rank17

Markets' Path to Recovery Will Be Bumpy

Less bad is good.
In a nutshell, that's the second derivative for you. It's what economists turn to when they're hunting for signs of a change in economic trend. It's what drove the remarkable bounce in equities from their early March lows.
You'll often hear talk that the sharemarket leads turns in the economy. The rule of thumb is a six months headstart. On the way down. Then on the way up.
But what we're often seeing is frontrunning of a turn in the first derivative - that is, the speed of the economic advance or decline. This translates to a coincident turn in the second derivative - the rate of change of this economic advance or decline.
Which is why we're seeing the current focus on `less bad'. Because before we can see any sustainable turn in the global economy, readings first need to get `less bad'.
Think of this as a `shades of grey' exercise. A recession's black. When we're booming we're all white. What's exciting investors right now is the sighting of a little grey.
One of the better examples of this change in trend came last week with the release of the Philidelphia Fed's Future General Activity Index.
The April reading of this reliable leading index jumped from a March reading of 14.5 to an eighteen month high of 36.2. Better positive readings on new orders and shipments were a feature - as was a marked improvement in the outlook for prices received and employment - though both readings remained mildly negative. But they were `less bad'.
Significantly, similar readings on this key indicator accompanied market lows and preceded economic recoveries in the 1980's, 1990's and the early 2000's.
It's been a similar story in the UK, where the manufacturing purchasing managers' index (PMI) recently posted a reading of 39.1. Though a number below 50 still indicates contraction, it nonetheless represented the the highest reading in five months and helped the composite PMI to the largest three month recovery in over five years.
This change in trend has been reflected in Goldman Sachs' well regarded Global Leading Indicator, which forecasts global industrial production out 6 to 9 months. It's jumped to +9, for its first rise since July 2008.
This week we're seeing an understandable pullback in equities. After a 20 per cent-plus bounce from lows in most global markets, investors were searching for excuses to lock in gains. In the end the catalyst proved to be rumours over the US Treasury's bank sector stress testing. This looks unfounded, given the testing is still a work in progress and won't be released for a fortnight, but it helped relieve short term pressure on markets that were looking seriously overbought.
I fully expect the March lows to hold. With the range of improving second derivatives providing us with a clean reading on a turn in trend, this means that you can continue buying any dips.
This emerging shift in underlying economic trend looks justified, given the scale of the fiscal and monetary stimulus that have been committed. What's impressed has been the scale of the common resolve. Whilst there have been leaders and laggers in terms of the quantum and timing of the dollars committed, the end result has been a surprisingly synchronised response.
Take a look at the raw data. Nomura has calculated that economic stimulus measures will total 4.2 per cent of gross disposable product (GDP) for Japan, 4 per cent for China, 3.8 per cent for the US and Australia and 3.5 per cent from Germany.
This not-so-random walk has meant that the global economy is fast approaching the point where all this pump-priming should deliver the required return. Rate cutting for most of the Group of 20 economies got underway by mid 2008, whilst fiscal stimulus began at the end of the September quarter. Given the usual lags, this means that the global economy should soon begin to reap the benefits.
We'll get a fresh perspective on prospects later this week when finance ministers and central bank governors gather again in Washingon. On Friday the Group and Seven and G20 will hold seperate meetings, ahead of the Saturday meeting of the IMF. This is the first meeting of the IMF since the G20 leaders summit determined to dramatically expand its resources and involvement in the unfolding global response.
It's likely we'll hear more on efforts to support a number of the economic outliers in Africa and Asia. On Monday, the IMF warned of the creeping contagion that has only now being felt: ``After first striking the advanced economies and then emerging markets, a third wave of the global financial crisis has begun to hit the worlds poorest and most vulnerable countries, threatening to undermine recent economic gains and to create a humanitarian crisis.''
Ahead of this we'll see the release of the IMF's latest Global Financial Stability Report. Given last week's sobering assessment of the likely recovery trajectory, which focussed on the fact that the current recession was both synchronised and financial sector driven, you'd have to assume this will paint a none too positive outlook.
I'd have to say that the key IMF `finding' - that `bad' plus 'bad' equalled `worse' - looked to be predicated on a particularly narrow statistical sample covering just 6 of 122 recessions studied (those of Finland, Greece, France, Germany, Italy and Sweden).
Given the scale of the global response to date, perhaps more weight could have been given to its finding that ``expansionary macroeconomic policies have been associated with shorter recessions and stronger recoveries.'' This looks to be at least as relevent.

Rally Over? We'll See if March Lows Hold

Less bad is good.
In a nutshell, that's the second derivative for you. It's what economists turn to when they're hunting for signs of a change in economic trend. It's what drove the remarkable bounce in equities from their early March lows.
You'll often hear talk that the sharemarket leads turns in the economy. The rule of thumb is a six months headstart. On the way down. Then on the way up.
But what we're often seeing is frontrunning of a turn in the first derivative - that is, the speed of the economic advance or decline. This translates to a coincident turn in the second derivative - the rate of change of this economic advance or decline.
Which is why we're seeing the current focus on `less bad'. Because before we can see any sustainable turn in the global economy, readings first need to get `less bad'.
Think of this as a `shades of grey' exercise. A recession's black. When we're booming we're all white. What's exciting investors right now is the sighting of a little grey.
One of the better examples of this change in trend came last week with the release of the Philidelphia Fed's Future General Activity Index.
The April reading of this reliable leading index jumped from a March reading of 14.5 to an eighteen month high of 36.2. Better positive readings on new orders and shipments were a feature - as was a marked improvement in the outlook for prices received and employment - though both readings remained mildly negative. But they were `less bad'.
Significantly, similar readings on this key indicator accompanied market lows and preceded economic recoveries in the 1980's, 1990's and the early 2000's.
It's been a similar story in the UK, where the manufacturing purchasing managers' index (PMI) recently posted a reading of 39.1. Though a number below 50 still indicates contraction, it nonetheless represented the the highest reading in five months and helped the composite PMI to the largest three month recovery in over five years.
This change in trend has been reflected in Goldman Sachs' well regarded Global Leading Indicator, which forecasts global industrial production out 6 to 9 months. It's jumped to +9, for its first rise since July 2008.
This week we're seeing an understandable pullback in equities. After a 20 per cent-plus bounce from lows in most global markets, investors were searching for excuses to lock in gains. In the end the catalyst proved to be rumours over the US Treasury's bank sector stress testing. This looks unfounded, given the testing is still a work in progress and won't be released for a fortnight, but it helped relieve short term pressure on markets that were looking seriously overbought.
I fully expect the March lows to hold. With the range of improving second derivatives providing us with a clean reading on a turn in trend, this means that you can continue buying any dips.
This emerging shift in underlying economic trend looks justified, given the scale of the fiscal and monetary stimulus that have been committed. What's impressed has been the scale of the common resolve. Whilst there have been leaders and laggers in terms of the quantum and timing of the dollars committed, the end result has been a surprisingly synchronised response.
Take a look at the raw data. Nomura has calculated that economic stimulus measures will total 4.2 per cent of gross disposable product (GDP) for Japan, 4 per cent for China, 3.8 per cent for the US and Australia and 3.5 per cent from Germany.
This not-so-random walk has meant that the global economy is fast approaching the point where all this pump-priming should deliver the required return. Rate cutting for most of the Group of 20 economies got underway by mid 2008, whilst fiscal stimulus began at the end of the September quarter. Given the usual lags, this means that the global economy should soon begin to reap the benefits.
We'll get a fresh perspective on prospects later this week when finance ministers and central bank governors gather again in Washingon. On Friday the Group and Seven and G20 will hold seperate meetings, ahead of the Saturday meeting of the IMF. This is the first meeting of the IMF since the G20 leaders summit determined to dramatically expand its resources and involvement in the unfolding global response.
It's likely we'll hear more on efforts to support a number of the economic outliers in Africa and Asia. On Monday, the IMF warned of the creeping contagion that has only now being felt: ``After first striking the advanced economies and then emerging markets, a third wave of the global financial crisis has begun to hit the worlds poorest and most vulnerable countries, threatening to undermine recent economic gains and to create a humanitarian crisis.''
Ahead of this we'll see the release of the IMF's latest Global Financial Stability Report. Given last week's sobering assessment of the likely recovery trajectory, which focussed on the fact that the current recession was both synchronised and financial sector driven, you'd have to assume this will paint a none too positive outlook.
I'd have to say that the key IMF `finding' - that `bad' plus 'bad' equalled `worse' - looked to be predicated on a particularly narrow statistical sample covering just 6 of 122 recessions studied (those of Finland, Greece, France, Germany, Italy and Sweden).
Given the scale of the global response to date, perhaps more weight could have been given to its finding that ``expansionary macroeconomic policies have been associated with shorter recessions and stronger recoveries.'' This looks to be at least as relevent.

A Look at Gold Sentiment

I've got the feeling we may well be heading for a gutser.

Take a look at the $A gold chart - provided a major 'sell' last night.

Part of this will be a rally in the aussie, but with gold momentum non-existant and with news last night of impending IMF sales, i'd at the very least be heading for the sidelines..

Nixing 'Mark to Market' Won't Solve the Problem

Why nix mark to markeyt? This is what I wrote yesterday in Oz...
It's amazing the positives that can flow from a little market adversity.
Following a particularly savage kicking from Wall Street, a chastened Congress appears to have "discovered" the logic of the US Treasury's Troubled Assets Relief Program.
At the same time, in a move that could considerably boost TARP's effectiveness, the Financial Accounting Standards Board (FASB) and the US Securities and Exchange Commission have embarked on a timely "interpretive" review of the much-maligned "fair value accounting" rule.
This move to capture more of the spirit, rather than simply the letter, of the law opens the door to a more expansive representation of banking sector balance sheets.
Fair value, or mark-to-market, accounting has proved a major killer for global credit markets over the life of the sub-prime crisis. This approach to asset valuation calls for companies to assess a disposal price of financial assets "at the measurement date" and not the potential value of the asset at some future date.
This may have been logical in a stable market, but when asset values are in retreat and a majority of holders become potential sellers, then the "at the measurement date" requirement has forced accountants to gravitate towards what in essence are fire sale valuations. This is particularly so when the assets in question are over-the-counter obligations that do not trade in a liquid marketplace, such as issuer-sponsored residential mortgage-backed securities, or the collateralised debt obligations that they spawned.
The result has been a seemingly self-fulfilling spiral lower in the asset values underpinning financial market balance sheets. Write-downs have at best led to significant contraction in the supply of credit. At worst they've precipitated full-scale corporate collapse.
Over recent weeks I've discussed the "duration" logic behind TARP - its capacity in the short term to soak up distressed assets from banks with a view to retaining them, long term, for "orderly realisation".
This in effect points to a Treasury arbitrage of FASB's fair value rule, as it would see assets acquired approaching fire sale book value then disposed of at valuations that would apply in an orderly market.
This distinction highlights why any change to mark-to-market accounting is so important. Whether through its scrapping or through a less draconian interpretation, the banking sector would immediately face the prospect of a round of positive financial asset revaluations.
Balance sheets would be boosted. System lending capacity would be lifted. Ultimately, the unfolding credit squeeze would be eased.
Given these are the very goals that TARP is aimed at achieving, were it to be implemented in conjunction with a change to fair value accounting rules, its task would overnight become a whole lot easier. In effect, $US700 billion ($840 billion) of acquisition capacity would deliver far greater bang for the buck.
Even if it meant relying upon a more flexible interpretation, rather than a wholesale rescinding, of FASB fair value accounting statement 157, this sounds like a logical win for legislators.
On Tuesday FASB issued "clarifications" aimed at delivering a looser application of existing rules. In particular, it encouraged companies to rely on their own judgements in determining asset values, including "expectations of future cash flows" from an asset, so long as appropriate risk premium had been applied.
This opened the door to "present value" assessments, which could prove radically higher than "at the measurement date" valuations.
The FASB statement also suggested alternative means of looking beyond the "temporary impairment pricing" that results from "disorderly" market disposals.
Given impaired value write-downs have been a key feature of many of the substantial losses that have been booked by investment banks over recent months, this could prove a major concession.

Changes in P/E Ratios During the Current Bear Market

Piece I wrote earlier this week...

Multiple reasons to love low US inflation

Without fanfare, global equities markets have gained an unexpected fillip this week, with a development that looks capable of firing a fresh round of sharemarket buying support.
The catalyst is a clear break lower in United States long-term inflation expectations. This can deliver meaningful price/earnings multiple expansion for a market showing signs of wanting to track higher.
Over recent weeks, the S&P 500 has lifted almost 10 per cent, whilst the technology-based Nasdaq has climbed some 13 per cent. Even more impressive has been the recovery in the Value Line Index. This equal-weighted, broad-based equity index is more than 17 per cent off its lows.
This has reversed half of the losses that accrued from the 2007 high.
Whilst to date this recovery has been a stop-start affair, it's demonstrated an investor willingness to look beyond what will inevitably be a sluggish period of global growth over coming months and to focus instead on the expected recovery as 2009 unfolds.
But a fresh impetus has emerged, following a drop to new five-year lows in a reading of the implied long-term level of US inflation.
US 10-year Treasury Inflation Protected Securities, or TIPS, generate one of the best guides to investor expectations for inflation in the US. The "expected inflation" reading is calculated by deducting the yield on the inflation bond from the yield on the standard 10-year Treasury bond.
As oil threatened to break above $US150 a barrel in early July, this closely watched measure of long-term inflation pushed to a two-year high above 2.6 per cent.
But this week, with oil falling sharply, the TIPS inflation reading has dropped back to 2.14 per cent - a level last seen in October 2003.
Inflation expectations have a major impact on equity pricing - in particular a stock's price/earnings multiple. Higher inflation assumptions drive a lower P/E pricing environment, whilst diminishing inflationary concerns will invariably allow market multiples to expand.
Over the past nine months, with soaring energy and food prices raising inflationary expectations, equity markets have been subjected to significant P/E compression.
Morgan Stanley calculates the forward P/E on the S&P 500 at just 12.8 times - compared with more than 15 times in mid-2007. According to Goldman Sachs JBWere, the Australian market multiple is now less than 12 times - against readings of about 17 times in late 2007. These are levels not seen since inflation last spiked in the early 1990s.
But the shift in inflationary expectations over recent weeks has been dramatic. Sharply falling food and energy prices have had an immediate impact on investor thinking. So long as this sentiment shift is maintained, investors will soon take a second look at P/E pricing. And there is much to like about the prospect of market multiple expansion when pricing is already looking historically cheap.
A second positive has emerged over recent weeks. The dramatic recovery of the US dollar is supporting the view that the greenback may be in the process of reversing what has been a savage seven-year bear trend.
This is important as recent analysis has suggested that a strong US dollar is usually accompanied by above-average equity returns.
This may seem counter-intuitive, given the support offered to the US market over the past year by a weaker dollar. Exporters have benefited from a lower greenback, ensuring that net exports have largely been responsible for keeping US gross domestic product growth on a positive trajectory.
But given the long-term nature of dollar trends and the natural propensity for equity markets to rise, on average shares will tend to advance whether the dollar is moving up or down.
So it's the quantum of gains that accrue during periods of US strength or weakness that differentiate the relative appeal of the dollar trend.
US fund manager Bespoke Investment Group has calculated the average return of the S&P 500 during US dollar bull markets is more than 80 per cent. During periods of US dollar declines, the return falls to less than 20 per cent.
Given that equities and the US dollar may be undertaking coincident trend reversals, this prospect of 60 per cent relative trend outperformance bodes well for investor returns.

Today’s Bull Market Is Tomorrow’s Bear Trap

I'm sorry, but you shoot yourself in the foot with your first key takeaway -

"Until the rebound reflects stronger earnings, sales growth and a generally improving economic scenario, rapid upside moves like those last week are nothing more than king-sized bear traps ready to snare the unsuspecting."

If you'd been around for the past half dozen major market turns (and history actually suggests most of those prior to this) then you'd know that this is absolute rubbish.

Stronger earnings, rising sales and a generally improving economic scenario are almost always lacking over the first weeks and months of a major bottom.

Global Investing, BRIC by BRIC

Re Jmar11 "There's an article that lists Mexico, Korea, Bangladesh, Egypt, Indonesia, Iran, Nigeria, Pakistan, the Philippines, Turkey and Vietnam as the next big countries for investors: greenfaucet.com/th...
While one should do their DD, it makes sense to look at other countries besides BRICs"

You're dead right...these are what is known as the N-11 or 'next 11' - another Goldmans acronym from a couple of years ago.

Was That a Bottom? Should We Even Care?

RE 'Muddling investor' and his reviewing/rebalancing comment - good advice, though as a criticism it applies more to direct stock portfolios than funds/ETFs where the ongoing index rebalancing occurs internally.
Constructing a simple portfolio via ETFs can work well.
For those looking for a secure strategic approach (which is the gist of James' article), why not set aside, say, 20 per cent of your investable balance for active/tactical/tradin... positions and then focus on a strategic portfolio approach with the balance. This 80 per cent rump can have a simple allocation (say, 60% US equities (assuming this is your home market), 20% overseas (which could be split 50/50 on a BRIC/developed basis) and 20 per cent yield (bonds/money market)).
Rebalance according tho market risk (ie over the past six months you would no doubt have de-weighted equities, re-weighted bonds). For what its worth i'd be back onto the core portfolio balance after the past weeks action. To give a feel - I wouldn't anticipate rebalancing this for another 3-6 months.
Re the 60 per cent core equities, you can rebalance between subsectors on a regular basis (i'd be 30 per cent financials, 30 per cent tech, 20 per cent transports, 20 per cent mining/oil going into this week).
Just a thought.

The Push for a Stronger Dollar

A piece I wrote yesterday....

US dollar's key role in oil drama
Oil up, US dollar down. Or is that oil down, US dollar up?
The past week has demonstrated just how important the dollar/oil polka has become.
Oil's recent stratospheric surge has become the market's dominant investment driver. It's becoming a threat to economic activity and has raised the very real spectre of 1970s-style stagflation.
The pain of a $US135-plus price has highlighted just how inelastic oil's demand profile can be - at least in the short term. But the increasingly vociferous howls of protest from consumers suggest that "demand destruction" is at last starting to bite.
It's been interesting watching the market response to the latest round of price rises. There is a view that what we are experiencing is somehow unique - or at least, not something we've seen since the oil shocks of the 1970s.
But how accurate is this? Let's take a quick recap.
Over the past three months, oil has jumped 58 per cent. In just over four years, it has risen 240 per cent. Pretty remarkable.
But, then take a look at the market in the four years prior. In October 2004, when oil hit a record high of $US55, it had just completed a three-month, 55 per cent rise. In the preceding three years it had risen 218 per cent. Sound familiar?
So this takes us back to December 2001. What of the prior period? In September 2000, oil had peaked at $US37. This happened to follow a five-month, 55 per cent price rise. And a 247 per cent rise from its 1998 low of $US10.72 a barrel.
So investors should be used to the quantum of these moves.
But the fact that they're not, and that this one is creating some very real pain, suggests we may at last be testing the market's choke point - the point at which price does indeed trigger a significant consumption response.
In 2004, when the market "adjusted" to then-record prices, we saw a 27 per cent correction back to $US40 - the launch point for the current price run.
In 2000, prices eased 30 per cent over the first few months following the September peak. By way of comparison, were we to now see prices fall back to around the $US100 level, this would equate to a 27.5 per cent correction.
How realistic an expectation is this? Three inputs would be needed to precipitate such a price response: increased supply, decreased demand and a strengthening US dollar.
Saudi Arabia has again led the way on a possible supply response. This week, Saudi Oil Minister Ali al-Naimi called for a meeting between consumers and producers over "how to deal with record prices".
Given Saudi Arabia has some 2 million barrels a day of spare production capacity, it has a key input into any price correction.
But also, expect pressure on the US government to consider "targeted" sales from its 727 million barrel US Strategic Petroleum Reserve. This has been utilised as a safety valve in the past - most recently after supply disruptions that followed Hurricane Katrina.
On the demand side, apart from declining US and European off-take, expect mounting pressure on China to begin a phased reduction in its fuel price subsidies. Without this, there will be no consumption response from the second-largest oil importer.
But the biggest impact on prices could come from a meaningful move on the US dollar.
After the setback of European Central Bank president Jean-Claude Trichet's rate rise comments, the focus has returned to what appears to be a concerted effort by US authorities to lift their ailing currency.
The week began with US Treasury Secretary Henry Paulson hinting that active currency intervention was being considered.
"I would never take intervention off the table, or any policy tool off the table," he said.
This followed comments last week by US Federal Reserve chairman Ben Bernanke that he was working with Treasury to "formulate policy" that would prevent the dollar from declining further.
From a Fed perspective, this implied that US rates were at best "on hold", the next move more likely to be up.
This view was reinforced on Monday after New York Federal Reserve president Tim Geithner indicated that "tighter monetary policy" may be needed globally.
On the issue of recent US dollar weakness, he pointedly added that "no government, nor central bank, can be indifferent to changes in the value of its currency".
Completing the pro-dollar jawboning, US President George Bush was interviewed ahead of the US-European Union summit in Slovenia. He indicated that he would be telling the summit of the need for a strong dollar.
"We want the US dollar to strengthen," he said, adding that "relative evaluations of economies will lead to that dollar strengthening".
He received unlikely support from OPEC president Chakib Khelil.
"The economic crisis in the US caused the US dollar to drop sharply and the threats against Iran heightened geopolitical tensions. If it wasn't for these factors, the price of oil would probably be $US70," he indicated.
All told, plenty of talk. The market will now be waiting to see how this converts into action.