Words from the (investment) wise for the week that was (February 9

“Words from the Wise” this week comes to you from my abode in a visibly depressed Europe, from where I am compiling this report as welcome relief from gloomy conversations with taxi drivers and cheerless meals in deserted eateries.

Events during the past few days were dominated by the announcement of US Treasury Secretary Timothy Geithner’s financial stability plan and a deal reached by Congress on the economic stimulus bill. However, the much-anticipated bailout bang soon whimpered as investors were disappointed about the lack of “beef”. Meanwhile, markets were also mired in uncertainty on the back of fresh evidence of headwinds facing the global economy – notably in major economies such as the UK, continental Europe and Japan.

Jim Rogers gave the bank rescue plan a big thumbs-down: “(Geithner) … has been dead wrong about everything for 15 years in a row … This (the rescue plan) is not going to solve the problem, it’s going to make it worse.”

Referring to the stimulus bill, Steve Forbes said: “It’s just a grab bag of every spending proposal that’s been banging around Congress for years.”

And Bill King (The King Report) commented as follows: “A cure should have something to do with the diagnosis. The classic argument for fiscal stimulus presumes that the central cause of our current economic problems is this: We, the people and our government, are not doing nearly enough borrowing and spending on consumer goods. The government must step in to force us all to borrow and spend more. This diagnosis is tragically comic once said aloud.”

Stock markets were on the receiving end as risk-averse investors sought out the safe havens of the US dollar (+0.8% in the case of the US Dollar Index), gold (+3.1%) and bonds (with the yields of 10-year Bunds and Gilts down by 21 and 17 basis points respectively).

The week’s movements of the MSCI Global Index (-3.9%, YTD -9.0%) and MSCI Emerging Markets Index (-0.6%, YTD -2.2%) reflect global investors’ skepticism about the rescue plans. Strong performances came from China (+6.4%) and Russia (+14.3%), but still left these markets in the red by 61.9% and 63.0% since their respective bull market highs. As mentioned before, the chart pattern of the Chinese Shanghai Composite Index shows arguably one of the most bullish formations of the major stock market indices.

The major US indices suffered their worst weekly losses this year (to record five losing weeks out of six): Dow Jones Industrial Index -5.2% (YTD -10.6%), S&P 500 Index -4.8% (YTD -8.5%), Nasdaq Composite Index -3.6% (YTD -2.7%) and Russell 2000 Index -4.7% (YTD -10.2%).

John Nyaradi (Wall Street Sector Selector) pointed out that among the exchange-traded funds (ETFs) none of the main economic sectors registered positive returns, as summarized in the chart below. Not shown, the KBW Bank Index ETF (KBE) lost 14.3% on the week, and the Dow Jones US Real Estate Index ETF (IYR) 12.0%. The ProShares Short Dow30 ETF (DOG) led the way among inverse funds with a gain of +5.3%.

Source: StockCharts.com

As investors became more fearful of the economic situation, gold bullion (+3.1%) assumed its traditional safe-haven role. “Inflows into gold-backed exchange-traded funds surged in January, pushing their bullion holdings to an all-time high of 1,317 tons. Last month’s flows of 105 tons were above September’s previous record of 104 tons, and absorbed about half the world’s gold mine output for January,” said Barclays Capital, as reported by the Financial Times.

The chart below shows the long-term trend of the yellow metal (green line) together with a 14-month rate of change (ROC) indicator (red line). Monthly indicators come in handy for defining the primary trend. In this case the ROC line above zero depicts the bull market in bullion that commenced in 2001. And there is more to come: According to Gary Dugan, the chief investment officer of Merrill Lynch, gold prices may hit US$1,500 an ounce in the next 12 to 15 months.

Source: StockCharts.com

In addition to last week’s bailout actions, policymakers are also working on a housing subsidy plan that will use government money to help reduce interest rates for struggling borrowers. The details are to be announced by President Obama on Wednesday.

Needless to say, Capitol Hill’s various actions come at a hefty price. According to The Wall Street Journal, Strategas Research estimates that the federal budget will work out to roughly 13.5% of GDP in 2009. Asha Bangalore (Northern Trust) added: “2009 will go down in history as the year during which the US economy recorded the largest federal budget deficit as a percent of GDP in a span of eighty years, excluding the war years. The budget deficit as a percent of GDP through the war years of 1942 to 1945 was 14.2%, 30.3%, 22.7% and 21.5%, respectively.”

Next, a tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. As the saying goes: A picture paints a thousand words …

But back to the stock market. Key resistance and support levels for the major US indices are shown in the table below. All the indices are trading below their 50-day moving averages and the Industrial and Transportation Averages have also breached the December 1 lows. The all-important November 20 lows are now within close reach – already broken by the Transportation Average – and must hold in order to prevent considerable technical damage.

Richard Russell (Dow Theory Letters), 84-year old doyen of investment newsletter writers, interprets the technical situation as follows: “The Point & Figure chart below may currently be the most important single chart in the world. This is the DJ Industrial Average, and it’s in the act of testing its November 20 low. If the Dow violates its low, it will have confirmed the prior bearish penetration of the Transportation Average. If that happens, the primary bear market will be reconfirmed. But if the Industrials stubbornly refuse to break to a new low, then the inference is that something else is happening. The inference is that the bear market may be forming a temporary bottom.”

“What I think we’ve seen, so far, is the end of forced selling. At this point, professionals are trying to gauge whether the huge market collapse of 2007-2008 has discounted the worst to come or whether ‘the worst’ still lies ahead,” said Russell. “The drama should be played out over the next week or so.”

Given all the cross-currents, short-term movements are almost impossible to predict and traders will simply have to remain level-headed and wait for Mr Market to show his hand, especially as far as the November 20 lows are concerned.

For more discussion about the direction of stock markets, also see my recent posts “Finally, the plan … sort of” and “Video-o-rama: Risk appetite fades on stimulus gloom“.

Economy
“There is no let-up in the dark pessimism that engulfs nearly all businesses across the globe. Global business sentiment weakened again in early February back close to the record low set in mid-December,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. “Confidence is poor across the globe; if there is a distinction it is that Asian businesses are a bit more upbeat than businesses everywhere else.”

A snapshot of the week’s US economic data is provided below. (Click on the dates to see Northern Trust’s assessment of the various reports.)

Friday, February 13
• Fiscal stimulus package in a nutshell
• Federal budget deficit in turbulent times
• Consumer sentiment remains gloomy

Thursday, February 12
• Retail sales stabilized in January, future remains gloomy

Wednesday, February 11
• Sharp drop in exports and imports reflects global recession

Tuesday, February 10
• Geithner unveils financial stability plan

Monday, February 9
• Market spreads – moving in the desired direction but more is necessary in the mortgage market

In last Sunday’s “Words from the Wise” I referred to the surge in the Baltic Dry Index (BDI) – measuring freight rates for iron ore and other bulk goods. The Index has gained 188% over the past two months after plunging by 94% since its high in May. In my opinion, the rally in the BDI is in the expectation (or, should I say, “hope”) that the manufacturing Purchasing Managers’ Indices (PMIs) will start improving, i.e. moving closer to the neutral level of 50 (see graph below). This does not mean the global economy will expand, but merely that the trough of the logjam in international trade might have been reached. Not shown, the trends of the BDI and credit spreads follow a strong inversely correlated path.

Source: Plexus Asset Management

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Date	Time (ET)	Statistic	For	Actual	Briefing Forecast	Market Expects	Prior
Feb 10	10:00 AM	Wholesale Inventories	Dec	-1.4%	-0.7%	-0.7%	-0.9%
Feb 11	8:30 AM	Trade Balance	Dec	-$39.9B	-$36.0B	-$35.7B	-$41.6B
Feb 11	2:00 PM	Treasury Budget	Jan	–	NA	-$75.0B	-$83.6B
Feb 12	8:30 AM	Initial Claims	02/07	623K	600K	610K	631K
Feb 12	8:30 AM	Retail Sales	Jan	1.0%	-0.6%	-0.8%	-3.0%
Feb 12	8:30 AM	Retail Sales ex-auto	Jan	0.9%	-0.6%	-0.4%	-3.2%
Feb 12	10:00 AM	Business Inventories	Dec	-1.3%	-1.2%	-0.9%	-1.1%
Feb 13	10:00 AM	Mich Sentiment-Prel	Feb	56.2	62.0	60.2	61.2

Source: Yahoo Finance, February 13, 2009.

In addition to Fed Chairman Bernanke speaking at the National Press Club in Washington (Wednesday, February 18) and the Bank of Japan’s monetary policy announcement (Thursday, February 19), the US economic highlights for the week include the following:

Source: Northern Trust

Click the links below for the following reports:

• Wachovia’s Weekly US Economic & Financial Commentary (February 13, 2009)

• Wachovia’s Global Chartbook (February 2009)

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global markets performed during the past week.

Source: Wall Street Journal Online, February 13, 2009.

“It is the markets’ job to reallocate money from the ignorant to the intelligent, from the lazy to the hard working and studious, from the naive to the educated, and from the speculator to the investor,” said Barry Ritholtz (The Big Picture). Hopefully the “Words from the Wise” reviews offer assistance to Investment Postcards‘ readers not to get separated from their hard-earned funds in these taxing times.