Wednesday, August 30, 2006

8/30 Semiconductor Stocks Recently Lead, Cyclical Info or Light-Trading Noise?

August 30 (Econotech FHPN) – This article gives a brief update on equity markets, which have light pre-holiday trading, followed by a round-up of recent news in real estate, the economic outlook, emerging markets, globalization and geopolitics. Since this and my Aug 14 article (“After the Fed’s Pause,” link) have a lot of news excerpts, I am bringing back my earlier FHPN label, for "Fair, Honest, Principled News" as one goal for my blog.

U.S. semiconductor stock index/etf have been in a long and steep downtrend relative to the rest of the world’s equity markets since January 2004. E.g. the relative strength of SMH, semiconductor etf, vs MSCI World (ex US) index has declined about -50% over that period, with only very short relative strength counter-trend rallies, such as May, July and Nov 2005.

But since my last article a little over two weeks ago, the lagging U.S. semiconductor stocks are up about 10%, helping to lead the equity market upward, including yesterday, Aug 29, when SMH easily cleared its post mid-July rally highs, closing up 2%. Part of this recent strength may just be due to the fact that semiconductors had been among the hardest hit stocks in the sharp decline from the May 10 global equity markets peak, continuing down another month past the June 13 global equity market lows.

In addition to the recent signs of a little strength in semiconductors and the tech-laden Nasdaq 100, a couple of other very short-term movements in the global equity markets the past two weeks have been relative weakness in the MSCI emerging markets and the oil services stock indexes/etf's, which had been major leaders during the four-year bull market. Unlike the semiconductor stocks, they have been unable to top their highs from last week’s rally on the weaker-than-expected U.S. price inflation data.

It is still too early to tell whether this represents a significant change from the major trends of the nearly four-year old bull market of relative strength in emerging and international markets, energy, small cap and non-tech.

I am a little skeptical of a rally in the lagging U.S. semiconductor and technology sector on very light pre-holiday trading volume that is just now breaking through key regression trendlines over varying longer-term timeframes on the charts. Perhaps we’ll know better when trading volume picks up after Labor Day, since, as is well known, September is on average the worst month of the year for the U.S. stock market.

One Silicon Valley-based portfolio manager, when pressed on Bloomberg tv the other day as to why he favored tech stocks going forward in the second half of this year, only opined that they were high beta and thus would outperform, since in his opinion the markets seemed to be looking for higher risk, a usual rationale (which downplays the desirability of risk-adjusted excess return, alpha) during the standard fourth-quarter silly season in tech stocks that often begins in early October.

Prior to this business cycle, semiconductor and electronics technology stocks were often viewed as a leading indicator of global economic cyclical strength, especially in East Asian export-oriented economies.

E.g., “Taiwan's stock index had its biggest gain in six weeks, as the Federal Reserve suggested it may hold off further U.S. interest-rate increases and oil closed below $70 a barrel for the first time in two months. Exporters such as Taiwan Semiconductor Manufacturing Co. and Hon Hai Precision Industry Co. paced the advance.” (Bloomberg, Aug 30)

Equity Market Continues to Like Fed Pause Bet

As I noted in my June 2 article (“Did May’s Sharp Global Sell-off Signal…” link) and several follow-up articles since, the four-year cyclical bull market seems bruised but still intact following the sharp May 10 - June 13 decline.

Since their June 13 lows, equity markets have rallied sharply on each of the four occasions that the odds increased of a Fed pause or stop of its tightening cycle that I listed in my August 14 article, starting with the June 29 FOMC meeting, when 10-year Treasury yields peaked. Since then, these yields rapidly have declined about 40 bps.

A fifth equity rally opportunity came with the release of U.S. inflation data as my Aug 14 article was posted. This pushed key global equity indexes past the key levels noted in that article, taking out their previous June-July highs, putting in a “higher high” to go with their previous “higher lows” and confirming the global equity rally from June 13.

At this point, a Fed pause at its September and October FOMC meetings is strongly priced into the futures markets, at over 80% probability. The chance of one last rate hike before year-end has been around 40%.

In other words, the good news on a pause has been discounted in the equity and bond markets rally since June 13, with a halving of U.S. equity market volatility (VIX) since that time.

For equity markets to go forward from here, not only must the Fed pause scenario survive any future inflation fears, but so must the goldilocks soft landing scenario that forecasts continuation of good earnings growth, in the face of continuing concerns over a real-estate, consumer-led economic slowdown, exacerbated by the lagged effects of rising rates and high energy prices. (Bond market bulls are betting on a sharper slowdown.)

While the housing slowdown continues to draw enormous investor and media attention with each statistical release showing it getting worse, as of yet this hasn’t translated into enough concern about the overall economy to stop the post-June 13 rally. And as mentioned above, long-term rates have sharply declined the past two months, and crude oil futures are at a nearly five-month low.

When recognition of a “tipping point” in consumer confidence, which was reported to have sharply declined yesterday, Aug 29, and spending might occur is anyone’s guess. Nationwide annual housing price changes are hovering around 0%. Also being swept under the rug for the moment are a host of other concerns, including several obvious geopolitical risks in the Mideast and elsewhere, and the long-term U.S. dollar risk on twin deficits.

Comment on a Couple of Recent News Items

In the sections following this one, I show by a few key topics recent relevant quotes from news articles in the mainstream media (the few op eds are indicated by author’s name).

Please note very well that inclusion of a quote does NOT necessarily mean that I agree with its viewpoint, particularly in the final geopolitical section, always an area of considerable controversy and emotional reactions, but rather that I think these viewpoints are simply ones that might be considered in trying to make a little sense of this rather messy, confusing world.

One news item mentioned below was the recent deal cut by 1990's TMT equity bubble mega-star investment banker Frank Quattrone. I mention this here not because of the individual's story, Quattrone was highly regarded and supported by many prominent figures throughout his trials and may “receive as much as $120 million from former employer Credit Suisse,” according to news stories.

Far more significant is that an even more powerful form of private equity speculation than venture capital IPO’s in the late 1990s (which strongly contributed to the subsequent $7-8 trillion collapse of the equity bubble), leveraged buyouts, is once again massively misallocating global capital. Venture capital IPO's were presumably based on the premise of positive innovation, unlike private equity LBO's.

Yet very few seem to be overly concerned about the economic and moral implications of LBO’s oligopolistic (see excerpt on "club deals" in the globalization section below), speculative, very high return on leveraged legal looting (ROLLL). (Please see my Aug 14 article link for an extensive news summary on private equity.)

I start off the news summaries below with a quote from this week’s “Economist” magazine that goes to the essence of the economic problem with the housing bubble. I have tried to make a similar point re the bubble's massive hyper-speculative misallocation of global capital flows several times on my blog. Of course, the "Economist" has been wrong on the housing bubble’s impact for a long time, so I'm not sure citing it helps.

Not only is hyper-speculation poor economics, I also believe that the resulting endemic “free lunch” "won the lottery" mentality, especially of business (outrageously unjustified stock options) and political (corrupting lobby money) leaders, is a main underlying factor behind eroding morality in financial markets, corporate America, politics, popular culture, and also to the severe erosion in the standing of the U.S. in world public opinion.

With rampant financial speculation now the dominant feature of the U.S. economic landscape, what American freedom now stands for becomes a key question. What is America's compelling, positive tag line for its and the world's citizens, not only what it is allegedly fighting against, but what is it building and creating?

Admittedly I am guilty of overkill with news summaries on real estate in this and my Aug 14 article, but the sector remains critical for the prospects of the U.S. and global economy.

“Biggest Bubble in American History” Continues to Rapidly Leak

“This is the biggest bubble in American history: in real terms home prices have risen at least three times as much as in any previous housing boom … prices could simultaneously fall in enough places to give America its first nationwide price decline since the Great Depression. … The tech bubble left behind a modern capital stock that continues to yield productivity gains. In contrast, the investment stimulated by a property boom does little to boost long-term growth. Expensive houses merely redistribute wealth to home-owners from non-home-owners. Worse still, the boom has diverted resources away from productive sectors and caused households to save less, exacerbating America's economic imbalances. It is surely better for Americans to start saving in the old-fashioned way by spending less of their income rather than relying on rising asset prices.” (Economist mag, Aug 24)

“The real-estate market during recent years had many unhealthy economic and psychological effects. Soaring prices forced many people, especially young people buying their first homes and starting families, out of many markets. It pushed too many people into dreadful mortgages. It misallocated capital to construction for which there was no fundamental demand.” (WSJ, Aug 30)

“Investors are pushing prices for securities backed by mortgages and home equity loans to near record levels, in spite of data pointing to a slowdown in the US housing market. The rising prices – and falling yields – for these securities are an example of how the financial markets have been affected by the rising popularity of collateralised debt obligations (CDOs) … a counter-intuitive rally in an asset class that has been a source of growing public concern … CDO structurers and buyers are taking comfort from the belief that a slowdown in house price appreciation will not lead to a doomsday scenario of widespread house price declines.” (FT, Aug 24)

“sales of new homes in July fell 4.3% from June to a rate of 1.07 million units, a pace that is 21.6% slower than a year ago. The inventory of unsold homes on the market rose to a supply of 6.5 months, up from 4.2 months a year earlier, while the median price fell to $230,000 in July and is essentially flat compared with a year ago. (WSJ, Aug 25)

“Sales of previously owned homes fell in July to the lowest level in 2 1/2 years … off 11.2% from a year ago … inventory of unsold homes rose 3.2% to a record 3.85 million, a 7.3-month supply at the July sales rate, the highest since April 1993. The past year has seen the sharpest increase in inventories on record … The median price of a home sold last month was $230,000. That was up just 0.9% from the same month last year and marked the smallest year-over-year increase since May 1995.” (WSJ, Aug 23)

“Over the past year, the number of previously occupied homes listed for sale nationwide has risen nearly 40%. In some metropolitan areas, including Orlando and Phoenix, the supply has quadrupled.” (WSJ, Aug 23)

“Purchases and prices in areas of the country that didn't fully participate in the boom are now weakening as well, raising concern the slowdown nationally will be more pronounced … In the Midwest … sales slumped to the lowest level in almost nine years.” (Bloomberg, Aug 25)

“Housing starts fell 2.5% in July to an annual rate of nearly 1.8 million units following a 5.7% plunge in June. The pace of new-home construction is off nearly 21% from its peak in January and is 13.3% lower than a year ago. Similarly, permits for new construction … were down 6.5% from June to an annual rate of 1.75 million, and are running almost 21% lower compared with last year … the rising rate of cancellations, which by his latest estimate has increased to 7.4% of new sales, up from 3.5% a year ago.” (WSJ, Aug 17)

“builders will be much more aggressive than individual homeowners in cutting prices … home prices in 2007, nationwide, will be up slightly less than incomes for the first time in years. In the first quarter of 2006, Freddie Mac data showed that 88% of refinancing was equity take-out refinancing, which is about the highest it’s ever been … something we’ve never seen before, was the fact that in more than 50% of the equity take-out refinancings, the homeowner refinanced into a higher rate to take out equity … Over the last six years, the boom in housing has created $5 trillion more value in homes than mortgages have gone up … this is going to be a problem down the road but we don’t think it is close to a problem yet.” (Scott Simon, Pimco’s website, Aug 2006)

“a typical $250,000 three-year adjustable-rate mortgage with a 2% rate-hike cap … After the second adjustment, the monthly payment is $1,748, a $625-per-month increase … • 32.6% of new mortgages and home-equity loans in 2005 were interest only, up from 0.6% in 2000 • 43% of first-time home buyers in 2005 put no money down • 15.2% of 2005 buyers owe at least 10% more than their home is worth • 10% of all home owners with mortgages have no equity in their homes • $2.7 trillion dollars in loans will adjust to higher rates in 2006 and 2007 … At the end of 2003, 1% of WaMu's [Washington Mutual] option ARMS were in negative amortization (payments were not covering interest charges) … At the end of 2005, the percentage jumped again to 47%. By value of the loans, the percentage was 55% … WaMu's situation is the norm, not the exception.” (Lon Witter, founding partner at Witter & Westlake Investments, Barron’s, Aug 21)

“discounts are almost entirely missing from the statistics on new-home prices reported by the government and on existing-home prices reported by the National Association of Realtors. As a result, home prices may now be falling, despite what the official numbers show, many economists say. The use of rebates … making the real estate market look healthier than it may truly be and by preventing a snowballing decline in home prices.” (NYT, Aug 25)

“The home-builders association says interest in new home auctions is up as builders experience an increase in contract cancellations -- 30% this summer, compared with 15% last summer. Builder confidence, as measured by the trade group's monthly survey of its members, is at a 15-year low.” (WSJ, Aug 25)

“The average for 30-year fixed mortgage rates for the week ended Aug. 24 was 6.48%, down from 6.52% a week earlier, Freddie Mac said in its weekly primary mortgage market survey. A year ago, the rate averaged 5.77%. The average for 15-year fixed-rate mortgages this week was 6.18%, down from 6.20% a week earlier but up from the year-earlier 5.35%.” (WSJ, Aug 25)

“the number of first-time homebuyers dropped to a 25-year low last year … [former BoE economist] Vosa says. ``The risk is at some stage, the value of the housing stock falls precipitously because there are simply no buyers left.'' … Bank of England governor Mervyn King says … ``Clearly, in the long run, the market requires first time buyers to come in and provide base demand.''” (Bloomberg, Aug 18)

“Among the states where home prices rose more than the national average from 2000 to 2005, John Kerry won 155 electoral votes in 2004, compared with just 55 for President Bush. But among states where home prices rose less than the national average, Mr. Bush gained 231 electoral votes to just 97 for Mr. Kerry.” (NYT, Aug 26)

Btw, I’ve noted the same thing several times on my blog, from the viewpoint of the negative effect of over-reliance on real estate speculation by the leaders and active supporters of both political parties, but especially "blue state" "liberal" Democrats.

Macroeconomic Outlook Tilt toward Fed Pause Continues for Now

“Investors are betting not only that the Fed is done raising its target rate for overnight loans between banks, but that the next step will be to reduce interest rates after the central bank left its target rate at 5.25 percent on Aug. 8. The 5.185 percent yield on Eurodollar futures maturing in June 2007 shows traders expect the Fed to cut rates by about a quarter percentage point by that date. Eurodollar futures, which are tied to expectations for three-month U.S. interest rates, have historically averaged about 21 basis points higher than the overnight lending rate.” (Bloomberg, Aug 28)

“The index of leading economic indicators unexpectedly dropped in July, yet another sign that economic growth will continue to slow over the next three to six months. The 0.1 percent decline followed a 0.1 percent gain in June … The index dropped at an annual rate of 1.4 percent over the last six months, the worst performance since February 2001 … The index isn't signaling a contraction: it would take a 3.5 percent annualized drop during a six-month period to signal a shrinking economy, according to the Conference Board.” (Bloomberg, Aug 18)

“Federal Reserve officials may be prepared to live with a pickup in inflation over coming months as they consider the cost to housing and jobs of higher interest rates … Richard Berner, chief U.S. economist at Morgan Stanley in New York [said] ``The Fed may implicitly be choosing a slightly higher inflation objective than previously thought.'' … Berner and his counterparts at Lehman Brothers Holdings Inc. and JPMorgan Chase & Co. detect a more patient stance, and say Bernanke may be wary of the costs of being more aggressive in reducing inflation.” (Bloomberg, Aug 29)

“If the business investment binge is a no-show, they [some economists] say, a contraction in the economy becomes more likely. … ``It makes little sense for businesses to accelerate their capital-spending plans at a time when final consumer demand, the largest source of demand, is decelerating,'' says Jan Hatzius, chief U.S. economist with Goldman Sachs.” (Bloomberg, Aug 28)

“A slump in housing, near-record oil prices and the highest Fed interest rates since 2001 have prompted some economists to speculate the world's largest economy may slip into recession next year after five years of expansion. David Rosenberg, chief North American economist at Merrill Lynch & Co., has said there is a 40 percent change of such a slump. (Bloomberg, Aug 25)

“The sacrifice ratio measures how much unemployment has to increase to bring inflation down by 1 percentage point. In the U.S., the ratio has risen to 4 percent from 2 to 3 percent during the mid-1980s, according to Fed economists.” (Bloomberg, Aug 22)

“The taxable profits of corporate America will fall 8 per cent next year and remain on a downward trajectory until 2010, a new study by the Congressional Budget Office predicts. The CBO estimates that total taxable profits will inch up in 2008 but fall again in 2009 and 2010, and will not recover their current level in nominal cash terms for almost a decade.” (FT, Aug 17)

“”The Fed seems to be moving from a pause, which connotes further rate increases, to a full-fledged stop,'' said Paul Kasriel, director of economic research at Northern Trust Securities in Chicago and a former Fed economist. ``The next move is more likely to be a cut in rates.''” (Bloomberg, Aug 30)

“As far as I know, Nouriel Roubini … is the only well-known economist flatly predicting a housing-led recession in the coming year. Most forecasters consider his call alarmist, and many Federal Reserve officials remain optimistic … While I don’t share Mr. Roubini’s certainty, I see his point: housing has been the main engine of U.S. economic growth over the past three years, and with that engine now going into reverse, it’s hard to see how we can avoid a serious slowdown.” (Paul Krugman, NYT, Aug 25)

“The likelihood of a recession has risen since 2005 but remains at a little less than 20 per cent. Essentially, the cautionary message from the convergence in short- and long-term bond yields is counter-balanced by less negative data elsewhere … Were the [Fed] to … push the Fed Funds Target Rate up by another half a percentage point, the recession probability indicator would probably rise above 50 per cent.” (Simon Ward, investment strategist, New Star Asset Management, FT, Aug 17)

“Economists lowered their forecasts for Japan's 2006 economic growth after the nation's second- quarter expansion was below estimates and amid concern exports will ease as the U.S. economy cools. Japan's gross domestic product will expand 2.7 percent this year, according to the median estimates of 13 economists surveyed by Bloomberg News. That's below the 3.1 percent forecast by economists last month.” (Bloomberg, Aug 24)

“Federal Reserve Bank of Dallas President Richard Fisher said Wednesday inflation has been running higher than he'd like to see, and said the central bank must make sure price pressure remained contained … "the slowing of housing and consumption frees up resources for investment and a more balanced economy," he said.” (WSJ, Aug 30)

“The US Federal Reserve is wrong to focus on core measures of inflation that exclude energy prices, Charles Bean, chief economist at the Bank of England, has suggested. It should focus instead on headline inflation, which is much higher, he argued. Including energy and food costs, US consumer price inflation is running at an annual rate of 4.1 per cent, against 2.7 per cent for core inflation.” (FT, 8/27)

“the rate of change in sales by new-car dealers, comparing the most recent 12 months with the 12 months before that; it is adjusted for inflation … if the figure is down 2 percent or more, a recession is either under way or set to begin within a few months. The figure fell to a negative 2.4 percent when June sales figures were released … In July, sales at gasoline stations accounted for 10 percent of all retail sales, the highest figure in decades.” (NYT, Aug 19)

“``frankly, nobody knows with precision how the dynamics of the global economy affect these lags or the practicability of our policies,'' [Dallas Fed Pres] Fisher said. Economists and analysts who say the Fed has stopped raising interest rates or will keep boosting them in coming months are ``only guessing.''” (Bloomberg, Aug 16)

Emerging Markets

“China's government has been throwing up some new hurdles for foreign investors in recent months, including increased scrutiny of foreign-backed mergers … government's growing preoccupation with helping China's expanding universe of domestic companies and pressing social issues such as poverty and wealth disparities. Top leaders insist that fast-growing China, the developing world's biggest recipient of foreign investment for many years running, isn't closing off its economy … [China] lets foreign businesses compete in its domestic markets to an extent that few if any developing countries have matched … China has systematically stripped away many of the previous barriers to entry for foreign companies. Roughly 280,000 companies backed by foreign investors operate in China … [government] giving prominent media exposure to those who support increased economic openness.” (WSJ, Aug 30)

“China's top planning agency said an oversupply of steel in the country, the world's biggest producer of the metal, may depress prices and hurt steelmakers' profits, and warned that the industry ``can't blindly pursue growth.' … statement was issued as Baoshan Iron & Steel Co., China's biggest steelmaker, posted a 27 percent decline in second-quarter profit yesterday.” (Bloomberg, Aug 30)

“Of the 30 BRIC [Brazil, Russia, China, India] -related equity funds tracked by Bloomberg data, 75 percent were started in the past year. Assets in 12 of the biggest have more than doubled to $10 billion in 2006 … [MSCI] BRIC Index has gained 25 percent this year. That compares with an 8.9 percent advance in the broader MSCI Emerging Markets Index … All four markets have gained more than the MSCI index since their troughs in mid-June, with the dollar-denominated Russia Trading System Index jumping 33 percent.” (Bloomberg, Aug 17)

“OAO Gazprom's weighting in the [MSCI] Emerging Markets Index will almost double in September, when the world's biggest natural-gas producer becomes the largest component of the benchmark … [Its] shares have jumped 56 percent this year … Since 2004, Gazprom's market value has surged fivefold to $277 billion … bigger than every other publicly traded company in the world except Exxon Mobil Corp. and General Electric Co ... The higher weighting will raise Russia's representation in MSCI's index to 11.1 percent, making it the third-largest emerging market worldwide … will trail only South Korea and Taiwan.” (Bloomberg, Aug 18)

“China's statistics bureau has set up a special department to investigate cases of data being falsified by government officials. ``Some leaders, seeking to advance their careers, interfere in the statistics, and encourage statistics bureau officials to inflate data,'' the Beijing-based National Bureau of Statistics said in a statement on its Web site yesterday.” (Bloomberg, Aug 18)

“[China] public companies are required to meet international accounting standards by next year, spurring demand for accountants. The country has 69,000 licensed accountants and needs more than 300,000, says Chen Yugui, secretary-general of the Chinese Institute of Certified Public Accountants.” (Bloomberg, Aug 15)

“Vietnam's $3 billion garment industry, which supplies Nike Inc. and Limited Brands Inc., may see a surge in bankruptcies because of rising labor costs and competition from China, the nation's biggest clothing maker said … The industry is Vietnam's second-biggest foreign-exchange earner after crude oil, and its decline may curb growth in an economy the government projects will expand 8 percent annually in the next decade … Vietnam's 1 million apparel-factory workers make about $100 a month, almost twice the $55 minimum wage.” (Bloomberg, Aug 30)

Globalization – The Good, …

“the main story of consistently high underlying real growth explains, more than anything, why globalisation has helped central banks so much. Central bankers deserve credit for taking advantage of these good times to establish and enhance their credibility … what might happen if globalisation hits a really large bump in the road. Then, at least in a few big countries, inflation will end up being far higher than policymakers or market participants now seem to think possible. Market convictions that inflation is forever dead will be shattered.” (Kenneth Rogoff, Harvard economics professor, former IMF chief economist, FT, Aug 29)

“[the near East] needs modern industry, jobs and better education geared to competing in the global market … I set up five industrial parks in Israel to provide employment and last year, established my first venture in Turkey… provide opportunities for people from diverse backgrounds … special kind of regional economic development that promotes industrial production for export industries … each of the parks works with an educational institution … starting 100 industrial parks is equal to buying fewer than 50 fighter aircraft … need contributing companies to establish branches in the new parks … need the support and commitment of national governments to set up the incentives.” (Stef Wertheimer, Israel-based industrialist, founder of Iscar, manufacturer of metalworking tools in which Warren Buffet bought 80% stake in July, FT, Aug 24)

“There has never been a more critical time to ensure that mining contributes to long-lasting development. Soaring metals and minerals prices are bringing billions of dollars in tax revenues to mineral-endowed countries throughout the developing world, enhancing prospects for economic growth. It is essential that these windfall funds are used effectively for community development … popular pressure is mounting in poor mineral states that have yet to demonstrate to their citizens that foreign direct investment can generate economic and social benefits … Enhancing the impact of mining on development requires joint action and new forms of partnership between governments, companies, civil society and international development agencies.” (Wayne Murdy, chairman of International Council on Mining and Metals, chairman, CEO of Newmont Mining, FT, Aug 24)

“In a new book, ''The Central Liberal Truth,'' Harrison takes up the question that is at the center of politics today: Can we self-consciously change cultures so they encourage development and modernization? … this is incidentally a book about the war on terror, and whether it is possible to change culture in the Middle East and the ghettos of Muslim Europe … Harrison and a team of global academics … concluded that cultural change can't be imposed from the outside, except in rare circumstances. It has to be led by people who recognize and accept responsibility for their own culture's problems and selectively reinterpret their own traditions to encourage modernization.” (David Brooks, NYT, Aug 13)

Globalization – The Bad, and the Ugly

““It became evident in 2000 that oil consumption would increase and the major publicly held oil companies should have doubled their spending for increased production, says [Wall Street oil guru] Maxwell, who began working in the oil industry in 1957. They didn't. ``You can lay this at their doorstep,'' he says. Exxon Mobil Corp. has spent tens of billions of dollars buying back its shares, Maxwell says, money that would have reaped additional profit if it had been spent on production capacity. National oil companies, which control the lion's share of world production, didn't expand capacity either, Maxwell says, because they didn't get enough money from their governments and because they turned away private investment by tough bargaining.” (Bloomberg, Aug 16)

“The number of suicides among India's 235 million farmers is rising as seed and pesticide costs increase and the rural economy provides few other job opportunities. More than 18,000 farmers may kill themselves this year, the most ever recorded by the government … The deaths show the plight of India's farmers, whose destitution is overshadowed by the country's booming software and pharmaceutical industries. About 27 percent of India's rural population, or almost 200 million people, live below the poverty line.” (Bloomberg, Aug 30)

“The median hourly wage for American workers has declined 2 percent since 2003, after factoring in inflation … As a result, wages and salaries now make up the lowest share of the nation’s gross domestic product since the government began recording the data in 1947, while corporate profits have climbed to their highest share since the 1960’s … For most of the last century, wages and productivity … have risen together, increasing rapidly through the 1950’s and 60’s and far more slowly in the 1970’s and 80’s. But in recent years, the productivity gains have continued while the pay increases have not kept up. Worker productivity rose 16.6 percent from 2000 to 2005, while total compensation for the median worker rose 7.2 percent.” (NYT, Aug 28)

“Japan's wages unexpectedly slipped for the first time in six months, as record corporate profits and increased demand for workers failed to translate into higher pay. Wages, including overtime and bonuses, fell 0.1 percent … in July from a year earlier …” (Bloomberg, Aug 30)

“Since the 1920’s there have been four eras of American inequality: • The Great Compression, 1929-1947: The birth of middle-class America. The real wages of production workers in manufacturing rose 67 percent, while the real income of the richest 1 percent of Americans actually fell 17 percent. • The Postwar Boom, 1947-1973: An era of widely shared growth. Real wages rose 81 percent, and the income of the richest 1 percent rose 38 percent. • Stagflation, 1973-1980: Everyone lost ground. Real wages fell 3 percent, and the income of the richest 1 percent fell 4 percent.• The New Gilded Age, 1980-?: Big gains at the very top, stagnation below. Between 1980 and 2004, real wages in manufacturing fell 1 percent, while the real income of the richest 1 percent … rose 135 percent … except during stagflation … what happened in each era was what the dominant political tendency of that era wanted to happen.” (Paul Krugman, NYT, Aug 18)

“Federal Reserve Chairman Ben S. Bernanke told Congress in July that he is disturbed by the growing chasm between the rich and the poor … The dream of greater prosperity has bypassed his hometown of Dillon, South Carolina, which is honoring its native son with Ben Bernanke Day on Sept. 1 … The town of 7,000 people hasn't recovered from textile layoffs in the 1990s prompted by competition from lower-cost Asian imports, nor from the decline of its tobacco crop … Dillon County's unemployment rate was 9.7 percent, more than twice the national average … Average income of $20,342 a year came to 62 percent of the U.S. average in 2004.” (Bloomberg, Aug 30)

“Banker Frank Quattrone's deal with U.S. prosecutors that allows him to avoid a third trial on obstruction-of-justice charges, clears the way for him to receive as much as $120 million from former employer Credit Suisse, people familiar with the matter said on Wednesday. The settlement approved by a federal judge on Tuesday would allow Quattrone, 50, to avoid any penalty without admitting any wrongdoing. If he obeys the law for the next year, prosecutors will dismiss charges that were filed against him in 2003.” (Reuters, Aug 23)

“Justice Department's failed attempt to convict Frank Quattrone, the former Credit Suisse Group banker, highlights how Wall Street executives have largely escaped a government crackdown on corporate crime … During the six years that Quattrone faced accusations of wrongdoing, prosecutors secured about 1,000 corporate-fraud convictions … Prosecutors have largely concluded bankers didn't commit financial crimes and misconduct by them is better handled by civil regulators, lawyers said.” (Bloomberg, Aug 23)

“At Dana, the U.S. auto parts company that is in bankruptcy and facing lawsuits claiming that it manipulated its books to hide rising costs, there is talk of saving money by reducing or eliminating retirees' health benefits. But at the same time the bosses, including the chief executive, Michael Burns, want guaranteed multimillion- dollar payouts. … John Dempsey, a principal at Mercer Consulting, which helped draw up the pay package … [said] something needed to be done to offset the fact that Burns's stock and options were now close to worthless.” (IHT, Aug 17)

“the successes enjoyed by private-equity firms over the past few years have enabled public pension funds with exposure to the sector to achieve returns far superior to those on equity and bond markets … the record levels of buy-out activity and the unprecedented involvement of public pension funds raise the risk that a lean period in private equity would hit public funds just at a time when many of them are struggling to meet mounting pension obligations.” (FT, Aug 26)

“Deals involving consortiums of buy-out funds total about $265bn so far this year and account for more than 70 per cent of the value of all private equity take-overs, compared with less than half that for the whole of 2005. … Industry observers say club deals have proliferated recently because attractive takeover targets are scarce and buy-out funds are under pressure to invest the $14bn-plus raised this year. Private equity firms like club deals because they can buy companies too big to be taken over by a single fund.” (FT, Aug 28)

“Private equity groups are stepping up their efforts to lure senior executives away from public companies and making it more difficult for listed groups to attract and retain top talent … the offer of large financial rewards by cash-rich buy-out groups and the prospect of being shielded from the short-term pressures of capital markets are prompting more top managers to move to private equity … Private equity’s interest comes when many executives are complaining about the burdens of US legislation introduced after the Enron and WorldCom scandals.” (FT, Aug 29)

Geopolitical Risks

“Arab nations want the U.N. Security Council to help launch a new peace process to end the broader Arab-Israeli conflict, saying the "road map" unveiled in 2003 to establish a Palestinian state is dead. Arab League foreign ministers have asked to send a delegation to a ministerial meeting of the Security Council in September to initiate a new effort to bring lasting peace between the Israelis and Palestinians after nearly 60 years of conflict … To counter Hezbollah's rising influence, diplomats said the Arab moderates sought to restart an Arab-Israeli peace process.” (AP, Aug 18)

“Russia’s defense minister said Friday that it was premature to consider punitive actions against Iran despite its refusal so far to suspend its efforts to enrich uranium as the United Nations Security Council has demanded … Ivanov’s remarks made it clear that Russia would not support taking the next step that the United States and Britain have called for: imposing sanctions against Iran or its leaders over its nuclear programs … Mr. Ivanov, a close ally of Mr. Putin who also serves as deputy prime minister.” (NYT, Aug 25)

“Iran, the ultimate source of terrorist money and arms, is too far away for effective Israeli retaliation. Syria, however, is a weak link in the quartet. Syria's importance as an advance base for Iran — the two countries concluded a formal alliance on June 16 — cannot be exaggerated … State Department optimists dream that Syrian dictator Bashar Assad can be weaned from Iran through concessions from the United States and Israel, such as the return of the Golan Heights … History suggests that only force, or the threat of force, can win substantial concessions from Syria.” (Max Boot, well-known “hawk,” LAT, Aug 23)

"Joshua Landis, a historian of Syria … says that from Assad's standpoint, abandoning Hizbullah means abandoning his country's claims to the Golan Heights, which were captured by Israel during the Six-Day War in 1967… Syria's overtures over the past two years to reopen negotiations over the Golan have repeatedly gone unheard. (CSM, Aug 25)

“since 1999. IDF [Israel Defense Forces] Chief of Staff Shaul Mofaz and his successor, Moshe Yaalon, both recommended peace negotiations with Syria and were prepared to make significant territorial compromises to reach a peace settlement. Prime Minister Ehud Barak and his successor, Ariel Sharon, vigorously opposed this approach.” (WP, Aug 25)

“Iraq, sitting atop the biggest conventional oil reserves after Saudi Arabia and Iran, is facing what may be the direst threat yet in its eight decades as a petroleum powerhouse: a brain drain … Of the top 100 or so managers running the Iraqi oil ministry and its branches in 2003, about two-thirds are no longer at their jobs, according to current and former Iraqi officials and outside analysts.” (WSJ, Aug 22)

“In April, the [US intelligence] community produced a National Intelligence Estimate on terrorism, which, according to people who have read it, says that Hezbollah is the only major terrorist group with global reach currently not trying to kill Americans … Despite suggestions by some politicians that Islamic radical groups are all alike, Hezbollah is not Al Qaeda.” (Boston Globe, Aug 13)

“Hamas is gaining support in Gaza as its opponents say the mounting death toll [more than 200 Palestinians since June 25] diminishes support for politicians such as Palestinian President Mahmoud Abbas, considered by Israel a potential negotiating partner. … About 70 percent of Gazans now rely on food aid, according to the United Nations. … While support for Hamas swells, Palestinian support for Hezbollah, which is backed by Iran and Syria, is also palpable.” (Bloomberg, Aug 16)

“Political Islam was widely seen as the antidote to the failures of Arab nationalism, Communism, socialism and, most recently, what is seen as the false promise of American-style democracy … There is a wide diversity of views and agendas under the pan-Islamic-Arab umbrella. But as is often the case in politically aligned movements, those differences are easily papered over when that movement is in the opposition.” (NYT, Aug 20)

“Israel's effort this time to eradicate Hizbollah was no remake of past Israeli-Arab wars. It signified several complex - and seemingly contradictory - trends in the Middle East: First is the revival of a radical Islamic front that rejects the Arab-Israeli peace process. Second is the growing divide between Shia and Sunni Muslims in the Gulf region. Finally is the changed political dynamic after the recent entry by radical Islamist movements - such as Hizbollah and Hamas - to mainstream electoral politics.” (Olivier Roy, professor at Ecoles des Hautes Etudes en Sciences Sociales, author of “Globalised Islam,” FT, Aug 18)

“One of the participants at the Monday [Aug 14] lunch [with Pres Bush on Iraq], Eric Davis, a Rutgers University political science professor … Mr. Davis said he urged the creation of more jobs for younger Iraqis, and proposed a major reconstruction fund to be underwritten by Saudi Arabia and other Arab oil states seeking regional stability.” (NYT, Aug 16)

Monday, August 14, 2006

8/14 After Fed’s Pause, What's Next for Global Economy and Equity Markets?

August 14 (Econotech) -- Since global equity markets topped on May 10, investors, traders and economic forecasters have subjected every little bit of new economic and corporate data to the too cold -- too hot -- just right “goldilocks” test.

Following a sharp correction from that date, global equity markets began from June 13 the bounce off their rising 200-day moving averages, so far retracing about the standard 50% of the prior decline. They have put in higher lows but generally have not clearly surpassed the June-July highs for a higher high. In recent weeks, they have been swinging, even intra-day, near key levels on each daily data point. (All stock index data in this article is as of the close on Friday, Aug 11).

Starting with the June 29 FOMC meeting, equity markets rallied sharply the next three times the just right "goldilocks" economic scenario was reinforced, Bernanke’s July 19 Humphrey-Hawkins testimony, the July 28 second-quarter U.S. GDP report, and the August 4 U.S. employment report (see my 7/19 article, “Bernanke's More Difficult Dilemma” link). Since the bull’s long hoped for Bernanke pause finally occurred August 8, the “buy the rumor, sell the news” equity market reaction has been muted.

Equity markets have tried to regain their footing the past two months by gradually adopting an uneasy view, for the moment, in favor of the "just right" Fed soft landing forecast that the U.S. economy will slow just enough to 2.5% or so growth, modestly but enough below trend to presumably rein in currently too high “headline” (above 4%) and “core” current and expected inflation, but still high enough to continue the string of twelve straight quarters of double-digit earnings growth in the U.S.

As market reaction to second-quarter earnings reports seemed to indicate, there is less margin for error than earlier in the economic cycle with the "just right" soft landing scenario.

"U.S. companies that fail to meet earnings estimates are taking more punishment than usual in the stock market. The losses may widen as analysts cut forecasts for the rest of the year. The percentage of Standard & Poor's 500 Index members to fall more than 10 percent after second-quarter reports is the highest since the current bull market started in October 2002, according to Birinyi Associates Inc ... those that trailed estimates dropped 3.3 percent, the most since the first quarter of 2005. Companies beating estimates rose by an average of 0.3 percent, the smallest advance since the current bull market began." (Bloomberg, July 31)

"The price of labor has taken a sudden jump and is likely to keep climbing, threatening to end the longest U.S. corporate profit boom in more than 40 years ... Labor costs have shot up 3.2 percent over the past 12 months, after average increases of just 0.8 percent a year from 2000 to 2005, the Labor Department reported last week. Companies will have a hard time raising prices to recover those costs, as weakening consumer demand slows the economy for the rest of this year. That means profits will take a hit ... The Commerce Department revised first-quarter data on growth in wage and salary disbursements, a broader measure of compensation than Labor Department data, to 6 percent year-over- year, from 4.2 percent. That picked up in the second quarter to 6.8 percent." (Bloomberg, Aug 14)

Investors and Economists Remain Split Over Macro Outlook in Difficult Phase of Business Cycle

The views of market participants on the global economy remain more split now than earlier in the economic cycle, which is normal at this stage.

Some believe the global economy is too strong and/or liquidity still too high, and the world’s central bankers, including the Fed, will need to continue to tighten. For the moment, this view got a modest boost Friday with the stronger-than-expected retail sales report.

Others think that the economy will slow too much, and the Fed will need to ease next year to avert recession, leading to a bond market rally. The weakness of the U.S. housing market and consumer spending, and slowing of the high growth and profitability of China’s massive investments are well-known keys to determining the extent of a slowdown.

And of course the vast majority of Wall Street and the investment community seem to currently believe that the Fed will achieve the usually elusive mid-cycle “soft landing,” a la 1994-95.

At this stage of the economic cycle, the Fed has obvious difficulty trying to balance inflation expectations and economic growth. How that trade-off is ultimately resolved may be less important at the moment than the simple fact that it exists, whereas earlier in the cycle it was much less a concern, making the “just right” outcome less likely and hence market risks higher the past three months.

"Many economists, though, warn that the soft landing may seem anything but soft, and suggest that the Fed is either too rosy about the looming slowdown or naïve about the difficulty of reaching its goal for inflation ... the Fed has achieved only one true soft landing — in 1994-95 ... This time, many analysts say that the Fed and its new chairman, Ben S. Bernanke, face considerably tougher challenges. Crude oil, at more than $70 a barrel, is selling at prices that would have been unthinkable in 1995. Productivity growth, which was accelerating in 1995, is slowing these days. The dollar, which was climbing against other major currencies in 1995, is declining against most of them now ... Analysts and other experts say that if Mr. Bernanke is serious about his goals for controlling inflation, at least two million more workers may have to lose their jobs over the next two years ... Many other economists contend that inflation is more entrenched and will be more painful to reverse than the Fed thinks. Others predict that inflation will indeed subside, but only because the economy will weaken much more than the Fed is expecting." (NYT, Aug 11)

“By leaving interest rates unchanged yesterday after two years of steady increases, the Federal Reserve sought to balance the risks of a sharp slowdown and rising inflation -- an effort many economists said might not succeed. Reflecting the difficulty of the Fed's task, economists -- like the Fed's policy makers themselves -- aren't unanimous about what the central bank should do as the economy sends mixed signals. Some economists feel the Fed has raised rates too far already, while others say it hasn't raised them enough … The Fed is entering what has traditionally been one of the most delicate phases of the business cycle. The economy has reached full strength and inflation pressures have built. There are signs that higher interest rates are slowing the economy, but it remains unclear if they have slowed it enough -- or too much” (WSJ, Aug 9, by Greg Ip, who is close to Fed officials).

OECD Area Leading Indicators Growth Turns Down, China’s to Follow?

The Aug 4 release of the OECD’s composite leading indicators (CLI, which forecast industrial production) shows the 6-month rate of change for the OECD countries starting to turn down from a lower peak than in the beginning of 2004 (see chart on the first page of the release link). The data is only through June, but once a turn is made, it seems to continue in that direction due to the smoothing.

The same chart shows China’s leading indicator still rising. Whether China’s will continue to do so, as it did after the OECD’s CLI growth peaked in early 2002, or follow the OECD’s down, as it did in 2004, and the resulting impact of China demand on other exporters, remain key questions. (An investment bank recently has questioned whether declines in Asian stock markets follow downturns in the OECD leading indicators, but their data show they do with only single exceptions the last 4-5 times.)

A recent data point: “Japanese machinery orders unexpectedly jumped 8.5 percent in June, adding to the central bank's case that borrowing costs may need to be raised again this year.... The median forecast of 35 economists surveyed by Bloomberg News was for a 0.3 percent gain. Companies including Toshiba Corp. are building factories to benefit from climbing demand for their products at home and overseas, fueling the strongest surge in investment since 1991.” (Bloomberg, Aug 9)

Off further in time, as one Wall Street economist has just noted, the ability to stimulate the U.S. economy through policy will be much less limited in the next cycle, whenever that starts, due to already large fiscal and current account deficits, and far less room to lower the average mortgage rate than occurred in the previous cycle. Another Wall St economist feels that as long as the dollar remains weaker, as indicated by the gold price, the risk of inflation will be a problem.

Weakening U.S. Real Estate, When/How China's High Growth Slows, Areas of Concern

To get to a review below of trends in global equity markets, I will not cover here various economic issues which most investors are by now very familiar, e.g. a U.S. Treasury yield curve that recently has become more inverted, high energy prices, ARM resets biting next year, the very high growth of China’s huge investments, etc.

Though a great deal is published, often with dire headlines, regarding the statistical data and anecdotal evidence on the U.S. housing bubble and China’s booming investments, two key areas of concern, the experts with the strongest opinions on them often seem to simply assert their side of the facts more strongly without making a truly compelling case, at least as of yet, since both situations are historically unique and thus very difficult to forecast.

E.g., yields on 10-year Treasury notes have declined about 30 bp, making mortgages more attractive recently. “U.S. mortgage applications rose for the first time in four weeks as long-term home loan interest rates plunged to their lowest levels since March.” (Reuters, Aug 9)

The current consensus views on the U.S. housing market is captured in the following quotes.

“Nothing has been more important in driving the U.S. economic expansion that began nearly five years ago than housing. It could be just as vital as growth slows. Federal Reserve officials are watching warily to see whether the housing retrenchment that began late last year will remain modest or turn into a rout that could damage the economy severely.” (Bloomberg, July 26 by John Berry, who is close to Fed officials)

"The house party had to end eventually, even if sellers refuse to believe it. Many remain defiant to the point of delusion, demanding one more drink at the housing bar. Real estate bulls point out that the nation's median home price is still up 0.9% this year, to $231,000. But that stat is misleading. There's a stalemate between buyers and sellers: property owners are reluctant to cut prices, and buyers are patrolling from the sidelines, hoping for fire sales." (Time mag, Aug 6)

“The boom has depended heavily on the upbeat psychology of consumers, builders and lenders. As moods swing, the landing could be very hard indeed ... signs of the housing slowdown grow stronger. In June, total single-family-home sales fell 8.7% from a year earlier -- the sharpest year-to-year drop since April 1995 ... they [economists] expect the decline in housing ... to shave about a percentage point off inflation-adjusted GDP growth in 2007 ... Today's housing boom differs radically from its predecessors ... Economists can't quantify some risks, including the biggest: the chance that a sharp drop in house prices -- what economists call a "disorderly downturn" -- would leave many homeowners owing more on their mortgages than their homes are worth. If that led to a wave of foreclosures and losses on riskier mortgage-backed securities, banks and investors could get spooked and cut back on all kinds of lending -- a move that could snuff out economic growth.” (WSJ, Aug 7)

"William Wheaton, a housing economist at the Massachusetts Institute of Technology, says the wild cards include how many investors [i.e. speculative flippers-econo] or second-home owners will dump properties on the market and how many borrowers will default. Even if there is no surge in defaults or selling by investors, he says, some of the formerly hot local markets may be heading into five or 10 years of flat to slightly higher home prices. He believes many baby boomers on the coasts will cash out of expensive homes and move to cheaper areas; that would restrain price increases along the coasts." (WSJ, July 20)

"The biggest risk, economists say, is that the optimism that fed the real-estate boom will reverse dramatically. The number of homes for sale has surged in recent months, particularly in once-hot markets, like the Northeast, Florida, California and parts of the Southwest. As builders delay land acquisition and construction it could reduce employment and spending in the coming months. More broadly, just as rising housing prices during the boom added to Americans' sense of wealth and well-being -- encouraging them to spend more on a variety of goods and services -- the reverse could dampen sentiment and lead consumers to pull back on their purchases ... many economists say, the biggest question is whether the orderly real-estate slowdown the Fed has engineered thus far will continue." (NYT, July 29)

“’It's clear that we've seen a very significant slowdown [in price appreciation] and may be approaching an episode of overall declines,’ says Richard DeKaser, chief economist at National City Corp. in Cleveland. He added that ‘I would call this, thus far, a very orderly correction.’ Meanwhile, inventories rose 3.8% to 3.73 million existing homes for sale in June, which is a 6.8-month supply of homes at the current sales pace. That was the highest inventory level since July 1997 and compares with a 4.4-month supply in June 2005.” (WSJ, July 26)

“The popularity of adjustable-rate mortgages means that nearly 25% of all outstanding U.S. mortgage debt is due for an interest-rate reset within the next two years, according to, a Web site run by Moody's Corp. Some $400 billion in loans will get a new rate this year, and another $2 trillion are set to move in 2007. Those moves won't be pretty. Just two years ago, the prime rate stood around 4%; today, it is more than twice that. As a result, payments on some ARMs will double too. The current forecasts from a number of experts have defaults on those loans increasing by 10%.” (MarketWatch, Aug 2)

"As the overall housing market weakens, the interest in buying vacation homes, from the most modest condominiums on up, appears to be falling faster. Unlike most metropolitan areas — where underlying demand and the normal turnover in primary homes as a result of job moves, new households and family changes provide a more solid floor under prices — the second-home market relies on a different set of motivations that tends to exaggerate booms and busts ... In second-home markets around the country, the number of sales is shrinking even as the properties on the market increase. Prices at all levels are softening, and in a few places recently have begun dropping." (NYT, Aug 10)

And the current consensus on China’s investments:

E.g., “China's leaders are finding that the world's largest command economy no longer responds to their commands. Growth is hurtling along at the fastest pace in a decade, defying official efforts to curb investment in unneeded factories and real-estate projects. The government's immediate concerns are that overheated growth will saddle China with excess capacity, create more asset bubbles, and increase friction with the U.S. and other trading partners … Many of China's overheating problems result from the fact that the Chinese economy is still 'in transition from a command economy to a market economy,' says [well-known China expert Nicholas] Lardy. 'A lot of the controls they've had in the past have weakened, but they don't have the market controls in place yet.''' (Bloomberg, July 31)

Btw, as you know, enormously speculative real estate markets are a critical global, not just U.S., issue.

"[China] mainlanders lucky enough to have gotten into the housing market over the last decade are enjoying a sweet ride. Younger couples and rural transplants are having a tough time finding affordable housing ... Nobody wants to see a Japanese-style property bust visit a still-developing economy like China's. Yet even if it doesn't come to that, [President] Hu's government needs to worry about a possible social backlash among a sizable chunk of the population whose incomes aren't growing fast enough to keep up with spiraling housing costs. And we aren't even talking here about the 800 million or so Chinese living in rural regions (where outrageous land seizures by local governments are common) but rather urban dwellers in Beijing and Shanghai." (BW, Aug 9)

"Real estate prices have risen as much as 100 percent in the eight former communist states that joined the EU in 2004, driven by buyers from Western Europe. Many locals, with less than a quarter the buying power of their neighbors, have been locked out of the market, adding to frustration with EU membership and eroding support for budget cuts needed to adopt the euro. East Europeans are angry about rules that prevent them from working in most of the 15 older EU nations, while their own governments reduce spending on pensions, health care and other social programs to join Europe's single currency ... wages in the region are a fraction of those in Western Europe." (Bloomberg, Aug 10)

"Historically Istria [in Croatia] is a poor region of farmers and fishing folk, occupied by fascist Italy, the Austro-Hungarian Empire, and medieval Venice. Now it is fast becoming a summer playground for the monied classes of Europe ... In a country where the average monthly wage is around £500, it is already clear that the locals are priced out of the property market." (Guardian UK, Aug 8)

Private Equity Cancerous Growth Out of Control?

"U.S. companies' second-quarter earnings rose by an average of 19 percent as energy producers, bolstered by record oil prices, regained their standing as the fastest-growing industry group. Profit for members of the Standard & Poor's 500 Index climbed more than 10 percent for the 12th straight quarter, matching the longest streak since 1950, according to Thomson Financial. Oil and gas companies reported a 45 percent increase on average, the largest among the index's 10 main industry groups." (Bloomberg, Aug 4)

Usually minimized by bulls is that about two-thirds of the S&P operating profit increase in the past year has come from just two sectors, energy and financial, with the former often considered a tax on the real economy.

But much financial profit can also be viewed as a tax on productive assets, since it is increasingly generated from speculative trading by hedge funds, which now dominate global market daily activity, and legalized leveraged looting of corporations by private equity LBO’s and M&A, which add little to finance innovative new products and services.

Back in the 1980s, private equity LBO's may have served a useful economic purpose of making corporate America more efficient. Today, however, with that task largely completed, private equity is morphing into speculative financial parasites that "suck out" their loot, to use the phrase in the front page of the Aug 14 Financial Times, seeking a "free lunch," from a July 25 WSJ article.

When will the private equity legal looting finally be enough already? As with equally unjustifiable venture capital returns during the late 1990’s TMT equity bubble, today's exorbitant private equity returns are de facto evidence of excessively speculative, oligopolistic financial markets that are misallocating global capital, and the critical talent and resources it deploys, on a massive scale.

“One year buyout returns saw a very slight increase posting 25.5% for Q1 2006 compared to 25.3% for Q4 2005.” (PRNewswire, July 31) Three-year buyout returns were 17.6%, all data through March 31.

“The sharp rise in leveraged recapitalizations, described as the cocaine of private equity by one US buy-out chief, is damaging companies’ credit quality and could lead to an increase in default rates, Standard & Poor’s will say today. The credit rating agency has found that default rates among a sample of companies that have undergone recaps – a refinancing method that allows private equity groups to suck out large dividend payments by loading their portfolio companies with additional debt – were as high as 6 per cent … ‘Buy-out groups are living dangerously,’ said Steven Bavaria, head of S&P’s bank loan ratings business. ‘They are skating towards the end of the envelope but we won’t know whether they are over the edge until the market tightens up and some of the weaker credits get into trouble.’” (FT front page, Aug 14)

“A rush of multibillion-dollar buyouts has catapulted the volume of private equity deals to their highest level on record, data published on Tuesday shows. Monday's deal by three private equity firms to acquire HCA Inc. , the No.1 U.S. hospital chain, for $21 billion helped lift the total volume of deals so far this year to $372.6 billion. That's already higher than all of last year's total and higher than any other full year on record, according to financial data provider Dealogic. The rise in private equity-backed deals comes as the volume of global mergers and acquisitions has risen to $2.18 trillion in the year to date, topping the $2.13 trillion notched up during the same period in 2000 at the height of the Internet boom, Dealogic data shows." (Reuters, July 25)

"Some analysts said HCA's new owners could end up tempted to seek cost cuts to pay its debt -- only to find the company to be far leaner than it was in the past ... 'The intriguing question is what has Jack Bovender [HCA's CEO] not done for shareholders that Kohlberg Kravis Roberts can do, particularly when KKR wants to earn' double-digit returns on its investment, said Uwe Reinhardt, a Princeton University health economist. 'You've got to ask yourself, where's the free lunch here?' Mr. Bovender is expected to stay as CEO after the buyout. Jeff Goldsmith, president of Health Futures Inc. noted that HCA already has twice culled its sizable hospital holdings in the past two decades to weed out underperforming assets. The company 'isn't known for fluffy staffing numbers,' he said. HCA's hospitals 'are mature franchises that for the most part they've owned for 20 years. It's a very interesting strategic question of what it is going to do to create value to pay down all that debt.'" (WSJ, July 25)

“Buyout firms announced an unprecedented $287 billion of takeovers this year through the end of July, up from $265.5 billion during all of 2005, according to Bloomberg data.” (Bloomberg, Aug 3) “Besides traditional lenders, sales of leveraged loans to investors including managers of collateralized loan obligations and hedge funds rose 69 percent to $162 billion in the first half of the year, according to S&P. The amount compares with 2005's full-year record of $183 billion.” (Bloomberg, Aug 1)

“After a blistering first half, big Wall Street investment banks are seeing a significant third-quarter slowdown, driven by reductions in trading volumes and new securities offerings, and a drop in US mergers and acquisitions. The slowdown is likely to damp earnings at big brokerages that report quarterly figures next month … several analysts said slowing U.S. economic growth, rising chief executive uncertainty and difficult international markets could exacerbate the usual seasonal trends and cut into the traditional fourth-quarter recovery.” (FT, Aug 14)

A “Big Picture” Comparison of Major Global Equity Market Trends since May 10 Top

We can try to make economic guesses and/or search for trends in the world’s stock markets, in an iterative process of testing hypotheses about economic data and market signals, and how each responds to the other. So let’s once again look at the charts following up on my 6/2 article, "Did May's Sharp Global Market Sell-off Signal" link.

A very simplistic “big picture” review below seems to indicate that global markets still remain in their nearly four-year old bull market uptrends, but with a number of indexes flashing cyclical warning signs. I don’t take into account here more sophisticated views of market structure that may better detect more trouble just below the surface.

Note that all data is through the close on Friday, August 11.

Since May 10-11 top, the best performing major indexes have been the S&P 500, DJ Stoxx 50 European stocks, down about 5%, the same as Hong Kong’s China H shares, with its own Hang Seng flat. The first two have been among the weakest indexes during the bull market since Oct 2002, up around 50%, the H shares has been one of the strongest, up nearly 200%.

Since the May top, the worst performing major indexes have been the MSCI emerging markets, industrial metal prices, gold price, S. Korea’s Kospi, and Nasdaq, down -11-13%. The first two have been among the best performing during the nearly four-year bull market, up 200% and more. Nasdaq has been one of the worst, up about 70%.

In other words, since the early May top, two large lagging but less volatile stock indexes, S&P 500 and DJ Stoxx 50, have outperformed most others, though still losing money, while the more volatile star performers of the four-year bull market, emerging market stocks and industrial metal prices, have underperformed.

From the June 13 lows, the best performers once again have been the more volatile assets, led by Hong Kong’s China H shares and Hang Seng indexes, MSCI emerging markets stock index, and gold and industrial metals prices. The worst performing has been Nasdaq and tech stocks.

Btw, I’d guess that the performance of the S&P 500 in the nearly four-year bull market would be even more lackluster if the energy and financial sectors were excluded from the results.

“If insider selling is any guide, the stock-market rally for energy companies may be waning. Sales of shares by officers and directors at oil refiners climbed to a record in July, according to a scoring system used by the Leuthold Group since 1999. Among a broader group of 142 energy producers, insider selling peaked in May, according to Leuthold.” (Bloomberg, Aug 3)

Major Global Equity Markets Now at Important Levels

Throughout the four-year bull market, international indexes have far outperformed U.S. large cap ones. Global markets may now be at an interesting juncture. The “normal” 50% retracements of the sharp declines over May 10-June 13 have been made, and many indexes are near key levels, usually their 200-day moving averages and/or or their June-July rally highs.

The three most comprehensive indexes, the MSCI world (ex US), EAFE (developed economies) and emerging markets, all bounced off their rising 200-day moving averages in both mid-June and mid-July. They closed Friday at or just slightly above their early July peaks, re-tracing about 50% of their May-June sharp declines.

I.e. if these three indexes were to rally further from here, then they would then put in a “higher high” to go along with the higher low made in mid-July, for the moment a short-term uptrend, with the emerging markets index a little stronger but more short-term overbought. Conversely, failure to do so would be a noticeable negative.

Similar comments apply to key individual international markets, especially S. Korea’s Kospi index, which is considered to be particularly cyclically sensitive, and Japan’s Nikkei, but with the big caveat that they both fell well below their 200-day moving averages and now have rallied to just below them. Both countries’ exports are increasingly heavily oriented toward China.

China’s “H” shares are at new highs in their post mid-June rebound, starting to close in on the early May peak, which Hong Kong’s Hang Seng has just reached. China’s “A” shares look more like the overall emerging markets index. As for the other BRIC markets, energy-driven Russia is also closing in on its May peak, while India’s BSE and Brazil’s Bovespa have rallied well to put in modestly higher highs off their mid-June lows.

In the U.S., the S&P 500 closed Friday at 1267 four points below its 200-day moving average; it has tried twice but so far been unable to take out the June-July rally high of 1280. As mentioned, since May 10, it is down about -4%, outperforming U.S. small and mid-cap indexes, down over -10%, which had been U.S. market leaders during the bull market.

The tech-laden Nasdaq is down about -12% since May 10, and the Dow transportation average (which performed better than most other U.S. index over this cycle) about -17%, versus the Dow utilities up 6%, all signs of a cyclical slowdown, along with the ongoing downtrend in retail stocks and the strength in defensive stock groups. The homebuilder stock indexes have collapsed all the way down to their levels in early 2004. Some high-flying popular consumer growth stocks, such as Whole Foods, Starbucks and Cheesecake Factory, have declined sharply in recent months.

Again, failure by major indexes to take out their June-July rally highs, and continued weakness in the more cyclically sensitive domestic and international indexes mentioned above would not bode well for the global economy and equity markets. And conversely, new higher highs in the rally off the June 13 lows could embolden the bulls.

Back in my March 24 article on "Potential Tipping Points" link, I expressed my guess that the U.S. market might see a significant low in the October timeframe, per the usual four-year election cycle. That remains my bias, but I will try to look at the charts and global situation going forward with as an open mind as I can muster.

It's Difficult to Implement Rational Economic - Monetary Policies with Hyper-Speculative Capital Markets

I believe that it is more difficult to implement rational economic/monetary policies when the underlying incentives in the economy may lead to massive capital misallocation, either through formally legal but immoral rampant financial speculation, which permeates the U.S. system, or by local political/economic bosses circumventing national policy, as in China.

“America’s slowdown represents an important transition in the sources of economic growth, away from the vigorous wealth creation of asset bubbles – first equities, then housing – and back towards more subdued labor income generation … In a post-bubble climate, US households will be unable to save through asset appreciation, prompting America to increase income-based saving and reduce its claim on the pool of global saving.” (MS chief economist Stephen Roach, op-ed, FT, Aug 14)

Roach, along with his colleague Andy Xie, for years have been the only major Wall Street economists to very honestly and capably warn of the economic dangers and distortions of the asset bubble economy. But writing without qualifying about “vigorous wealth creation of asset bubbles” and “save through asset appreciation” unintentionally plays into the American mindset which can no longer distinguish between actual, real wealth creation and savings from the new production of innovative goods and services, and mere speculative financial bookkeeping entries on paper assets, be it already existing home property titles, stocks and bonds, and a seemingly infinite array of derivatives, regardless of future cash flow prospects from real economic profit/income generation.

But for that speculative paper wealth transfer to continue without price inflation spiraling out of control, someone somewhere must actually generate enough real economic wealth that the inflated asset prices have claims on, and that someone are the populations and businesses of those countries financing the unprecedented U.S. twin deficits. How long can and will they allow that to continue, trading real economic wealth for speculative, low-yielding pieces of U.S. paper of increasingly dubious future value?

With U.S. national annual home price increases now approaching flat (there has not been a national decline in many decades), will homeowners be willing to give up what they consider their rightful, hard-earned massive equity “wealth” creation from the engineered (by the Fed and government tax and other policies) real estate bubble?

To ask the question is to answer it. Which is why I noted in my last article link that real estate prices are "sticky" to the downside, as currently indicated by the game of chicken between buyers and sellers.

With regard to the difficulty China's leaders are having in gaining control over its economy: “lenders have been fighting corruption in preparation for more foreign competition starting in December. Industrial & Commercial Bank of China and China Construction Bank, both in Beijing, say they have improved risk management, loan practices and technology … Last year, fraud and other irregularities in China's financial institutions amounted to $95.9 billion, a 31 percent increase over 2004, according to the China Banking Regulatory Commission.” (Bloomberg, Aug 1)

Global Hyper-Speculation Continues to Lead to Increasingly Glaring Wealth Inequality

A few recent examples of the glaring inequalities created by the current consensus fantasy view of the hyper-speculative global economy:

“The average U.S. teacher salary fell 0.1 percent in the past school year to $46,953” (Bloomberg, July 25)

``’It bothers me,’'' former Federal Reserve Chairman Paul Volcker said in an interview. ‘I tell you, I don't know why there hasn't been more discussion and more unhappiness about this because it's become quite distinct. For a long time now, if we believe the statistics, the average working guy does not have an increase in income.’'' (Bloomberg, Aug 3)

“Private equity has paid off handsomely for Henry Paulson Jr., the former chief executive of Goldman Sachs. For the past two years, Paulson, now the Treasury secretary, has banked $24 million in investment returns from lucrative partnerships made available to top Goldman executives. The sudden flowering of these investments - last year, Paulson's return was $12.7 million, according to the firm's 2006 proxy - signals vividly how Goldman's growing private-equity business has been gushing profits not only for the firm's executives but also for the investment bank as a whole.” (NYT, July 26)

“Prominent economists of all ideological persuasions long believed that raising the U.S. minimum wage would retard job growth, creating unintended hardship for those at the bottom of the ladder. Today, that consensus is eroding, and a vigorous debate has developed as some argue that boosting the wage would pull millions out of poverty. A moderate increase in the minimum wage won't raise unemployment among low-skilled workers, according to recent studies, many economists say. They are joined by some business executives who say they can live with that, especially if it's coupled with tax relief.” (Bloomberg, Aug 7)

“A federal appeals court reversed a lower court's finding that International Business Machines Corp.'s pension plan discriminated against older workers. The ruling, which involved IBM's move to change from a traditional pension to a cash-balance pension plan, may spur more companies to make the switch, employers say, and may have implications for some of the roughly 400 companies with a total of more than 1,200 cash-balance plans among them. When older workers are shifted from a traditional pension to a cash-balance plan, they lose the steep buildup of pension benefits and can end up with pensions that are 20% to 50% lower. Most companies that adopted the cash-balance formula had large older work forces.” (WSJ, Aug 8)

“in the United States today, there’s a new twist to the familiar plot. Income inequality used to be about rich versus poor, but now it’s increasingly a matter of the ultra rich and everyone else. The curious effect of the new divide is an economy that appears to be charging ahead, until you realize that the most of the people in it are being left in the dust. President Bush has yet to acknowledge the true state of affairs, though it’s at the root of his failure to convince Americans that the good times are rolling.” (NYT, 7/19)

Emotionally Charged National Security and Geopolitical Issues Need Creative Approaches to Lower Global Risks

I always wrestle with how much to say in my articles about often emotionally charged geopolitical and national security issues, and this time is no exception.

Re the Lebanon situation, I won’t go into who did what to whom, when, why and how, in part because it would take far too long, and because viewpoints are once again so strongly entrenched, in large part due to the corporate mass media and major political parties.

For some background on the Lebanon situation, I suggest Seymour Hersh’s "Watching Lebanon" in the August 21 “New Yorker” link (some may think it more balanced than they would expect from Hersh). To balance, for a view from the “realist” conservative Republican faction often identified with Bush Sr, see his close colleague Brent Scowcroft’s July 30 Washington Post op-ed "Beyond Lebanon" link.

Scowcroft lists seven points as "outlines of a comprehensive settlement," starting with “A Palestinian state based on the 1967 borders, with minor rectifications agreed upon between Palestine and Israel” and also “King Abdullah of Saudi Arabia unambiguously reconfirming his 2002 pledge that the Arab world is prepared to enter into full normal relations with Israel upon its withdrawal from the lands occupied in 1967.”

I’d guess that the old U.N. Security Council resolutions and especially the 2002 Saudi proposal that are the basis of Scowcroft's outline solutions are unknown to the vast majority of Americans, not surprisingly, since the Saudi proposal was ignored by the Bush administration and buried by the mainstream media in the concerted push to invade Iraq (during which Scowcroft evidently was no longer welcomed in the Bush/Cheney White House).

The Lebanon situation obviously has further inflamed Arab/Muslim anger against the U.S. political leadership, where both major parties have shown themselves through Congressional resolution to be nearly unanimously strongly pro-war when it comes to Israel.

Yet reality is usually not as simplistic as good vs evil, even when it may appear so. Events leading to wars, hot or cold, develop over long convoluted, messy histories, usually willfully ignored and distorted in mass media sound-bites and political sloganeering.

To take one of the clearest examples, whole-hearted support of war against Nazi Germany was a very necessary moral and geopolitical imperative, libertarian views notwithstanding, but how things could have been prevented from ever getting to the point of incurring casualities in the tens of millions would have required changing decades of misguided policies by the major powers of the era.

As with the case leading up to the invasion of Iraq, it is not too difficult to see very different viewpoints perceived as strongly legitimate by their holders re what led up over the decades to this latest conflict in Lebanon and elsewhere in the Middle East.

Once again perhaps the truth may become clearer as the outcomes unfold over time, maybe even in time to matter, though the nature of war in general and an ultra-secretive “war on terror” tend to go against that.

Despite the hype about a 24/7 connected world, it seems questionable to me whether public opinion is becoming significantly more well-informed about events in distant places. E.g., not to beat a dead horse but to simply illustrate that point:

“Did Saddam Hussein's government have weapons of mass destruction in 2003? Half of America apparently still thinks so, a new poll finds, and experts see a raft of reasons why: a drumbeat of voices from talk radio to die-hard bloggers to the Oval Office, a surprise headline here or there, a rallying around a partisan flag, and a growing need for people, in their own minds, to justify the war in Iraq.” (AP, Aug 6)

This indicates an embarrassing and dangerous lack of knowledge of world affairs by the U.S. public. According to a Bloomberg/LA Times poll, “just 9 percent of teens aged 12 to 17 and 17 percent of young adults aged 18 to 24 in the survey said they read a newspaper for current events.” (Bloomberg, Aug 10)

Obviously Americans can spend their leisure time however they please. But this is not 19th century isolationist America.

Official published U.S. national security policy since 2002 has been to assert the right to militarily intervene when deemed necessary by the President on a preventive, not an imminent pre-emptive (a critical distinction), basis, on the suspicion of a chance of great danger (e.g., see the 2006 book "The One Percent Doctrine" by Ron Suskind), a sharp departure from more than two hundred years of U.S. history and international law.

With that policy change, the public learning as much as possible about those very risky and very costly interventions would seem to be critical for all most directly concerned, including the large number of innocent civilians at the receiving end of the preventive "smart" bombs.

I.e., if the U.S. population continues to acquiesce in the Bush administration claim of a right of alleged preventive wars, then it would seem fair that at minimum the American people would also fully accept the corresponding responsibility to know as much as possible about the situations surrounding such grave proposed actions. Unfortunately, this is very unlikely to happen, given the current abysmal state of the corporate mass media and two major political parties.

With one major U.S. political party with strong ties to big energy, and the other to “blue state” real estate speculation and big corporate media, neither is going to take serious aim at the hyper-speculative mega financial interests dominating the global economy whose distortion of capital market flows away from critical productive investments for a just global economic development continue to underlie many major problems.

Perhaps most importantly, the financial and corporate global 1000 have little national loyalties whatsoever, but rather play nations and regions off against each other.

Only time will tell whether the U.S. "preventive" war policy will result in less national security and greater geopolitical and economic/financial risks down the road, or the “birth” of a “new,” presumably better, Middle East per Rice and Bush. So far, at least, the current trends don’t seem too promising to a great many Americans and a large majority of those outside the U.S., according to the public opinion polls.

It's too bad, for both the U.S. and the world, that Americans currently don't have viable electoral choices to politically express their views. The increasingly dysfunctional major parties find it safer to continue to blame each other while pocketing lobbyists’ money, even though the blame game doesn't work for the public good.