Investment News: Money Morning » Main Essay http://www.moneymorning.com Investment News Provider Fri, 20 Nov 2009 20:52:26 +0000 http://wordpress.org/?v=2.8.4 en hourly 1 Investors Can’t Ignore a Rebounding Japan http://www.moneymorning.com/2009/11/20/investing-in-japan-4/ http://www.moneymorning.com/2009/11/20/investing-in-japan-4/#comments Fri, 20 Nov 2009 09:00:48 +0000 Martin Hutchinson http://www.moneymorning.com/?p=10132 By Martin Hutchinson
Contributing Editor
Money Morning

In a visit to Japan in the early 1990s, U.S. President George H.W. Bush threw up over the Japanese prime minister. When President Barack Obama visited Japan last weekend, he offered an effusive bow to the Emperor Akihito.

Politically, U.S.-Japanese relations have improved dramatically during that two-decade stretch.

Yet investor regard for Japan has gone the opposite way. Twenty years ago – in the midst of the Japanese stock-and-real-estate bubble – U.S. and other world investors were kowtowing to Japanese investments – and banging their heads on the floor in the process.

Today those same investors are much more likely to throw up in the direction of those Japanese investments.

The up-chuck response to Japanese investment is a reasonable one, given that country’s stock-market performance since 1990. After all, the Nikkei 225 share index is down more than 75% from its January 1990 peak. If my broker had locked me into Japanese stocks for the last 20 years I’d probably beat him about the head with the performance report, too.

As Japan fans have been saying for the last decade, the market is a much better buy with the Nikkei at 9,000 than it was when the index was at 39,000. Needless to say, that hasn’t enhanced Japan-backers’ credibility as the market has meandered around without a trend, performing similarly to Wall Street during the period overall, but without the excitement of hitting all-time highs even in 2007.

Japan’s stock market will only recover when Japan’s economy shows some signs of real growth. The good news, however, is that real growth may be resuming. Japan’s third-quarter gross domestic product (GDP) rose at a 4.8% annual rate, after revised growth of 2.7% in the second quarter. That puts it well ahead of the U.S. recovery, and means that Japan is outpacing the rebounds of most of the European Union, the other comparably rich bloc of countries.

Japan’s recession was very different than those suffered by the United States, Great Britain or most European countries. It had already suffered a banking meltdown during the 1990s, and had experienced no significant real estate bubble this decade. Thus, the only new bad debts in the Japanese banking system were the few it picked up from dabbling in the U.S. and British housing markets – investments that were foolish, but not significant in terms of the Japanese economy as a whole. Even Nomura Securities (NYSE ADR: NMR) – the most dedicated unprofitable dabbler in Western markets – scored a notable success in October 2007, when it wrote off its entire participation in the U.S. subprime-mortgage market. That write-off gave it one bad quarter, but left the remainder of its operations in good shape.

Even during its recession, Japan has had a better productivity performance than the United States or Germany, its principal rich-country rivals. From 1990 to 2008, Japan’s labor productivity increased by 39.7%, just fractionally better than the United States at 39.1% and significantly ahead of Germany’s 32.6%.

Thus, while the 1990s and 2000s were for most of the time an era of U.S. economic triumphalism and Japanese despair, neither was really warranted. During the 2008-2009 downturn, Japan’s principal problem was an export decline that reached 50% at its nadir – because of the yen’s strength against the dollar and most of the other major trading currencies.

In the period since March, Japanese exports have rebounded nicely. But unlike its U.S. counterpart, Japan continues to enjoy a balance-of-payments surplus and a strong yen.

The new Democratic Party of Japan government – led by Yukio Hatoyama and elected on Aug. 30 – is pledged to shift Japan’s priorities away from exports and infrastructure spending and towards the domestic economy. The government has already cancelled a substantial chunk of the previous government’s heavy infrastructure program and has pledged to introduce monthly allowances of about $300 per child to families with children. That will increase domestic spending, and should helpfully reorient the Japanese economy towards the small business sector.

Japan’s major problem is the government deficit and the debt that accompanies it. Its public debt is now 200% of GDP, although that ratio will come down if GDP improves strongly. The DPJ finance minister, Hirohisa Fujii, is pledged to substantial budget savings, and the rebound in GDP should reduce the pressure for more “stimulus.” Then you have to remember that with its high savings rate and payments surplus, Japan’s government debt is owned primarily by the Japanese people. So in this area, too, Japan is better-placed than many other countries.

With other East Asian countries – notably China, South Korea and Taiwan – rebounding nicely, Japan is poised to show good growth in 2010, far better than the Economist’s estimate of 1.5% GDP growth.  The wise investor will thus keep a portion of their money in Japan, concentrated in domestically oriented companies – it is, after all, still the world’s second-largest nominal economy.

[Editor's Note: Martin Hutchinson has terrific foresight. He warned investors about the dangers of credit-default swaps - half a year before those deadly derivatives ignited the worldwide financial firestorm. Hutchinson even predicted where and when the U.S. stock market would bottom (a feat that won him substantial public recognition).

During the stock-market rebound that started in mid-March, Hutchinson's calls on gold, commodities and high-yielding dividend stocks made winners of investors who took his advice.

Experts are taking notice. And so should you.

Hutchinson is now making those insights available to individual investors. His trading service, The Permanent Wealth Investor, combines high-yielding dividend stocks, gold and specially designated "Alpha-Bulldog" stocks into winning portfolios.

To find out more about The Permanent Wealth Investor, please just click here.]

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]]> http://www.moneymorning.com/2009/11/20/investing-in-japan-4/feed/ 0 New Technology Turns Coal Into Clean, High-Powered Gas http://www.moneymorning.com/2009/11/19/new-fuel-revolutionizes-turbines/ http://www.moneymorning.com/2009/11/19/new-fuel-revolutionizes-turbines/#comments Thu, 19 Nov 2009 07:59:46 +0000 Guest Editorial http://www.moneymorning.com/?p=10110 [Editor’s Note: Money Morning recently conducted a Q&A with Dr. Kent Moors on the future of energy. Dr. Moors last wrote about Marcellus Gas Shale, a new energy-sector profit play.]

By Kent Moors, Ph.D.
Contributing Editor
Money Morning

A new fuel technology – unveiled just two weeks ago – is about to revolutionize the energy business.

I saw it firsthand.

General Electric Co. (NYSE: GE) asked me to present “The Future of Natural Gas” at the company’s Gas Turbine Symposium in Greenville, S.C. That’s where GE revealed a new generation of its market-leading turbine technology.

Most of GE’s major North American power-production end users attended the event. And the proceedings were simulcast to GE research centers in Munich, Bangalore, and Shanghai.

They made a fuss about this new technology for a reason: A change is coming to electricity production – a big one. The power-plant managers, technicians and government observers at the symposium knew this.

A confluence of market conditions, technical advances and politics right now is ushering in the next generation of power stations. The low price of natural gas – combined with the unlocking of unconventional gas production in the United States – is one reason. But the ongoing concerns over the role played by carbon emission caps and trade provisions in pending legislation may be a more pressing consideration.

The U.S. Senate is reviewing the Clean Energy Jobs and American Power Act, better known as the “Climate Bill.” It will no doubt impact coal-powered generation. That, of course, makes gas turbines a more significant energy option.

And GE knows turbines.

Indeed, its turbine center in Greenville is the largest in the world. And the “integrated gasification combined-cycle” (IGCC) technology GE is making now is changing everything.

It’s even creating opportunities for other businesses – companies developing, fabricating and servicing/supplying turbines. They’re becoming compelling targets for investors.

First, here’s why GE’s technology is so significant…

The Energy is Clean and Powerful

IGCC technology is a product of GE’s “ecomagination” overture.

It takes low-value fuel – coal, petroleum coke, extra-heavy oil or bitumen (also called orimulsion), biomass or even municipal waste – and turns it into a high-hydrogen-content gas. The gas is then used as fuel in a turbine system to generate power.

The transition removes fuel sources having a high carbon footprint and replaces them with a less environmentally suspect source of power.
This is huge, since most people in the industry see the writing on the wall.

While coal and natural gas each provide about 23% of total current U.S. energy, coal is under greater pressure as carbon emissions face greater scrutiny by lawmakers.

With the U.N. Copenhagen energy summit approaching next month, there may just be enough political pressure from the White House for the passage of the Climate Bill. Yet even if there is a delay in the legislation, carbon concerns will remain. Coal-state senators are busy trying to grandfather existing coal power plants at home under whatever provisions emerge in the law – another clear indication higher carbon accountability is on the horizon.    
That’s great news for the IGCC market, of course, which GE’s been in for two decades now. Business is picking up – big time.

On Oct. 29, the company announced the signing of a technical agreement for a new 250-megawatt IGCC power plant in Kern County, Calif., near Bakersfield. The plant will be built by a joint venture of the BP PLC (NYSE ADR: BP) Alternative Energy division and the hydrogen project unit of international mining major Rio Tinto PLC (NYSE ADR: RTP). It is also the first of five worldwide to result from a 2007 joint venture between GE and BP.
Expect more of these ventures globally as environmentally friendly technologies obtain political support.

The new plant will join IGCC facilities GE already built in California (Coolwater in Barstow) and Florida (Polk in Tampa). The company is also providing the technology for the Duke Energy Corp. (NYSE: DUK) plant in Edwardsport, Ind., which will be the largest IGCC facility in the world upon reaching commercial operation in 2012.

In total, GE has constructed some 70 gasification facilities of various types worldwide – so far. About 40 of these are already separating carbon using available commercial technology. 

This market will be growing quickly.

A Range of New Investment Options

While I was in Greenville, I had a chance to see the new gas turbine technologies in development and review operations at the GE manufacturing and testing plants. I also discussed the technical breakthroughs and challenges with GE’s top turbine executives.

We are just beginning to see some of the potential for this new direction in power production. And it is going to bring with it a range of new investment options.

First, in addition to a more positive environmental impact, there are profitable secondary applications resulting from IGCC and related gas turbine uses. For example, the Kern County plant will capture 90% of its carbon emissions and pipe them to enhance recovery at nearby oil fields. Word is, this plant will be the first in a new generation of IGCC applications to generate additional revenue streams from the carbon capture and sequestration process. The carbon dioxide will increase production (and therefore profitability) at what are now mature crude oil extraction sites.

Second, the new IGCC applications will spawn a number of new spin-off opportunities. The process significantly reduces emissions such as sulfur dioxide, nitrous oxide, mercury and particulate matter, while at the same time decreasing water consumption by as much as 30% in comparison to conventional coal-powered plants. Each of these advances will provide markets for a range of new, smaller, more-focused, technically based service, application and new product providers. What used to be waste is now a value-added product stream.

Third, the increasing market presence will assist companies in addition to GE and the electricity providers. New targeted applications are quickly developing in support of the transition to IGCC and other turbine applications. Providing services and parts (the so-called “aftermarket”) is currently controlled by the big boys – GE and its main turbine-producing competitors: Pratt & Whitney [a division of United Technologies Corp. (NYSE: UTX)], Rolls-Royce Group PLC (OTC ADR: RYCEY) and Siemens AG (NYSE ADR: SI).

However, several smaller companies will profit from the turbine breakthroughs.

At the head of this list are upstarts like Gas Turbine Efficiency PLC (PINK: GTBEF). It’s an Orlando-based company specializing in customer products and services for the entire line of GE gas turbines, including the Frame 7EA and newly unveiled 7FA lines – certain to be the center for an expansion of turbine usage worldwide.

Another is Dynamic Turbine LLC of Norcross, Ga. The company makes turbine blades, already approaching a $4 billon-a-year parts-and-services market to the turbine industry. Currently a privately held company, my sources tell me Dynamic Turbine is likely to expand into an integrated outfit by acquiring a recently closed foundry outside Phoenix. That will require a working capital infusion, which means an initial public offering (IPO) or private placement.  

This is rapidly developing into an exciting “next stage” in energy. Now that the technology is available – and companies are employing it – there’s considerable upside potential. All the way from product development to service and support.

[Editor’s Note: Dr. Kent Moors, now a regular contributor to Money Morning, is the executive managing partner of Risk Management Associates International LLP, a full-service global management consulting and executive training firm. He is an internationally recognized expert in global risk management, oil/natural gas policy and finance, cross-border capital flows, emerging market economic and fiscal development, political, financial and market risk assessment, as well as new techniques in energy risk management.

Dr. Moors has been an advisor to the highest levels of the U.S., Russian, Kazakh, Bahamian, Iraqi and Kurdish governments, to the governors of several U.S. states and the premiers of two Canadian provinces, a consultant to private companies, financial institutions and law firms in 25 countries and has appeared more than 1,400 times as a featured television and radio commentator in North America, Europe and Russia. He has appeared on ABC, BBC, Bloomberg TV, CBS, CNN, NBC,  Russian RTV, and regularly on Fox Business Network. ]

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]]> http://www.moneymorning.com/2009/11/19/new-fuel-revolutionizes-turbines/feed/ 2 Warning: You May Not be Making as Much on Gold as You Think http://www.moneymorning.com/2009/11/18/taxes-gold-investment/ http://www.moneymorning.com/2009/11/18/taxes-gold-investment/#comments Wed, 18 Nov 2009 09:00:16 +0000 Keith Fitz-Gerald http://www.moneymorning.com/?p=10084 By Keith Fitz-Gerald
Chief Investment Strategist
Money Morning/The Money Map Report

Millions of investors who bought gold in the last 12 months are undoubtedly very happy at the moment – considering that the yellow metal has risen 60% since last November to a recent close of $1,138.60 an ounce on Monday.

But chances are good that many won’t be smiling when they discover just what the taxman has planned for their gains.

Unbeknownst to most investors, gold is considered a collectible not a capital asset. In plain English, this means that despite the fact that many people believe they are investing in gold, the Internal Revenue Service (IRS) believes that they are collecting it.

This is no small distinction and hurts investors because it means that gold does not qualify for the 15% maximum tax bite that most of us employ as a matter of routine when we mentally calculate profits earned on investments held for more than a year. That 15% cut for Uncle Sam is the long-term capital gains tax rate that applies to most stock or mutual fund investments.

Precious metals are a completely different story. Profits from these “investments” can be subject to a 28% maximum tax rate if held for more than 12 months. And if they are sold in less than a year, the profits count as ordinary income.

The long and the short of it “is that as a result of gold’s spectacular run-up, many investors may have a tax problem they haven’t counted on when they go to sell,” said Gary E. Ham Jr., of the Oregon-based accounting firm of Jones & Ham PC

This may be especially true for investors who have piled into such asset-backed, exchange-traded funds (ETFs) as the SPDR Gold Trust (NYSE: GLD), the iShares Silver Trust (NYSE: SLV) and the iShares COMEX Gold Trust (NYSE: IAU), for example, because precious-metals ETFs are set up as something called a “grantor trust.” According to Barron’s, ETF investors are treated as owning undivided interests in the actual metal that’s owned by the fund. Therefore, when an investor sells shares in the ETF, the tax code treats that investor as having sold a share of the metal backing the fund.

Adding insult to injury,  if the ETF sells some of its hard assets to pay expenses or management fees – as many have done recently, the resultant gains (or losses) flow directly through to investors and shareholders even if those investors don’t receive any distribution or cash whatsoever.

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And the net results can be mighty startling. For example, Doug Fabian, president of Fabian Wealth Strategies, a California-based investment advisor, noted several painful examples in an article on his firm’s Web site about the tax traps of commodity ETFs, including:

  • An investor who experienced a trading loss of $741 in the United States Oil Fund LP (NYSE: USO) – with no interest received – but a K-1 tax form reporting a taxable profit of $9,136 and interest of $210.
  • Another who had actual trading profits in the United States Natural Gas Fund LP (NYSE: UNG) of $1,900, with no interest received, and a K-1 reporting taxable profits of $4,319 and $120 in interest.
  • An investor who had an enviable trading profit of $4,335 in the PowerShares DB Agriculture (NYSE: DBA), without receiving any interest – activity that triggered a K-1 form that reported profits of $6,963 and interest of $207.
  • Finally, an investor who notched trading profits of $337 and no interest in the PowerShares DB Commodity Index Tracking Fund (NYSE: DBC) triggered a K-1 listing profits of $3,406 and interest of $195.

K-1’s, in case you are not familiar with them, are tax forms used by partnerships, corporations and ETFs to report a partner or a shareholder’s share of distributed profits and income. If you own one of the ETFs I’ve just mentioned, chances are you’ll be getting one just after the New Year to file with your taxes.

Here’s how this works.

Because the XYZ ETF does not pay income taxes itself, its profits are passed through to the actual owners – in this case, the shareholders, who must claim those profits as their own. If you own 50% of XYZ ETF, and XYZ files for a $100,000 profit in 2009, you’ll receive a K-1 for 50% of the net profits – or $50,000 – which you then will have to claim on your personal 2009 income-tax return.

By the way, conventional gold and metals stocks – gold producers are a good potential example of what we mean – are treated “normally,” so investors who have chosen to buy these more-traditional investment vehicles will escape these “unexpected” tax consequences.

If there is a moral to the story, it’s that nothing is what it seems anymore – not even gold.

[Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning and The Money Map Report. Fitz-Gerald has pulled all his best thoughts together in his new book, "Fiscal Hangover: How to Profit From the New Global Economy." The reviews are excellent. Investors interested in ordering the book can save $10 off the cover price at Amazon.com. Just click here.]

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]]> http://www.moneymorning.com/2009/11/18/taxes-gold-investment/feed/ 19 Open Letter to Timothy Geithner: Is Your Nose Getting Longer? http://www.moneymorning.com/2009/11/17/open-letter-geithner/ http://www.moneymorning.com/2009/11/17/open-letter-geithner/#comments Tue, 17 Nov 2009 09:00:24 +0000 Martin Hutchinson http://www.moneymorning.com/?p=10028 Dear Treasury Secretary Geithner:

I noticed you recently told the Japanese press that you intended to maintain a strong dollar, and that the Obama administration would bring the U.S. fiscal deficit back to a “sustainable balance.”

Tell me, don’t you feel your nose extending like Pinocchio’s when you tell these fibs to innocent Asians?

The dollar is not strong. In fact, it’s sinking to record levels of weakness, and it’s going to stay that way, for three reasons:

  • First, the U.S. Federal Reserve is running a zero-interest-rate policy and has announced that it intends to continue doing so. While it does, there’s easy money to be made out of borrowing dollars and lending almost anything else – especially Russian rubles at the moment (maybe we lost the Cold War, after all!). That will actually make the dollar drop.
  • Finally, the U.S. government is running huge deficits and pretty much everyone else in the United States has debt coming out the wazoo. A weak dollar – ideally mixed with a teensy, weensy bit of inflation – will make all those debts get smaller … like magic!

There are some very good reasons why the U.S. dollar is weak, and given the constraints on your policy, you’d probably like it weaker. It’s just that you can’t say so, because then foreign investors might stop buying U.S. Treasury Bonds.

Which brings me to the other point. We all know – don’t we? – that the budget deficit for the 12-month-period that ends next September will be even larger than the $1.4 trillion shortfall recorded for the 12 months that ended in September of this year.

Even though you’ve stopped bailing out banks – well, except for the odd $100 billion for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) – there are just too many other demands on the public purse. There’s the rest of February’s stimulus, most of which actually doesn’t get spent until the 2010 fiscal year. There are little details, like the extension of the $8,000 tax credit for first-time buyers – one that’s now extended by a $6,500 tax credit for non-first-time buyers.

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And still to come is the medical reform bill (which we know isn’t “deficit neutral” at all), the cost of which will kick in around 2013, just as the other budget pressures are abating. (Or not, since Congress will probably have found something else to spend money on by then).

It’s a mess, isn’t it? I mean, we’re actually talking about trillion-dollar deficits as far as the eye can see, aren’t we? Of course, Japan can’t really grumble about that, because it has public debt of almost 200% of its gross domestic product (GDP). On the other hand, Japan runs a balance-of-payments surplus and has lots of savings, so it actually owes that money to itself.

I’m not saying that it won’t be a challenge to restore American prosperity. Indeed, as the old saying goes: “If I wanted to get there, I wouldn’t start here.” At the same time, as a veteran banker who’s worked with troubled economies before, I do have a few tips to pass along:

  • First and foremost, enough with the stimulus. You’re going to run into trouble soon in the bond markets, and that will prevent small business from getting the capital it needs. Cut at least $100 billion of the flaky projects out of the stimulus bill.
  • If you want to encourage clean energy, put in a small-but-simple carbon tax and take away an equal amount of handouts to ethanol producers and clean-tech companies: You’ll get double the deficit cut – without having to boost your clean-energy incentive.
  • Know who’s making money right now? Goldman Sachs Group Inc. (NYSE: GS) – that’s who. Unfortunately, those profits aren’t being delivered via sound capitalist practices. They instead stem from such contrivances as credit-default swaps and high-speed trading. And those are short-term rent-seeking activities – not long-term wealth-generating initiatives. Place a small Tobin tax on each trading transaction – the country needs the revenue much more than do the partners of Goldman Sachs.

You may think those changes are “politically impossible.” We disagree. In fact, we believe there’s no time to lose. And we’d very much like to hear your reaction to our proposals. If you write to us here at Money Morning, we’ll gladly share your thoughts with our readers.

We’ll look forward to that time.

Sincerely,

Martin Hutchinson
Contributing Editor
Money Morning

105 West Monument Street
Baltimore, Maryland 21201

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]]> http://www.moneymorning.com/2009/11/17/open-letter-geithner/feed/ 11 Is a Second U.S. Stimulus Package Headed Our Way? http://www.moneymorning.com/2009/11/16/second-stimulus-package/ http://www.moneymorning.com/2009/11/16/second-stimulus-package/#comments Mon, 16 Nov 2009 07:56:42 +0000 Guest Editorial http://www.moneymorning.com/?p=9996 By Jon D. Markman
Contributing Writer
Money Morning

Is the recent market softness something to be worried about?

Not if U.S. President Barack Obama & Co. comes through with a second stimulus package – as I’m expecting.

Let me explain …

There are a few reasons to suspect that the softness we’ve been seeing will continue for a week or so. Small-cap stocks –  which continue to drag along like road kill caught on the rear bumper of the market – are our main cause of concern at the moment.

There is also the possible head-and-shoulder reversal pattern on the Nasdaq Composite Index and “double top” patterns on the Russell 2000 Index and Standard & Poor’s 500 Index. And a number of short-term indicators have moved into over-bought territory.   

As you can see in the chart that follows, there’s a battle going on at the 85-day moving average, which was the support level back in July. Small-caps fell below that level two weeks ago, pressed above it last week, and now could go either way. If they drop more decisively below the 850-day moving average, the weakness is likely to persist.


Within the context of a bull market elsewhere, the most sensible response is to step away from small-cap stocks. More aggressive investors may actually wish to short them. With the index in suspended animation at the moment, though, neither action should be taken yet. The next move will come soon enough, and is likely to be both explosive and just the start of something larger.

And with good reason.

More Stimulus? Count on It

Stocks are most likely still just consolidating, because that’s what they do. They go up, they back off, they go sideways, they go up again.
Let’s just call it wash, rinse and repeat.

The development of a “double top” now in the S&P 500 is going to get bears excited, and the fact that a head-and-shoulders topping formation may be forming to boot will also renew their courage.

For a new round of buying to emerge, we’ll need a catalyst to provide a spark. And just what might come along to spark a new round of buying? What would bring people who are currently on the sidelines into the market, and what would cause investors who currently have a high bond allocation to make the switch into equities?

A company like Swiss eye care products maker Alcon Inc. (NYSE: ACL), which was one of my newsletter positions this summer, is a great example of a leader so far, with a perfectly lovely recovery chart (See below).

But what will lead skeptic to blink and join the action?

I might have an answer. Late Thursday, I learned that Goldman Sachs Group Inc. (NYSE: GS) is telling its clients that the Obama administration is going to announce another major stimulus package. That would mean that the combined monetary and fiscal infusion package that is already historic in proportions might actually be kicked up a notch.

Of course the administration would have to persuade Congress to pass the legislation at a time when conservatives are already screaming about the extreme state of the nation’s deficit. But this would fit into my view, expressed here many times, that the government has gone all-in with low interest rates and fiscal stimulus, and is ready to go way overboard in its attempt to get the U.S. economy rolling again. 

This is not because the politicians are altruistic, mind you. It’s because they’re, well, politicians. And my many years of covering government at the Los Angeles Times led me to realize that the first, second and third motivation of politicians is to get re-elected. Everything else pales in comparison.

If President Obama wishes to make sure it retains a Democratic majority in Congress in the mid-term elections, it must act swiftly to boost employment. Stimulus packages act with a lag, so Obama & Co. must get the new package passed and get the money spent as quickly as possible.

In that context, Goldman says that we should pay attention to two developments that suggest a greater likelihood of more stimulus ahead:

  • First, we have comments from U.S. Senate Majority Leader Harry Reid, D-NV that the Senate was likely to consider a jobs bill in early 2010.
  • Second, President Obama announced Thursday that the White House would convene a jobs summit in December.

Goldman says a more-explicit focus on job creation would achieve four things:

  • Increase the likelihood of new polices, rather than simple extension of existing ones.
  • Raise the odds of additional fiscal assistance for states and infrastructure spending.
  • Incrementally increase the probability of additional tax relief in 2010.
  • And push healthcare reform and energy legislation down lower on the agenda for 2010 – and probably increase the likelihood that Congress scales back the legislation it is contemplating in these areas.

Goldman analysts believe that Congress will enact $250 billion in additional fiscal measures to support growth over the next three years, including $75 billion more in 2010. However, recent developments – including the $45 billion bill to help homebuyers enacted last Friday – make this assumption look conservative. 

The analysts say that the timetable would be similar to what we’ve seen in each of the past two years: policy formulated internally in December, debated publicly in January, enacted in February. But they note that it would likely take longer to create and pass due to concerns about the effectiveness about prior efforts.

So how would stocks react? Considering that the entire rally out of the March lows has resulted from the first major Obama stimulus package, I would think that the reaction to a second package would also be positive. This could be news that kicks off the next leg higher, or at least forestalls the recent consolidation phase that seems to have gotten under way. 

Week in Review

Stocks swept higher on Friday after recovering from an early bout of anxiety over a weak consumer confidence report.  The Dow Jones Industrial Average gained 0.7%, the S&P 500 gained 0.6%, the Nasdaq gained 0.9%, and the Russell 2000 gained 1%.

There was plenty of good news. Government reports showed that the Eurozone economy returned to growth in the third quarter with an expansion of 1.5%. U.S. home foreclosures slowed for the third straight month. Global policy makers from Asia to Europe indicated that stimulus efforts will continue at least through 2010 and possibly into 2011. Canada’s financial minister added that he sees "very substantial" risk from ending stimulus early.  And thanks to the Fed’s ongoing purchases of mortgage debt, mortgage rates fell to a seven-month low. 

All the major sector groups, save the bank stocks, moved higher. Consumer discretionary stocks were the top performers, with the Consumer Discretionary SPDR Exchange-Traded Fund (NYSE: XLY) rising 1.8% after a number of retailers expressed increased confidence. High-end teen retailer Abercrombie & Fitch Co. (NYSE: ANF) gained 10.7% after it reported better-than-expected quarterly numbers.

Technically, though, the Friday action stayed within the bounds of Thursday’s sell-off. Known as an "inside day" –  or a "bearish harami," in the lingo of Japanese candlestick chartists – it suggests that that activity may have been a temporary pause within the small downtrend that started this week. The pattern can be erased with a modest up session on Monday or Tuesday.

Volume dropped 6.2% as just 985 million shares traded on the New York Stock Exchange. This continues the slide in activity we’ve seen since the market bottomed and turned higher last week: Since Oct. 28, Big Board (NYSE) volume has dropped 41% in what is normally a fairly active time of the year. Paul Desmond and his team of veteran technicians at Lowry Research Corp., noted that, while light volume rallies "often prove fragile, they most frequently lead to short term rather than major market tops."

There are other signs that the market’s recent softening isn’t indicative of something more severe. There has not been a large and sustained increase in selling pressure. Large-cap stocks remain buoyant. And breadth – net advancers vs. net decliners – has been improving after a brief slip. 

Monday: Stocks rallied after G20 leaders meeting over the weekend in Scotland pledged to maintain stimulus programs despite rising fiscal deficits. Although the global economy has shown signs of renewed vitality, the central bankers and finance ministers called the recovery ”uneven and … dependent on policy support.”

Elsewhere, the International Monetary Fund said the U.S. dollar was still slightly overvalued – a  statement that acted like a shot of Red Bull to traders using the dollar to fund ultra-leveraged carry trades.

Tuesday: Again we saw equities respond closely to the vagaries of the foreign exchange market. Tuesday’s action was driven in large part by what was happening in the United Kingdom. First, analysts at Fitch Ratings Inc. said that Britain was "potentially most at risk" of losing its AAA credit rating as fiscal deficits soar. This sent the pound lower and the dollar higher. Risk assets like stocks and gold sold off as a result.

Then, U.K. trade minister Mervyn Davies said the government’s credit rating was ”absolutely” safe. The pound stabilized and the dollar slipped, and in turn risk assets recovered from their lows.

Wednesday: Stocks pushed higher again on Wednesday, continuing a global wave of strength that started overnight in Asia after China release a slew of solid economic reports. Industrial production increased 16.1% year-over-year; well ahead of the 15.5% consensus estimate. It was the sixth consecutive monthly increase and the fastest growth since March 2008.

Thursday: Jobless claims continue to improve. Claims fell 12,000 to 502,000. The four-week average dropped 4,500 to 519,750. This is the lowest level since last November and is a sign employers are beginning to slow down payroll cuts.

Friday: The Reuters/University of Michigan’s Consumer Sentiment Index made a surprise drop to 66. This is well below the consensus estimate of 71 and the previous reading of 70.6. Weakness was divided between the current conditions and expectations sub-indices. The reading on expectations had increased to 74 in September before falling to 69 in October and just 64 now.


Separately, the U.S. trade deficit widened to $36.5 billion from $30.7 billion previously as a weakened U.S. dollar helped drive up oil prices. The result was below the consensus estimate of $32.5 billion. Exports rose 2.9% but it wasn’t enough to overcome the 5.8% jump in imports. The trade deficit is a drag on gross domestic product (GDP) growth. 

The Week Ahead

Monday: The Commerce Department’s report on October retail sales is due. Analysts expect sales to have increased 0.9% for the month after September’s 1.5% decline. The result will be an important gauge of consumer health as we head into the holiday shopping season. Watch motor vehicle sales to see if demand has bounced back after the expiration of the cash-for-clunkers auto rebate program.

Tuesday: Industrial production data for October will be released. The consensus estimate stands at 0.4%. This is down from the 0.7% growth seen in September and the 1.2% jump in August. Investors will be closely monitoring this release for clues into the recovery underway in the manufacturing sector.

Wednesday: A read on inflation from the Consumer Price Index. Expectations are low as the economy maintains a large amount of excess capacity and wage growth remains constrained.

Thursday: The Conference Board releases its latest index of leading indicators. The index jumped 1% in September for its sixth consecutive gain. Analysts believe the string can continue and expect an increase of 0.4% for October.

Friday: A quiet session. Philadelphia Fed President Charles Plosser speaks in Singapore.

[Editor's Note: New Money Morning contributor Jon Markman is a veteran portfolio manager, commentator and author. He is currently the editor of two investment-research services, Strategic Advantage and Trader's Advantage. For information on obtaining a two-week free trial to the daily commentary of the Strategic Advantage, please click here.

Markman, an accomplished author, will have his fourth book debut in the middle of December.  That book is an annotated edition of the 1923 book, "Reminiscences of a Stock Operator," an investment classic that most experts rate as one of the top business books of all time. For more information on the book, which is due to debut in early January, please click here.]

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]]> http://www.moneymorning.com/2009/11/16/second-stimulus-package/feed/ 3 Is Mexico the “New” China? http://www.moneymorning.com/2009/11/13/mexico-leapfrogs-china/ http://www.moneymorning.com/2009/11/13/mexico-leapfrogs-china/#comments Fri, 13 Nov 2009 10:53:01 +0000 Keith Fitz-Gerald http://www.moneymorning.com/?p=9943 [Editor's Note: Money Morning Chief Investment Strategist Keith Fitz-Gerald's new book - "Fiscal Hangover" - will be published on Monday.]

By Keith Fitz-Gerald
Chief Investment Strategist
Money Morning/The Money Map Report

When it comes to global manufacturing, Mexico is quickly emerging as the “new” China.

According to corporate consultant AlixPartners, Mexico has leapfrogged China to be ranked as the cheapest country in the world for companies looking to manufacture products for the U.S. market. India is now No. 2, followed by China and then Brazil.

In fact, Mexico’s cost advantages and has become so cheap that even Chinese companies are moving there to capitalize on the trade advantages that come from geographic proximity.

The influx of Chinese manufacturers began early in the decade, as China-based firms in the cellular telephone, television, textile and automobile sectors began to establish maquiladora operations in Mexico. By 2005, there were 20-25 Chinese manufacturers operating in such Mexican states Chihuahua, Tamaulipas and Baja.

The investments were generally small, but the operations had managed to create nearly 4,000 jobs, Enrique Castro Septien, president of the Consejo Nacional de la Industria Maquiladora de Exportacion (CNIME), told the SourceMex news portal in a 2005 interview.

China’s push into Mexico became more concentrated, with China-based automakers Zhongxing Automobile Co., First Automotive Works (in partnership with Mexican retail/media heavyweight Grupo Salinas), Geely Automobile Holdings (PINK: GELYF) and ChangAn Automobile Group Co. Ltd. (the Chinese partner of Ford Motor Co. (NYSE: F) and Suzuki Motor Corp.), all announced plans to place automaking factories in Mexico.

Not all the plans would come to fruition. But Geely’s plan called for a three-phase project that would ultimately involve a $270 million investment and have a total annual capacity of 300,000 vehicles. ChangAn wants to churn out 50,000 vehicles a year. Both companies are taking these steps with the ultimate goal of selling cars to U.S. consumers.

Mexico’s allure as a production site that can serve the U.S. market isn’t limited to China-based suitors. U.S. companies are increasingly realizing that Mexico is a better option than China. Analysts are calling it “nearshoring” or “reverse globalization.” But the reality is this: With wages on the rise in China, ongoing worries about whipsaw energy and commodity prices, and a dollar-yuan relationship that’s destined to get much uglier before it has a chance of improving, manufacturers with an eye on the American market are increasingly realizing that Mexico trumps China in virtually every equation the producers run.

“China was like a recent graduate, hitting the job market for the first time and willing to work for next to nothing,” Mexico-manufacturing consultant German Dominguez told the Christian Science Monitor in an interview last year. But now China is experiencing “the perfect storm … it’s making Mexico – a country that had been the ugly duckling when it came to costs – look a lot better.”

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“Credit Crisis Report.”

The real eye opener was a 2008 speculative frenzy that sent crude oil prices up to a record level in excess of $147 a barrel – an escalation that caused shipping prices to soar. Suddenly, the labor cost advantage China enjoyed wasn’t enough to overcome the costs of shipping finished goods thousands of miles from Asia to North America. And that reality kick-started the concept of “nearshoring,” concluded an investment research report by Canadian investment bank CIBC World Markets Inc. (NYSE: CM)

“In a world of triple-digit oil prices, distance costs money,” the CIBC research analysts wrote. “And while trade liberalization and technology may have flattened the world, rising transport prices will once again make it rounder.”

Indeed, four factors are at work here.

Mexico’s “Fab Four”

  • The U.S.-Mexico Connection: There’s no question that China’s role in the post-financial-crisis world economy will continue to grow in importance. But contrary to the conventional wisdom, U.S. firms still export three times as much to Mexico as they do to China. Mexico gets 75% of its foreign direct investment from the United States, and sends 85% of its exports back across U.S. borders. As China’s cost and currency advantages dissipate, the fact that the United States and Mexico are right next to one another makes it logical to keep the factories in this hemisphere – if for no other reason that to shorten the supply chain and to hold down shipping costs. This is particularly important for companies like Johnson & Johnson (NYSE: JNJ), Whirlpool Corp. (NYSE: WHR) and even the beleaguered auto parts maker Delphi Corp. (PINK: DPHIQ) which are involved in just-in-time manufacturing that requires parts be delivered only as fast as they are needed.
  • The Lost Cost Advantage: A decade or more ago, in any discussion of manufactured product costs, Asia was hands-down the low-cost producer. That’s a given no more. Recent reports – including the analysis by AlixPartners – show that Asia’s production costs are 15% or 20% higher than they were just four years ago. A U.S. Bureau of Labor Statistics report from March reaches the same conclusion. Compensation costs in East Asia – a region that includes China but excludes Japan – rose from 32% of U.S. wages in 2002 to 43% in 2007, the most recent statistics available. And since wages are advancing at a rate of 8% to 9% a year, and many types of taxes are escalating, too, East Asia’s overall costs have no doubt escalated even more in the two years since the BLS figures were reported.
  • The Creeping Currency Crisis: For the past few years, U.S. elected officials and corporate executives alike have groused that China keeps its currency artificially low to boost its exports, while also reducing U.S. imports. The U.S. trade deficit with China has soared, growing by $20.2 billion in August alone to reach $143 billion so far this year. The currency debate will be part of the discussion when U.S. President Barack Obama visits China starting Monday. Because China’s yuan has strengthened so much, goods made in China may not be the bargain they once were. Those currency crosscurrents aren’t a problem with the U.S. and Mexico, however. As of Monday, the dollar was down about 15% from its March 2009 high. At the same time, however, the Mexican peso had dropped 20% versus the dollar. So while the yuan was getting stronger as the dollar got cheaper, the peso was getting even cheaper versus the dollar.
  • Trade Alliance Central: Everyone’s familiar with the North American Free Trade Agreement (NAFTA).  But not everyone understands the impact that NAFTA has had. It isn’t just window-dressing: Mexico’s trade with the United States and Canada has tripled since NAFTA was enacted in 1994. What’s more, Mexico has 12 free-trade agreements that involve more than 40 countries – more than any other country and enough to cover more than 90% of the country’s foreign trade. Its goods can be exported – duty-free – to the United States, Canada, the European Union, most of Central and Latin America, and to Japan.

In the global scheme of things, what I am telling you here probably won’t be a game-changer when it comes to China. That country is an economic juggernaut and is a market that U.S. investors cannot afford to ignore.  Given China’s emerging strength and its increasingly dominant financial position, it’s going to have its own consumer markets to service for decades to come.

Two Profit Play Candidates

From a regional standpoint, these developments all show that we’re in the earliest stages of what could be an even-closer Mexican/American relationship – enhancing the existing trade partnership in ways that benefit companies on both sides of the border (even companies that hail from other parts of the world).

In the meantime, we’ll be watching for signs of a resurgent Mexican manufacturing industry that’s ultimately driven by Chinese companies – because we know the American companies doing business with them will enjoy the fruits of their labor.

Since this is an early stage opportunity best for investors capable of stomaching some serious volatility, we’ll be watching for those Mexican companies likely to benefit from the capital that’s being newly deployed in their backyard.

Two of my favorite choices include:

  • Wal Mart de Mexico SAB de CV (OTC ADR: WMMVY): Also known as “Walmex,” this retailer has all the advantages of investing in its U.S. counterpart – albeit with a couple of twists. Walmex’s third-quarter profits were up 18% and the company just started accepting bank deposits, a service that should boost store traffic. And while the U.S. retail market is highly saturated – which limits growth opportunities – there are still plenty of places to build Walmex stores south of the border. After all, somebody has to sell products to all those thousands of workers likely to be involved in the growing maquiladora sector.
  • Coca-Cola FEMSA SAB de CV (NYSE ADR: KOF): Things truly do go better with Coke – especially higher wages and an improved lifestyle. According to Reuters, Mexicans now consume more Coca-Cola beverages per capita than any other nation in the world. The company just posted a 25% jump in its third-quarter net earnings, aided by a strong 21% jump in revenue. Coca-Cola FEMSA continues to experience strong growth from its Oxxo convenience stores, and strong beer sales, too. And all three product groups are logical beneficiaries of strong maquiladora development and the growing incomes and rising family wealth that will translate into higher consumer spending in the immediately surrounding areas.

[Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning and The Money Map Report. Fitz-Gerald has pulled all his best thoughts together in his new book, "Fiscal Hangover: How to Profit From the New Global Economy." The reviews are excellent. Investors interested in ordering the book can save $10 off the cover price at Amazon.com. Just click here.]

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]]> http://www.moneymorning.com/2009/11/13/mexico-leapfrogs-china/feed/ 12 Jeremy Grantham: With Great Depression II Nowhere in Sight, Look to the “Emerging Markets Bubble” for Maximum Profits http://www.moneymorning.com/2009/11/11/grantham-emerging-markets-bubble/ http://www.moneymorning.com/2009/11/11/grantham-emerging-markets-bubble/#comments Wed, 11 Nov 2009 09:00:54 +0000 Guest Editorial http://www.moneymorning.com/?p=9867 [Editor's Note: This market-outlook commentary appeared as part of the most recent GMO LLC Quarterly Letter, and was excerpted with permission. To view the full newsletter on the GMO Web Site, please click here.]

By Jeremy Grantham
Chief Investment Strategist
GMO LLC

The good news is that we have not fallen off into another Great Depression. With the degree of stimulus there seemed little chance of that, and we have consistently expected a global economic recovery by late this year or early next year.

The operating ratio for industrial production reached its lowest level in decades. It should bounce back and, if it moves up from 68 to 80 over three to five years, will provide a good kicker to that part of the economy. Inventories, I believe, will also recover.

In short, the normal tendency of an economy to recover is nearly irresistible and needs coordinated incompetence to offset it – like the 1930 Smoot-Hawley Tariff Act, which helped to precipitate a global trade war. But this does not mean that everything is fine longer term.

It still seems a safe bet that seven lean years await us.

Corporate profit margins [excluding financials] remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/Earnings (P/E) ratios, adjusted for even normal margins, are also significantly above fair value after the rally.

Fair value on the Standard & Poor’s 500 Index is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places [the] market [as of Oct. 19, when the S&P 500 closed at 1,097.91] at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% down by more than 3% a year. [Editor's Note: The S&P 500 closed yesterday (Tuesday) at 1,093.01 - essentially in the same neighborhood as the Oct. 19 close that Grantham referenced].

Doesn’t it seem odd that we would be measurably overpriced once again, given that we face a seven-year future that almost everyone agrees will be tougher than normal? Major imbalances are unlikely to be quick or easy to work through. For example, we must eventually consume less, pay down debt, and realign our lives to being less capital-rich.

Global trade imbalances must also readjust. To repeat my earlier forecast, I expect developed markets to grow moderately less fast – about 2.25% – for the next chunk of time, and to look pretty anemic compared to emerging countries growing at twice that rate. We are nervous about the possibility of a major shock to Chinese growth.

(My personal view of a major China stumble in the next three years or so is that it is maybe only a one-in-three chance, but is still the most likely important unpleasant surprise of the fundamental economic variety).

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“Credit Crisis Report.”

Notwithstanding this concern, I believe we are well on the way to my “emerging bubble” described 18 months ago (in the First Quarter 2008 Quarterly Letter). I would recommend to institutional investors, including my colleagues, to give emerging equities the benefit of value doubts when you can.

For once in my life, I would like to participate in a bubble – if only for a little piece of it, instead of getting out two years too soon. Riding a bubble up is a guilty pleasure totally denied to value managers who typically pay a high price to the God of Investment Discipline (Thor?) for being so painfully early. I think the first 15 percentage points over fair value would satisfy me. If I’m right, the first 15% will be a small fraction of the eventual bubble premium.

So in a sense, we would be early once again.

We believed from the start that this market rally and any outperformance of risk would have very little to do with any dividend-discount-model concept of value, so it is pointless to “ooh and ah” too much at how far and how fast the market has traveled. The lessons, if any, are that low rates and generous liquidity are a little more powerful than we thought, which is a high hurdle because we have respected their power for years. And what we thought were powerful and painful investment lessons on the dangers of taking risk too casually turned out to be less memorable than we expected.

Risk-taking has come roaring back. Value, it must be admitted, is seldom a powerful force in the short term. The U.S. Federal Reserve weapons of low rates, plenty of money, and the promise of future help if necessary seem stronger than value over a few quarters. And the forces of herding and momentum are also helping to push prices up, with the market apparently quite unrepentant of recent crimes and willing to be silly once again.

We said in July that we would sit and wait for the market to be silly again. This has been a very quick response, although, as real silliness goes, I suppose it is not really trying yet. In soccer terminology, for the last six months it is Voting Machine 10, Weighing Machine nil!

Price, however, does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors.

First, the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fix of short-term labor cuts fades away.

Second, the slow gravitational pull of value as U.S. stocks reach +30% to +35% overpricing in the face of an extended difficult environment.

On a longer horizon of two to 10 years, I believe that resource limitations will also have a negative effect (see GMO’s Second Quarter 2009 Quarterly Letter). I argued that increasingly scarce resources will give us tougher times, but that we are collectively in denial.

The response to this startling revelation, for the first time since I started writing, was nil. It disappeared into an absolutely black hole. No one even bothered to say it was idiotic, which they quite often do. Given my thesis of a world in denial, though, I must say it’s a delicious irony.

So, back to timing.

It is hard for me to see what will stop the charge to risk-taking this year. With the near universality of the feeling of being left behind in reinvesting, it is nerve-wracking for us prudent investors to contemplate the odds of the market rushing past my earlier prediction of an 1,100 S&P 500. It certainly can happen.

Conversely, I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again. I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. “Painfully” is arbitrarily deemed by me to start at minus 15%. My guess, though, is that the U.S. market will drop below fair value, which is a 22% decline (from the Oct. 19 S&P 500 level of 1,098).

Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.

Of course, they would probably be slightly happier with, say, 550. The point is that this is not a situation like 2005, 2006, and 2007 when, for the first time, a great bubble – 2000 – had not yet broken back through its trend. I described that reversal as a near-certainty.

I love historical consistency, and with 32 bubbles completely broken, the single one outstanding- the S&P 500 – was a source of nagging pain. But that was all comfortably resolved by a substantial new low for the S&P 500 last year.

This cycle, in contrast, has already established a perfectly respectable S&P low at 666, well below trend, and can officially please itself from here. A new low (or not) will look compatible with history, which makes the prediction business less easy.

[Editor's Note: Talk about market calls … In its May issue, in an article titled "Why Jeremy Grantham Changed his Mind," SmartMoney magazine detailed how the veteran investment strategist warned investors of the dangers of a global investing bubble ahead of the global financial crisis that lead to a near-collapse of the world's securities markets. And that's not all. In March, Grantham exhorted investors to buy back in - ahead of one of the strongest market rebounds in market history.

Grantham co-founded GMO in 1977. Prior to that, Grantham was co-founder of Batterymarch Financial Management, where he recommended commercial indexing in 1971, one of several claims to being first. He began his investment career as an economist with Royal Dutch Shell. Grantham is GMO's chief investment strategist and is an active member of GMO's asset allocation division. He is a member of the GMO board of directors and has also served on investment boards of several non-profit organizations.

Grantham has been featured in Forbes, Barron's and BusinessWeek and is routinely quoted by the financial press. He earned his undergraduate degree from the University of Sheffield and an MBA from Harvard Business School. To learn more about GMO, please visit the company's Web site by clicking here.]

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]]> http://www.moneymorning.com/2009/11/11/grantham-emerging-markets-bubble/feed/ 2 It Was a Wonderful Life – And Then Came Securitization http://www.moneymorning.com/2009/11/10/securitization-market-crisis/ http://www.moneymorning.com/2009/11/10/securitization-market-crisis/#comments Tue, 10 Nov 2009 09:00:29 +0000 Martin Hutchinson http://www.moneymorning.com/?p=9849 By Martin Hutchinson
Contributing Editor
Money Morning

Massachusetts Land Court judge Keith C. Long recently ruled that foreclosure sales of two properties with securitized mortgages were invalid, a decision that ties up thousands of Massachusetts real-estate transactions.

If nothing else, this landmark court case should make one thing very clear: Securitization – the product of the finest brains of Wall Street for more than two decades – doesn’t work as advertised.

Historically, mortgage loans were made by small local institutions, which knew the borrowers personally and took the credit risk themselves.

You can see how it worked in the 1946 classic movie “It’s a Wonderful Life.”  Main character George Bailey (Jimmy Stewart), as heir to a local building-and-loan company, battles the evil capitalist Henry F. Potter (Lionel Barrymore) to change the character of his local town by offering affordable housing loans to the poor but upwardly mobile.

It is an appealing model, but has one real flaw: If a local savings and loan is in financial difficulty (as was Stewart’s “Bailey Bros. Building & Loan” in 1932), it will not be able to attract deposits, and no mortgage loans will be made in that locality. With the rise of interstate banking, that problem would have been soluble – mortgage loans would be more expensive in an area if a large national bank was their only potential source, but they would still be available.

Jimmy Stewart and his building-and-loan peers were forced out of business by the inflationary surge that we saw from 1974 to 1982. That surge caused short-term interest rates to rise sharply, while long-term returns on the lender’s mortgage loans remained fixed. By 1982, the great majority of U.S. mortgage lenders had lost their capital and were insolvent. It was almost another full decade for them finally to go out of business, but the damage had been done.

The initial securitizations were done by Ginnie Mae (the Government National Mortgage Association) in 1970; the government agency had guaranteed home mortgages, and wanted a way to finance the result.  Thus, when the U.S. savings-and-loan crisis began, and S&Ls actually began to fail, the securitization markets were available to pick up the slack.

It didn’t hurt that two government sponsored entities – Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) – were ready to guarantee everything in sight, and to prevent investors from worrying too hard about the underlying credit risk.

Under securitization, instead of making mortgage loans directly, mortgage bankers only “originated” them, doing whatever paperwork was thought necessary, then sold them on to a Wall Street broker, which packaged them into a shell company with other mortgages. The resultant mortgage-backed security and sold the resulting package to bond investors.

There are two major problems with securitization.

First, in modern securitization markets, nobody is really responsible for the credit risk. Instead of taking loans onto their own balance sheet, and losing money if they default, mortgage companies merely sell the loans they originate to Wall Street, pocketing a fee for doing so. Wall Street, in turn, retains very little of the resultant mortgage packages: It sells them on to investors, who can hardly expect Wall Street to be responsible for each individual mortgage.

Thus, all the parties involved in originating the transaction became salesmen. Since it was no longer necessary to have a balance sheet to originate mortgages, mortgage brokers became pure sales operations.  The sales business being what it is, the more unscrupulous and aggressive the sales operation, the more business it did.

That’s how we ended up with so-called “Liar Loans.”

In newly unveiled draft legislation, the U.S. Treasury Department has proposed to reduce this problem by making securitization originators keep 5% of the resultant credit risk. This seems a sensible move, and should help matters considerably, even if it does reduce the attraction of the more-exotic securitizations.

A second problem with securitization, highlighted by the Massachusetts court decision, is that of documentation.  As I can testify from experience, securitizations are by far the most tiresome of all Street transactions to document, with a non-standard securitization creating incalculable costs while taking 18-24 months to complete.

You can see why the more complex transactions were complicated: Hundreds – or even thousands – of mortgages were being bundled and sold as a bundle to maybe tens of thousands of investors.

From the comments of Judge Long, corners were cut here as everywhere else during the housing bubble that subsequently precipitated the global financial crisis. If you take the documentation seriously, foreclosures are made very difficult by securitization, because each of those 10,000 investors owns a tiny piece of, say, a $300,000 foreclosed loan – while at the same time also owning pieces of loans not in foreclosure.

If you get to the point where loans that had already been packaged are repackaged and resold, the paper trail may become completely inscrutable, in the sense that it is no longer possible to figure out who owns what.

At that point, the owners can’t foreclose, because nobody can identify them. That’s true even if the documentation was done correctly. And we now know that during the bubble, it wasn’t – the lawyers had inexperienced interns working on this stuff. You can then either ignore the fine print, allowing securitizing banks to sweep the problems under the rug, or – as Judge Long has done – insist that the precise ownership position be known.

This may be a huge blow to the entire securitization industry. If given normal human fallibility, you can’t track down the true owners of a mortgage, then the ownership of thousands of houses in default, all over the country, comes into question. Whatever solution is found will inevitably involve increased costs.

And that means that the risks of securitization just got much greater.

Is this a pity? No. You see, the move to securitization actually cost home mortgage borrowers money. The average differential between Treasury bond yields and 30-year mortgage yields in 1971-76 (before securitization really got going) was slightly more than 1%. In 2000-06, before the housing finance crash made mortgages still more expensive, it was more than 1.5%.

In other words, securitization has added 0.5% to mortgage costs since moving away from the Jimmy Stewart mortgage-market model – something free-market theory says shouldn’t happen.

As you might expect, securitization was just a way for Wall Street bankers and lawyers (don’t forget the lawyers, who made out like bandits from all the documentation) to extract additional “rents” from the rest of us. In the long run, in a free market, this should not be able to happen.

In the ongoing battle between Wall Street, the Obama administration and the public interest, it will be interesting to discover whether the United States has a true free market.

If it does, securitization should die.

[Editor's Note: Throughout the global financial crisis, longtime market guru Martin Hutchinson has managed to call both sides of the market correctly. His warnings about the dangers of credit-default swaps - issued half a year before those deadly derivatives ignited the worldwide financial firestorm - would have steered investors clear of ugly bank-stock plays. Hutchinson even predicted where and when the U.S. stock market would bottom (a feat that won him substantial public recognition).

During the subsequent rebound, Hutchinson's calls on gold, commodities and high-yielding dividend stocks made winners of investors who took his advice.

Experts are taking notice. And so should you.

Hutchinson is now making those insights available to individual investors. His trading service, The Permanent Wealth Investor, combines high-yielding dividend stocks, gold and specially designated "Alpha-Bulldog" stocks into winning portfolios. And the strategy is designed to work in any kind of market- bull, bear or neutral.

To find out more about the Alpha-Bulldog strategy - or Hutchinson's new service, The Permanent Wealth Investor - please just click here.]

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]]> http://www.moneymorning.com/2009/11/10/securitization-market-crisis/feed/ 7 Investors Needn’t Fear a Double-Dip Recession http://www.moneymorning.com/2009/11/09/double-dip-recession-study/ http://www.moneymorning.com/2009/11/09/double-dip-recession-study/#comments Mon, 09 Nov 2009 07:43:19 +0000 Guest Editorial http://www.moneymorning.com/?p=9830 By Jon D. Markman
Contributing Writer
Money Morning

A new report contains some very good news for investors: Double-dip recessions are very rare.

That means that a drop back into recessionary conditions looks less and less likely even as unemployment creeps higher and has crossed the 10% threshold for the first time in a quarter century.

After reviewing U.S. economic history all the way back to the 1850s, Deutsche Bank AG (NYSE: DB) economists found that double-dip recessions are exceedingly rare: There have only been three episodes in which the economy has fallen back into recession within a year of a previous recession ending. And that’s out of 33 recessions that have taken place since 1854.

Indeed, when these double-dip downturns do occur, they happen under circumstances quite different from today’s situation.

Two of the three double-dips happened in the years prior to World War II – in 1913, and again in 1920. The more relevant example was the double-dip recession of the early 1980s, which was driven by the fight against double-digit inflation rates.

U.S. President Jimmy Carter imposed credit controls in March 1980, which resulted in a sharp but short-lived recession before the economy expanded again for 12 months. Then U.S. Federal Reserve Chairman Paul A. Volker hiked short-term interest rates to 20% in the summer of 1981, as he pushed the economy back into recession but dealt a death blow to inflation.

With deflation just as likely as inflation at the moment, a repeat of the 1980s just isn’t in the cards, as the Fed is set to keep rates at very low levels until the end of 2010.

Tom McClellan of the McClellan Market Report has some more potentially good news. As you can see in the chart above, the level of employment tends to follow stocks on a 12-month lag. It’s not a perfect match: The red numbers show the actual lags of important turning points over the last forty years. But the correlation is strong enough to provide one more piece of evidence that the “turn” in employment is perhaps four months or so in the future.

So while the public will continue to be preoccupied by a still rising unemployment rate and political chatter over the perceived failure of the Obama administration’s stimulus package – the market will continue to anticipate the improvement just over the horizon.

One final note: The economists at ISI Group note that outside of the United States, employment already started to grow in 11 economies. These include Japan, Canada, Singapore, Brazil, Russia, Sweden, and Taiwan. Stocks have sniffed out the fact that a global employment turn is already happening. The U.S. economy just isn’t fully participating yet, but it will.

Financial television was all atwitter last week during the Fed’s policymaking Federal Open Market Committee (FOMC) meeting, wondering if central bank governors would raise rates. They shouldn’t have wasted their breath. The Fed is very unlikely to raise rates next year – and if it does, it won’t be until the 2010 fourth quarter.

History shows the Federal Reserve has never increased interest rates while unemployment was still rising. In fact, the Fed has waited at least six months after the peak in unemployment and when the unemployment rate has dropped by 0.7% from its high before hiking rates according to the Deutsche Bank report. Moreover, during periods of low to no inflation – like we have now – the Fed can wait twice as long before raising rates.

http://www.markmancapital.net/charts/fed04

Given their forecast for unemployment – peaking this quarter before falling back to 9% in the latter part of 2010 – Deutsche Bank economists expect the first tightening of 0.25% to occur at the Fed’s August 2010 meeting. They see another 0.25% hike the ensuing September meeting to be followed by a 0.5% hike at the November meeting. After that, the team expects 0.5% hikes during alternating meetings. This would bring short-term interest rates to 1.25% next year and 3.25% in 2011.

Yet an ultra-low interest rate is not the only policy tool the Fed is using. Various rescue programs, along with unconventional “quantitative easing” strategies that saw the Fed make direct purchases of U.S. Treasury Department debt and mortgage securities, has more than doubled the Fed’s balance sheet to more than $2 trillion. Some believe that the Fed will start to sell off its assets, thereby pushing up long-term interest rates, before it raises its short-term policy rate. This would raise both mortgage rates as well as the government’s cost of borrowing.

Given the worries over the federal deficit as well as the fragile state of the housing market, I don’t think this is likely. Instead, I expect the Fed will increase the interest rate it pays to banks that park extra cash in its vaults instead of lending it out. This helps suck extra dollars out of the system while not disrupting the bond market with an influx of supply.

Starting late next year, look for the Fed to possibly raise its policy rate as well as the interest rate it pays to banks. Mortgage rates and other long-term interest rates should start creeping higher next spring as the Federal Reserve ends its direct purchase program. But a large spike in rates will likely be avoided as the Fed slowly sells the debt it’s already purchased. The Fed will try to avoid being seen as the heavy for any dislocation that might follow at all costs.

Stocks are poised to recover and to pounce toward new highs. They are oversold, the Fed is holding the line, and earnings growth is on track. The past week’s performance was anemic, but bulls still have control of the wheel.

How to play this: Just to keep it simple, continue to hold Vanguard Total World Stock Market Exchange Traded Fund (NYSE: VTI) to participate.

The ETF is currently trading at $42.21. The target price is $45. Set a sell stop at $39.49 in case of trouble.

The Week in Review

Stocks shrugged off a tough jobs report on Friday to post gains for the fifth straight day: The Dow Jones Industrial Average gained 0.2%, the Standard & Poor’s 500 Index gained 0.3%, and the Nasdaq Composite Index gained 0.3%. The Russell 2000 was the exception, falling 0.1%.

Industrial/finance/media giant General Electric Co. (NYSE: GE) was the day’s highlight, rising 6.2% on a pair of analyst upgrades. This helped push the Industrial SPDR (NYSE: XLI) up 0.9%. Other top performers included materials stocks, up 0.9%, as well as consumer discretionary stocks, up 0.9%. Financial stocks lagged as sellers focused on embattled insurer American International Group Inc. (NYSE: AIG) after it reported better-than-expected quarterly results. AIG sank 9.7% while the Financials SPDR (NYSE: XLF) dropped 0.4%.

The U.S. dollar was largely unchanged. Crude oil lost 2.8% as it flirts with the $80 level. Gold added 0.5% as it moved to yet another new high of $1,101.40.

Total volume fell 16.8% as just 1.08 billion shares traded on the New York Stock Exchange (NYSE:NYX). It was the lightest session since the rally peaked in mid-October, but was that significant?

Well, much of the loss of trading was probably attributable to traders’ distraction during the parade in Manhattan to celebrate the World Series victory of the New York Yankees. But that doesn’t explain the whole story.

Recent rallies out of oversold conditions in July, August, and October were accompanied by a much greater expansion of volume than the recent rally even when you don’t count Friday, so the light volume in the past week is a black mark against the bulls.  Breadth has also been lackluster as the percentage of stocks above their 10-day moving average has stalled near 66%.

Buying intensity has also failed to live up to the precedent set by previous rebounds. Since the March low, the first five days of a rebound rally have typically returned more than 5%, which shows up in a five-day Rate of Change chart like the one above. While the S&P 500 was able to snap a two-week losing streak, it has only gained 3.2% over the past five days. The only other sub-5% five-day rebound was during the brief bounce the end of June before the market dropped into the July low.

What this means is that U.S. stocks have put in a pretty meager rebound after the 90% downside day last Friday. These rallies typically last five to seven days before they fall apart. To receive a clear indication that stocks put in a durable bottom out Oct. 30, from which an intermediate-term rally can develop, we need to see a stronger rise in volume and an expansion in breadth.

I’m not saying it can’t happen. I’m just saying that clock is ticking. If the bulls don’t show decisive strength, then the bears will interpret that as a sign of weakness and jump back into the fray with claws and fangs flashing. Heading into the new week, we’re in “show me” mode, particularly for the badly deteriorating Nasdaq 100 stocks not named Google Inc. (Nasdaq: GOOG), Microsoft Corp. (Nasdaq: MSFT), Amazon.com Inc. (Nasdaq: AMZN) or Apple Inc. (Nasdaq: AAPL). Stay alert.

To close on an optimistic note, remember that history, economic fundamentals, corporate profits, and easy monetary policy all suggest that stocks should ultimately vault to higher highs.

It may take another harrowing drop to really engage the buyers, but I’m still projecting a rally through the end of the year. Watch the 1,070 level of the S&P 500 as your guidepost. If the bulls can get over that level and hold it for a week, bears will likely stand aside and give them a free past at least to 1,100, and possibly all the way to 1,200. If bulls are not able to surmount 1,070 in the next week or two, then we may be in for six months to nine months of pushing and shoving in a range between 985 to 1,070 that satisfied neither side but ultimately proves to be a springboard late next year.

Monday: The ISM Manufacturing Index rose farther into expansion territory in October with a reading of 55.7. This was well above the consensus estimate of 53 and September’s 52.6 result. Any reading above 50 indicates expansion. Much of the gain was due to some much needed improvement in the employment sub-index: The measure increased nearly seven points to 53.1 as manufacturers added to payrolls during the month.

I’ve been closely watching the rise in the new order gauge over the past few months, waiting for manufacturers to respond with new hiring and expanded inventories as production ramps. Managers waited until the last second, but they had no choice – the economic recovery has forced them to replace their recession mindset with a more constructive outlook.

Tuesday: Consumer demand for new cars continues to recover even after the expiration of the government’s rebate program: Domestic auto sales jumped nearly 20% in October to an annual rate of 7.9 million vehicles. This was well ahead of the consensus estimate of 7.3 million vehicles.

Wednesday: The Federal Reserve ended its two-day policy meeting. As expected, interest rates were left unchanged since economic conditions “warrant exceptionally low levels of the federal funds rate for an extended period.” But policymakers did note recent stabilization in the housing sector and an uptick in consumer spending.

The only meaningful change was a $25 billion reduction, to $175 billion, in the amount of mortgage debt the Fed will purchase. While the Federal Open Market Committee members said the reduction was done to reflect “the limited availability” of the debt, my hunch is that they wanted to test the market’s reaction to a modest withdrawal of support as they plan their exit strategy.

Thursday: Initial jobless claims continue to decline and registered its smallest loss since January. The four-week average dropped for its ninth straight week to 523,750. This is down by 25,000 since September.

Friday: Consumers are rapidly reducing their debt burdens. The Federal Reserve reported that consumer credit fell by a larger than expected $14.8 billion in September. The bulk of the decline, some $9.9 billion, was due to credit cards and other revolving credit.

In conclusion, stocks are poised to recover and pounce toward new highs. They are oversold, the Fed is hold, and earnings growth is on track. The past week’s performance was anemic, but bulls still have control of the wheel. Just to keep it simple, continue to hold Vanguard Total World (NYSE: VTI) to participate. It’s at $42.21 currently. Target $45. Set a sell stop at $39.49 in case of trouble.

The Week Ahead

Monday: No major economic releases.

Tuesday: A number of Federal Reserve officials will speak, including the San Francisco Fed President Janet Yellen. She will be talking about the economic outlook and real estate in Arizona.

Wednesday: The Veterans Day holiday will be celebrated, but stock and futures markets will remain open. Retailer Macy’s Inc. (NYSE: M) will report earnings.

Thursday: Weekly initial jobless claims will be reported. Retailer Nordstrom Inc. (NYSE: JWN) and entertainment giant The Walt Disney Co. (NYSE: DIS) will report earnings.

Friday: An update on the trade balance and consumer sentiment. J.C. Penney Co. (NYSE: JCP) will report earnings.

[Editor's Note: New Money Morning contributor Jon Markman is a veteran portfolio manager, commentator and author. He is currently the editor of two investment-research services, Strategic Advantage and Trader's Advantage. For information on obtaining a two-week free trial to the daily commentary of the Strategic Advantage, please click here.

Markman is also an accomplished author and, as mentioned in this story, has his fourth book about to debut. That book is an annotated edition of the 1923 book, "Reminiscences of a Stock Operator" an investment classic that most experts rate as one of the top business books of all time. For more information on the book, which is due to debut in early January, please click here.]

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]]> http://www.moneymorning.com/2009/11/09/double-dip-recession-study/feed/ 11 Has Asia Dethroned Detroit as the Auto Sector Leader? http://www.moneymorning.com/2009/11/06/asia-emerges-as-auto-leader/ http://www.moneymorning.com/2009/11/06/asia-emerges-as-auto-leader/#comments Fri, 06 Nov 2009 07:20:34 +0000 Martin Hutchinson http://www.moneymorning.com/?p=9816 By Martin Hutchinson
Contributing Editor
Money Morning

Back in May I recommended that readers should buy shares in Ford Motor Co. (NYSE: F) on the grounds that the U.S. carmaker would gain market share from the bankrupt General Motors Corp. (OTC: MTLQQ) and Chrysler Group LLC. Ford’s third-quarter profit and healthy October sales growth show I called that one right. One doesn’t like to blow one’s own trumpet excessively, but if you’d followed my advice in May, you would today be sitting on a profit of nearly 50%.

However, while I admire Ford for its brilliant strategic decision not to cave in and accept government-sponsored bankruptcy, and wish it well in its future battles with GM and Chrysler, I’m not sure the company that Henry founded represents the future for the global automobile industry.

More likely – while Chrysler will become a money-pit that is closed only by political means, and GM will limp on as a smaller and marginally profitable U.S. and European producer – Ford will slim down to become a specialty producer of cars tailored to the tastes and needs of the U.S. market. It’s well known that the auto preferences of U.S. consumers differ greatly from those of their European counterparts.

It comes down to this: Ford should be able to make money by limiting its “world car” ambitions and focusing on those needs.

Detroit Will Need to Learn From Asia

In the world as a whole, the big auto story has been the continued advance of manufacturers from China and India.

In China, the cheap-money policy of the People’s Bank of China has helped fuel a continued boom in automobile purchases, to the point that 2009 vehicle sales in China will reach the 11 million mark – making the Asian nation a bigger auto market than the United States.

In fact, even if China were to suffer a recession, that market is likely to remain the world’s largest long-term – despite the fact that the U.S. market will recover substantially from its 2009 lows.

If China has the world’s largest automobile market, we should be paying attention to trends in Chinese manufacturing, because those guys will now possess economies of scale that in the long run should enable that country’s factories to undercut the cost structures of Western manufacturers.

From 10,000 miles away, the most interesting Chinese automobile manufacturer would appear to be Geely Automobile Holdings Ltd. (OTC: GELYF/Hong Kong: 175). Geely manufactures automobiles for China’s domestic market. More interesting, it has specialized in “pastiche” reproductions of famous Western brands, which sell at discounted prices to wealthy Chinese. It has several Mercedes-type models, some Ferraris and other Italian sports cars, and a Rolls Royce/Mercedes hybrid.

Of course, Geely can only do this because of China’s slowly improving, but-still-problematic disregard for intellectual property laws. However, in a world where China is the largest automobile market, it may well be that Geely’s approach to automobile design and manufacture is the wave of the future. Indeed, the ability to manufacture efficiently even in much-shorter production runs may bring this to the U.S. market.

One can imagine a business in which the customer could order a product tailor-made to his or her specifications from a catalogue that includes the broadest possible design cornucopia. If, for example, you want a 1924 Hispano-Suiza H6B, you’ll be able to have one. It makes a Hispano-Suiza H6B noise, and probably rides like the original. But it will also have modern safety features, low maintenance costs and a modern, efficient non-polluting engine.

In the immediate term, Geely has submitted a bid of around $2 billion to buy Swedish automaker Volvo from Ford. From Ford’s point of view, this makes sense.

Ford sold the luxury brands Jaguar and Land Rover to India’s Tata Motors Ltd (NYSE ADR: TTM) last year, having taken the view that high-quality/small-volume automobiles were tough to make money on, and had little synergy with its mainstream business. Selling Volvo would get Ford out of the specialty market altogether, and enable it to concentrate on its core Ford and Lincoln/Mercury brands. The only major impediment appears to be intellectual property: Ford owns a large number of Volvo patents and design specifications and doubtless regards Geely’s insouciant attitude to intellectual property as a threat.

Geely shares trade in the U.S. Pink Sheets, as well as in Hong Kong, and currently trade at about 13 times historic earnings.  But the share price has really run up – to the tune of about 800% – during the past year as the company became better-known to Western investors. At current levels, Geely shares are trading at about twice their inflated 2007 peak price, so investors should conduct their own due diligence and approach the stock with due caution.

India Enters the Picture

China is not the only source of new competition for the United States’ Detroit and Germany’s Wolfsburg. The Indian market has also been expanding rapidly, although it is still only about one quarter the size of the Chinese market.

Tata Motors appeared well placed in early 2008 in that market. However, its Jaguar/Land Rover purchase – made at roughly the market peak – made the company appear very unstable, indeed. Tata’s other new product venture – the Tata Nano, which is designed to sell for 100,000 rupees (about $2,300), a price that’s roughly 40% lower than rival offerings – also was delayed in September 2008, when Tata had to move its proposed manufacturing facility owing to local opposition.

The upshot: Tata looked to be in severe danger last winter.

However, Tata’s earnings in the quarter to September more than doubled from the same period in 2008, on only a 13% increase in revenue. Since the company also raised $750 million in convertible bonds during the quarter, the immediate cash flow worries have largely dissipated.

Moreover, the Nano introduction was a great success. Production is expected to ramp up to 250,000 vehicles in 2010-11, and the car is expected to maintain a large price advantage over competitors for at least a couple of years. Losses at Jaguar/Land Rover also are lessening, so Tata looks likely to survive and grow rapidly in the years to come.

Like Geely, its shares have run-up sharply in the last few months, but look like a sound long-term investment.

In Europe and the United States, the automobile sector looks mature and not very interesting. In Asia, however, there is true growth ahead. Asia also possesses companies such as Geely and Tata, which are trying innovative strategies to capture that growth. As an investor, I prefer to go where the growth is, even if relative prices are higher and risks more substantial.

[Editor's Note: Throughout the global financial crisis, longtime market guru Martin Hutchinson has managed to call both sides of the market correctly. His warnings about the dangers of credit-default swaps - issued half a year before those deadly derivatives ignited the worldwide financial firestorm - would have steered investors clear of ugly bank-stock plays. Hutchinson even predicted where and when the U.S. stock market would bottom (a feat that won him substantial public recognition).

During the subsequent rebound, Hutchinson’s calls on gold, commodities and high-yielding dividend stocks made winners of investors who took his advice.
Experts are taking notice. And so should you.

Hutchinson is now making those insights available to individual investors. His trading service, The Permanent Wealth Investor, combines high-yielding dividend stocks, gold and specially designated "Alpha-Bulldog" stocks into winning portfolios. And the strategy is designed to work in any kind of market- bull, bear or neutral.

To find out more about the Alpha-Bulldog strategy - or Hutchinson's new service, The Permanent Wealth Investor - please just click here.]

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