Thursday, October 22, 2009

Shift in Global Markets?

I wanted to follow-up an an earlier post on curbing your enthusiasm. But first, let me go back and retrace my thoughts as briefly as possible.

Some have accused me of being a "perma-bull". However, if you go back to my comments in June 2008 and July 2008 when I started my blog, you would have labeled me a "perma-bear". I saw deflation, an imploding securitization/hedge fund/ private equity/ commercial real estate bubble. I also saw the end of the great pension con job in alternative investments.

Then came August 2008, where I predicted that AIG's disastrous results spelled trouble for pension funds and that the global Ponzi scheme in alternative investments was unraveling fast. Sure enough, when September 20o8 rolled along, we all thought the end of the world had arrived. Operation "AIG" swung into full force, capitalists of this world united, and we narrowly escaped "the Apocalypse".

In January 2009, I started talking about post-deleveraging blues and made the right call on many stocks except I totally missed the big rally in financial stocks. What a fool I was! How could I have not seen that all that TARP and BARF money was feeding the banksters on Wall Street? Not only did they get billions in bailout funds (thanks to Hank "the Tank" Paulson), but they got to borrow at zero interests rates (thanks to "Helicopter" Ben Bernanke).

What did the banksters do with all that free money? Did they lend to small businesses that were in desperate need of funds? Hell no! They did what they know best, they traded away in the world's biggest Casino buying all sorts of risky assets from high yield bonds, to emerging markets bonds and stocks, to commodities and commodity currencies.

As unemployment kept soaring, the banksters knew they had a free call option. As long as unemployment kept climbing, the Fed wouldn't dare raise rates. So you move up the yield curve, get more yield and buy as much risk from all around the world as you can.

In May 2009, I saw that massive liquidity injections were drowning out the meaning of inflation and that the "W" recovery would be postponed. I wrote about why small is beautiful in this new Wild West of investing.

In June 2009, I wrote about how the sharp rally from March lows was causing some serious performance anxiety among big institutions. Massive liquidity and performance anxiety were driving equities higher. Every dip was being bought and I knew we were going much higher.

We are now in October and barring some unforeseen event (terrorism, war with Iran?), I don't see why things have changed much since June. In other words, there is still plenty of liquidity and lots of performance anxiety going into year-end that will drive risk assets to higher levels.

Now, let me offer you some other thoughts on where we are heading. On October 16th, E.S. Browning of the WSJ reported Dow at 10000 as Crisis Ebbs. The article noted the following from Ned Davis Research, one of my favorite independent research firms:

Ned Davis Research has been comparing the current bull market to the one that ran from late 1974 through 1976, when the Dow rose 76%. Like the current rally, that one came in the midst of a troubled period for stocks. If this rally is similar, it would have longer to run, but most of the gains already would be made.

The median stock in the Standard & Poor's 500-stock index trades at about 20 times the company's profit for the past year, Ned Davis Research calculates, above the average of 17 since 1972. But that is below the level of 22 which has been a ceiling for stocks in recent years, the firm says. It calculates that the S&P 500, which rose 1.75% on Wednesday to 1092.02, could hit 1200 before it starts to look pricey. "We think the rally still has legs," says Ed Clissold, senior global analyst at Ned Davis. Like many research firms, the company is expecting some kind of temporary pullback given stocks' gain since March.

One oddity is that, historically, the levels of 10000, 1000 and 100 all have been stumbling blocks for the Dow, which has tended to stall around those levels. It first touched 1000 in intraday trading in the 1960s, but then spent well over a decade floundering. It didn't lastingly move past 1000 until 1982.

But be careful with historical comparisons. With the amount of liquidity sloshing around the world, this will be the Mother of All bear market rallies as asset prices totally detach from fundamentals.

By the way, the fundamentals aren't as bad as the pessimists claim. On Thursday, the Conference Board said that its index of leading economic indicators for the U.S. rose in September:

A private forecast of economic activity rose for the sixth straight month in September, a sign the economy will keep growing next year.

The Conference Board said Thursday that its index of leading economic indicators rose 1 percent last month after a 0.4 percent gain in August. Wall Street economists expected an increase of 0.8 percent last month, according to a survey by Thomson Reuters.

Economists expect the economy grew about 3 percent in the third quarter after falling for a record four straight quarters. But many wonder if that pace can continue in the current quarter and next year as unemployment rises and consumers remain hesitant to spend.

The Conference Board said the indicators' 5.7 growth rate in the six months through September was the strongest since 1983, but joblessness was weighing on the rebound.

"These numbers strongly suggest that a recovery is developing. However, the intensity of that recovery will depend on how much, and how soon, demand picks up," said Conference Board economist Ken Goldstein.

A sustained pick-up in demand can only come from employment gains. We'll see if U.S. job growth finally shows up in the upcoming reports and whether companies are finally hiring (I think they'll slowly start hiring).

Outside the U.S., things are looking better, especially in China where the growth rate accelerated to an 8.9 percent pace in the third quarter:

Lavish government spending and bank lending helped China's growth rate accelerate to an 8.9 percent pace in the third quarter, far outstripping expansions elsewhere around the globe and raising questions about whether the rapid rebound can be sustained.

China also announced Thursday that industrial production and investment spending are growing at a faster pace. That seemingly good news unsettled local stock investors, however, on fears Beijing may need to rein in its stimulus policies to avoid asset bubbles and inflation.

Companies, central bankers and political leaders around the world are increasingly counting on growing demand from Chinese producers and consumers to offset sluggish home markets. Corporations from Coke to Caterpillar are seeing their strongest sales in Asia, particularly China. So far, the growth is coming mostly from government-backed spending on construction and other projects, but demand from China's traditionally frugal, still relatively poor consumers is also rising.

The world's third-largest economy began to falter in late 2008 as exports plunged and thousands of factories shut down, throwing millions out of jobs. China fought back with a 4 trillion yuan ($586 billion) stimulus plan involving massive spending and bank lending for construction of infrastructure such as railways and roads to pump up the domestic economy.

Growth fell to a low of 6.1 percent in the first quarter, but rebounded to 7.9 percent in the second quarter, hitting 8.9 percent in the third quarter compared with a year earlier. That puts the economy on track to at least meet the official target of an 8 percent expansion for 2009.

With China in the forefront, "Asia appears to be leading the global recovery," Federal Reserve chairman Ben Bernanke said earlier this week. "Recent data from the region suggest that a strong rebound is, in fact, under way."

Yet sustaining the upswing beyond a few quarters hinges on stronger demand for exports from important markets such as the U.S., Europe and Japan which are emerging only slowly from the worst global recession since World War II.

"We'll see strong growth from China for the next six months, possibly another year," said Standard Chartered Bank economist Stephen Green. "The problem is what happens after another year and a half. What will be the growth driver then?" he said.

Signaling another set of concerns, China's top leaders said Wednesday that policies will increasingly focus on countering inflation — a problem that had seemed below the horizon with consumer prices down 1.1 percent so far this year. They also resolved to clamp down on waste, industrial overcapacity and other imbalances brought on by the rapid resurgence in growth.

Still, the announcement that growth continued to accelerate in the third quarter contained a hint of jubilation over Beijing's progress in mending damage from the global economic crisis.

"We can say we have made obvious and remarkable achievements in our economic growth," National Statistics Bureau spokesman Li Xiaochao told reporters in Beijing.

"We have quickly reversed the economic slowdown. The momentum of the recovery is solid and overall, our economic performance is showing signs of improvement," Li said.

Industrial output rose 8.7 percent in the first three quarters of the year, and 12.4 percent in July-September — signaling accelerating demand for steel and other industrial goods.

While China's imports still fall far short of its exports, its recovery is playing a stabilizing role for other, harder-hit economies, said David Cohen, director of Asian economic forecasting for the consultancy Action Economics in Singapore.

"The Chinese are the biggest customers for many countries around the world," he said. "They matter like never before."

Surging purchases of coal, iron ore and other minerals have aided global miners BHP Billiton and Rio Tinto.

Automakers such as Ford Motor Co. and General Motors Co. are increasingly reliant on China with its auto market surging ahead of the U.S. to become the world's biggest this year.

Caterpillar Inc., which makes heavy equipment, raised its earnings forecast for the year because of performance in Asia, its best-performing region. Deliveries of its products in China were higher than they had ever been for the third quarter. Coca-Cola Co. plans a $2 billion investment along with its bottlers in China in the next three years to meet the growing popularity of fizzy drinks.

Even as China's rapid recovery sees it loom ever larger for companies in the West, it is grappling with problems that could undermine that progress.

Heavy reliance on spending on public works and other investments has raised worries that wasteful and redundant outlays on new factories and unneeded construction will worsen gluts, while inviting financial problems as projects fail to pay off.

Record bank lending has also helped spur potentially unhealthy run-ups in property and share prices. On Wednesday, top bank regulator Liu Mingkang ordered banks to show more caution in lending in coming months.

The government this week also outlined fresh curbs on investments in steelmaking and other industries plagued by massive overcapacity.

China's planners are seeking to widen the sources of growth beyond exports and investment in state-dominated industries by channeling spending to areas of the economy expected to spur more consumer spending and improve productivity.

While China's domestic consumption remains low compared with other major economies, it is rising. Retail sales grew 15.1 percent in the first three quarters, the statistics bureau said. Housing sales have been rising and new housing starts are also picking up.

"I never trusted what the economists were saying on TV about the recovery until our orders doubled last month. Now I'm convinced," said Zhang Yizheng, general manager of Shanghai Rising, a trading company that deals in plastic pipes used mainly in vehicles.

"Our orders from car makers, electric equipment makers and construction companies tell me that their business is returning to normal, too."

China is not immune to boom bust cycles. A bust in China can spell trouble down the road because it will mean another wave of goods deflation at a time when the developed countries will be struggling with debt deflation.

But the remarkable growth in China is leading the global recovery. And it's adding to global liquidity in financial markets. The Chinese Investment Corporation (CIC) has billions to invest and they're allocating aggressively to stocks, hedge funds, private equity and real estate.

Speaking of private equity, it seems the golden age is behind us. On Thursday, TPG announced it will return $20 million in fund fees:

Private equity firm TPG has told investors that it plans to return $20 million in fees paid on its $19 billion buyout fund, a source familiar with the situation said on Wednesday.

The firm told investors about its plans, reported earlier by the Wall Street Journal, at its annual conference this week, the source said.

"We took this proactive step in order to share the economic cost of a deal market that has been slower than anyone anticipated," the WSJ quoted James Coulter, co-founder of TPG, saying.

TPG could not be immediately reached for comment by Reuters.

Private equity firms have had a tough time finding new investments since the credit crisis shut off the availability of easy financing.

They have also struggled to keep investments healthy as the economy suffered. Fundraising for new funds has also become very difficult, as investors have been hard hit by the slump in global equity markets.

Investors originally committed about $20 billion to the TPG VI fund, but TPG later allowed them to reduce their commitments, a source told Reuters in December, which brought the size down to about $19 billion. TPG, formerly Texas Pacific Group, is one of the largest private equity firms in the world.

Its founding partner, David Bonderman, is considered one of the most influential figures in the U.S. private equity industry.

Mr. Bonderman and Mr. Coulter are not returning fund fees because they see tons of opportunities in private equity. They're obviously managing expectations downward and to their credit, they're not charging fees for assets they're not using.

On another note, PE Hub revealed that Grant Thornton to Release "Blockbuster" Study:
Grant Thornton confirmed that the study will be rolled out at a press conference on November 9th. It’s been in the works for two years.

One VC who’s aware of it, Pascal Levensohn, said he was “shocked” when he learned what’s in it. “It has really scary statistics about the secular decline in marketshare, globally, that all listed markets in the U.S. have been experiencing since 1997,” he said. “This proves that (the IPO drought) has nothing to do with Sarbanes Oxley and the tech bubble. The reality is that America peaked in 1997 as a capital markets force in equities, and since then it’s gone straight down and every other market has gone up.”

The study is co-authored by David Weild, a former vice chairman of NASDAQ who also co-authored the last eye-opening study by Grant Thornton– “Market Structure Is Causing The IPO Crisis,” which was released earlier this month.

Weild told me he became concerned about the fundamental health of U.S. markets after watching the “massive volatility” created by bubbles, specifically the dot-com bubble, while he was working at NASDAQ.

“I was sitting in an executive committee meeting — I was there from 2001 to 2004 — and I was in charge of all listed companies, and we were delisting companies like mad,” he said. “I had to change the rules not to delist so many. I felt like I was running on a tread mill. I said, ‘We’ve created this incredible delisting machine and companies can’t get out of their way. There’s something wrong about this.’”

The dot-com bubble was not a listings bubble, Weild said — “it was a valuation bubble in a narrow industry group that left out the rest of the economy. It was highly destructive, maybe even more so because bona-fied, decent businesses couldn’t get capital. The capital allocation function was failing.”

Weild started collecting data to understand what had gone wrong, and he ended up tracing the problem to what he calls well-intentioned but misguided regulations — the SEC’s Manning and Order Handling Rules implemented in 1997, and decimalization, implemented in 2001.

The effect, he said, was to take away many of the economic incentives that support small-cap public companies. One proof point to him is Omeros, the biotech company that went public October 8 at $10 a share and is now trading at just under $7. Its product speeds recovery after surgery. Weild is not an investor in Omeros.

“They invested $113 million in this business, had over 100 patents already issued and over 100 pending, and raised $62 million, so that’s $175 million,” he said. “If you multiply their trading price by the number of shares outstanding, they’re trading at a discount to total money invested plus new money raised.

“There’s nothing in this business to represent the years and years of work and human equity that’s gone into it.”

Here’s an interview that Weild did two weeks ago with Bloomberg TV on the Grant Thornton IPO paper that explains more of his thinking (watch video by clicking here). He wants a new market for small-cap companies that would protect price spreads, so brokers would get higher commissions and commit to paying for research, trading and sales to support small-cap stocks.

Finally, Pan Pylas of the AP reports there are worries about the dollar slide_ but what to do?:

Concerns worldwide about the dollar's slide have escalated to the point where currency markets are beginning to wonder when governments might try to do something about it.

For now, any attempt to put a floor under the dollar's exchange rate is expected to remain rhetorical, with actual market interventions by central banks unlikely — especially if China won't change its currency policy.

But with the dollar sagging against the euro, the yen and a host of other peers, policymakers around the world are voicing worries a weak dollar will dampen their still-shaky economic recoveries. A falling dollar hits exporting countries because they find it more difficult to sell their products to the U.S.

A weak dollar also raises the cost of commodities such as oil, which are priced in the U.S. currency.

So far, currency traders have largely ignored escalating rhetoric from government officials. They pushed the euro above $1.50 on Wednesday for the first time in 14 months and it has hovered round that level all day Thursday.

And the dollar could get weaker yet, if the stock market rally has further legs. That's because dollar investments were used as a refuge as markets tanked. Now that markets are rising, that money is flowing back out of the dollar safe haven into stocks or emerging-market currencies.

And so far, the third-quarter U.S. corporate results season has been strong — around 75 percent of companies that have reported so far have beaten expectations. Larger U.S. budget deficits weigh on the dollar, as do Federal Reserve efforts to spur the economy, such as low interest rates and efforts to expand the supply of money.

At some point, governments could consider intervention — buying dollars to drive up its exchange rate. Or they could start hinting more strongly to markets they might consider such a step, which could have much the same effect.

"Assuming that the euro closes above $1.50 this week it technically has plenty of open ground on the run up to the record high of $1.6040 hit in July 2008, but there will also be plenty of official resistance to limit its appreciation," said Mitul Kotecha, head of global foreign exchange strategy at Calyon Credit Agricole.

"Such resistance may currently be limited to rhetoric, but it will not be long before markets begin discussing the prospects of actual intervention," he added.

The dollar's current slide has recalled memories of the coordinated intervention of September, 2000. Then, the U.S. Federal Reserve, European Central Bank, Bank of England and Bank of Canada intervened to stop an alarming drop in the euro that threatened competitiveness of U.S. companies. The central banks bought billions of euros for dollars and yen. The risky move helped halt the euro's slide.

Today, however, analysts think any successful intervention to stem the dollar's fall would require not just support of the U.S. authorities, including the Federal Reserve. It would have to also involve the Chinese, who have have kept their currency artificially low against the dollar. That helps them boost their exports to the United States — and China has been cool to suggestions it ease its currency practices.

But that could change if the Chinese start to fret about inflation. Premier Wen Jiabao told a Cabinet meeting Wednesday that policy will focus on balancing economic growth while managing inflation. Analysts said it that could mean that the Chinese authorities might even allow their currency to rise against the dollar. That would reduce the costs of imports and help keep inflation down.

In turn, that would ease some of the upward pressure on the euro, which has been bearing the brunt of the dollar's adjustment — a move that by itself could lessen any need for Western central banks to intervene.

And it would also help cut China's massive trade surplus with the United States, a key objective of the Group of 20 rich and developing countries.

The arena for any coordinated action could be the G-20 finance ministers meeting at St. Andrews, Scotland early next month. "The topic of China's exchange rate can be expected to get increased attention in the approach to the next G-20," said Jane Foley, research director at Forex.com.

Some finance ministers in attendance may have reached their dollar pain thresholds. Already this week, Canada's Jim Flaherty expressed worries the U.S. dollar could derail his country's recovery, while Brazil's Guido Mantega has announced a 2 percent financial transaction tax on foreign investment flows. That was intended partly to curb the rise in the value of the Brazilian real against the dollar.

Europeans have started expressing concern. European Central Bank president Jean-Claude Trichet has for weeks been warning that "excessive volatility" in exchange rates could damage economic and financial stability.

For the U.S. to agree to intervene, however, the current dollar decline will have to turn into a rout. President Barack Obama's administration says it wants a strong dollar — but the fact is, a weaker dollar helps exports and the U.S. recovery.

"Unless the dollar collapses, the U.S. is unlikely to feel compelled to adjust its policy levers," said Bank of New York Mellon currency strategist Neil Mellor.

As you can see, there are many things going on in the world and I am just trying to connect all the dots as best as I possibly can, focusing on the major trends that will shape our future.

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