None the wiser, I also did not succeed in capturing a leprechaun and finding the gold during my visit last week to the Emerald Isle. However, the beautiful Irish scenery, hospitality and “open for business” attitude resulted in a very successful trip and will keep me going back in search of the “buried treasure”.

Nervousness about the financial system was still paramount as investors realized that none of the problems were likely to be fixed anytime soon. The upshot of the week’s trading was a further weakening in credit markets, judging by the elevated credit spreads. Global stock and bond markets ended another volatile week on a mixed note, whereas crude prices gained surprisingly little on the impending arrival of Hurricane Gustav and a festering geopolitical situation with Russia.

Next, a tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. As expected, words such as “banks”, “prices”, “credit” and “financial” featured prominently in my reading matter.

I do believe we are still in a primary bear market where stock markets are, at best, faced with a prolonged convalescence period characterized by sub-optimal returns. Whether significant further declines will take place from these levels and valuations overshoot to bargain levels is anybody’s guess.

However, in the short term I give the nascent stock market rallies the benefit of the doubt provided the mid-July lows are sustained. For any rally to become more enduring will require further base building and an eventual shift in central bank policy to targeting GDP growth rather than inflation.

The rally’s lack of breadth, however, is worrying, causing Richard Russell (Dow Theory Letters) to warn: “If July 15 was a true bottom, the market should be roaring up today, and that’s not what’s been happening. Caution is warranted!”

But we should also take note of the fact that 64% of stocks in the S&P 500 are currently trading above their 50-day moving averages, as pointed out by Bespoke. “As shown in the chart below, the reading has been creeping higher and higher since mid-July, and looks to be on its way to the 80% to 85% levels seen twice over the last year. Readings above 50% are signs of a healthy market, and it hasn’t been above 50% for much of 2008.”

Seasonality indicates that “September has firmly secured the rank as the worst month of the year” (Stock Trader’s Almanac), but that a year-end rally typically starts in late September / early October.

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

Economy
“Global business sentiment remains weak and fragile and consistent with recession in the US, Europe and Japan,” according to the Survey of Business Confidence of the World conducted by Moody’s Economy.com. The survey results suggest that the Asian economy (ex Japan) continues to post growth that is near its potential. “Across the globe, sentiment is consistent with an economy that is near recession. Pricing pressures remain very elevated, but fell notably last week.”

The minutes from the FOMC meeting of August 5, released on Tuesday, indicate that committee members were concerned about the near-term risks to growth. Most participants expected inflation to fall, although they remained wary about upside risks to inflation. Given the problems in financial markets, members did not view current monetary policy as overly stimulative.

Other economic reports released in the US during the past week included the following:

• The GDP growth rate in the second quarter was revised upward to 3.3% from 1.9%, exceeding expectations. In the first quarter, real GDP increased by 0.9%. The better-than-expected outcome did not change most economists’ view that the economy was weakening, with the beneficial effects of rebate checks and foreign demand fading fast. Corporate profits edged down for the fourth straight quarter, falling twice as fast as in the first three months of the year.

• New orders for durable goods rose by 1.3% in July, surpassing expectations for only a slight increase. Core capital goods orders also surprised on the upside, increasing by 2.6% over the month.

• Existing home sales increased by 3.1% over the month in July, according to the National Association of Realtors. This increase put the annualized pace of sales up to 5 million units. However, substantial slack persisted, with inventories hitting a record high of 11.2 months. Furthermore, the median price of an existing house declined by 7.1% in year-ago terms, slightly worse than in June.

• Personal income tumbled by 0.7% in July after rising by 0.1% in June. Excluding the tax rebate effect, disposable personal income rose by 0.5% in July, up from 0.3% in June. Spending growth slipped to 0.2% from 0.6% the previous month. Real spending fell by 0.4% as price growth remained high. The core PCE deflator rose by 0.3%, matching the fastest rate since September, while the top-line deflator rose by 0.6%. The saving rate fell back to 1.2% from 2.5% in June but remained inflated by rebates.

Source: Slate

Summarizing the US economic situation, John Mauldin (Thoughts from the Frontline) said: “Even many mainstream economists are now suggesting we will be in a recession by the fourth quarter, if we are not in one now. The recovery, when it comes, will be tepid until credit spreads signal an end to the credit crisis. It is going to be Muddle Through for 2009. This is NOT going to be good for the stock market. When will it be safe to get back into the water? Pay attention to credit spreads.”

Data releases from Europe and Japan underlined rapidly deteriorating economies flirting with recession. The Japanese government announced a $107 billion set of fiscal measures, including tax cuts and larger government-guaranteed loans, in response to the weakening economy.

Week’s economic reports

Source: Yahoo Finance, August 29, 2008.

In addition to the Fed releasing its beige book on September 3 and interest rate announcements by the Bank of England and the European Central Bank on September 4, next week’s US economic highlights, courtesy of Northern Trust, include the following:

1. ISM Manufacturing Survey (September 1): The consensus for the manufacturing ISM composite index is 49.5 vs. 50.0 in July. If the consensus forecast is accurate, it would be consistent with weakness in other parts of the economy. Consensus: 49.5 versus 50.0 in July.

2. Employment Situation (September 5): Payroll employment in August is expected to have dropped by 85,000, taking the tally of consecutive monthly declines to eight. The jobless rate is predicted to have held steady at 5.7%. Consensus: Payrolls: -75,000 versus -51,000 in July, unemployment rate: 5.8% vs. 5.7% in July.

3. Other reports: Construction spending, auto sales (September 2), factory orders (September 3), ISM non-manufacturing (September 4).

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

A summary of the release dates of economic reports in the UK, Eurozone, Japan and China is provided here. It is important to keep an eye on growth trends in these economies for clues on, among others, the trend of the US dollar.

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

Source: Wall Street Journal Online, August 31, 2008.

Equities
Global stock markets, in general, were mixed during the past week. The MSCI World Index rose by 0.6%, with the MSCI Emerging Markets Index closing unchanged.

Among mature markets, the US stock indices were mostly lower, but European stocks turned in good performances, for example Italian Comit 30 Index (+2.6%), French CAC 40 Index (+1.9%) and German XETRA Dax Index (+1.3%). Australia (+4.1%), Japan (+3.2%) and Canada (+2.4%) also shrugged off the gloomy economic outlook and moved higher.

The emerging markets category saw solid gains in Hong Kong (+4.3%) and Taiwan (+2.0%), whereas large declines were registered by Pakistan (-7.9%), Russia (-3.3%) and Turkey (-2.6%). The Russian Trading System Index ( 16.3%) and the Chinese Shanghai Composite Index (-13.6%) were the worst performers for the month of August.

With the exception of the Russell 2000 Index (+0.3%; YTD -3.5%), the US stock markets closed lower as shown by the major index movements: Dow Jones -0.7% (YTD -13.0%), S&P 500 Index +0.7% (YTD -12.6%) and Nasdaq Composite Index -2.0% (YTD 10.7%).

Particularly noteworthy, the MSCI World Index has outperformed the MSCI Emerging Markets Index over the past month (-1.6% vs -8.2%), past three months (-11.9% vs -21.0%), YTD (-15.4% vs -23.2%), and also since the stock market peaks of October 2007 (-20.7% versus -28.6%).

The Russell 2000 Index is trading above both its 50- and 200-day moving averages, whereas the Dow Jones Industrial Index, S&P 500 Index and Nasdaq Composite Index are above their 50-day averages but still below the important 200-day line – often used as an indicator of the primary trend.

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

The thrifts and mortgage finance group (+16%) was the best-performing group for the week, led by Freddie Mac (FRE) and Fannie Mae (FNM), up 61% and 37% respectively. This is a strong reversal from being the worst-performing group during the previous week with a decline of 23%. The stocks were driven down recently by speculation on whether a government bailout was imminent, a prospect that would probably wipe out the equity holders. Those concerns seemed to diminish last week after some analysts estimated that the firms had enough capital to last at least until next year.

The homebuilding group was the second-best performing group, gaining 9% on housing reports being interpreted as showing signs of a stabilizing market.

The trucking group (-7%) was the worst performer, led by its single member, Ryder System (R). A brokerage analyst downgraded the trucking sector, predicting that freight volumes in the peak shipping season through November might be weaker than expected because of the soft US economy.

The Internet retail group (-6%) was the second-worst performer, led by its largest member, Amazon (AMZN). A blog posting by a newspaper reporter raised the topic again of how well Amazon’s Kindle electronic book reader was actually selling.

Fixed-interest instruments
Global government bond yields were mostly lower during the past week, as investors dismissed the threat of inflation and priced in concerns about a global recession.

The ten-year US Treasury Note declined by 4 basis points to 3.83%, the UK ten-year Gilt yield by 13 basis points to 4.48%, the German ten-year Bund yield by 5 basis points to 4.17% and the Japanese ten-year bond yield by 5 basis points to 1.42%.

Currencies
The US dollar maintained its recent rally as the currency benefited from the view that foreign central banks will be quicker to cut rates than the Fed will be to tighten rates.

The past week saw the greenback rising against the euro (+0.7% – a six-month high), the British pound (+1.6%), the Swiss franc (+0.2%), the Australian dollar (+1.2%) and the Canadian dollar (+1.6%).

Sterling has come under further selling pressure as pessimism about the UK economic outlook intensified, dropping to a 12-year low on a trade-weighted basis ahead of the Bank of England’s interest rate announcement next week.

The Japanese yen was the only currency to gain against the US dollar during the past week, closing 1.1% higher on the back of better-than-expected economic data and the announcement of a $107 billion fiscal stimulus package.

Commodities
The dollar’s strength and growing concerns of slowing demand knocked dollar-denominated commodity prices as seen in the Reuters/Jeffries CRB Index, which declined by 0.8%.

West Texas Intermediate crude traded between $115.0 and $118.76 a barrel last week before closing 0.8% up at $115.46 on Friday. The gain was relatively small given the impending arrival of Hurricane Gustav and concerns about the geopolitical situation with Russia, but word from the Department of Energy that it would release strategic oil stocks to combat any disruption kept oil prices in check. (The Gulf of Mexico is responsible for 25% of US crude oil production and 15% of US natural gas production.)

The chart below shows the past week’s movements for the various commodities:

Now for a few news items and some words and charts from the investment wise that should be of help with keeping our investment portfolios on a winning path. As the Irish say: “Go n-eírí an bóthar leat. May the road rise with you.” And also wishing you a fabulous Labor Day weekend.

Hat tip: Barry Ritholtz’s Big Picture

YouTube: Take a load off Fannie
The story of Fannie Mae, as narrated by The Band.

Source: YouTube, August 24, 2008. (Hat tip: Barry Ritholtz’s The Big Picture.)

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(FRE) Words from the (investment) wise for the week that was (August 25 – 31, 2008)

With the exception of Friday, crude prices closed each day with a gain or loss of more than 1%, with US stocks doing likewise as sentiment waxed and waned on the back of a barrage of economic and corporate earnings reports. Economic data were mixed, whereas earnings were mostly better than feared. After all the action, the S&P 500 Index closed the week virtually unchanged, posting a small gain of 0.2%.

David Fuller (Fullermoney) re-emphasizes that the oil price is currently by far the most important factor in terms of global GDP growth. Consequently it is also a huge influence on the direction of various stock market indices, and big moves up or down have a psychological leash effect on currencies and other commodities.

Source: Financial Times, July 29, 2008.

Also center to the roller-coaster ride was Merrill Lynch (MER), plunging 11.6% on Monday, prior to announcing drastic steps to right its capital position on Tuesday. Its stock fell by 9.5% to a 10-year low on the news, but then rebounded to finish the day 7.9% higher.

Traders speculated that the latest capital raise was a sign that the worst was over for financials, but Meredith Whitney, analyst of Oppenheimer & Co and “godmother” of financials, had no illusions and said in an interview that 25 institutions would have to bolster their balance sheets within the next two months.

Offering some reprieve to the financial sector, the Fed, together with the European Central Bank and the Swiss National bank, announced that “emergency” lending facilities to bolster the money markets would stay in force until January 30. The facilities were implemented to improve liquidity arising from the credit market turmoil.

Formalizing the housing bill, President Bush signed into law legislation to support homeowners facing foreclosure and to offer a lifeline to Fannie Mae (FNM) and Freddie Mac (FNM).

Separately, the SEC is extending its temporary restriction on naked short selling on 19 financial institutions until August 12.

Next, a tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. It is quite obvious that the key areas last week were “banks”, “prices”, “inflation” and “growth”, with “housing” and “financial” also prominent. As the saying goes: A picture paints a thousand words …

Volatility of the S&P Financials Index is as high as it has been since 1987. Gavekal states: “Spikes in volatility have often signaled a turning point.” I maintain that what is good for the banks is good for the overall stock market and vice versa, and one should pay particular attention to this group.

Stock Trader’s Almanac alerts us that August typically ranks among the worst months of the year and anchors the middle of the worst four months of the year, namely July to October. “The month is generally weak in the first half, then stronger in the middle,” says editor Jeffrey Hirsch.

This is an exceptionally difficult market to read. In my opinion, we are still in a primary bear market, but this does not preclude powerful rallies. From a short-term perspective, a decline below the July 28 lows will cause a serious headwind for any recovery rally, whereas a drop below the mid-July lows will significantly increase the risk of another general sell-off. On a multi-year horizon, we are probably in for an extended convalescence period of relatively low returns. In short, not a dartboard market, but also not necessarily bad from a canny stock-picking perspective.

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

Economy
“The global economy continues to skirt recession,” according to the Survey of Business Confidence of the World conducted by Moody’s Economy.com. “While the US, European and Japanese are contracting moderately, the Asian economy continues to experience growth that is near its potential and South American growth is just below potential.”

Economic reports released in the US during the past week included the following key data:

• Real GDP increased by 1.9% in the second quarter at an annualized rate, below the consensus expectation of 2.4% growth. Over the past year, real GDP has increased by 1.8%. Growth was 0.9% in the first quarter, revised downward from 1% last month. Relative to the first quarter, trade and consumer spending were positives for growth; there was also a smaller decline in homebuilding. A large drop in inventories offset these positives to some extent.

• The economy lost fewer jobs than expected in July, but it is certainly not out of the woods yet. Payrolls fell by 51,000, while losses for the previous two months were revised downward. However, the unemployment rate increased by 20 basis points to 5.7% – the highest level in more than four years.

• The Institute for Supply Management’s Manufacturing Index inched slightly lower to 50 for July compared with June’s 50.2. The modest dip is about on par with expectations and the ISM Index is consistent with a sluggish economy that has avoided a severe downturn.

• The Conference Board Index of Consumer Confidence rebounded slightly in July, rising to 51.9 from June’s 51.0 (revised from 50.4).

Summarizing the economic situation, Drew Matus, economist of Merrill Lynch, said in a research report: “Recent data releases and reports suggest that the consumer will continue to be pressured on all fronts: income (or cash flow), wealth and credit. Consumers can spend using any of these buckets. However, with the labor market continuing to weaken, housing continuing to deteriorate and credit harder to come by, the outlook for spending remains bleak despite recent declines in gasoline prices.”

“The US may now be in a ‘very long’ recession that will drive the unemployment rate higher, with little that the Federal Reserve can do to help,” remarked Harvard University’s Martin Feldstein. “I don’t see recovery on the horizon,” Feldstein, who headed the National Bureau of Economic Research until June and serves on the group’s recession-dating panel, said in an interview with Bloomberg.

Hat tip: Barry Ritholtz’s The Big Picture, July 31, 2008.

As far as the Fed’s upcoming interest rate decision on Tuesday is concerned, Asha Bangalore (Northern Trust) said: “It is nearly certain the Fed will leave the Federal funds rate unchanged at the August 5 meeting. The market expects a higher Federal funds rate at the end of the year. We do not. The details of the GDP report point to significant weakness in the economy. Against this backdrop and financial market fragility, the Fed would only exacerbate the economic situation by raising the Federal funds rate in haste. Fighting inflation will have to remain on the back burner until financial and economic conditions improve. By that time, inflation is likely to be moderating as it is a lagging economic process.”

Asha’s colleague Paul Kasriel (Northern Trust) added: “If it walks like a recession and talks like a recession, it must be a recession. Is the Fed going to raise its funds rate target over the remainder of 2008? Not bloody likely!”

In the Eurozone, inflation accelerated to the fastest pace in more than 16 years, with the 15-nation number rising to 4.1% in July. Furthermore, economic sentiment declined to its lowest level in five years and the manufacturing PMI dropped to 47.4 in July from 49.2 in June. (A value below 50 means contracting activity.) Germany, the largest economy of the region, seems destined to record negative GDP growth in the second quarter.

Also, the data from Britain remain grim, with the Nationwide Housing Price Index falling for the ninth consecutive month in July (down 8.1% since a year ago), consumer confidence plunging to its lowest level since the survey began in 1974, and the manufacturing PMI dropping from 45.9 in June to 44.3 last month – the lowest reading since December 1998.

Moving to Asia, industrial production in Japan contracted 2% month to month in June, making it three down-months out of the past four. Inflation accelerated to 1.9% in June, the fastest pace in more than a decade.

China’s manufacturing PMI dropped below 50 for the first time since 2005, suggesting a contraction in manufacturing that is hurt by both slower exports and higher input costs.

In summary, a more pronounced slowdown in global economic activity is rapidly manifesting itself.

WEEK’S ECONOMIC REPORTS

Source: Yahoo Finance August 1, 2008.

In addition to the Federal Open Market Committee interest rate announcement (Tuesday, August 5) and Bank of England and European Central Bank rate decisions (Thursday, August 7), next week’s economic highlights, courtesy of Northern Trust, include the following:

1. Personal Income and Spending (August 4): The earnings and payroll numbers for June indicate moderate growth in income (+0.2%). Auto sales fell to an annual rate of 13.6 million from 14.3 million in May. Non-auto retail sales were lackluster, excluding price-related hikes in gas and food sales. All of the available information points to a steady reading of consumer spending in July. Consensus: Personal Income -0.2%, Consumer Spending 0.5%.

2. Other reports: Factory orders (August 4), Pending Home Sales (August 7), Productivity and Costs (August 8).

Click here or on the thumbnail below for a summary of Merrill Lynch’s economic and interest rate forecasts.

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

Source: Wall Street Journal Online, August 3, 2008.

Equities
Global stock markets, in general, ended the volatile past week in the red, with the Dow Jones World Index registering a loss of 0.6%.

The Japanese Nikkei 225 Average was the worst performer among developed markets, declining by 1.8%.

The emerging markets category included a mixed bunch, varying from Turkey (+14.4%), the Philippines (+2.9%) and India (+2.7%) that performed strongly, to the less fortunate markets such as Pakistan (-7.8%), Taiwan (-3.2%) and China (-2.2%).

The MSCI World Index has been outperforming the MSCI Emerging Markets Index over the past month (-2.5% versus -4.2%), the past three months ( 9.4% versus -12.6%) and the year to date (-14.0% versus -16.4%). (Click here for a comprehensive global stock market performance round-up.)

The US stock markets were mixed, with mid-cap and small-cap stocks outperforming their larger counterparts. The major index movements were: Dow Jones Industrial Index -0.4% (YTD -14.6%), S&P 500 Index +0.2% (YTD -14.2%), Nasdaq Composite Index 0% (YTD 12.9%) and Russell 2000 Index +0.8% (YTD -6.5%).

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

The paper products group was the best performer for the week, rising by 18%. Both members of the group, International Paper (IP) and MeadWestvaco (MWV), rose after posting better-than-expected earnings reports. The personal products group was the second-best-performing group, up by 14%, led by Avon Products (AVP), which reported earnings in excess of the analyst consensus estimate.

The real estate management and development group was the worst performer, down by 26%, led down by its single member, CB Richard Ellis Group (CBG), which reported earnings substantially below expectations. The specialized finance group (-7%) was also among the underperformers. Stock exchange operator NYSE Euronext (NYX) reported earnings that were slightly below the consensus estimate.

As far as corporate news was concerned, Exxon Mobil (XOM) – the world’s largest company by market capitalization – posted a 14% increase in net income to $11.68 billion, marking the largest quarterly profit in US history.

General Motors (GM) declined by 14%, swinging to a massive $15.5 billion second-quarter net loss as consumer preferences shifted away from large trucks and SUVs in the face of record gasoline prices.

Fixed-interest instruments
Government bonds gained ground as the global economic outlook worsened and the prospects faded of interest rate increases any time soon.

The two-year US Treasury Note dropped by 21 basis points during the week to close at 2.51%. Similarly, the UK two-year Gilt yield declined by 19 basis points to 4.86%, the German two-year Schatz yield by 17 basis points to 4.27% and the Japanese two-year bond yield by 3 basis points to 0.75%.

US mortgage rates also declined, with the 15-year fixed rate dropping by 7 basis points to 5.97% and the 5-year ARM 9 basis points higher at 5.95%.

Credit markets eased somewhat as shown by the slightly narrower spreads of both the CDX (North American, investment grade) Index and the Markit iTraxx Europe Crossover Index.

Currencies
Currency traders’ benign view of the US economic situation caused the US Dollar Index to rise by 0.9%.

Individually, the greenback gained ground against the euro (-0.9%), the British pound (-0.8%) and the Swiss franc (-1.3%), but lost marginally against the Japanese yen (+0.2%).

The Australian dollar declined sharply on indications that the Reserve Bank of Australia would seriously consider cutting interest rates at its policy meeting next week. With the Chinese manufacturing PMI falling below 50, concerns were also raised that Chinese demand for Australian commodities might have peaked.

Commodities
Crude oil prices seesawed during the past week, with West Texas Intermediate hitting a high of $128.60 and a low of $120.80, settling the week with a 1.5% gain as a result of an unexpected drop in gasoline inventories. Oil lost 11.5% during July – the biggest monthly decline in absolute terms in 25 years and in percentage terms since 2004 – on concern that global consumption is falling amid slowing economic growth.

Platinum (-5.5%) and palladium (-4.2%) came under heavy selling pressure as poor results from the vehicle manufacturers stoked fears of much weaker demand. Gold bullion (-2.1%) experienced further weakness, but silver (+0.8%) bucked the trend.

The chart below shows the past week’s performance of the various commodities.

Source: StockCharts.com.

Now for a few news items and some words and charts from the investment wise that will hopefully assist in preserving our capital in these demanding times. And remember the old Boy Scout motto: “Be prepared” for all eventualities.

Source: Slate

Barron’s: Nouriel Roubini – $2 trillion of credit-related losses

Source: Robin Goldwyn Blumenthal, Barron’s, August 4, 2008.

Charlie Rose: A conversation with Pimco’s Mohamed El-Erian

Source: Charlie Rose, July 24, 2008.

CNBC: Housing, economy still far from recovery – Greenspan
“Former Federal Reserve Chairman Alan Greenspan said the US is ‘nowhere near the bottom’ of the housing slump and is ‘right on the brink’ of a recession.

“In an exclusive interview on CNBC, Greenspan said the US economy is holding up ‘rather well’ considering the ‘extraordinary pressures from the financial sector’. But he added that a recession appears inevitable.”

Click here for the full article.

Editor’s comment: Greenspan has been the world’s worst economic forecaster.

Source: CNBC, July 31, 2008.

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(MER) Words from the (investment) wise for the week that was (July 28 – August 3, 2008)

Source: Lisa Benson, Slate

US stocks plummeted on Thursday after two days of gains as investors’ recent optimism was dented by renewed doubts about financials stocks, manifesting in the sector dropping 6.8% – its largest one-day decline in more than eight years.

In a rare Saturday session, the US Senate passed housing rescue legislation aimed at helping struggling homeowners avoid foreclosure and providing financial support to troubled mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), reported TheStreet.com. The bill, which cleared the House on Wednesday, now goes to President Bush.

Reuters highlighted that US banks’ direct primary credit borrowing from the Federal Reserve rose to the highest level ever in the latest week, reflecting the growing need of the banking sector to rely on the central bank for cheap funding. On the day of July 23, banks’ primary credit borrowings rose to $17.68 billion, the highest borrowing since September 12, 2001 when banks borrowed $45.5 billion in a single day.

No wonder John Paulson, who recorded what was thought to be the single biggest profit in the history of the hedge fund industry last year by betting on a financial collapse, is planning a new fund to provide capital to cash-strapped banks.

President George W. Bush, as reported in the Financial Times, also had his take (albeit unofficial) on matters: “There’s no question about it. Wall Street got drunk … it got drunk and now it’s got a hangover. The question is how long will it sober up and not try to do all these fancy financial instruments.”

Given all the shenanigans, Richard Russell (Dow Theory Letters) thought there was too much complacency. “… I guess everybody thinks the Fed or the Treasury is going to bail the whole economy out. Why worry, if you’re in trouble, call Mr. Bernanke, and he’ll drop a bundle of Federal Reserve notes in your mail box. Be sure the box is big enough,” said Russell a day after turning a youthful 84.

Now for a new feature of this report: A tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. It is quite obvious that the key areas last week were “bank”, “prices”, “inflation”, “oil” and “economy”. As the saying goes: A picture paints a thousand words …

Key to mapping out the intermediate stock market cycle is whether the July 15 levels for the S&P 500 Index (1,215) and Dow Jones Industrial Index (10,963) will hold. Specifically, the extent to which bank shares can sustain their moves above recent lows will be a vital determinant as to how well stock markets in general can rally from these levels. Short-term movements aside, do not expect a quick convalescence period.

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

Economy
The Federal Reserve’s Beige Book, released on Wednesday, noted slower growth since the last report issued on June 11. Weakness in consumer industries, housing and finance offset strength in IT and healthcare. Retail and wholesale price pressures were mounting, although there was little concern yet about wage inflation.

More specifically, the past week’s economic reports in the US included the following notable releases:

• The Index of Leading Economic Indicators (LEI) fell by 0.1% in June, following a revised 0.2% drop in May. The quarterly average of LEI is down 2.0% from a year ago, the largest decline in the current business cycle. Historically, such large year-on-year declines of the quarterly average of the Index were associated with recessions.

• Weakness continues to characterize the housing market. Existing Home Sales declined by 2.6% month on month in June, according to the National Association of Realtors. Sales declined to 4.86 million annualized units. Inventories are rising and the months of inventory are about flat at 11. The median existing home price is declining, with a year-on-year drop of 6.2%, but not as severely as earlier this year.

• The Census Bureau reported a -0.6% month-on-month decrease in New Home Sales in June. However, the Bureau revised the monthly sales figures upward back to March, and thus June sales were stronger than expected at 530,000 annualized units. The median new home price declined slightly in June, as did months of inventory. Months on the market, however, are rising.

Furthermore, US foreclosure filings more than doubled in the second quarter compared to a year ago, representing an increase of 121% from a year earlier and 14% from the first quarter, according to RealtyTrac.

Summarizing the economic situation, David Rosenberg, North American economist of Merrill Lynch, said in a research report: “Though fiscal stimulus will provide a lingering boost to 3Q, we expect GDP to plummet 2.5% in 4Q and see a similar decline in 1Q. In all, we have shaved our 2009 GDP forecast to -0.5%, a full percentage point lower than where it was previously, while 2008 is broadly unchanged at 1.5%.”

As far as interest rate policy is concerned, Asha Bangalore (Northern Trust) remarked: “It is … important to recognize that the Fed is not in a position to raise rates until there is financial market stability, the housing market crisis improves, and firms decide to expand their payrolls. Concerns about economic growth will prevail over inflation, for now. In other words, tough talk about inflation will continue but it cannot be translated into action in the near term.”

Across the pond, the UK was faced with a relentless stream of negative economic news. The minutes of the Bank of England’s (BoE) monetary policy committee meeting in June showed that the BoE was struggling to balance the downward price pressures of slowing economic growth against the upward price pressures of strong oil and food price growth.

A slew of weak data also came from the Eurozone, with the RBS/Markit composite PMI dropping from 49.3 in June to 47.8 in July, the lowest since November 2001 and clearly indicating a contracting economy. It appears unlikely that the European Central Bank (ECB) will hike rates any further in the second half of this year.

Elsewhere, Japan’s trade surplus was nearly 90% lower than last year’s surplus, and core inflation ballooned to a fresh decade high of 1.9% year on year in June.

WEEK’S ECONOMIC REPORTS

Source: Yahoo Finance, July 25, 2008.

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

1. Real GDP (July 31): Real GDP is predicted to have advanced at an annual rate of 1.5% in the second quarter, supported by consumer spending. The fiscal stimulus package accounted for the strength in consumer spending, a one-off event. Real GDP grew by 0.6% in the fourth of 2007 and by 1.0% in the first quarter of 2008. The forecast range for growth in GDP in the second quarter is 1.4% to 3.0%. This report will contain revisions for the period 2005:Q1 to 2008:Q1. Consensus: 2.4%.

2. Employment Situation (August 1): Payroll employment in July is predicted to have declined by 75,000 after a loss of 62,000 jobs in June. The forecast range is -150,000 to -10,000. The unemployment rate is projected to have risen to 5.6% in July from 5.5% in June. Consensus: Payrolls: -72,000 versus -62,000 in June, unemployment rate: 5.6% versus 5.5% in June.

3. ISM Manufacturing Survey (August 1): The consensus for the manufacturing ISM composite index is 49.2 versus 50.2 in June.

4. Other reports: Consumer Confidence (July 29), Construction Spending, Auto Sales (August 1).

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

Source: Wall Street Journal Online, July 27, 2008.

Equities

Global stock markets, in general, maintained their positive tone during the past week after the strong recovery of the previous week, with the Dow Jones World Index registering an increase of 0.9%.

The Japanese Nikkei 225 Average was the strongest performer among developed markets, rising by 4.2% – its biggest weekly gain for five months.

The real stars, however, were among the emerging markets, including Pakistan (+7.8%), Taiwan (+6.1%), South Korea (+5.8%), the Philippines (+5.2%), Indonesia (+4.8%) and India (+4.7%). On the other side of the scale, previous strong performers Russia (-8.6%) and Brazil (-4.7%) suffered as oil and commodities fell further.

The US stock markets were mixed, with smaller and technology stocks outperforming their larger counterparts, as shown by the major index movements: Dow Jones Industrial Index -1.1% (YTD -14.3%), S&P 500 Index -0.2% (YTD -14.3%), Nasdaq Composite Index +1.2% (YTD 12.9%) and Russell 2000 Index +2.5% (YTD -7.3%).

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

The managed healthcare group was the best performer for the week, rising by 13%. The Internet retail group was the second-best performer (+9%), led by Amazon.com (AMZN), its largest member, with better-than-expected earnings and guidance.

The thrifts and mortgage finance group was the worst-performing group, down by 14%. Washington Mutual (WM) was down 35% after it reported second-quarter losses in excess of expectations. Fannie Mae (FNM) and Freddie Mac (FRE), the two largest members of the group, were each down by more than 10%.

The consumer finance group was the second-worst performer, declining by 12%. The largest group member, American Express (AXP), reported second-quarter earnings below analysts’ consensus estimate.

Halfway through the second-quarter earnings reporting season in the US, the numbers have generally been better than feared. Of the 248 S&P 500 companies that have reported results, 72.2% have registered positive surprises, 4.8% have been in line, and 23.0% have missed expectations, according to Bloomberg.

Data from Thomson Reuters show that S&P 500 earnings so far are down by 17.9% versus a year ago, but 7.7% higher when excluding financials.

Fixed-interest instruments
Government bonds experienced a mixed week, with yields declining in countries/regions with poor economic data (Eurozone, UK, Japan) and rising where the economic numbers exceeded expectations (US – consumer sentiment, durable goods orders and new home sales).

For example, the two-year US Treasury Note increased by 6 basis points during the week to close at 2.72%, whereas the UK two-year Gilt yield declined by 11 basis points to 5.05% and the German two-year Schatz yield dropped by 10 basis points to 4.44%.

US mortgage rates also increased, with the 15-year fixed rate rising by 7 basis points to 6.05% and the 5-year ARM 16 basis points higher at 6.04%.

The three-month US Treasury Bill jumped by 35 basis points during the week to close at 1.69% as investors’ risk appetite recovered.

Credit markets eased somewhat as shown by the slightly narrower spreads of both the CDX (North American, investment grade) Index and the Markit iTraxx Europe Crossover Index.

Currencies

Currency traders’ benign view of the US economic situation, together with lower oil and commodities prices, caused the US Dollar Index to rise by 0.9%.

Individually, the greenback gained against the euro (-0.9%), the British pound (-0.3%), the Swiss franc (-1.3%), the Japanese yen (-0.9%) and the Australian dollar (-1.6%).

Commodities
Oil prices declined further during the week under review, with West Texas Intermediate sinking by 4.8% to $123.26 by Friday’s close. The crude price has declined by 16.3% since reaching a record high of $147.27 on July 11.

The correction in oil prices again weighed heavily on the entire commodities complex (especially precious metals), with traders reducing their commodities exposure on the back of mounting global growth concerns. The chart below shows the past week’s negative performance of the various commodities.

Now for a few news items and some words and charts from the investment wise that will hopefully assist in preserving our capital in these demanding times.

Source: Ken Catalino, Slate

Jon Stewart (The Daily Show): It’s the stupid economy
Jon Stewart rightfully gets confused with the various utterances about the economic outlook, and in so doing brings laughter to an otherwise serious matter.

Source: Jon Stewart, The Daily Show, July 16, 2008.

Bloomberg: Faber says Fannie, Freddie should split up, not get aid
“Marc Faber talks about the future of Fannie Mae and Freddie Mac, the global economy, and the outlook for stocks and commodities.”

Source: Bloomberg, July 23, 2008.

David Fuller (Fullermoney): Predicting the markets
“Predicting is among the most hazardous of professions, as you know, because we can only guess. Nevertheless we need to focus on these challenging questions, so here are my guesses:

“US 30-Year Treasury Bond futures – I think Bill Gross’ deficit forecast is probably right, and I also maintain that the US government will err on the side of inflation, as debtor nations invariably do. Therefore increased government borrowing is likely to face a buyers’ strike at some point, turning US 30-year T-Bonds into one of the better shorts of the decade. Tactically, I will look to short the rallies as they lose momentum.

“The US Dollar Index – While the US government does not want a currency freefall, it can ill afford a strong dollar because it needs an export led recovery. Moreover, while the dollar remains the world’s main reserve currency, the US is unlikely to kick its addictive habit of printing too many greenbacks. This will also lead to a buyers’ strike, eventually forcing the US Dollar Index lower, with an even bigger decline occurring against the Chinese renminbi and the currencies of other high-growth economies. Tactically, I will look to short rallies as they lose momentum.

“Gold – In a fiat currency world, with the main reserve unit enfeebled, and resources inflation continuing when global GDP growth increases, people everywhere will continue to regard gold as real money for investment purposes. This will eventually support an extension of bullion’s secular uptrend, once the current medium-term consolidation has been completed. Tactically, I will continue to buy following setbacks within the overall upward trend.

“Crude oil – Assuming and very much hoping that there will not be a military strike against Iran’s nuclear installations, I maintain that oil has peaked for the medium term, defined as anything from a few months to two years and occasionally even longer. However as with gold and many other resources, there is a scarcity factor for oil resulting from increasing costs of production and finite supplies of light crude. Also, demand will rise following any significant correction in prices, not least because cheaper oil will boost GDP growth. Therefore crude oil will eventually resume its secular uptrend following what I suspect will be a lengthy correction. Tactically, I would consider longs in petroleum futures and also oil drillers and equipment stocks on evidence of renewed support building following a significant setback.”

Source: David Fuller, Fullermoney, July 23, 2008.

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(FNM) Words from the (investment) wise for the week that was (July 21 – 27, 2008)

In Part 1 Roubini argues that the bear market is only half over, but that it is not Armageddon. He sees a “severe recession” that will last 12 to 18 months, but does not foresee the US sliding into a prolonged Japan-like economic malaise. Similarly, while a further 20% decline for the major US averages is not pretty, it will not be as bad as the bursting of the tech bubble or the Great Depression.

Click here or on the image below for Part 1 of the interview.

In Part 2 Roubini states that more than $1 trillion will be needed to solve the housing crisis.

“We have to find a solution where government intervention prevents a disorderly outcome” in the housing market that leads to a “systemic banking crisis,” Roubini says. The housing bill, which earmarks $300 billion to backstop mortgages after lenders agree to lower mortgage payments, is “a step in the right direction” but “doesn’t do enough,” he says, predicting the government will need to spend more than $1 trillion in total.

Roubini believes US house prices will ultimately fall by 30% from their peak – versus 18% to date according to the S&P Case-Shiller Index – “before bottoming out at some point in 2010”.

Click here for Part 2 of the interview.

In Part 3 Roubini says the US broker/dealer business model was “inherently unstable” and the four remaining major firms will not be independent in a few years. With US financial giants like JPMorgan (JPM), Citigroup (C) and Bank of America (BAC) dealing with internal issues, the most likely buyers are international financial firms or sovereign wealth funds, Roubini says.

Click here for Part 3 of the interview.

Source: Yahoo News, July 22, 2008.

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(JPM) Video Interview: Roubini – More pain, but not Armageddon

Furthermore, Treasury Secretary Henry Paulson’s plan to rescue the Government Sponsored Enterprises (GSEs), Fannie Mae (FNM) and Freddie Mac (FRE), left investors unconvinced.

The US government plan caused some agitation since Paulson was essentially asking for a blank check to ensure the funding backstop would be successful in helping the GSEs fulfill their role of providing financing for the US mortgage market. Debt holders were happy with the implications of the plan, but equity holders faced the possible dilution from a government purchase of the equity and/or the possibility of the equity becoming worthless.

As the credit crisis approached its first anniversary – literally a “year of living dangerously” – SEC Chairman Christopher Cox’s announcement that naked short selling of 19 financial companies, including the GSEs, would no longer be allowed, set the stage for a reversal of fortune.

The SEC’s announcement, together with a sharp drop in oil prices and a series of better-than-feared earnings announcements from US banks – including JPMorgan (JPM), Citigroup (C) and Wells Fargo (WFC) – triggered a recovery in investors’ risk appetite, resulting in a strong stock market rebound.

This type of event was precisely what Charles Kirk (The Kirk Report) was referring to when he said: “Technically, we are scraping against the bottom of the long-term trend channel in the S&P 500 but we need something to go right for a change for this constant selling pressure to end.”

Fed Chairman Ben Bernanke was in the hot seat on Tuesday, delivering his semi-annual monetary policy testimony before the Senate Banking Committee in Washington. In short, he abandoned his June assessment that the threat of an economic downturn had diminished, telling lawmakers that growth and inflation risks were increasing. There were “significant downside risks to the outlook for growth”, and “upside risks to the inflation outlook had intensified”, said Bernanke. His testimony had little impact on financial markets.

“So is the decline over?” asked Richard Russell (Dow Theory Letters). “I’ve said that I can’t see the market hitting bottom until at least the financials stop declining. Did the financials make the crucial turn to the upside yesterday? We should know shortly.”

David Fuller (Fullermoney) adds: “There is still plenty of fear and uncertainty out there. However, I think most stock markets have reached medium-term lows and should range higher in tradable rallies over at least the next month or two.”

On the other hand, Bill King (The King Report) sees more pain: “For about one year we tried to make two points: 1) If you’re not scared, you’re not doing your work; and 2) If you aren’t negative, there is no fathomable non-violent environment that would make you negative.”

In my opinion, it’s too soon to call a major market bottom, but the short-term picture has certainly improved for the better. Technical rallies aside, I still believe the convalescence period will not be an overnight affair. Why is it that Cat Stevens’ lyrics “… oh baby baby it’s a wild world …” keep mulling through my head?

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

Economy

“Global business confidence has remained in a tight range since late May consistent with a global economy that is barely growing. Developed economies including the US, Europe and Japan are contracting moderately, while most developing economies are expanding moderately,” reported the Survey of Business Confidence of the World conducted by Moody’s Economy.com.

A barrage of economic reports was released in the US over the past week (as summarized in the table below), none of which changed the outlook for economic growth, housing and inflation in any meaningful way.

Regarding the outlook for interest rates, Asha Bangalore (Northern Trust) said: “Chairman Bernanke’s testimony suggested that the Fed is on hold, for now. The Fed is in a tight spot and the best it can do in the months ahead is to help stabilize financial market conditions, with one of the prerequisites for this being an accommodative stance … given the backdrop of a housing market recession, a credit crunch, and weak real consumer spending.”

No short-term remedy for the economic woes exists, as John Mauldin (Thoughts from the Frontline) stated: “… we are in for a period of very tepid growth that will last through at least 2009. We have to work our way through the after-effects of the twin bubbles of housing and the credit crisis bursting. There is no magic Fed wand. That simply takes time. No (rational) government or Fed policy is going to change the facts on the ground (although they can make things worse). But, in the fullness of time, we will in fact get through this.”

It was not only in the US that surging inflation was on centre stage, but elsewhere in the world Thailand, Mexico, the Philippines and Turkey increased interest rates in reaction to mounting inflationary pressures.

Mildly good news, however, was that Chinese consumer price inflation declined from 7.7% in May to 7.1% last month, whereas the economy grew by 10.1% in the second quarter, down from 10.6% in the first – the fourth successive quarter in which growth has slowed and the lowest rate since the last quarter of 2005.

The annual rate of Eurozone consumer price inflation in June was 4% while last month prices in the UK rose by 3.8% in year-ago terms. Both figures were significantly higher than the European Central Bank and Bank of England’s inflation targets.

As widely anticipated, the Bank of Japan left the overnight call rate target at 0.5% following last week’s two-day monetary policy meeting.

WEEK’S ECONOMIC REPORTS

Source: Yahoo Finance, July 18, 2008.

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

1. Leading Indicators (July 21): Interest rate spread and supplier deliveries are the only two components likely to make a positive contribution in June. Stock prices, initial jobless claims, manufacturing work week, consumer expectations, real money supply and building permits are expected to make negative contributions. Forecasts of