Words from the (investment) wise for the week that was (November 3

Welcome to Wall Street, Barack Obama. His victory signaled a change in US political direction, but the biggest election day rally ever – a surge of 4.1% in the S&P 500 Index on Tuesday – was quickly overshadowed by the grim realities of the worsening economic and earnings picture, resulting on Wednesday and Thursday in the S&P 500’s biggest two-day loss (-10.0%) since 1987.

Mr Obama gave his first press conference as President-elect on Friday afternoon, summarizing a discussion he had had with his economic advisory team. He pledged to confront the US’s economic crisis “head on” and said he wanted to see “a rescue plan for the middle class” that would include a new fiscal stimulus package. The week closed on a positive note as a late rush of buying on Friday left the stock market indices higher for the day, although still in the red for the week.

BCA Research said: “While Obama has a laundry list of policy objectives, fixing the economy will be his top priority and will dominate the legislative agenda in 2009. A fiscal stimulus package to support consumers is already being drawn up in Congress, and Obama is likely to propose additional infrastructure spending programs shortly after taking office. But fiscal policy will be hamstrung – the budget deficit is already large, while aggressive tax increases would be inappropriate in the current economic climate and there is little scope for significant spending cuts in other areas.”

“I don’t know how successful Obama will be in bringing back prosperity to the US, but his amazing victory in rising to the US Presidency has inspired billions of people around the world. It has also lifted America in the eyes of the world …,” commented Richard Russell (Dow Theory Letters). The newspaper headlines tell the story …

Underscoring economists’ concerns about the depth of the global economic slowdown was a warning from the International Monetary Fund (IMF) that developed economies as a whole would shrink by 0.3% next year. It would mark the first overall contraction in developed economies since World War II. Aggressive interest rate cuts by a number of major central banks only partly assuaged investors’ fears.

Nouriel Roubini (RGE Monitor) said: “Deterioration in the health of the financial sector and related severe strains in funding markets have increased the tail risk of deflation for the real economy.”

Although the banking system remains in the grips of a massive deleveraging process, there are early signs that the various central bank liquidity facilities and capital injections are beginning to have the desired effect. Restoring confidence will take a significant amount of time, but the narrowing of financial sector spreads such as the TED spread (i.e. three-month dollar Libor less three-month Treasury Bills) shows that the healing process is under way.

Next, a tag cloud of the text of the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. The key words include the usual suspects.

Relying on his 50 years’ market experience, Richard Russell questioned whether we were perhaps dealing with another fake-out advance. “One item that bothers me a bit is this – have we seen enough black pessimism to believe that this bear market has bottomed? My guess is that we will see more pessimism next year as unemployment climbs and as it becomes almost impossible to find a good job.”

However, John Bogle, founder of the Vanguard Group, said in an interview with Reuters on Tuesday that the fundamentals of the US stock market had “improved radically” and declines in valuations were overblown.

Across the pond, European equities received a boost from Morgan Stanley’s European strategist Teun Draaisma saying that stocks were now flashing a “full house” buy signal after these markets have priced in an earnings recession, and retail investors, purchasing managers and sell-side analysts have all capitulated. Draaisma’s prior calls were on the money.

Albert Edwards of Société Générale is less sure. “It has been a house of cards waiting to fall,” Edwards said according to the Financial Times. “The market has to slide much further down the slope of hope into Dante’s inferno.” He believes markets are currently in the eighth of Dante’s nine circles of hell.

The stock market is likely to see a lot of back-and-forth churning as it tries to map out a bottom. A 90% down-day is normally followed by a rally of two to seven days. In this instance we are dealing with two consecutive 90% down-days that occurred last week. For a year-end rally to materialize, it is essential that the recent lows (8,176 on the Dow Jones Industrial Index and 849 on the S&P 500 Index) not be taken out and that credit spreads continue to contract. But for confidence to return, sustained moves above 10,000 for the Dow and 1,000 for the S&P 500 are required.

Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance round-up.

Economic reports
“Global business confidence fell again at the end of October to a new record low,” said the Survey of Business Confidence of the World conducted by Moody’s Economy.com. “The financial panic has been a body blow to global business confidence and the global economy is now in recession. Sentiment is extraordinarily negative in North America and Europe and measurably weaker in Asia and South America.”

Economic reports released in the US during the past week confirmed the dire economic conditions and included the following:

• Payroll employment fell by 240,000 – the 10th consecutive decline – and there was a net downward revision of 179,000 jobs to the previous two months. The unemployment rate increased by 0.4 of a percentage point to 6.5%, a figure above the peak reached in the last cyclical downturn. The economy has lost 1.2 million jobs this year, with about half the decline coming in the last three months as businesses respond to shrinking demand and tighter credit by cutting costs.

• The ISM Non-manufacturing Survey plunged to 44.4 in October from 50.2 from the previous month. This indicator had been one of the few not to show recession-like behavior, but that quickly changed with this release.

• The Institute for Supply Management’s Manufacturing Index fell 4.6 points to 38.9 for October. The larger-than-expected decline puts the Index at its lowest level since the early 1980s – consistent with an economy in a severe recession.

• Credit conditions tightened during the third quarter across most of the major credit and loan categories reported in the Federal Reserve’s Senior Loan Officer Opinion Survey.

• US vehicle sales fell sharply in October to 10.5 million units on a seasonally adjusted annualized basis. This pace of sales was last seen in the early 1980s.

US interest rate futures are fully pricing in a 25 basis point cut by the Federal Reserve next month, and accord a 64% chance to a 50 basis point easing.

Commenting on the outlook for US interest rates, Asha Bangalore (Northern Trust) said: “At this point in the economic crisis, the severity of the malaise points to expectations of a lower Federal funds rate, which the Fed may deliver sooner rather than later. We need to step back and ponder about the benefit of additional easing of monetary policy.

“There are strong expectations that a significant stimulus program will be implemented shortly. A fiscal stimulus program may be more effective in stimulating demand and bringing about a recovery than additional easing of monetary policy. Also, the recapitalization of banks that is under way should eventually erase the credit crunch and revitalize lending to the private sector, which is the key to a full-fledged economic recovery.”

Elsewhere in the world, major central banks were following up the October 8 coordinated interest rate reductions with cuts of their own, often larger than expected.

The European Central Bank eased monetary policy and cut its key monetary policy rate by 50 basis points to 3.25%. With inflationary pressures easing, it seems the Bank has shifted its bias towards monetary loosening to support the rapidly deteriorating Eurozone economy.

The Bank of England has stunned markets and cut its main policy rate by 150 basis points as the UK’s recession is deepening. The rate is now 3% versus 5.5% at the start of the year and a cyclical peak of 5.75% a year ago.

Central banks in Switzerland, Denmark, Australia and India have also slashed benchmark interest rates.

The November 15 G20 meeting in Washington will be the next of a series of summits to assess global responses to the financial crisis. Discussion will likely focus on assessing short-term stabilization efforts, specific regulatory and capital market reforms, and institutional structures (including the role of the IMF).

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
Nov 3	10:00 AM	Construction Spending	Sep	-0.3%	-0.8%	-0.8%	0.3%
Nov 3	10:00 AM	ISM Index	Oct	38.9	43.0	42.0	43.5
Nov 4	12:00 AM	Auto Sales	Oct	–	4.5M	NA	4.3M
Nov 4	12:00 AM	Truck Sales	Oct	–	5.5M	NA	5.3M
Nov 4	10:00 AM	Factory Orders	Sep	–	-1.0%	-0.8%	-4.0%
Nov 5	8:15 AM	ADP Employment	Oct	–	–	-100K	-8K
Nov 5	10:00 AM	ISM Services	Oct	–	47.0	47.0	50.2
Nov 5	10:35 AM	Crude Inventories	11/01	–	NA	NA	NA
Nov 6	8:30 AM	Initial Claims	11/01	–	475K	476K	479K
Nov 6	8:30 AM	Productivity-Prel	Q3	–	1.0%	1.0%	4.3%
Nov 7	8:30 AM	Average Workweek	Oct	33.6	33.6	33.6	33.6
Nov 7	8:30 AM	Hourly Earnings	Oct	0.2%	0.2%	0.2%	0.2%
Nov 7	8:30 AM	Nonfarm Payrolls	Oct	-240K	-200K	-200K	-284K
Nov 7	8:30 AM	Unemployment Rate	Oct	6.5%	6.4%	6.3%	6.1%
Nov 7	10:00 AM	Pending Home Sales	Sep	–	–	-3.4%	7.4%
Nov 7	10:00 AM	Wholesale Inventories	Sep	-0.1%	0.0%	0.3%	0.6%
Nov 7	11:30 AM	Pending Home Sales	Sep	-4.6%	–	-3.4%	7.5%
Nov 7	3:00 PM	Consumer Credit	Sep	$6.9B	$5.0B	$0.0B	-$6.3B

Source: Yahoo Finance, November 7, 2008.

Next week’s US economic highlights, courtesy of Northern Trust, include the following:

1. International Trade (November 13): The trade deficit is predicted to have narrowed to $57.0 billion in September from $59.1 billion in August.

2. Retail Sales (November 14): Auto sales fell sharply in October (10.6 million units versus 12.5 million units in September). Non-auto retail sales surveys show significant weakness. Based on this information, retail sales probably declined by about 2.0% in September. Consensus: -1.9%% versus -1.2% in September; non-auto retail sales: -1.0% versus -0.6% in September.

3. Other reports: Inventories, Import prices, Consumer Sentiment Index (November 14).

Click here for a summary of Wachovia’s weekly economic and financial commentary.

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, November 7, 2008.

Equities
Stock markets experienced a volatile week on the back of large swings in sentiment as investors digested Barack Obama’s election victory, worsening economic reports and central bank interest rate cuts. Although the major global indices closed the week with losses – MSCI World Index -1.9% and the MSCI Emerging Markets Index -1.0% – the performances of individual markets varied greatly.

Among developed markets, Italy (+2.4%), New Zealand (+0.7%), Australia (+0.6%), the UK (+0.3%) and Japan (+0.1%) recorded positive returns, whereas the US markets, Canada (-1.7%), Germany (-1.0%) and France ( 0.5%) were under the water.

As far as emerging markets are concerned, Singapore (+3.9%), Hong Kong (+2.0%), South Korea (+1.9%), India (+1.8%) and China (+1.1%) all registered gains. On the other hand, Turkey (-4.3%), Mexico (-3.1%), Taiwan (-2.6%), Russia (-1.7%) and Brazil (-1.6%) did not give investors much to smile about.

The table below by Finviz summarizes the past week’s performances (in US dollar terms, whereas all the gains/losses referred to elsewhere in this post are in local currency terms) for various stock markets. Click here or on the thumbnail for a large table.

For the week ended November 5 there were net inflows of $413 million into emerging-market stock funds, according to US Global Investors. This is a significant improvement from the previous week when there were net redemptions of $1.6 billion. For the year to date, the outflows are estimated at $45 billion, nearly 40% of the cumulative inflows from 2003 through 2007.

The US stock markets all declined over the week as shown by the major index movements: Dow Jones Industrial Index -4.1 (YTD -32.6%), S&P 500 Index -3.9% (YTD -36.6%), Nasdaq Composite Index -4.3% (YTD -37.9%) and Russell 2000 Index -5.9% (YTD 34.0%).

The Dow needs to increase by 12.2% to reach its 50-day moving average and 29.9% to get to the key 200-day line.

Click here or on the thumbnail below for a market map, obtained from Finviz.com, providing a quick overview of the performance of the various segments of the S&P 500 Index over the week.

The automobile group (-14%) was among the underperformers for the week. On Friday both General Motors (GM) and Ford (F) reported losses and substantial cash burns during the third quarter – Ford used $7.7 billion cash and General Motors $6.9 billion. Both firms are seeking financial assistance from Government.

Fixed-interest instruments
Yields on government bonds declined during the past week, spurred on by mounting economic woes and interest rate cuts in a number of countries.

The 10-year US Treasury Note declined by 18 basis points to 3.78%, the UK ten-year Gilt dropped by 34 basis points to 4.19% and the German ten-year Bund fell by 24 basis points to 3.67%. Emerging-market bonds fared even better as the risk premium eased from elevated levels.

A number of commentators are of the opinion that government bonds are topping out. “… further deflation and economic decay will induce more inflation-stoking nationalization, socialism and monetary promiscuity – so sell bonds. Cascading global bond markets would be the next big crisis,” said Bill King (The King Report).

US mortgage rates also declined, with the 30-year fixed rate falling by 42 basis points to 6.14% and the 5-year ARM by 7 basis points to 5.92%.

The cost of buying credit insurance for US and European companies eased as shown by the narrower spreads for both the CDX (North American, investment grade) Index (down from 200 to 188) and the Markit iTraxx Europe Crossover Index (down from 765 to 762).

Money-market rates declined as a result of easier monetary policy and the ongoing provision of liquidity. The three-month dollar Libor rate declined by 74 basis points to 2.29% during the week – 103 basis points above the Fed’s target rate of 1.0%. The spread was 43 basis points at the start of the year.

Bespoke provided an interesting table of the credit default swap prices for individual countries. These prices represent the cost per year to insure $10,000 of debt for five years. Argentina is in the most trouble, with a cost of $4,453 per year to insure just $10,000 of debt, followed by Venezuela, Lebanon, Egypt and Indonesia. Of the G8 countries, Russia has by far the highest default risk with a CDS price of $523. Japan, France, the US and Germany have the lowest default risk of the group of countries, but they have all spiked more than 200% this year.

Currencies
Interest rate reductions by a number of central banks, especially much larger-than-expected cuts by the Bank of England and the Reserve Bank of Australia, together with the expected impact of the lower rates on a specific country’s economy, influenced currency movements during the past week.

Over the week the US dollar gained against the euro (+0.2%), the British pound (+2.7%) and the Swiss Franc (+1.8%), but lost ground against the Japanese yen (-0.3%), the Canadian dollar (-1.8%), the Australian dollar ( 1.2%) and the New Zealand dollar (-0.7%).

Commodities
The negative implications of the deteriorating global economic situation on demand resulted in commodities remaining under pressure during the past week, with the Reuters/Jeffries CRB Index falling by 4.3%.

Precious metals bucked the trend and edged higher, with gold, silver and platinum all up by more than 2%. Platinum benefited from the closure of a South African smelter by Anglo Platinum, reducing global supply by 3%. The charts (gold shown below) seem to indicate that a rally could be in store for precious metals.

The following graph shows the past week’s movements for various commodities:

Now for a few news items and some words and charts from the investment wise that will hopefully assist in keeping our portfolios afloat in the treacherous waters characterizing the investment landscape. Also remember what Elroy Dimson of the London Business School said: “Risk means more things can happen than will happen.”

That’s the way it looks from Cape Town.

Source: Chicago Tribune

Financial Times: Obama and Biden take the stage
“President-elect Barack Obama was joined by Vice President-elect Joe Biden in Chicago’s Grant Park, minutes after Obama clinched the presidency in a historic win.”