a sustainable recovery cannot come from a return to (over) leveraged home purchases.  Instead, the recovery of a consumer-driven economy can only come a from a healthy labor market.  The job picture however, does not give rise to a positive outlook on earnings anytime soon.  Yet, there could be a silver lining in the much debated dollar weakness.  A weaker Dollar bodes well for US exports.  At least in the short to medium term, the US Dollar weakness may be a blessing in disguise.  

More On The Dollar
Please consider the video interview with Mark Dow, hedge fund manager at Pharo Management.

Mark Dow gives a different view on the much debated topic of the falling US Dollar.  While most of the rationale for a weaker Dollar has been focusing on the supply side thus far, he argues that the lack of demand may be the more significant factor determining the price level of the Greenback.  To his point, one should note that there has been a significant shift in attitudes since the beginning of this decade, not just for economic but also for political reasons.  All other things being equal, non-Dollar denominated assets have been increasingly appealing to international investors.  Outside of the flight-to-safety phenomenon which sparked a reprieve for the US Dollar during the financial crisis, the capital flows have been ever more one-sided and out of the US into other jurisdictions.  As the risk appetite increases, this trend will continue.  Contrary to that, there is also an increased risk of yet another bubble as more asset classes are moving in tandem to higher levels.  The potential risk of a double-dip recession and a return to deflationary asset prices may be the impetus for a stronger Dollar yet again.

More On Currencies   
Currencies have been getting a lot more attention from the general public but much of the focus in the press has been on the questionable value of the Chinese Yuan or Renminbi versus the US Dollar.   No matter where the exchange rate of this currency pair may be at, based on the current global economic conditions, each outcome creates various sets of problems for both China as well as the US.  In reality, there is no more or less desirable exchange rate as the economies of the two nations are increasingly inter-twined. 

For a change, we would like to focus on exchange rate of the Chinese Yuan (CNY) versus other currencies.  The chart below shows the exchange rates of the CNY versus the Euro and versus the Australian Dollar.  For comparison, we have also included the CNY versus US$ which is a managed rate and does not freely float. 

CNY-Crosses

Almost in line with the rally in stocks since March of ‘09, the Euro and Australian $ have gained against the CNY by almost 20% and 46% respectively   China is still the largest trading partner of the US; however, as their currency, along with the US$, depreciates against other major currencies, exports to other countries become more attractive through massive price advantages from a weaker CNY.  A new focus on other export markets also makes sense from the Chinese perspective, keeping in mind that the US consumer may no longer be liquid enough to consume.  Massive pricing advantages as a result of favorable exchange rates will allow China to flood Europe and other hard-currency nations with goods from the recent build up in capacity.  It will be interesting to see however, if China can convince consumers of other nations that Chinese goods are more important than the inherent and culturally dominant desire to save rather than to consume.

Fed Balance Sheet  
The US Federal Reserve's balance sheet has grown substantially during the financial crisis. Total assets of the Federal Reserve have increased significantly from $869 billion on August 8, 2007, to well over $2 trillion until today.  As Mark Dow alluded to in the video interview above, the Balance Sheet has been relatively stable and did not increase since the end of 2008.  The chart below is a good visual representation as to why much of the stimulus and efforts by the US government have only limited impact on the real economy.  Supply-side economics may not work in the current scenario.  A focus on the demand side of the equation may produce faster and more sustainable results.

Fed Balance Sheet

A Different Approach To Financial Regulation  
Please consider Peter Smith’s article in the FT:  Australia tightens monitoring of rating agencies

You have to give it to the Australians!  They were the first of the G20 nations to tighten monetary policy and now they have shown a move towards financial regulation which makes a lot of sense, directly targeting ratings agencies in order to prevent irresponsible and obscure financial engineering.  We have expressed our dismay with ratings agencies on numerous occasions.  Conflicts of interest are caused by an inherent flaw in the system:  Ratings agencies are paid by the companies whose debt instruments they are supposed to rate.

From the start of next year, ratings agencies operating in Australia would require a financial services licence. To keep the licence, they would have to manage conflicts of interest, have resources that match the "scale and complexity" of their business, and have risk management systems.  They would need to file annual compliance reports, disclose procedures and methodologies for ratings affected by "material changes" within six months. The watchdog has closed a loophole whereby retail investors were unable to sue a rating agency if it had not given its consent to have its rating used in marketing material.

This is a very good and important step in the right direction towards more effective, not necessarily more complex financial regulation.  It is encouraging to see how fast the Australian regulators reacted and that significant disincentives are placed upon ratings agencies to '”over-rate” financial instruments.  Albeit less complex and not as liquid as US and European financial markets, regulators should look towards the Australian model in making regulation and financial markets more transparent and more effective.

Good luck and good trading!

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.

November 15, 2009

Market Insights – 15 November 2009

Dear Friends & Fellow Investors

This week's market insights comes in a short format; due to time constraints I'd like to focus on just a few topics.  For questions, please email: info@fxistrategies.com.  Enjoy reading!

Weekly Snapshot
• Bank of China hints at possible revaluation of Renminbi (FT)
• Gold reached a new record high of $1,123.50 on Thursday (Stockcharts.com)
• The US trade deficit in September 2009 increased 18.2%, to $36.5 billion (ESA)
• Bank of England’s projects a robust recovery approaching 4% by the end  2010 (Economist)
• Industrial production up by 0.3% in euro area (Eurostat)
• Euro area GDP up by 0.4% and EU27 GDP up by 0.2% (Eurostat)
• US consumer prices in September eased to a 0.2% gain after jumping 0.4% in August (Bloomberg)
• China’s industrial output grew by 16.1% in October compared with a year earlier (Economist)
• US producer prices fell 0.6% in September after rebounding 1.7% the month before (Bloomberg)

Chart Of The Week  
unemployment-SP-Composite-since-1948-large   
Source: http://www.dshort.com  

Having just returned from a week in Europe I was looking forward to catching up on the latest financial news. Plenty of newsworthy developments since the beginning of this month: Gold and other commodities at ever higher levels, a double-digit US unemployment rate at the highest level in nearly 30 decades and continued discussions as to whether general asset prices are approaching bubble levels again.  The most amazing and shocking news came from the beloved banking sector again.  In case you don’t dislike bankers enough yet, read on...

Really!?!  
Europeans came together in Berlin to commemorate the 20th anniversary of the fall of the Berlin Wall.  The leaders of major nations united in speeches calling the fall of the Berlin Wall a victory of freedom over oppression.  United in their appraisal of the importance of this event, they called on a renewed spirit of cooperation to tackle the problems of the 21st century.  While such lofty humanitarian and political goals are be highly commendable, it was again a banker topping everyone and everything else stated.  None other than Lloyd Blankfein, the new Superman of finance, would be worthy of the ultimate raison d'ĂȘtre. In an interview with the Times, Mr. Blankfein was quoted as saying: I'm doing 'God's work'.  This is certainly a big step up from our perceived notion of the recently quoted "Government Sachs" alluding to the massive influence that Goldman Sachs may have over politicians in the US and perhaps elsewhere.  I cannot seem to find the right words in expressing utter disgust and shock in the face of such an outrageous statement.  In the style of the popular comedy show Saturday Night Life, all I can think of is: Really!?!

CoCo’s   
It’s not food, not a drink, not a restaurant and it does not refer to Coco Chanel either.   CoCo’s  a.k.a. Contingent Convertible Bonds are yet again a new financial product (a new financial WMD?) this time dreamed up by Lloyd’s Banking Group.  The idea has been floating around for some time but Lloyd’s Bank has been the first to materialize some £9bn in capital from this new convertible bond.  Convertible Bonds have been around for a long time but this particular type raises some serious questions.   Traditional Convertible Bonds provide an incentive for Bond holders by giving them an upside potential.  If the company is doing well, they can be converted into equity, giving the investor a chance to profit from the stock appreciation.  As such, the investor foregoes a higher interest rate in exchange for taking part in that upside potential. 

CoCo’s by contrast convert into equity when a pre-determined measure of the Bank’s strength is breached.  Until then, the bank would pay a higher dividend from the normal bond yields to compensate the investor for the potentially higher risk. 

Given the recent history of bank failures and stock values that in some cases left equity holders with 10 cents on their invested dollars (or less), one would think that such an endeavour  would be a hard sale.  Yet, investors seemed to take up  the £9bn issue.  

From my perspective, these new instruments are as dangerous as CDO’s and CMO’s (the derivatives that caused the credit crisis).  The flaw in the concept is the notion of incentivizing failure versus success.   The bank issuing this bond can initially raise capital albeit at a higher cost for them.  Once the capital is raised, the incentive for the bank is no longer to do well, but to “fail” because that would trigger the Bond version to Equity, enabling them for forego interest payments.  I see no sense in purchasing these CoCo’s; the odds are clearly in the bank’s favor giving a negative incentive to perform.   I suggest you treat yourself to some hot cocoa instead. 

Recommended Lecture Series   
George Soros gave a series of lectures at the Central European University in Budapest, sharing his views on financial markets from a practical and philosophical perspective. He unveiled the concept of reflexivity as the main cause of what determines market prices.  His explanations are are conceptually abstract and may be difficult to digest.  However, the lectures give a rare insight into the mind of one of the most successful investors and show his desire to do be a recognized as a philantropist rather than a trader.  The entire series is somewhat lengthy but particularly the lecture on financial markets is well worth a view.  Click on the image below to view the series as well as the transcripts.

Soros

Good luck & good trading!

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.

November 04, 2009

Fed Keeps Rates Near Zero

As expected, today’s FOMC meeting concluded with more of the same: short term rates near zero,  a continuation of quantitative easing policies and providing additional support for US housing markets by purchasing $1.25 trillion in mortgage backed securities and $175 billion of agency debt.

The FOMC Statement below is also available at: http://www.federalreserve.gov/newsevents/press/monetary/20091104a.htm

FOMC Statement - Release Date: November 4, 2009

For immediate release
Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period. Activity in the housing sector has increased over recent months. Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. 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 will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.