Money WhizDom ¥$€£¥$€£ Adhvith Dhuddu

2010-03-14T06:42:00.000-07:00

AAGANAN: BUDGET ANALYSIS 2010 - KEYNOTE ADDRESS

at Reva Institute of Technology and Management on 13th March, 2010

AAGANAN Budget Analysis 2010

The recent budget was well received in many quarters as it assuaged the concerns of deficit hawks, helped the rural masses as social sector schemes continued and satisfied urbanites as tax slabs were revamped and there was renewed focus on infrastructure development. Although no speech, presentation or document can fully capture the essence of a budget, I recently spoke to 250 MBA students from different colleges about various aspects of the budget. The presentation I shared with students is given here for viewing and downloading. Comments, suggestions and criticisms/appreciation are always welcome!!

A few notes for the students.

1. You may visit the Ministry of Finance website by clicking here.

2. If you want to read the first chapter (and other chapters) of the Economic Survey, it is accessible here.

3. The Union Budget 2010 website with many resourceful links is given here.

4. A brief document that summarizes important Budget initiatives is given here.

2010-01-12T10:38:00.000-08:00

NEW RULES OF THE GLOBAL MARKETPLACE

By Adhvith Dhuddu

(Op-ed as appeared in the Hindu Business Line on January 13th, 2010)

A decade of boom and bust has culminated in a new set of global standards even as India's image has soared as a credible survivor of the financial crisis.

The first decade of the 21st century has been unprecedented in many ways with the tech bust in the early 2000s, the rise of the BRICs and other emerging economies, the commodity boom and of course, the global financial mess in the recent years. As we enter the last lap of this decade, there are many “new normals” that have been scripted in the Indian and global context.

There is a new normal in the global economic playing field: Regulatory shackles have resurfaced prominently in the western world and government is back amidst “free markets.”

Developed economies, led by the US, rewrote the rules of global finance during the crisis, which will have ramifications in the American, European and Asian continents. As countries, companies and individuals emerge out of this crisis, everyone can be sure that it's not going to be business as usual at least in the near future.

NEW FINANCIAL STANDARDS

In a recent article in The Wall Street Journal, JP Morgan CEO Jamie Dimon captured the new normal succinctly, when he welcomed the Obama Administration's proposals that “focus on strong capital and liquidity requirements — not just for traditional banks but for a broad range of financial institutions”. This quote is sufficient for an economist to conclude that the new normal (in the US) will mean: increased government intervention and oversight in the financial sector, significantly lower capital being available for new investments globally, diminished appetite for risky leveraging and sparse availability of cheap credit.

In addition to this, specific regulations requiring further transparency in key markets like derivatives, introduction of stronger oversight in hedge funds, checks and balances in the shadow banking system and stringent regulations for over-the-counter financial products are all consequences of the tectonic shift aimed at expanding governmental role in the US' economic landscape.

Understanding the new normals in the world's largest economy is crucial as many of their economic and financial legislations often have worldwide effects, thanks to the influence of global finance.

New global regulations, historic bailout packages, co-ordinated responses by numerous central banks and other sweeping actions taken during the financial crisis are guaranteed to have widespread affects. Despite the resilience and growing strength of the Indian economy, these drastic changes globally will significantly affect Indian business, trade and commerce.

CAPITAL CRUNCH

In the last few years, the ability to leverage gave institutions on Wall Street access to ample capital and simultaneously increased their risk appetite. The momentum built up in leveraging was felt across the globe as capital was pumped continuously into emerging markets and unconventional assets like commodities, complex derivatives, art, etc. But this financial fallout and massive government intervention has forced many firms to deleverage and use cash conservatively.

It is important to recognise that the accelerated growth our economy experienced from the early 2000s was driven to some extent by foreign investments, which are sure to dry up in the short to medium term. This is not because India is a less attractive investment destination, but because of insufficient capital and the inability to leverage available capital.

When investment banks, hedge funds and PE firms could access $1 billion with only $50 million in collateral (1:20 leverage), the $1 billion was distributed to India, China, Brazil and Middle East into equity, real estate, commodities and fixed income assets.

But in the post-crisis era, when the amount available is only $50 million (no leverage) or $250 million (1:5 leverage), any amount of distribution to emerging markets and asset classes translates to less capital inflows into India or other emerging markets. This credit crunch, or more appropriately, “capital crunch,” forces us to realise that there is less capital available.

INDIA'S PROSPECTS

Asset managers, financial experts and economists have realised that India was better insulated than many other emerging economies during this crisis. Not only has this cast away many apprehensions about our economy, but it has considerably altered how India is perceived at the global level.

This is definitely another “new normal” for India; our voice is perceived differently, it's respected in the global arena and India's say is not only a credible one but an influential one. The importance of this development is noteworthy, because something like this would have been impossible 10 or 20 years ago.

Finally, another significant “new normal” is the pressure on the local urban and rural markets to perform. It's important to recognise that the Indian consumer differs significantly from the US consumer; unlike the archetypal westerner, the Indian consumer is more of a saver than a spender and our economy is not credit-driven or consumer-driven, like in the US.

If India wants to continue growing at 8-9 per cent in the post-crisis era, where capital is scarce and expensive and leveraging is a thing of the past, our local markets, both rural and urban, must perform better than expected. If this doesn't happen and local demand doesn't gain momentum, moderate growth of 6-7 per cent can be expected in the next few years. The need for local demand to improve is crucial because, for the last decade, the true strength of the local market was overshadowed by rising overseas capital finding its way into India.

(The author is an asset manager based in India and the US)

ONLINE LINK TO THIS ARTICLE: CLICK HERE

2009-12-07T14:32:00.000-08:00

THE SUNNY SIDE OF CLIMATE CHANGE

By Adhvith Dhuddu

(Op-ed as appeared in the Hindu Business Line on December 8th, 2009)

In the US, discussions about climate change are often partisan and impassioned. While the Democrats, who control Congress and the White House, largely accept the potentially insidious consequences of climate change, Republicans continue to deny the climate change phenomena. I mention this political bickering about climate change in the US because, as they struggle to reach a consensus on this volatile issue, we in India have largely accepted that climate change is something to confront, but have perceived it as a threat to our economy rather than an opportunity.

How reforms paid-off

When I think of climate change, I often remember a quote that Dr Manmohan Singh, as Finance Minister, referred to during the 1991 reforms, “An idea whose time has come.” That was just two decades ago, and we all remember how these reforms were pronounced by many “experts” as harmful and a threat to the Indian economy and local businesspersons. Their gloomy forecasts have only been debunked.

Likewise, climate change according to me is, “A phenomena whose time is coming whether you like it or not.” A rendezvous with destiny is eminent; to accost climate change in India as a threat to our economy rather than an opportunity will be damaging to our society, the Government and the economy in the long run. The reforms in the early 1990s have been a win-win-win for the people, businesses and the Government.

Climate change presents a similar opportunity. If India is bold and seizes the moment, a similar win-win-win can be created with a thriving new industry in India. Like how the IT revolution spurred exports, created employment and helped the exchequer, an ET (Energy Technology) revolution can do the same. No one exemplifies the threat and the opportunity better than renowned author and columnist, Thomas Friedman, in his book, Hot, Flat and Crowded.

In two decades, by 2030, the International Energy Agency forecasts that global oil demand will rise to 116 million barrels/day from 87 mbpd. But the startling fact is that two-fifths of this increase will come from India and China.

Clean energy

Clearly, energy consumption is set to rise considerably. But what matters is how the rise in demand is met: by embracing climate change and favouring an ET revolution and clean energy initiatives, or “protect” our economy under the veil of “let's become serious about climate change later, after we've had our share of polluting,” only to buy modern and advanced energy technologies from China and the West at a future date.

On this particular issue, the Chinese deserve credit as they've shown leadership and recognised climate change as a significant opportunity. Some of the leading solar, clean energy and green tech companies are now based out of China. Both the government and industries are investing millions in research and development of clean energy technologies and very soon the Chinese will be exporting affordable and quality energy technology solutions to many countries.

Enthusiastic youngsters

But in India one heartening observation is that Gen Y has identified this as an opportunity. Students and young entrepreneurs are churning out business plans and setting up small businesses in the clean energy sector.

A few months ago I was privileged to be on the jury of Manthan 2009, a paper presentation competition arranged by the Federation of Karnataka Chamber of Commerce and Industry (FKCCI).

Amazingly, the first and second place winners presented intriguing and innovative solutions in the green energy and alternative energy sector. Fuel from coconut fibre and the business of carbon credits won top accolades.

Ministry initiative

It's unfortunate to see the media and the Environment Ministry preoccupied with the wrong issue, i.e., whether we agree to legally binding emission cuts or not. What matters is if the Environment Minister, Mr Jairam Ramesh, can envision a clean and green India, whether he can inspire a generation to embark on an entrepreneurial journey in the clean energy and ET sector, whether his ministry can facilitate and stimulate this, and whether he can present an energy vision for India.

We don't need to bind ourselves with emission cuts, what we do need to bind ourselves with, is the fact that the climate change phenomena is a tremendous and unprecedented opportunity for an emerging, developing and vibrant economy like ours. If one recognises this and takes the required steps, we can automatically alleviate the emission problem.

Incentivise business

When it comes to actual policy-making, the Environment Ministry needs to realise that incentivising business' to adapt a clean and green approach will yield better results than mandating them to do so. To create a win-win-win for the Government, business and the people, it's imperative that the Environment Ministry assume a proactive and forward-looking stance as opposed to a protective and defensive stance.

Climate change will not wait for any country to fulfil its fair share of pollution, or any technology to be developed to combat emissions. One thing is certain: how climate change will unfold is highly unpredictable, but countries that are well prepared will be at a significant advantage during the crunch times. Opportunities like these don't present themselves often, and India is poised to seize this chance. We must not let it go by.

ONLINE LINK TO THIS ARTICLE: CLICK HERE

2009-11-09T11:48:00.000-08:00

WHAT'S NEXT FOR GOLD?

By Adhvith Dhuddu

(Op-ed as appeared in the Business Line Hindu on Oct 21st)

Gold recently broke through the $1,000/ounce psychological barrier, generating interest among investors, traders and even the common man. Currently there are many factors abetting the price rise in gold. Although no concrete prediction can be made about the price, the outlook appears bullish. There are nine crucial factors that affect the price in the short and long term.

LONG-TERM DRIVERS

Forex reserve allocations: The Asian Financial Crisis in 1997-98 resulted in an accumulation of forex reserves over the last decade. After amassing forex reserves in US treasuries, many Asian economies and export-oriented countries have exhausted their appetite for US debt.

The slow divestment from US treasuries to gold and other precious metals will impact the price of gold. An increasing proportion of forex reserves is being held in gold as countries realise that this could also be a sensible hedge against a slumping US dollar.

Dollar-denominated asset: Gold, like most other commodities, is a dollar-denominated asset. The implication of this is simple: Any significant movement in the US dollar directly impacts the price of gold. Broadly speaking, the price of any dollar-denominated asset (oil, gold, silver, etc) will increase as the US dollar declines and vice-versa (this is because as the US dollar erodes in value, it can buy less of the same commodity).

Over the long term, this will drive the price of gold as many economists and investors continue to express their bearish outlook on the dollar.

Commodity bull market cycle: The commodity bull market cycle will considerably impact the long-term price of gold. Commodity cycles usually last 15-20 years and this one, which started in early 2000s, will peak between 2017 and 2020. Prices of steel, copper, sugar and oil have risen significantly from the early 2000 and will continue to do so steadily for another decade or so.

Inflation fears: If the purchasing power of a currency erodes slowly, it is only because of the inflationary forces present in the system.

Similarly, the purchasing power of the dollar is a direct function of the supply and demand. For several decades, the supply of dollars has been increasing constantly but, concurrently, there has been a steady rise in the demand for dollars. Now, supply of dollars is rising at a higher than average rate, and there is no guarantee that demand will persist.This is why many pundits fear an inflationary spiral in the US that could send gold prices soaring.

Dow-gold ratio: Many analysts use this ratio to gauge the long-term trend of gold and the Dow Jones. The Dow-gold ratio is nothing but the Dow Jones Index divided by the price of one ounce of gold. Currently, it takes approximately 9.9 ounces of gold to “buy” the Dow. This number has ranged from two to 44 in the last 80 years but 9.9 is slightly below the long-term average of 12-13.

According to the mean reversion theory, one of two things should happen: The price of gold should fall from its current levels or the Dow has to rise considerably. It is really anyone’s guess what could happen.

As a safe haven: The supply-demand equation of an asset is what determines its price in the marketplace. Like many other commodities, the supply of gold will always be constant and increase slowly as mines become operational and new technologies to unearth gold are invented.

But the demand for gold can surge if there is a sudden perception of weakness in a currency, the economy or the stock market. New highs in gold prices clearly reflect that demand for gold is rising and will continue to. Gold has always been a safe haven investment in times of economic and financial crisis, and it could happen again if the current recovery shows cracks.

SHORT-TERM DRIVERS

Surpassing resistance: When gold surpassed $1,000/ounce, a crucial resistance level was broken. In the last four-five years, gold had difficulty breaching the $1,000 level and backed off three times after hovering around the high $900 levels.

This time, after breaching $1,000/ounce, it has shown considerable strength and could reach $1,250-1,300/ounce in a few months.

Technical chart: In addition to breaching resistance, two other important technical indications point to higher prices. The price of gold is comfortably above the two critical moving averages, the 50-day and 200-day moving averages. If a six-seven-year gold chart is examined, gold prices form higher tops and bottoms consistently.

This bullish chart formation only strengthens the case for higher gold prices. Worth mentioning in this context is that the dollar index chart forms the exact opposite structure with lower tops and lower bottoms, confirming that the dollar might continue to weaken in the short term.

Indian festival season: According to analysts, the Indian festival season could give a temporary impetus to gold prices and help sustain the bullish run.

Although not a driving factor in the long-term price of gold, the appetite of the common man for gold in countries such as India and China does impact the price. It is true that the long-term average return on gold is a measly 3-4 per cent; but the next few years could see greater yields on investments in the yellow metal.

(The author is an asset manager based in India and the US.)

ONLINE LINK TO THIS ARTICLE: CLICK HERE

2009-11-02T11:03:00.000-08:00

Make use of forex reserves

RBI’s primary use of forex reserves is twofold: As an emergency fund in case of a fiscal crisis or food crisis, and to help mitigate any significant volatility in the rupee

By, Adhvith Dhuddu

As appeared in Mint-WSJ on Sept 14th, 2009

Recently, surpassing $2 trillion, China’s foreign exchange (forex) reserves make up close to one quarter of the total reserves in the global economy. Though a pittance compared with China’s reserves, India’s forex reserves have grown healthily over the last decade and a half and are in many ways a reflection of our success as an economy. With close to $260 billion—approximately 25% of our gross domestic product (GDP)—in forex reserves, our coffers are extremely well padded to tackle a crisis. But what’s disappointing is the Reserve Bank of India’s (RBI) reluctance to deploy these funds in creative and resourceful ways.

In his book, Making Globalization Work (2007), Nobel Prize winning economist Joseph Stiglitz dedicates a whole chapter to explaining how the global reserve system should be reformed for the greater good of the world economy. After analysing how Asian countries have accumulated significant reserves following the Asian financial crisis, Stiglitz says: “The money put into reserves is money that could be contributing to global aggregate demand; it could be used to stimulate the global economy. Instead of spending the money on consumption or investing the money, governments simply lock it up.”

Not surprisingly, India is a victim of this flawed strategy. RBI’s primary use of forex reserves is twofold: As an emergency fund in case of a fiscal crisis or food crisis, and to help mitigate any significant volatility in the rupee. In its half-yearly Report on Foreign Exchange Reserves, RBI states that, “safety and liquidity constitute the twin objectives of reserve management in India and return optimization becomes an embedded strategy within this framework.” Despite its stated intention, RBI conveniently chooses to ignore how return optimization will be achieved.

There are several ways to measure return optimization of forex reserves. One standard reliable way is to see if forex reserves meet, exceed or lag reserve adequacy ratios.

Some rule-of-thumb reserve adequacy ratios are: sufficient reserves to cover three-four months of imports; reserves that amount to 20% of M2, a broad classification of money supply; a reserves-to-GDP ratio of 10%; and reserves-to-total external liabilities ratio of 100%. Measured against all these global reserve adequacy standards, India’s forex reserves exceed the requirements. Our forex reserves can cover seven-nine months of import; they are at 85-100% of M2; at 25-27% of GDP; and cover our short-term liabilities five-six times over. By this count, the optimal level of forex reserves for India would be somewhere in the $170-190 billion range.

As a start, 10-15% of reserves can be invested in India for various purposes: infrastructure, agricultural loans, educational loans, and so on. Lawmakers and regulators should understand that deploying just $25-30 billion will in no way increase our external vulnerabilities and a sudden outflow of capital would still be manageable.

In fact, the Asian Development Bank endorsed this strategy in early 2008 and encouraged India to use forex reserves to augment infrastructure development. Recently, the India Infrastructure Finance Co. Ltd successfully tapped our forex reserves through its UK subsidiary to fund capital goods purchases for infrastructure projects. So, whether it’s creating special purpose vehicles for investment in India, forming a sovereign wealth fund (SWF) or allocating $100 million each to the best 100 investment ideas in India, the options available to RBI are abundant.

Creative deployment of forex reserves will have political hindrances —SWF investments, for instance, can be badly politicized. But as Stiglitz points out, the current alternative is “governments just (locking) up” these reserves without putting them to work. Old habits, such as investing heavily in government securities and staying satisfied with substandard returns for forex reserve funds, are hard to break.

Adhvith Dhuddu is an asset manager based in India and the US. Your comments are welcome at otherviews@livemint.com

Online link to this article: Click Here

2009-11-01T15:03:00.000-08:00

WEEKLY ECONOMIC ANALYSIS: December 4th, 2009

Provided by TEAM Financial Services

"I will do everything I can to stop your nomination and drag out this process as long as I can. We must put an end to your and the Fed's failure and there is no better time than now. Your Fed has become the creature from Jeckyll Island."
- Senator Jim Bunning, December 2009

Items for discussion

For those readers who don't live all things financial markets/economy, you may have missed Senator Bunning's "questioning" at Fed Chairman Bernanke's confirmation hearing this week. It is the first time we've seen a government official address Mr. Bernanke, or Mr. Greenspan, in a way we can relate to. The 13 minute video can be seen on Youtube here. Personally, I probably haven't cheered on someone so gleefully since John Elway during the last touchdown drive of the 1998 Super Bowl versus the Packers.

The rolling waves of internal market correction finally reached our shores in a violent fashion Friday, as many commodities and related stocks suffered a substantial selloff. As we have long warned our clients, positions in the precious metals industry are infamous for incredible volatility, and the past few weeks have certainly not disappointed in this regard. From the beginning of November, the HUI precious metals stock index was up over 36% into its peak reached this week. Friday ushered in a vicious one day decline of over 7% at one point on Friday. December gold futures declined over 6% from the Thursday peak of about $1,226 per ounce at their low on Friday.

The US dollar enjoyed a violent rally versus every major currency, as the US dollar index was up over 1.5% - a huge move for the index. It appears that the one sided anti-dollar trade finally attracted one too many adherents, at least in the near term, and the vicious process of the pendulum reverting in the opposite direction may have commenced.

It is always difficult to experience these types of violent moves regardless of how many times one has experienced them in the past. The better than expected November US employment report released Friday morning appears to be the major catalyst for this latest shift in markets. TEAM is busy trying to ascertain whether a fundamental and intermediate term inflection point may be developing or whether this is simply a nasty shakeout/correction that will serve to scare the you-know-what out of those who own these positions. At present, it is too early for us to offer a definitive “forecast”, but we can offer our initial take.

Markets appeared to have priced in the base case assumption that the Federal Reserve would keep interest rates near zero through 2010 and even into 2011. Friday’s employment report appears to have re-introduced some anxiety over the wisdom of that assumption. We certainly understand the rationale behind this anxiety and respect the fact that markets often move violently once too many people have moved to one side of the boat – just a small number of people shuffling back to the other side can cause a rapid period of the boat tossing back and forth.

While the current reshuffling of the boat deck could certainly take a couple/few weeks to unfold, we do not yet see signs that the cyclical recovery in commodities is over. There has been a Pavlovian reaction from traders to sell commodities with any whiff of US dollar strength, which is something that historically is not a given. There have been many periods historically in which commodities rallied with the US dollar in relation to foreign currencies, and TEAM believes that a similar scenario is possible. In addition, this latest spike in the US dollar could end up being very temporary, though significant in percentage terms, before it resumes its downtrend.

We continue to retain our significant allocation to commodities and related stocks, as painful as doing so was on Friday, as we believe they continue to present a compelling risk/reward opportunity over the intermediate term. We were encouraged to see that precious metals stocks were down about in line with the metal itself. Often times during these types of violent moves the stocks will be down a multiple of the metal. This suggests to TEAM that the stocks may be poised to finally lead the metal once the current decline exhausts itself, whenever that may be.

Market/Economic Climate

The strength in Friday’s employment report corroborates the forecast we made a couple of months ago that job growth could actually resume by the end of 2009. As completely unlikely as it seemed at the time we expressed that forecast, it now appears within reach – such is the “magic” of well constructed leading indicators! TEAM continues to forecast that government reported GDP growth in the 1st and 2nd quarters of 2010 will surprise many with the extent of the strength. Our research suggests that there is widespread aggressive inventory management across many industries. Whether it is retailers petrified of a weak holiday shopping season or an industrial firm worried the demand for their widgets will not resume.

We already know that firms have cut payrolls aggressively over the past two years, so if/when demand does pick up, even if it is modestly and regardless of whether it is being created by government stimulus, a cyclical “perfect storm” could unfold. With inventories extremely low and labor cut to the bone, production and labor pressures could emerge quickly. There is no question that the US has lost a huge amount of its manufacturing base to other countries, so employment trends in the US could continue to lag. However, whether a widget is manufactured in Malaysia or Michigan, the demand for raw materials is the same.

We believe this combination of low inventories, dramatically reduced work forces and incredibly loose monetary policies globally is likely to keep a significant wind in the sails of commodity prices. As we stated several months ago, leading indicators suggest the US service sector is poised to lead the US recovery, so service jobs and end demand may revive faster than most expect.

Humor for the Weekend

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.

2009-10-30T15:11:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: October 30th, 2009

Provided by TEAM Financial Services

"All objects, all phases of culture are alive. They have voices. They speak of their history and interrelatedness. And they are all talking at once!"
- Camille Paglia

Items for discussion

There have been two important developments in the past two weeks that most readers are probably not aware of. The central banks of Australia and Norway both raised their interest rates. This has coincided with the market carnage of the past two weeks. TEAM believes these developments are important over the intermediate to long term, as it is indicative of an end to the global synchronized monetary regime that has existed over the past twelve months.

Since the financial crisis took full force last fall, central banks around the world have followed fiscal stimulus with monetary stimulus. Spending has increased by governments around the world while interest rates have been slashed. Fiscal deficits have exploded and rates have remained at record lows. The fact that two central banks have moved to begin removing some monetary stimulus is indicative of something we expected to be inevitable. Countries were never likely to maintain a uniform perception of reality or their self interests.

If we are correct, then we are likely early in the transition towards the third of the three crises. The financial crisis morphed into an economic crisis, and now we believe that government responses and policies around the globe are likely to usher in a global currency/funding crisis. While we may be in the beginning stages of this transition, it could take quite a period of time until the crisis becomes main stream and dramatically impact the broader economy and financial markets.

Market/Economic Climate

Something we learned long ago is that if one makes an economic or market forecast long enough, then one is likely to be correct….eventually. After fighting our shadow for a few months and preparing for the correction of substance that was seemingly never to arrive, it appears to have finally arrived. We had communicated a basic scenario for the fall which we expected to play out and it now appears possible. It appears that renewed concerns about the durability of the economic recovery have many investors running for shelter.

The major stock market averages are down about 6% from the peak reached just seven trading days ago. That rate of decline would be on par with the June-July mini-correction over the summer, but we expect this correction to be deeper. Our base case scenario is a correction to evolve into 10-15% decline from the recent peak around 1,100. Market sectors hit hardest in the initial stage of this correction have been those sectors that lead the March-October move higher. Financials, energy and materials have been hit the hardest. Small companies have been hit harder than large companies, and foreign (especially emerging markets) have been hit harder than domestic.

At this point, TEAM believes the unfolding correction may end up being similar to the 4-6 week correction markets suffered in May-June of 2006. Economic fundamentals remained strong on a global basis during that correction, which was largely a purging of excess optimism on an intermediate term basis. Major market rallies/bull markets often experience three major phases. Phase one is when the rising tide lifts all boats and low quality stocks tend to outperform. Phase two is typically ushered in via a correction in which many of the low quality stocks never recover. These stocks, as a group, typically make their peak at the end of phase one. Phase two unfolds with investors upgrading their portfolios into higher quality company stocks and leadership narrows in the market. Breadth and advance/decline indicators typically begin to diverge as fewer and fewer stocks participate in the advance. Phase two can include a new market high in the broad market averages, but it does not have to. Phase three includes the final stages of the exhaustion in the market and the transition to the beginning of the bear market.

At this point, TEAM believes that phase one has ended and that the current correction should usher in phase two. Client portfolios have been structured to weather this transition for several weeks – about two weeks premature as it turned out. While shorter term market forecasts are always treacherous, our base case is for the current correction to be quite violent in both directions and last into late November. We expect to maintain significant portfolio hedges until we see signs that the correction has exhausted itself. At that time, it is very possible that we may significantly reduce or even eliminate portfolio hedges and add addition positions to portfolios.

Of course, it is possible that we’ve reached a major market peak and that the market will simply crumble into a major collapse. While this is a very low probability in our opinion, we always approach market declines with a disciplined process that waits for some signs of stability prior to increasing portfolio risks.

Humor for the Weekend

2009-10-10T10:33:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: October 10th, 2009

Provided by TEAM Financial Services

"At twenty a man is full of fight and hope. He wants to reform the world. When he is seventy he still wants to reform the world, but he know he can't."
- Rodney Dangerfield

Items for discussion

While we covered this topic recently, we believe it is important enough to highlight once again. Bond mutual funds have seen an explosion in inflows from retail investors over the past year. The inflows have dwarfed the amount of assets that have flowed into stock mutual funds, despite the 50%+ recovery in the major stock market averages since the absolute March low.

For those readers who actually have a life and don’t follow such things closely, much of the bond market trades on what is known as a “spread basis”. Essentially, the value of a bond is gauged relative to what is considered a “risk free equivalent”. For example, company XYZ may issue a new 10 year bond and its spread to the 10 year US Treasury bond may be 2%. The current yield on the 10 year US Treasury is 3.384%, so a 2% spread would result in a yield of 5.384%. Many bond investors worry mostly about this RELATIVE spread far more than they worry about the ABSOLUTE yield of bonds. TEAM hopes most of our clients know by now that our primary obsession is focusing on absolute returns in general – i.e. whether the stock market is up or down 50% in any given year, our goal is to make reasonable positive returns. We view bonds through a similar “absolute return” lens.

The Federal Reserve has purchased well over ½ of the massive amount of US Treasury bonds issues in the past 3 months. TEAM is left to wonder where Treasury yields would be if this artificial demand was not in play. As we’ve chronicled in the past, the Fed is printing money out of thin air in order to monetize/buy these Treasury bonds. Would yields be .5% higher or 1% higher if this wasn’t occurring? We have no idea, but we suspect they would be higher.

In our opinion, those bond investors relying on spread relationships in order to invest may be making a terrible mistake. We believe there is a tremendous risk that US Treasury yields will head significantly higher over the next 3-5 years. We’ve identified a US “funding crisis” as the next potential crisis to face investors, and part of such a potential crisis would likely include significantly higher Treasury yields.

For anyone who has invested for more than the past 10 years, or at least is familiar with market history (yes I admit to being in my mid 30’s!), a 10 year Treasury yield of 7-8% would be considered reasonable. Many may remember when yields were in the mid double digits in the early 1980’s. My colleague, Sam Lindenberg, is fond of telling the story about his 15% mortgage when he bought his house when he moved to Central PA (much like the old “I walked to school in 3 feet of snow stories” some of our seasoned citizens share!). Money market rates have commonly been in the 4-6% range over time.

Many bond investors appear willing to lock up money for 10 years at mid single digit returns and justify it because they are getting an “adequate” risk spread over US Treasuries. TEAM has seen this game before on several occasions. Relativism can be a very dangerous practice as an investor. There were dot com stocks in 1999 that were “cheap” relative to other dot com stocks. There were Las Vegas condos that were “cheap” relative to other Vegas condos in 2006.

One of the most pernicious and morally reprehensible components of our government’s current policy is what it is doing to otherwise conservative savers who are now being “forced” to take risk. We witnessed this with horror during the 2003-2007 period as many seniors rushed into bank preferred stocks and other vehicles that subsequently "blew up". A senior living off of a 10 year CD that may have been at 6% may be finding out that a comparable CD may only yield 3% today. In a quest to preserve their income for such gratuitous items such as medications, food and shelter, is it any wonder why someone in that situation may be willing to move out the risk curve to try and preserve that level of income? Why not buy a “conservative” bond mutual fund that yields around 5%?

Despite all of the crazy market developments since 2000, investors haven’t faced a good old fashioned bond bear market in a long time. There was a relatively brief flirtation with one in 1994 before Alan Greenspan folded (as he always did) to the Wall Street bond traders screaming for mercy. Prior to that time, it has been since the late 1970’s and early 1980’s that bond traders/investors have had to deal with persistently higher interest rates. While mob rule can get one run over if one tries to stand in the way of the stampede, they almost always end badly. We don’t yet have a good feeling as to when the current stampede may end. However, just as prior stampedes have left the masses with deep regrets (rushing into tech stocks in 1999 or flipping houses in 2007), rushing into bonds at the moment is likely to be bad for one’s financial health over the long run. We suspect those rationalizing bond purchases using relative metrics will eventually learn the expensive lesson of absolute value.

Market/Economic Climate

While the stock market remained extremely, and impressively, resilient this past week, there is some movement in the quicksand that lay in the foundation. The US dollar index reached a downside target in our model and bounced significantly off the lows late in the week. It has been very unusual for stocks to ignore a rally in the US dollar, yet that is precisely what occurred on Friday. The US Treasury market also reversed sharply on Friday, as bond prices dropped and yields rose. The synchronized trend in recent weeks has been stocks/commodities/bonds rallying as the US dollar drops. Friday was the first day in which these correlations broke down. The US dollar rallied with commodities and bonds falling. As mentioned, stocks defied the dollar rally and diverged.

Of course, this is just one day, but given the proximity of the major stock market averages to one of our longer term target areas, next week is likely shaping up to be very important to TEAM as to how we adjust client portfolios. At present, client portfolios remain positively exposed to stocks and commodities, but at a dramatically lowered level due to extensive portfolio hedges. This is due to our research and model indicating that there is a high probability that the US dollar is poised to enjoy at least a multi-week rally and that stocks will eventually relent and correct in price at the same time. Our current allocation should be fairly well positioned to weather such a scenario. Importantly, should things not develop as we expect, then we may need to swiftly shift portfolio exposure and scale back some of our hedges.

We recognize this kind of account activity can be unnerving to many clients, but it is a critical part of our flexible strategy that has enabled us to provide consistent absolute returns over time. As always, we are happy to address any client questions or concerns regarding portfolio holdings or activity.

Humor for the Weekend (From last week)

2009-09-24T10:36:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: September 19th, 2009

Provided by TEAM Financial Services

"We believe the effect of the troubles in the subprime sector on the broader housing market will be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or financial system."
- Ben Bernanke, May 17th, 2007

Items for discussion

Bubbles here, bubbles there.....bubbles everywhere. Each asset bubble of the past 15 years has been followed by an explosion in liquidity created by global central bankers. It appears so far this year that the latest version of inflating a new bubble is occurring in the bond market. Retail investors have begun to reverse the redemptions of over $251 billion in mutual funds that occurred during the 2nd half of 2008. Through August, $226 billion has been invested into mutual funds, according to Morningstar. However, the majority of this money has been invested in bond mutual funds. Pimco Total Return (PTTRX) is now the largest mutual fund in the country by a large margin, with over $177.5 billion in assets managed. That number is truly staggering, as this single fund now accounts for about 13% of the taxable bond mutual fund market.

TEAM finds these developments interesting for a variety of reasons. First, interest rates have been in secular decline for almost 30 years. With intermediate and long term high quality bonds now yielding low to mid single digits, the only way one could expect decent returns holding the bonds would be if the US suffers a horrendous deflationary collapse. We simply do not see that scenario as being likely. Therefore, as retail investors are apt to do, TEAM believes they are running fool speed ahead directly into an oncoming freight train.

We referenced our concerns over the morality of the Federal Reserve’s policy to peg interest rates so low and how it has encouraged, if not forced, many otherwise conservative savers to move out the risk spectrum out of desperation.

TEAM believes much of these retail flows into bonds have been the result of fleeing low or zero yielding money market funds in search for higher yields. This trend has become self-reinforcing as bonds have rallied as a result and accrued significant capital gains in addition to the better yields. Of course, as bond prices rally yields fall, so those adding money over time are getting an increasingly worse risk/reward profile.

One could question how stocks could be up so much if so much money is flowing into bonds? One of the characteristics of the market rally since March has been a historic lack of volume – i.e. the move higher has not occurred with the typical explosion in volume during the initial stages of a new bull market. TEAM believes the sharp move higher has been a product of three factors.

First, sellers truly exhausted themselves on an intermediate term basis during the October 2008-March 2009 period. If sellers are exhausted enough, then even tepid demand can thrust prices higher.

Second, many short sellers we know of who have been successful long term have abandoned shorting out of fear of the impact of the vast amount of money being printed globally. One prominent global investor who we hold in very high esteem, Jim Rogers, recently stated in public that he has zero shorts for the first time in many years. This relative absence of short sellers has likely removed a typical source of supply as the market has moved higher.

This also likely means that there is a vacuum developing below the market, as the absence of short sellers will remove a critical source of DEMAND when prices eventually do head lower. This was very evident last fall when the government outlawed the shorting of certain financial stocks. Once the initial pop concluded and shorts were absent, the share prices went into free fall – government bureaucrats strike again!

Third, equity fund managers have reduced the amount they hold in cash back to extremely low levels. After raising cash levels significantly last year to lower risk and meet investor redemptions, managers are now under massive pressure to keep up with the broad market. We’ve heard/read numerous accounts of “professional” fund managers who are buying stock as fast as they can, not because they think it is the wise thing to do, but because the management of their firm has told them to do so – or else.

Market/Economic Climate

The great irony with these developments is that our gauge of aggregate investor sentiment remains far more bullish than the aggregate sentiment on the economy. TEAM expects this divergence to invert sometime in the next three to six months. We are in the very awkward position of being amongst the most bullish forecasters for the economy over the next six to nine months. For long time clients/readers who have suffered through our weekly diatribe about the coming financial/economic apocalypse for many years, they may be questioning whether we’ve recently joined the cannabis appreciation society. One of the lessons we learned from 2003-2007 was that long term fundamental concerns do not necessarily prevent short and intermediate term cycles to develop.

As we’ve been expressing in recent weeks, our bullish economic forecast is very much time sensitive. We do not expect the recovery to be a long one or one that remains strong for an extended period. While we expect the early stages to shock many as to how sharp it will be, we also expect this surprise to shift many to adopt a more optimistic, and likely wrong, longer term outlook. One question we’ve been considering is how financial markets would react if 1st quarter 2010 GDP develops at 7%+? How with the bond market react, with the Federal Reserve fixated at keeping short term rates near 0%? How with global currency markets react with most global interest rates in low to mid single digits?

TEAM believes that the next bearish development for the stock market will be a growth shock. Given the massive amount of government intervention in the “Weekend at Bernie’s economy”, what happens when investors begin to question to wisdom of record deficits and 0% interest rates with the economy growing at a rapid pace. The Fed may argue that they are just being cautious for fear of committing the same “mistake” they believe was committed in 1937 in the US and the early/mid 1990’s in Japan. We’d expect markets to greet such complacency with displeasure for fear of the inflationary genie being left out of the bottle. If the Fed decides, or is forced by markets, to tighten liquidity, then will Bernie collapse under his own weight

Just as TEAM worried that the Fed had painted itself into a dangerous corner in 2005-2007, we see yet another episode of this long running mini-series. The series has gone global, with central banks across the world facing similar issues. Given the complexity of the situation and political forces in play, our confidence in a perfect landing for any “exit strategy” is extremely low. However, we expect these issues to remain on the back burner until the potential growth surprise clunks investors on the head sometime late this year or early next. When they do, we expect many of the retail bond investors this year will live to regret their decision to chase yield.

Humor for the Weekend (From last week)

2009-09-12T09:00:00.000-07:00

TV9 COMMENTARY ON GOLD

Main points made:

1. The price of gold should continue to rise as there are many factors that are abetting the rise.

2. As inflation fears plague the US economy, and as the true reality of the economic recovery is known, a safe haven like gold should see higher demand.

3. Unprecedented debt issued by the US government will result in inflation now or later, and this will devalue the US dollar significantly. As gold is a dollar-denominated asset, even if supply demand numbers are stable, a weakening of the dollar will mean a rise in the price of gold.

4. The recent economic crisis have forced many export oriented countries, and countires with bulging forex reserves to divest the US-dollar holdings (at least partially) and funnel them into gold both as a hedge and as a safe haven.

5. The supply of gold will only rise constantly and steadily. But the demand for gold can suddenly shoot up in times of crisis as a safe haven.

6. General commodity cycles last about 20-25 years; this one began in early 2000 and could last another decade or more. Of course 10-12 more years of bullish sentiment in commodities will be associated with some bearish periods.

7. Temporary seasonal factors (like the festival season in India for the next 2-3 months) also mean the bullish sentiment in gold is validated.

2009-09-07T10:57:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: September 4th, 2009

Provided by TEAM Financial Services

"I hope for an America where neither "fundamentalist" nor "humanist" will be a dirty word, but a fair description of the different ways in which people of good will look at life and into their own souls."
- Edward "Ted" Kennedy

Items for discussion

The monthly jobs report is one of the most closely followed figure released by the federal government. It is released at 8:30am the first Friday of each month, which happened to be this Friday morning. The headline unemployment number is the one most widely reported in the mainstream media, and hit reached 9.7% this month. Our experience is that most of the media, including the business media such as CNBC, does a pretty horrible job of explaining these numbers and what they may mean.

First, the numbers are based on a lot of statistical models created by people working at the Bureau of Labor and Statistics (BLS). We’ve chronicled this in the past, so we won’t beat a dead horse this week. The biggest issue we have is the use of what is known as the “Birth/Death Model”, which is the BLS’s attempt to model for small business creation and destruction during the business cycle. We have no idea how they calculate this fantasy number, but it doesn’t pass the smell test. This “model” has assumed that hundreds of thousands of jobs have been created by small business during the most severe economic contraction since the Great Depression.

In addition, the headline number, also referred to as U-3, is the number politicians have stressed over the past 15+ years. This figure has been tortured to exclude workers who stop looking for a job – not because they don’t want to work but because they become discouraged. It also does not account for the under employed, which is people who are working part time only because they cannot find a full time job.

The BLS does release a more comprehensive figure for unemployment called U-6, which was reported to be 16.8%, which we believe is far closer to reality. Interestingly, this number is not included in the official press release and must be located on the BLS website under “alternative measures of labor utilization”.

As bad as this number is, many forget that unemployment tends to be a lagging economic indicator. It is very typical for the unemployment rate to continue to rise during the initial stages of an economic expansion, as employers are reticent to take on the cost of new labor until their confidence that a recovery is more durable.

It is human nature to allow current conditions to cloud one’s judgment as to what is likely to occur in the near future. This kind of unemployment environment is truly a tragedy for many families in the US. However, this gloom does not preclude the possibility or, as we believe, the likelihood that an economic recovery that is much stronger than most expect will take hold later this year and into 2010.

As we’ve been arguing for weeks, we don’t believe the recovery will develop into a long expansion due to the artificial nature of the government’s massive involvement in propping up so much of the economy. This, along with some long term structural issues, suggests that the employment situation is not likely to reverse to the point of being a real economic strength. We expect the job situation to improve and unemployment to stabilize, but we unfortunately do not expect a robust recovery in jobs growth.

Market/Economic Climate

TEAM has not commented much recently on one of our core secular investment themes for our clients – precious metals equities. This industry took center stage this week, as gold and silver prices firmed up and related stocks skyrocketed. We remain extremely bullish on the industry over the next several years and continue to have a very heavy overweight to it – though the sector is infamous for vicious short term corrections. We’ve been fortunate enough to acquire a decent number of new clients over the past two years, and this has provided us with the opportunity to see how many other firms have their clients invested.

While this is anecdotal, we’ve seen near zero exposure to commodities in general, with precious metals also absent. We find this instructive, as bull markets typically don’t end with so little participation from investors. One need only have seen all the portfolios we saw in 1999 and 2000 that were riddled with large cap growth mutual funds and technology stocks to see this phenomenon. We’d expect commodity and precious metals related investing to become far more widespread before what we believe to be a long term bull market concludes.

The stock market reached an oversold level on a short term basis late this week. The character of the bounce will be instructive as to whether a deeper correction is in the cards. We believe a deeper correction in the 5-7% range is more likely than not, but we still see no significant signs of a major market top. We continue to carry a modest amount of portfolio hedges to balance out a significant overweight in commodities and related equities.

Humor for the Weekend

2009-08-29T02:53:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: August 28th, 2009

Provided by TEAM Financial Services

"In the school I went to, they asked a kid to prove the law of gravity and he threw the teacher out of the window."
- Rodney Dangerfield (Back to School 1986)

Items for discussion

After a one week hiatus, we are back to answer the questions to all the world’s problems….or at least attempt to figure some financial stuff out. We chose a good week for our hiatus, as not all that much happened price wise over the past two weeks, as the major indexes finished within 1% of where they were two weeks ago.

One of the major news stories in our world over the past two weeks was the reappointment of Ben Bernanke to the post of Federal Reserve Chairman. The widespread and intense accolades Mr. Bernanke received throughout the media was interesting to us since we view Mr. Bernanke to have been “Robin” to Alan Greenspan - aka “Batman” for our analogy.

The accolades showered upon Mr. Bernanke were largely centered on the fact that he “saved the financial system from collapse”. We find this humorous and ironic. We believe this would be like congratulating a reckless camper who left all kinds of fire hazards in a dry forest and is then congratulated as a hero for helping fight the inevitable fire.

Overall, we don’t view the reappointment of Mr. Bernanke as a huge development, as we suspect the alternatives would have been cut from the same cloth. However, the timing of the announcement is/was curious. His term was not to expire until January and the President interrupted his family vacation in order to make the announcement. What was the big hurry that couldn't wait until September?

One thing we’ve noticed is some strange behavior in currency and commodity markets in the past few weeks – particularly the past two weeks. One theory we heard floated this week by some savvy investors/traders is the potential for the Chinese to announce some kind of change in their pegging of the yuan to the US dollar. That would certainly make sense based on some of the weird market action of late, but it is obviously pure conjecture at this point.

It does highlight a critical long term issue we believe will be addressed – either by conscious political maneuvering or forced by markets. Due to the yuan-dollar peg, China “imports” our monetary policy to a large extent. To date, they’ve decided that doing so has been in their best interests, but we expect that to change at some point, and potentially in a significant way.

If/when the Chinese make a move, we expect it to be a positive catalyst for our significant overweight position in client portfolios to commodities and related equities. We continue to hold significant allocations to broad commodity indexes with additional concentrated exposure to agriculture. Our equity-related exposure continues to be very significant in precious metals stocks, and we recently ramped our energy equity exposure to a significant stake.

We own these positions for long term fundamental reasons, but we certainly wouldn't be upset if the Chinese create a catalyst to move things along.

Market/Economic Climate

ECRI’s Weekly Leading Index growth rate reached a 38 year high this past week, which suggests that the risks of a traditional “double dip” recession are extremely low. Ironically, TEAM believes that a stronger than expected economic outlook will eventually be much more bearish for stocks than a flat to modest recovery. It may be very difficult for the government to continue to prop things up in our “Weekend at Bernie’s” economy if things begin to show real signs of strength, as we expect to occur by the 1st and 2nd quarters of 2010.

Mr. Bernanke has written and spoken about the mistake the Federal Reserve made in 1936-1937 by raising rates and contracting monetary policy “too fast”, as the economy bounced off the 1933 lows. Given Mr. Bernanke’s view, we suspect the Fed may be VERY hesitant to take actions they believe could stymie the recovery. Such hesitance could leave the speculation and inflation genies out of their bottles, which we believe could eventually result in a dramatically weaker US dollar and higher long term interest rates.

Our current view is that this entire process could take some time to play out and will most likely be reflected in financial markets late this year or, more likely, some time in 2010. 2010 also just happens to be the infamous “2nd year of a presidency”, which has historically been the “kitchen sink” year for administrations to dole out any painful medicine (think MAJOR tax increase this time, in our opinion) in time for political recovery for reelection.

On a short term basis, we continue to carry some modest portfolio hedges to protect against the potential for a trap door. This insurance has cost clients some in performance this year, but we believe it remains prudent given the historic nature of how extended the market currently is technically. Such markets tend to persist for longer than most think, but then surrender much of the momentum driven gains in the “final move”. A comparable move at present would result in a correction of about 5-7% in the major stock market averages, which would be a typical correction even if the cyclical bull market is to extend to new highs.

Humor for the Weekend

2009-08-27T13:24:00.000-07:00

THE PRINCIPLES OF ECONOMICS!! AWESOME 5 MINUTE VIDEO ABOUT EVERYTHING YOU WANTED TO KNOW ABOUT ECONOMICS!! MUST WATCH!

2009-08-21T05:06:00.000-07:00

S&P 500 PE RATIO ANALYSIS

From Chart of the Day

Today's chart illustrates how the recent plunge in earnings has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1936 into the late 1980s, the PE ratio tended to peak in the low 20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s) and the dot-com bust (early 2000s). As a result of the recent plunge in earnings and recent stock market rally, the PE ratio spiked and just peaked at 144 – a record high. Currently, with 97% of US corporations having reported for Q2 2009, the PE ratio now stands at a lofty 129.

Notes:
- Where's the market headed? The answer may surprise you. Find out right now with the exclusive & Barron's recommended charts of Chart of the Day Plus.

Direct link to Chart of the Day, and the above chart: CLICK HERE.

2009-08-16T10:07:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: August 14th, 2009

Provided by TEAM Financial Services

"This is like deja vu all over again."
- Yogi Berra

Items for discussion

Just as Yogi would put it, we seem like we’ve lived this before. What do we mean by “this”? Of course, it is our emerging obsession with the “Weekend at Bernie’s” economy, which appears to have turned into a global blockbuster. While we spend most of our time in this commentary discussing the economy and financial markets in the US, we remain focused on global developments in our day jobs. While the US government has been active in propping up various “Bernies” like the auto industry and banks, the Chinese government makes the US look like amateurs.

The funny thing about an authoritarian regime is that it can pretty much get its citizens to do anything it wants – as long as it remains in power that is. Such control has surely been a driver of the speed at which China has built its infrastructure. When the Chinese government tells a couple of thousand of its citizens to build a nuclear power plan, they do it. In the US, it can take 10+ years to get a site chosen and the mountain of regulatory red tape navigated!

The Chinese government engaged in an economic stimulus program over the past year in which it has essentially mandated that banks lend money. State owned banks in many other countries, including India and Brazil, have likewise exploded lending. All this is occurring as privately own banks in those countries retrench.

Not surprisingly, state owned banks have complied very aggressively in China. The investment in productive capacity and infrastructure has been immense. Under free market conditions, these kinds of investments are the kinds we applaud and believe contribute to the long term health of an economy. However, when they are mandated by a government, we believe significant problems are likely.

Chinese industrial production entered the period of stimulus with massive excess capacity. As global consumer demand dropped (lead by the US and Europe), inventories piled up and production was shuddered. In a free market system, price signals would not begin to make additional investment in new capacity worthwhile until most, or even all, of the excess capacity is soaked up once economic activity and demand recovers. This is why we have economic cycles – these things take time to evolve. The political decision to “stimulate” by the Chinese has resulted in massive over capacity becoming even greater. Empty apartment buildings in Shanghai are no discouragement against building yet more building to sit empty.

We find it amazing that politicians, and many economists for that matter, never seem to learn anything from history. The Japanese attempted public works programs throughout the 1990’s in which roads and bridges were built in areas in which the demand for their existence was limited or did not exist – the proverbial bridge to nowhere. Such government spending certainly increases economic activity in the near term, but it does nothing to build long term productivity or wealth for society – i.e. raise living standards. The Chinese are engaged in a grand experiment like none the world has likely ever witnessed.

The now infamous "clash for clunkers" program in the US is another example of central planning. It rings hollow to us, as it reminds us of the broken window fallacy. Intentionally "destroying" productive assets may stimulate activity in the short term, but it does nothing to increase wealth or production long term. If things were so simple, we could simply instruct the Air Force to blow up all the major bridges in the US! That would surely create jobs in the short term!

There is no question one can argue there are non-economic aspects to the program. Increasing the overall fuel efficiency of the US auto fleet can be argued to have both environmental and national defense policy relevance. However, to argue that it is being done to "stimulate the economy" is simply ridiculous - as the broken window fallacy suggests.

This is just one more example we see in which our government leaders implement policies that make no sense to us over the long term, but do provide a false sense of stability in the short term. Another great example has been the shift in policy to allow banks to change their accounting rules to effectively pretend that their assets are worth more than the markets are saying.

We believe all of these shenanigans have contributed to investors having an excuse to take more risk - not only in the US but throughout the world. However, the consumer doesn't appear to be fooled. This is reflected in a very unusual divergence, as investor sentiment has reached a bullish extreme at the same time consumer sentiment is languishing. Typically, these move in tandom. At some point we expect these two to move back into synchronicity.

Market/Economic Climate

The growth rate on ECRI's Weekly Leading Index reached a 26 year high, which suggests that the economic recovery directly ahead is likely to be the sharpest since the US economy emerged from the double dip recession of the early 1980's - though the job market is likely to remain poor. TEAM believes that on a fundamental basis, the stock market is already reflecting this positive outcome. Based on our various valuation metrics, the S&P 500 is around 15% above what we consider long term fair value.

However, as we learned the hard way during the 2004-2007 period, a recovery built on quicksand can cause investors to whip into a frenzy of momentum that drives prices to be detached significantly from fair value. TEAM believes that a significant allocation to hard assets and related companies remains prudent given the chances of a recovery that surprises most with its intensity, and likely stokes up significant concerns that the Federal Reserve is letting the inflation genie out of the bottle.

We continue to maintain some portfolio hedges, which we believe is prudent insurance given the fundamental backdrop. However, we believe any short to intermediate term corrections in the price of commodities and related equities is likely to be transient and an opportunity to increase exposure.

Humor for the Weekend

2009-08-13T05:12:00.000-07:00

Fuss over private education

One of the main functions of the government should be to marry human capital with physical capital

By, D. Muralidhar

As appeared in Mint

Any developing country has a short supply of financial resources to provide even basic amenities. Though the current Indian government has been claiming to be a welfare one, the basic requirements of millions of people continue to be unmet.

Most of the developing countries are endowed with a large human capital, but any forward-looking government should leverage this capital in an efficient way. One of the main functions of the government should be to marry human capital with physical capital. This has to be done so that the country’s resources can be leveraged in the most optimal way. This transformation can occur only if human capital possesses sufficient education. The mercenary zeal of private enterprise can accelerate the process.

There is a marked shift in the demography of our country. The exponential growth of population in the band of 5-20-year-olds demands exponential investments in education. This has primarily not materialized due to the continuous demand on limited government resources for other purposes. In fact, government resources will never be enough. So there is an urgent need for the government to accept this reality and formulate policies for channelling private capital into this crucial sector.

It is relevant to draw a parallel with China here. The present Chinese population is what the Indian population will be in 2020-25. Apart from the various measures China adopted to augment continuous growth, education and skill development received a tremendous fillip. India must do the same.

The historical mindset of the Indian is to expect the government to undertake the responsibility of education. However, as incomes are inching up, paying for education is slowly gaining acceptance. The government must complement this change of mindset by freeing the education sector and allowing private capital. Private capital, by definition, smells profitable opportunities and gushes in; the pace of change is very brisk, thus gaining valuable time.

Having accepted the need for private capital in education, the next question posed by the naysayers is about cost, quality and control. We must start with a premise that some education is better than no education. As private capital flows in, many of these issues get sorted by simple market forces.

Education must be considered as any other amenity, without attaching any baggage. Factors such as reservations, source of capital, merit and beneficiaries should be kept out of the discussion in a country where millions have no access to basic education. We hear of many engineering colleges shutting down programmes in rural areas due to student shortages arising out of lack of infrastructure, teaching staff and other facilities.

So benchmarking must be done not against other countries, cultures, or systems, but against our own needs. This has to be the only yardstick to improve the availability of education.

Education being a part of the Concurrent List in the Constitution, Union and state governments must act as catalysts rather than controllers. The statements made by human resource development minister Kapil Sibal are indicative of the shift in the policy approach. But it’s not just the Centre: States that are progressive in their outlook on education will steal a march over others. Like private schools, states can also compete to get the best.

Having already lost decades, India has a long distance to cover. No further time should be lost; changes must be effected on a war footing. The only way out of this quandary is to use private resources with attractive policy incentives. The present inclination of the states to attract investment in industry should become a model to attract investments in education. Enlightened state governments can also leverage their demographic advantage.

D. Muralidhar is on the board of governors at the Indian Institute of Management, Bangalore, and member of the Planning Commission, government of Karnataka.

Online link to this article: Click Here

2009-08-11T02:23:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: August 7th, 2009

Provided by TEAM Financial Services

"A government big enough to give you everything you want, is strong enough to take everything you have."
- Thomas Jefferson

Items for discussion

TEAM has long argued that the Federal Reserve has been painting itself into a major corner from which it will eventually be extremely difficult to emerge. Using our terminology which we have borrowed from the science field, we’ve believed that a critical state has existed for some time. We’ll use a natural science example to explain what we mean.

Avalanches occur once the snow on a mountain reaches a critical state and a catalyst emerges. The critical state is accomplished when the pressure on the mountain reaches a certain point from which a large outcome can emerge. Whether it is a squirrel falling from a limb or a snowboarder yelling to their friend, at some point a catalyst causes the critical state to wreak havoc. Of course, knowing when or what the specific catalyst will be is impossible. However, we believe there is value in identifying a critical state so as to manage the risk of what is typically certitude – eventually a catalyst will emerge.

As things relate to the Federal Reserve, we’d argued that a critical state had been reached in the late 1990’s and that the deflation of the technology bubble could start the avalanche. Indeed, a decent sized avalanche did emerge, but it was only one section of the mountain – technology and large cap growth stocks. To bail out that segment of the economy, the Fed decided to dumb still more snow on the other sections of the mountain to try and compensate. They were “successful” in inflating a credit and housing bubble, which helped offset the prior avalanche. We long argued that the recovery from 2002 through 2007 was being built upon a faulty foundation that would eventually collapse under the mountain’s pressure, and the 2007-2008 global credit collapse and massive declines in credit, stock and commodity markets were certainly significant – an avalanche down the entire mountain.

This time, the Federal Reserve was aided and abetted by the Executive and Legislative branches of the US government. To try and contain this massive avalanche, the Fed cut short term interest rates to effectively zero, while ballooning its balance sheet with toxic assets from bank balance sheets and engaging in quantitative easing – basically printing money from thin air. The Treasury department chipped in with various programs like TARP, while Congress authorized a budget deficit that will likely come in around $2 Trillion dollars for the year. With all of this fire power, they have been “successful” once again in stopping the most recent avalanche.

Unfortunately, we believe the measures they have taken to do so are likely to result in a far more dangerous future avalanche once the current critical state eventually meets its inevitable catalyst. The leading economic indicators we place the greatest confidence in are now forecasting that the economy is likely to recover at a rate significantly higher than what most investors and economists are currently forecasting. One may assume that this would be good news, as faster growth should translate into higher employment and wages for the average household. This is where TEAM sees tremendous danger and the seeds being planted for the next crisis.

If the economy begins to show signs of significant improvement in the coming months, then the Fed will be required to make a very difficult choice. Markets will likely begin to demand higher short term interest rates due to higher commodity prices and increased fears of inflation. Indeed, the Economic Cycle Research Institute’s Future Inflation Gauge is showing early signs of a dramatic pickup in inflation over the next year. Raising short term interest rates would be dangerous for many reasons, but we’ll pinpoint two. First, there is hundreds of billions of dollars of prime mortgages due to reset over the next 12 to 24 months. Higher interest rates could compound a “next wave” in mortgage defaults and further impair a US banking system that appears to be trying to regain some stability. Second, the federal government has been borrowing tremendous amounts of money over short term maturities in recent years. At present, the government is borrowing money for 1 month to 5 years ranging from literally almost nothing to less than 3%. If rates were to double, which would hardly be unusual based on historical inflation and interest rate cycles, the added financing costs to the US government would blow yet another enormous hole into the budget.

Ben Bernanke is widely regarded as a leading scholar in studying the Great Depression as well as Japan of the 1990’s. He has gone on the record many times that the US and Japanese governments made critical errors in tightening monetary policy to soon into the initial economic recoveries that emerged in 1933 and in the early 1990’s in Japan. TEAM believes that it is unlikely that the US Fed would move aggressively to tighten unless forced to do so via a currency crisis. Just to make things interesting though, Mr. Bernanke’s term expires at the end of this year and his re-appointment is far from a certainty.

If the Federal Reserve is slow in addressing market concerns over inflation pressures building, then we suspect that long term interest rates could begin to increase significantly. Also, we believe that currency market volatility could explode, which would likely become a significant problem for global commerce. TEAM believes that commodity prices could increase dramatically, and that the US dollar could decline significantly versus the currencies of commodity linked economies. These trends have already emerged, but we believe could move into parabolic state when/if inflation begins to become self reinforcing.

This is our base case scenario, though is obviously far from being certain. It is certainly possible that the US Fed and US federal government will suddenly come to appreciate tighter monetary policies and fiscal discipline – we simply don’t think that is likely. We believe this is particularly the case due to the nature of what we are calling the “Weekend at Bernie’s” economy. In addition, there are other major global economic players engaged in their own monetary and fiscal experiments. We think China definitely fits this characterization and fear that Chinese policies could also end quite badly.

Ultimately, the big questions we are grappling with are when will investors shift from euphoria over a recovery to concerns over inflation and higher interest rates, and when will currency market volatility explode and create the potential for political unrest? We do not yet see signs that any of this is imminent, but believe there is value in exploring what we see as terrible risks on the horizon – even if they are down the road a bit.

Market/Economic Climate

It is always easy to get caught up in market euphoria, and the current market is showing many of the typical signs. The past two weeks have included explosive trading and moves in penny stocks, which frequently occurs during the most speculative of market periods. For example, AIG enjoyed a move of over 100% during the past week. The total market capitalization for the stock reached $3.65 billion as of Friday, despite our belief that the stock is likely to be worth very little or nothing over the long term. The stocks of Fannie Mae and Freddie Mac rallied by over 80% at one point during the week. Anecdotally, we’ve received some calls from clients expressing concern that they aren’t invested heavily enough. Our experience has been that such calls are the flip side of the coin to the kind of panicked calls we fielded in March (though not necessarily from the same clients!) – just five short months ago!

Along with this speculative activity, most technical measures and sentiment gauges we monitor are at levels that have historically raised the risks of at least a short term trap door for stock prices. Due to the current environment, we’ve taken some modest measures to raise defenses a little. However, we are growing increasingly bullish on commodity related stocks and will likely shift portfolio exposure further in coming weeks to take advantage of an environment in which inflation re-emerges. Energy and agriculture industry segments are two areas we continue to research and monitor for opportunities.

Humor for the Weekend

2009-08-08T10:29:00.000-07:00

India’s infrastructure woes

2009 AUGUST 6

As appeared in the Hamara Congrees site. Click here to visit Hamara Congress

- by guest contributor ADHVITH DHUDDU

The political and bureaucratic classes of India have finally manned up to accept the dilapidating state of our infrastructure. With all the right noises coming out of a rejuvenated Congress led UPA, the big question now is how words, plans and promises are translated to concrete action with long lasting impact. The Achilles Heel for policy decisions taken in India is the poor implementation of objectives, inefficient use of allocated resources and a lack of accountability. Whether its funds earmarked for rural food schemes or urban development of roads, capital often drips out unaccounted, from the leaky pipelines. What is originally envisioned by lawmakers and policy wonks seldom materializes on the ground.

Anyone would accept that a government cannot and should not function with profit as their motive; it’s just irresponsible and immoral. But an ironical observation here is the excellent accountability evident in every public-private partnership project with little or no leakage of funds. When private players are stakeholders with profit as their goal, accountability and responsibility reappears like magic. Government at all levels needs to take notice of this and try to replicate successful practices enforced in these partnerships. But delving into the critical infrastructure needs, one can easily identify many areas where long overdue development and improvement is needed.

Electricity (residential and industrial): India is replete with inefficient and outdated electric grids, a fatigued electricity transmission network and mediocre rural penetration. A lot of progress has been made in the power sector but its insufficient compared to what is required. Our archaic power transmission and dissemination methods contribute to huge losses in power, increased cost and needs desperate modernization. In many big metros, electricity is not a major concern as uninterrupted supply is somewhat reliable but rural areas continue to suffer as power generation and transmission still lags demand and power theft is rampant.

Industries bear the brunt of this problem as their costs surge and margins become slender. Manufacturing is a critical sector in any economy and its success depends heavily on how well the state abets them with uninterrupted and affordable electricity. Unfortunately many industrialists have shifted expansion plans abroad, and foreign players have scratched India off the list citing unreliable and expensive power as the deterrent.

Our government needs to recognize the tremendous benefits of having cheap, uninterrupted and reliable electricity. If the Congress led UPA can achieve this, it can usher in a new era of manufacturing in India as international players will relocate their bases to leverage inexpensive power with all the other advantages we already posses, i.e. affordable labor, language, technical skills, a growing market, etc.

Roads and highways: It’s a pity that the previous government’s brainchild and the NDA initiated Golden Quadrilateral (GQ) project was not pursued with rigor since 2004. This is why it’s important to leave political affiliations at the door when important national infrastructure issues are deliberated. The sluggish progress was evident after the NDA was voted out of power, which is disappointing.

Although the project is nearing its completion, tremendous amount of investment is required to maintain and expand the GQ and our complete highway network. Close scrutiny is required for all highway and road projects as contractors often try to make a quick buck by using cheap and low quality materials. Roads and highway networks need to be built for the future, keeping in mind the ever rising vehicular population and increasing dependence on highways for transporting goods.

Internet and broadband: Internet connectivity, broadband penetration and IT saturation is pivotal to the success of any nation in the 21st century. If India’s vision is to be a superpower in the coming decades, we need to equip our rural and urban population with the ability to leverage the internet in the most optimal way. Trying to win in this century without the internet is like trying to win a 21st century war with pitchforks and knives.

The internet is a productivity multiplier and the sooner it’s embraced by the population the better for the country. With this in mind, it’s disappointing to note that the rural penetration of computers and internet is poor and internet infrastructure in the urban areas requires extensive upgrading. Besides providing top quality IT infrastructure, tremendous investment is also required in training our rural masses.

City planning: There’s little talk about this in the mainstream media, but urban infrastructure planning is pivotal to the success of any large city. Many of our metros don’t even have up to date maps of sewage, drainage and sanitation lines, and rely on outdated maps for water and electricity lines. This often results in little or no coordination between different departments when roads are dug up for various reasons. Planning when it comes to the rural areas is downright appalling, as millions in villages still struggle to get basic sanitation facilities, good drinking water and electricity.

Infrastructure now: And for those still unconvinced about investing in infrastructure, here’s what a new, improved and modern India will look like: we can boast of efficient resource consumption, better capital utilization, soaring productivity which will lead to a higher GDP and incomes, accelerated growth, smart and agile supply chains for industries, faster movement of goods and equipment across the country, elimination of slack in the system, affordable travel for all, a highly educated population, an efficient marketplace, soaring foreign investments, and a country where superior infrastructure becomes so commonplace that citizens will finally focus on their jobs and stop complaining about the massive lags presently inherent in the system.

Our guest blogger Adhvith Dhuddu writes regularly for various publications in India and US about the economy and politics. He blogs regularly at www.AdhvithDhuddu.com and can be contacted at adhvithd@gmail.com.

Online link to this article: Click here

2009-08-02T10:05:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: August 2nd, 2009

Provided by TEAM Financial Services

"The government solution to a problem is usually as bad as the problem."
- Milton Friedman

Items for discussion

US stocks ended July with their biggest gain for the month since 1938, which is interesting as that gain occurred following the epic drop in the stock market in 1937. We always find it interesting when history rhymes a bit, as the 2007-2008 decline was one we’ve compared with the 1937 decline. The rally off of the March 2009 low has been unprecedented in a variety of aspects. From a technical perspective, it is unlike any major cyclical low since 1937. As we expressed in the quarterly commentary we sent to clients in mid July, we believe this is likely due to what we are now calling the “Weekend at Bernie’s economy”.

Despite widespread skepticism, TEAM has been forecasting that a cyclical low in the economy would form this summer, with a recovery of some significance emerging during the 2nd half of 2009. We do not pretend to have any great ability to forecast the economy – we’ve simply found others we believe do and trust their judgment even when most others are in disbelief. We’ve also communicated our concern that any recovery could be muted due to the overhanging challenges posed by the structural debt and economic imbalance that remain. As the weeks have passed and additional leading index data has arrived, it now appears likely that the economy will recover at a rate that exceeds what we see as the consensus at present. Such a cyclical recovery does not change our long term concerns one iota. In fact, it makes us even more concerned about the long term problems we face. This may seem like a contradiction at first glance, so we hope to clarify a bit.

The US government remains heavily involved in supporting major segments of the US economy: banks, auto manufacturing and the accompanying supply chain and insurance companies are prominent examples. As the following chart shows, military spending is just one more example of how the government is playing an increasing role in economic activity.

The Federal Reserve continues to fix short term interest rates near zero and maintain toxic assets on its balance sheet in exchange for providing essentially “free money” to banks. The Treasury department has guaranteed billions and billions of dollars of private corporate debt. AIG has been nationalized. Trillions of dollars of residential mortgages from Fannie Mae and Freddie Mac have been guaranteed by the US Treasury. First time home buyers are being given a MASSIVE tax credit. Now, the clunkers tax credit is the latest gimmick to emanate from the US Congress. On top of all this is a nearly $1 trillion “stimulus program” that is just now going to begin to be spent this fall and into 2010!

As TEAM has argued over the past few months, we’ve felt it is reasonable to expect Trillions of dollars in government intervention into the economy and “private” markets to have an impact – and potentially a very significant one over the short to intermediate term. It appears increasingly likely that the effect may be quite significant. However, just as occurred in the movie “Weekend at Bernie’s”, it is going to take a heck of a lot of energy and resources to try and keep the charade going. Bernie is dead and the government can try to prop him up for a while but they will not have endless resources available to keep him life like as rigamortis sets in over time.

An examination of history suggests to us that our politicians will not be able to help themselves and will likely ramp up programs – just as they’ve done with the clunker program. The rationalization for increased involvement is likely to go as follows. If there is some initial “benefit” from a program then more resources will be committed due to the “success” (again see clunker program). If things don’t react as hoped, more resources are committed as the initial commitment is obviously not enough….rather than admitting the program is fundamentally flawed (see AIG which has become a seemingly endless money pit for taxpayers).

TEAM believes that the end result of these tendencies will be the potential for an economic recovery that is more robust on its surface than most people expect at present. However, we believe it will be very much like the “excitable” Bernie early in his infamous weekend. As taxpayers and foreign creditors begin to fatigue due to explosive deficits and the potential for a declining US dollar, we suspect that the valley on the other side of the mountain could be even more severe than the one from which we are just now emerging. What will the Federal Reserve do under a scenario in which the economy is showing significant short term strength based on artificial stimulus? What if markets begin to create incredible stress demanding a more responsible monetary policy? Will they raise rates and risk destroying all of the supports that allowed the recovery to ensue? Will markets leave them a choice if the dollar begins to decline in a less than orderly fashion? What if commodity prices explode higher – particularly food prices?

Market/Economic Climate

The major US stock market averages have reached levels that historically can be considered to have very thin oxygen available to fuel additional market gains in the near term. This does not mean that further near term gains cannot occur – only that we believe it to be a significantly less likely scenario. Of course, as we’ve chronicled in recent weeks, the markets have been pursuing our less likely scenario for quite a while now! Ironically, a more vicious and sharp short term correction in the S&P 500 index back to the 950 level that is subsequently supported could be a very bullish development.

Importantly, the continuing upturn in leading economic indicators reinforces our extremely bullish outlook for commodity prices. While clients retain significant allocations to vehicles directly exposed to commodity prices, we re-initiated a position in energy stocks this past week. Energy stocks have lagged the overall stock market significantly over the past couple of months and we believe they are poised to take a greater leadership role over the next 6-12 months at least. We believe valuations are attractive at current crude oil prices and exceptionally cheap if oil prices increase dramatically, as we expect to occur over the next couple of years. Due to our concerns about a market correction in the near term, we’ve taken a partial position and left room to ramp up exposure if the sector is involved in a potential correction.

2009-07-31T03:42:00.000-07:00

DOW:GOLD Ratio and Analysis

From Chart of the Day

Today's chart presents the Dow divided by the price of one ounce of gold. This results in what is referred to as the Dow / gold ratio or the cost of the Dow in ounces of gold. For example, it currently takes 9.8 ounces of gold to “buy the Dow.” This is considerably less that the 44.8 ounces it took back in 1999. When priced in gold, the US stock market has been in a bear market for the entire 21st century and is currently trading 78% off its 1999 highs. The recent five-month rally, however, has the Dow (priced in gold) putting in a significant test of resistance of an accelerated downtrend that began in mid-2007.

Notes:
- Where's the market headed? The answer may surprise you. Find out right now with the exclusive & Barron's recommended charts of Chart of the Day Plus.

2009-07-25T08:13:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: July 24th, 2009

Provided by TEAM Financial Services

"There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."
- John Kenneth Galbraith

Market/Economic Climate

The stock market has enjoyed one of its most explosive rallies in history over the past 10 days. To say that we expected this to occur would be like saying that we would have expected the Cardinals to make the Super Bowl at the beginning of last year's NFL season - while theoretically it could happen we are very surprised when it becomes a reality.

The S&P 500 has moved up by about 12% in price over the past 10 trading days or two calendar weeks. We entered this two week period relatively cautious and positioned conservatively to defend against a potential re-test of the March bottom, or at least a move to the 800 area on the S&P 500. This has clearly been the wrong decision, as what we believed to be a relatively low probability scenario quickly morphed, as we expressed last week, into more of coin flip…and then tails when we were betting heads.

For those clients reading, we don’t mean to be alarmist! Client portfolios gained ground over the past two weeks and are back very near all time peak values at TEAM. Fortunately, our conviction level of a re-test was never high enough to become aggressively hedged as we had done effectively on several occasions in 2008. While we are frustrated that we did not do a better job capitalizing on the market move over the past two weeks, we remain committed to our process and strategy that has served us and our clients well over the years. More importantly, we remain flexible and not dogmatic. When markets evolve and indicate developments we had not anticipated, we try to re-double our analytical efforts to try and ascertain what the emerging environment means and how we should react.

At the present, markets are truly in very thin air. Historically, this has not been as definitive of an indication of a major correction as common sense may dictate. Many of the ongoing internal signs of weakness we have been reviewing in recent weeks have improved but not been eliminated. However, the 2006 to mid 2007 period was a good reminder that internal weakness can take a LONG time to finally impact stocks overall.

The stock market moved into our next target level on Thursday and Friday this week, and reached these levels in an explosive and high momentum fashion. A correction in time and/or price is something we believe is a higher probability scenario, but as the last two weeks reminded us, higher probability surely does not equate to certainty! A correction in time would result in the stock market trading sideways in a range for a period of 1 to 3 weeks or perhaps a bit longer. A correction in price would be a move lower of 3-5%, and a combination of the two is certainly possible/common.

At this point, our cyclical time frame analysis suggests that an eventual move to new highs is likely in the coming months. It is possible that the current move will be a terminal exhaustion followed by a major move lower, but we do not believe that is likely at this point. Our mistake during the past two months has been in expecting a deeper correction prior to this latest move higher. It turns out that the correction we expected was more so one of time rather than price.

As for portfolio strategy, we made some slight adjustments towards the end of the week for many client portfolios to raise cash. These moves were largely neutral from a stock market exposure perspective – effectively we reduced some hedges on the margins while also selling a comparable amount of stock exposure. This move was done to continue to maintain a reasonable portfolio hedge in the short term until we see how the monumentally overbought market resolves itself. Whether the market resolves this by a correction in time or price, we expect to reduce portfolio hedges in the coming weeks and potentially increase/initiate exposure to some of our favored themes such as energy.

Our long term reservations about underlying market and economic fundamentals remain. The broad market indexes have moved back into modestly overvalued territory based on our valuation analysis. However, we believe these issues do not preclude the potential for additional cyclical bull market gains, especially with leading economic indicators reaching their highest levels this week since 2004. We remain flexible in our approach and expect to shift from having one foot out the door to going back into the house in the coming weeks – but nervous as always about doing it.

Humor for the Weekend

2009-07-22T07:25:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: July 18th, 2009

Provided by TEAM Financial Services

"Adequately capitalized...in no danger of failing."
- Ben Bernanke on Freddie Mac and Fannie Mae July 16, 2008
"This is far and away the strongest global economy I've seen in my business lifetime."
- Hank Paulson July 12, 2008

Market/Economic Climate

The recent market rally over the past 7-10 days has been quite impressive on the surface, but not nearly as impressive “underneath the hood”. The latest move higher has narrowed market leadership further. For example, the S&P 500 index is broken up into 9 major sectors. While the overall index is within 1.7% of reaching a new high for the year, out of the 9 major sectors, just one has already moved to a new high for the year. Following is a summary of the 9 sectors and where they are in relation to their most recent high:

Technology +1.99%
Consumer Staples, Utilities and Healthcare – essentially flat
Consumer Discretionary -3.84%
Basic Materials and Financials -7.19%
Industrials -7.25%
Energy -11.62%

As one can see, the more economically sensitive market sectors are now lagging the overall market significantly. In addition to this development, the recent move higher has occurred with relatively low volume and signs of the increase being due more to sellers walking away rather than buyers increasing in intensity. Typically, a healthy and more durable market move is accompanied by a relatively symmetric relationship between the intensity of buyers increasing and sellers exhausting. This simply has not been the case since the initial thrust off the March low into early April.

The rally in technology shares has been narrowing into a relatively small number of big cap stocks. In addition, we believe the fundamental backdrop for many technology firms is being viewed too optimistically by many investors. Many of the companies at the top of the food chain continue to report weak demand from both consumers and business. However, inventories had been reduced significantly and orders have picked up to restock historically low levels, as well as in hopes that a significant pickup in demand will emerge during the 2nd half of 2009.

The companies at the bottom of the food chain have benefited from this inventory build and have been reporting as much. The companies at the bottom of the food chain are infamous for having terrible business visibility. We believe the technology sector is in danger of having already priced in a significant recovery, which would leave little upside in share prices even if a positive scenario develops. On the flip side, if things don’t go as hoped and the recovery is weaker than assumed, then we believe downside risk to share prices could be substantial.

Based on these signs of instability within the market, we believe that prices are at a very important level. If buyers are able to muster a renewed intensity and prices are able to move above the June peak with reasonable volume, then we would expect a resumption of the March to June rally. However, the fact that we continue to see signs of internal market weakness indicates to us that a more likely outcome remains an eventual retest of the March low. Throughout history, important market lows have been retested and often times many months following the initial low.

Our portfolio strategy remains relatively conservative and well hedged in our stock exposure. As we communicated last week, our exposure to commodity markets became un-hedged following our closing out of a short position in crude oil as prices approached $59 per barrel. We are pleased with this allocation for the time being until we can indentify whether the market is likely to break out or break down from the trading range that has emerged since mid June. We’d place the odds at around 60-40 that a break down is more likely, but that is hardly a high level of conviction. For this reason, we believe the more balanced approach we continue to implement is a prudent strategy.

2009-07-20T09:06:00.000-07:00

John Mauldin's Newsletter: Thoughts from the frontline

Europe on the Brink

July 17, 2009, By John Mauldin

We have avoided Armageddon, at least for now. Read the initial part of the newsletter here: http://www.frontlinethoughts.com/article.asp?id=mwo071709

Europe on the Brink

Globalization is a two-edged sword. On balance, it has brought prosperity to those who have embraced it, with rising lifestyles, better health, longer lives, and more. The more we need each other, the less likely it is that we'll shoot each other. Shooting your customers is not a good business strategy. And while the growth has not been even or smooth, only a Luddite would want to return to the early 1800s or 1900s, or even 1975.

The other edge of that sword? We are connected in so very many ways, far more than most of the world suspected. Who thought that insane lending policies at US mortgage banks would bring the world financial system to its knees, increasing unemployment and leading to a global recession? World trade is down 20% or more. US railroad shipments are down more than 20% year-over-year. Chinese (and Asian) factories have seen their orders drop, as US consumers have gone on strike. The US trade deficit was just $25 billion last month; and while our exports are still dropping, our imports are dropping more. Oil is becoming a bigger and bigger share of imports, and that does not come from Asian exporters.

The US is far and away the country with the largest gross domestic product (GDP). California would be the 7th largest country, but few think of California in such terms. For this letter, at least, I would like to think of Europe as a whole rather than as 27 countries. From that perspective, Europe is as economically important to the world as the US. What happens in Europe makes a difference in the US.

Last week we looked at the precarious position of Japan, the second largest economy (or third if you think of Europe as a whole). It was a sobering letter. When you realize the extent to which Japan has funded Asian expansion, what is happening there cannot be good for the world.

But Europe's banks have been much more aggressive in funding emerging-market expansion than US or Japanese banks. Western European banks have lent $4.5 trillion to various emerging-market countries, businesses, and consumers. Many Eastern European businesses borrowed in low-interest-rate euros. New homeowners in Hungary and the rest of Eastern Europe borrowed in Swiss francs and euros, and as their currencies have collapsed they now find they owe more on their homes than they're worth.

And here's the problem. Europe's banking system is in far worse shape than the US system. The losses may be bigger, and their capital to meet those losses is certainly less. Let's look at some charts. Remove sharp objects or pour another adult beverage.

As I noted last week, one of the real benefits of writing this letter is that I get to see a lot of really interesting information from readers and meet with very savvy investment professionals. I recently had the privilege of sitting with a team of analysts from Hayman Capital here in Dallas. Hayman runs a global macro hedge fund, so they spend a lot of time thinking about how all the different aspects of the global markets fit together. This week we again look at some of their analysis. There was a lot of work (as in months) done here; and Kyle Bass, the founder of the firm, graciously allowed me to share some of it with you (and kudos to Wes Swank, who pulled this together). The graphs are theirs, and my discussion about them is certainly informed by our meeting; but I am using the material as a launching point, so they are not responsible for my conclusions and interpretations.

And Then There Was Leverage

In the first few years of the G.W. Bush administration, the banking authorities decided it would be OK to allow five banks to increase their leverage from 12:1 up to 30:1. Which five banks, you ask? Bear Stearns, Lehman, Merrill Lynch, JPMorgan, and Goldman Sachs. How did that work out, just five years later? Three are gone and two survived with large dollops of taxpayer money.

(Sidebar: Is it really any surprise that Goldman and JPMorgan are making record profits on the underwriting and trading side of the business? Hell, if I could eliminate 50% of my competition, my profits would grow too! JPMorgan's consumer credit, credit card, and other business groups are losing money big-time.)

Thirty times leverage means that if you lose 3.3%, you wipe out all your capital. And we watched as banks too big to fail were bailed out with taxpayer dollars. Slowly, banks are buying time, writing down assets. Remember, this month is the second anniversary of the onset of the credit crisis. I wrote back then that the strategy would be to stretch this out as long as possible. Time heals a lot of bad debts, especially at a 0% Fed Funds rate.

Banks that are reporting so far this quarter seem to be saying that the write-offs will start to level off in about two quarters, although banking expert Chris Whalen says that the level may stay higher than we think for longer than we think. There are a lot of assets to write off, and they are just now getting to the commercial real estate problems. This is going to take time. (For an interesting interview on CNBC with Maine fishing buddy Chris Whalen, click here:http://www.ritholtz.com/blog/2009/07/christopher-whalen-banking/.)

The point, before we get to Europe, is that here there was a central bank and a government that not only could step in but was willing to. I know former Treasury Secretary Paulson had his critics, but I am not one of them. Did he do some things that in hindsight he might like to take a "mulligan" on? Sure. But he dealt with the problems in the best manner he could. The time to have taken action was when we were making liar and no-doc loans and calling then AAA, or allowing banks to go to 30:1 leverage. Paulson had to deal with eggs that were already broken. That the system did not crater is to his credit. Securitizing what he and everyone else should have known would be garbage while he was head of Goldman Sachs is not to his credit. But I digress.

I am going to give you four charts showing the leverage of banks in the US, the United Kingdom, the Eurozone, and Switzerland. The bottom, blue portion is assets to common and preferred stock; the red is assets to common equity, which can include good will; and the purple is assets to tangible common equity.

Tangible common equity is all the rage, and that is what the recent "stress tests" measured, as opposed to tier 1 capital, which includes preferred stock (which would basically be the blue portion.) TCE only includes common shares. Now, let's start with the US. These graphs show leverage. The average leverage of tier 1 capital of the five largest banks is in the range of 12:1, and is actually down from ten years ago. (By the way, a very good and simple explanation of all this can be found at http://baselinescenario.com/2009/02/24/tangible-common-equity-for-beginners/.)

While the TCE has obviously been rising and taking total leverage to rather lofty levels in the mid-40s, banks are raising capital, and over time leverage will come back down. It helps if you can borrow money at almost nothing and lend it out at much higher rates. Now, let's turn to the United Kingdom. This is uglier.

Regulators in the UK allowed 20:1 leverage on a regular basis. It is now almost 40: and with TCE is around 55. The assets of UK banks are about five times as large as UK GDP. By comparison, for the US the ratio is barely 2:1.

Think about that for a second. The UK has banking assets which are five times as large as the annual domestic output of the country. They also had a housing bubble. They have their own bailouts to deal with, which are massive and will potentially get much larger. But at least they have a central bank and government that can try to fix the problems.

But as the commercial says, "But wait, there's more!" Let's look at the Eurozone.

Leverage is now 35:1 and with TCE is almost 55. How did 35:1 work out for the US? Given the massive credit problems that Eurozone banks have with emerging markets (plus Spain's housing bubble, which is every bit as bad as that of the US), will this not end up in wailing and weeping?

Too Big To Save

And here's the real issue. They have no Paulson and Bernanke. Now some of my Austrian-economist friends will say, "Good, they should all be allowed to die;" but that is a very cavalier attitude when you start talking about actually increasing the unemployment rate to something like 20%. I agree that management should be changed (as well as the regulators: 35:1 to 1 - really? What were they thinking?) and shareholders wiped out, but I do not want the system to collapse. And this is a global risk, not just localized to Ireland or Spain or Austria. Sure, the pain might be worse in the local region, but we will all feel it.

The European Central Bank, at least as of now, cannot step in and start saving individual banks. How do you save a Spanish bank and not an Austrian bank? Austria's banks have made large loans to Eastern Europe, in euros and Swiss francs, and are going to have large losses, far more than 3%, which would wipe out their capital. But bank assets in Austria are 4 times GDP. What we have are banks that are too big to save for relatively small Austria. And for Italy, Spain, Greece, et al. More on this below. For now, let's turn our eyes to Switzerland.

Those Wild and Crazy Swiss

We think of Switzerland as a stodgy, by-the-numbers, clockwork type of banking country. I have done business with Swiss private bankers, and they are conservative. But somewhere, somehow, UBS and Credit Suisse ran up a little leverage. Before the crisis, they were over 40:1. And now they're nearly at a nosebleed-high 70!

As an aside, I was in Switzerland about two years ago, meeting with some very well-known Swiss, let's call them dignitaries. In a very off-the-record conversation, they told me UBS was technically bankrupt. As it turns out, there were a lot of banks around the world that were technically bankrupt.

Now, the next graph underscores the problem of "too big to save." Let's say the US will eventually pump $1 trillion into the banking system (in taxpayer losses). That is about 7% of US GDP. We may not like it, but it doesn't stop the game. US bank assets are only twice US GDP. Switzerland and Ireland are over 7 times, the UK is over 5, and the Eurozone is at 4 times. And so it goes.

Eurozone banks are already reeling from losses from US subprime-related problems. They are now getting ready to deal with even deeper losses from their own lending portfolios. If the losses were just 5% of the portfolio (an optimistic assumption), it would be 20% of Eurozone GDP. But each country is responsible for its own banks. While it is thought Germany will be able to handle its problems, the prognostication for Austria and Italy is not so sanguine. Italy is already running a massive deficit, and has no central bank to monetize its debt. The same goes for Portugal, Spain, Greece, and Ireland. 5% loan losses in Ireland would be 40% of GDP, the equivalent for my fellow US citizens of about $5 trillion. Where does Europe find a few trillion dollars?

I was writing in late 2006 that the subprime lending market would end in tears. And I think the European banking crisis that is on the horizon has the potential to be every bit as big a problem as subprime loans. The world depended on Europeans banks for much of the lending that allowed for growth and development. Like their counterparts in the US, they are going to have to reduce their loan portfolios. Deleveraging is not fun.

It takes time to build up a banking infrastructure that can raise the capital necessary to make and process loans. A lot of time. Europe is a big customer of the US and Asia. Their businesses are going to be hit hard by the lack of capital, which is of course no good for employment, etc. We are all connected. What happens in Rome no longer stays in Rome.

Let me reprint a graph from last week. Burn it into your mind. The world is going to need to find $5 trillion to finance government debt issuance. And we need to fund private business and consumer debt. Where is all this money going to come from? "If you lend me $5 trillion today, I will gladly repay you Tuesday."

A Positive Third Quarter?

Those who are calling for the end of the recession are shouting that the third quarter may be positive in terms of GDP. And that is possible. Read the rest of the newsletter here: http://www.frontlinethoughts.com/article.asp?id=mwo071709

New York and Maine

Read the rest of the newsletter here: http://www.frontlinethoughts.com/article.asp?id=mwo071709

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

To subscribe to John Mauldin's E-Letter please click here:
http://www.frontlinethoughts.com/subscribe.asp

2009-07-16T01:30:00.000-07:00

UPA 1.0 Vs. UPA 2.0: LEFT REALLY LEFT OUT?

By Adhvith Dhuddu

You don’t need a rocket scientist to decipher the capital markets’ vicious reaction to our FM’s highly anticipated budget. With expectations sky high, which were reflected in the May 18^th jumbo rallies, our FM under delivered on numerous aspects disappointing many stakeholders. Whether its investors, industrialists or the aam admi, but for the scattered green shoots, the broad strokes painted in the budget lacked the transformational and reformist tone that was required of Mr. Mukherjee. After the Left was left out, and the UPA launched its revamped 2.0 version; the towering expectations of a reformist UPA have been put to rest, at least temporarily.

The budget’s indifferent tone coupled with an unenthusiastic reception leaves one wondering if the Left was just a scapegoat in UPA 1.0 from ‘04 to ‘09. It’s imperative that the electorate ask this question because change has not come when the people demanded it. Voters couldn’t have sent a stronger message than by voting out the left parties who were vociferously obstructionist in nature, gleefully blocking every reform oriented policy initiative.

The primary culprit of this budget was the lack of details which the markets debunked almost immediately, sending the major indexes into deep red. So how can one accurately answer that question? Very simple, let’s explore if any major policy measure that the left would have blocked has been implemented.

FDI in banking, retail and insurance: Something that the Left parties vehemently opposed, fearing that outside competition would be detrimental to local industries. With the Left gone, there were high expectations that deregulation in these sectors would be initiated. But no concrete details were given in this segment.

PSU disinvestment: Another area that the Left strongly opposed believing the classic communist view that government is the best institution to run an industry. The prospect of moving forward here was very high as many analysts expected cash flows from PSU disinvestments to help pad the fiscal deficit. But again, besides a brief mention, little details were imparted in the FM’s speech.

Fuel Policy: Everyone’s aware of how the Left consistently voiced their irrational criticisms when fuel prices were hiked even a rupee or two. This budget was a golden opportunity for our FM to introduce sweeping policies to incentivize efficient use fuel, to encourage alternate energy companies, or to tax high polluters, all of which would’ve drawn the Left’s criticism. He could have leveraged this tremendous opportunity to provide an energy vision for India but failed to deliver from the pulpit.

Although these are just a few areas where UPA 2.0 could have initiated reforms, it clearly reflects the lack of political will to make bold moves in this opportune environment. While it’s true that the stock market is not the ideal barometer to measure the budget’s outcome, one has to pay attention to the markets as it was biggest post-budget drop in Indian history. Not only is it disappointing to realize that the Left was a scapegoat in UPA 1.0, but it’s also unfortunate to watch the Congress continue along the lines of UPA 1.0, lacking the ability to make bold moves, devoid of the required political will.

Also, few have dared to ask one tough question: What if we do stimulate, sending the fiscal deficit to 6.8 percent or higher (adding off-balance sheet items amplifies the deficit), and growth is still at moderate levels between 6-7 percent? That situation could be severely precarious for the Indian economy as the FM will then have to tackle a rising fiscal deficit, moderate growth, diminished receipts and India could fall prey to credit downgrades by international rating agencies. This outcome, which could be extremely detrimental to the economy, is very likely as the FM’s plan is a conditional one. A condition that growth will creep back into the Indian economy and the world economy will slowly pick up momentum.

I ask this question because although bold moves are required in this environment, it cannot be at the cost of fiscal prudence. Claiming that more money in the hands of the consumer will lead to higher spending is valid if you are in the United States, but the mindset of the Indian is to save more and spend only moderately. Given the gloomy environment, more individuals will be looking to pad their own bank accounts not someone else’s.

Overall this Budget is a relative disappointment because the FM has failed to capitalize on newfound popularity of the Congress party. A bird’s eye view of the budget lacked the needed lucidity in many reform areas, skipped the concerns about delivery mechanisms, has been blithe about FRBM targets, and was devoid of any visionary message or statement for the next five years of UPA 2.0

(The author is an asset manager and professional trader.)

2009-07-12T06:17:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: July 10th, 2009

Provided by TEAM Financial Services

"Pessimism is as American as apple pie - frozen apple pie with a slice of processed cheese."
- George Will

Market/Economic Climate

We will be relatively brief this week, as we will save our in depth commentary for our quarterly letter to clients, which should be sent early next week.

The correction is risky assets has been developing largely according to the scenario we have been laying out in recent weeks. The correction has been particularly sharp in cyclical market segments like materials and commodities. For example, since peaking around $73 at the end of June, crude oil prices dropped to under $59 this week – or a decline of almost 20% in less than two weeks. By comparison, less cyclical commodity segments like agriculture (down about 4% over the same period) and livestock (up about 3.5% over the same period) have hung in relatively well.

The same can be said for the stock market, as economically sensitive sectors have corrected sharply relative to more defensive sectors. The AMEX Oil stock index is down about 16% from its early June peak. The Dow Jones US Basic Materials stock index is also down about 16% from its mid June peak. By comparison, the 3.5% decline in the Dow Jones Healthcare stock index is pedestrian.

While this rotation towards defensive themes on a relative basis is something we believed was likely, we believe it will probably end up being an excellent opportunity to acquire positions into the weakness. We believe that economic sectors relating to the domestic consumer are likely to remain under significant stress for some time. However, this does not preclude the emergence of a cyclical economic recovery which is lead by the industrial sector.

Investors appear to have gotten a bit over excited about the now infamous “green shoots” many were pointing towards regarding an economic recovery. One of the things we find most fascinating about markets in the short to intermediate term is to monitor the relative perception of the aggregate investor psyche. It has more swings than a Hedonism vacation, while the underlying fundamental trends in the economy are far less volatile than investors’ perceptions.

While we believed that aggregate investor perception had grown overly excitable about recovery prospects during the May-June time period, we believe the current correction is helping shift perceptions to a point where investors may be overly pessimistic. The leading economic indicators we rely upon most continue to suggest that the recovery remains on track – though its slope and duration are still highly uncertain. At some point in the next couple/few weeks, we suspect markets will reach levels at which pessimism is over done and significant opportunities may be created.

We took some actions this week to modestly reduce our defensive hedges, as we eliminated our successful position hedging crude oil out of our clients’ commodity exposure. While a further decline in crude is certainly possible, our goal was to protect against an initial and sharp thrust lower, and we have been successful at doing so. We remain positive on crude oil long term and view sharp corrections/declines as opportunities to increase exposure.

Humor for the Weekend

2009-07-05T23:38:00.000-07:00

UNION BUDGET 2009: July 6th 2009.

Commenting on the Union Budget just before D-day on 5th July, 2009.

Some points made:

1. Given the gloomy state of the global economy, the Union Budget should be presented with growth as the primary aim.

2. Although our fiscal deficit is expected to rise as rural schemes and various subsidies weigh on India Inc's balance sheet, the growth imperative must not be sacrificed just to keep the deficit numbers in check. Of course, if the fiscal deficit gets out of hand, India could face a credit downgrade, but that is not very likely in the near future.

3. IT has been a source of growth for the last decade, and this would not be the best time to eliminate tax incentives in place as the US and UK (big markets for IT) are in a recessionary environment. Uncertainty on the 10A extension must be cleared out and IT companies must be given 1-2 more years of tax exemption.

2009-07-05T08:16:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: July 2nd, 2009

Provided by TEAM Financial Services

"The preservation of the sacred fire of liberty and the destiny of the republican model of government are justly considered... deeply, ...finally, staked on the experiment entrusted to the hands of the American people."
- George Washington

Items for Discussion

The housing bubble and subsequent collapse has been at the epicenter of the global credit bubble, the financial/banking crisis and the largest recession since the 1930’s. This is a topic we haven’t touched upon in a while, but we thought it was a good time to revisit given the number of prominent people calling for a housing bottom to emerge currently. The first chart this week is an update of a chart we’ve shown from the New York Times in the past. It shows a home price index compiled by Professor Robert Shiller of Yale University. The chart does a fabulous job of showing how insane the bubble was earlier this decade, as well as the fact that we are still significantly above the median long term range – let alone going to distressed levels as they did in the 1930’s-1940’s.

Part of the optimism we are seeing is based on initial signs of stabilization in some of the home price indexes. However, stabilization does not necessarily mean that a recovery is imminent. As the next chart shows, home prices took about 6 years to recover in real terms following the bottom of the early 1990’s housing price decline in the Case Shiller 10 index.

TEAM actually views the potential for stabilization in home prices as a very negative sign. This is very counterintuitive on the surface, so we’ll explain. A tremendous amount of recent home sales has occurred at the lower and mid levels of the housing stock. Subprime was the initial wave of mortgages that drove foreclosures and that market segment were disproportionately at the lower end of home prices. This major liquidation of homes is well into the process and we wouldn’t be surprised if prices in that market segment do stabilize or even head modestly higher (assuming interest rates don’t spike which is a whole other story).

The pending mortgage storm to hit is dominated by prime borrowers and in the higher price segment of the housing market, which until this year had held up reasonably well. The schedule for mortgage rate resets in Alt-A and Option ARM mortgages explode starting this summer and into mid 2011. TEAM expects there to be a long cycle of mortgage defaults in foreclosures in this market segment, which is likely to lower prices in the segment dramatically – just as it has in the lower price segment following the subprime implosion.

If prices in the higher price segment are going to go down, then how can we expect overall price indexes to go higher? This is a paradox that is easily explained with an example. Let’s assume that the sales mix for 10 buyers of cars is 9 Toyota Corolla’s and one Corvette. The Corolla’s were priced at $20,000 two years ago, but due to incentives and price cuts, the buyers can by their Corollas for $15,000, or a 25% decline. Over the past two years, the price of the Corvette remains stable at $50,000. The overall index for the 10 cars would drop by about 20% = (9 x $5,000)/9($20,000) + $50,000. The average price for a car sold is $18,500, down from $23,000 two years prior.

Now let’s use some more hypothetical assumptions. Let’s assume the Corollas recover in price by 10% back to $16,500, but that the price of the Corvette falls 20% to $40,000. This mix results in the average price of the cars to $18,850 – a 2% increase. This is obviously an example only to show how the math works. The housing stock in the US is dominated by lower and mid priced homes. What is the big deal if the “rich” or “mass affluent” see their home values decline significantly?

First, due to the crazy underwriting standards that developed during the bubble, many middle class households bought way too much house that they could not and cannot afford. Many were driving Corvettes when they should have been in a Corolla. The combination of job losses and mortgage resets can be toxic. Refinancing mortgages has been difficult due to prices coming down and mortgages becoming “under water”, where the mortgage balance is higher than the current value of the home. The modification program put in place at the federal level has largely been a failure, with recent reports showing that over 50% of modified loans have ended up in default and foreclosure anyway.

Second, the “rich” and “mass affluent” own a disproportionate percentage of the productive assets in this country. Most have already suffered massive declines in the value of their investment portfolios. Many businesses are in distress due to tight credit conditions and weak demand. If a significantly declining home value is thrown into the mix, this is just one more development that is likely to impact the aggregate risk preferences of our nation’s owners of capital. An increase in risk aversion could drive more and more of this capital into lower risk vehicles, like municipal bonds, CD’s, etc. A decline in available risk capital could serve as a major headwind to innovation and future job creation.

While we remain skeptical that a durable home price recovery is on the near term horizon, the best case scenario we can imagine one in which the lower and mid price market segment recovers modestly, while the higher end segment endures a significant decline. A second wave of mortgage defaults and foreclosures likely to hit that market segment would be yet another strain on our financial system. We certainly hope that the outlook is far better than we expect, but as we always say, we don’t forecast or invest based on hope.

Market/Economic Climate

TEAM believes that the broad stock market averages and economically sensitive segments of the commodity markets are in the early stages of what could end up being a significant correction. We’ve chronicled over the past two months how the market internals have been getting progressively weaker. This kind of analysis does not pinpoint precise market bottoms or tops, but it does provide a valuable context as to the potential vulnerability of a market if selling intensity picks up for whatever reason. It just so happens that investors appear to be having second thoughts as to the robustness of a potential economic recovery.

Thursday’s employment report certainly contributed to this anxiety, as job losses remained significant in the month of June. We still believe that a relatively uneven economic recovery will emerge during the 2nd half of this year and into 2010. However, we believe many markets had begun to price in a robust recovery and may adjust lower if perceptions shift more towards expecting a modest or disappointing recovery. Client portfolios remain defensive and significantly hedged.

Humor for the Weekend

2009-06-29T12:21:00.001-07:00

A BUDGET FOR YOUNG INDIA

By Adhvith Dhuddu

(Op-ed as appeared in Business Line Hindu)

There is much talk and anticipation surrounding the rejuvenated UPA’s interim budget expected in early July. While everyone’s discussing tax slabs, agricultural subsidies and fiscal discipline, it’s equally important that our Finance Minister focuses on presenting a budget with Young India in mind.

The demographics of our country calls for such progressive policies and young Indians have high expectations from a UPA that is partially spearheaded by Mr Rahul Gandhi and his young brigade. After all, young voters were crucial to the UPA’s thumping victory.

The 5 Es affecting young India are Education, Employment, Entrepreneurship, Environment and Energy.

Employment: Given the gloomy state of employment, tackling the labour problem first could mitigate fears of a prolonged slowdown with high unemployment. Thousands of graduates are added to an already strong Indian workforce each year, and if hiring does not gain momentum soon, it could be a source of problem for the Government.

The Finance Minister should consider providing temporary tax incentive to certain labour-intensive sectors (such as retail and manufacturing) which can have an immediate impact and alleviate some pain. But decisive and far-reaching action is needed soon or we could see many unemployed and disgruntled young graduates.

Education: The HRD Ministry has been asleep at the wheel for the last five years, adopting regressive policies when it comes to education reform. Caste and class have taken centre-stage for too long, overshadowing merit. Aimlessly increasing allocations and earmarking crores for more institutes will not ensure quality unless the ineffective command-and-control structure is comprehensively revamped.

Colleges and universities are not being allowed to make swift changes to meet 21st century requirements, and adding salt to our wounded education sector are laws that prohibit foreign universities, which are lining up to invest in India.

Mahatma Gandhi once said, “The youth of the nation is the salt of the country.” Our HRD Ministry’s inability to act is driving away thousands of talented and passionate students to other countries for graduate and postgraduate studies. If the Congress-led UPA is smart, it will enact extensive education reforms to leverage the favourable demographics of this country.

Entrepreneurship: A lot is said about the transformational reforms in 1991 that vaulted India into the global arena. But what Mr Manmohan Singh and his team did then was very simple: they provided an extremely conducive environment for entrepreneurship, which led to expansion in industries, innovation, employment, an enriched population and an active electorate.

The time is ripe for another entrepreneurial revolution, and policies favouring it. Even today corruption is rampant, capital is expensive, contracts are arduous to enforce and it’s tough setting up an enterprise. India ranks a dismal 122 out of 181 in the ease of doing business report published by the World Bank. The reforms in 1991 have shown us the right way; right policies today can foster entrepreneurship in a young population that will be the employers and employees of the future.

Energy: Energy consumption by individuals and industries is set to soar to unprecedented levels in the coming decades. Whether it is petrol, diesel, LPG or kerosene, it is critical to secure our energy future. Protecting and strengthening energy infrastructure is primary but, simultaneously, energy generating capabilities must be expanded. The Government should create a positive environment with sops for renewable energy projects and companies. Instead of choosing wind energy over solar or hydroelectric power over ethanol, we should adopt an all-of-the-above approach and promote all renewable energy companies.

The West has realised this and is rigorously trying to expand renewable sources of energy. We should create an energy infrastructure that is home-grown and self-sustaining. This issue is at the heart of every young Indian’s priorities, as energy shortages and rising prices loom ahead in the absence of long-term energy policies.

Environment: Although it may appear inconsequential at present, we will only be cursing ourselves (and our previous governments) in 2030 and 2040 if we fail to formulate and enforce concrete environmental regulations. India has experienced rapid industrialisation in the last 15 years and the pace is expected to increase in the coming decades.

The least we can do is leave the coming generations a clean and green environment. As Thomas Friedman points out in his book Hot Flat and Crowded, the 21st century will belong to leaders in Energy Technology. Energy and environment are strongly correlated and can be addressed through an all-of-the-above approach to renewable non-polluting energy.

With the right kind of policy focus, the Government can whet the youth’s appetite and simultaneously put the nation on the fast track to growth.

(The author is an asset manager and professional trader)

ONLINE LINK TO THIS ARTICLE: CLICK HERE

2009-06-27T02:47:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: June 26th, 2009

Provided by TEAM Financial Services

"The American polity is infected with a serious imbalance of power between elites and masses, a power which is the principal threat to our democracy."
- Paul Wellstone

Items for Discussion

As long time readers may remember, we like to step back from time to time in this weekly commentary and consider the long term macro environment. It is easy to get caught up in the day by day or week by week noise in the market place, so we will once again revisit some longer term factors we view as important.

With the major US stock market indexes like the Dow Jones Industrial Average and S&P 500 essentially flat over the past ten years and down so much over the past year, it would not be a terribly unusual deduction that stocks must be relatively “cheap”. Unfortunately, even with a “Lost Decade” for US stocks in general, the following chart provides one simple way to measure the value of the stock market versus the economy.

As the chart indicates, the ratio of stock market capitalization to GDP would have to fall by about 29% from the level at the end of May just to reach the long term average. It would have to fall by over 50% to reach levels approaching 40%, which was the minimal level from which prior long term bear markets ended in the 1930’s and early 1980’s. There are many other ways in which we gauge long term stock market value, and in total they point to a similar conclusion: stocks on average are no where near levels that have historically reflected long term lows.

What could the path to a long term low look like? The following chart provides one example of a major global stock market’s path:

The chart is of the Japanese Nikkei stock index and shows that the Japanese market peaked around 38,900 in 1989 and has been in a 20 year bear market ever since. A similar 20 year decline of 74% in the Dow Jones Industrial Average would result in the Dow trading around 3,700 versus its all time high around 14,200. This is by no means a forecast or prediction, but simply an example of one country’s stock market that has been in a bear market for 20 years.

We displayed a chart a couple of weeks ago showing the massive amount of debt in the US economy and explained our view that this imbalance is likely to be a major economic headwind for the foreseeable future. It has long been our premise that much of the economic growth in the US over the past 10+ years has been the result of excess debt/credit creation. We’ve also argued that once the major credit bubble finally popped, the horrendous mis-allocation of capital that resulted from the bubble could result in major dislocations in the economy and labor force. Where will all the mortgage brokers and real estate agents find jobs? Apparently the government is hiring….

As the chart above shows, the current recession has effectively wiped out almost all of the jobs growth in the economy over the past 10 years. The next chart provides still more insightful information as to why we are worried about the economy moving forward.

The private sector growth over the past 10 years has now been eclipsed by the growth in government jobs. Unfortunately, the news can be even worse. Inside the private sector, the leadership in job growth has been in the private industries that are either heavily influenced or subsidized by government, like healthcare and education.

Given this backdrop over the past 10 years, we are left to wonder where the jobs will come from now that the credit bubble has popped? The mis-allocation of capital to retail, home construction and financial services resulted in a massive amount of labor dedicated to those areas that is now obsolete. We believe it will take a long time for the economy to restructure and "replace" those lost jobs. The meddling of the government is likely to extend this problem and make it worse, in our opinion.

Market/Economic Climate

The internal health of the stock market continues to display warning signs that a correction of some significance is possible if not probable – at least in the 10%-15% from the recent high. Our model has shifted to a cautious posture on stocks, but also on many economically sensitive/industrial commodities like oil and copper. At the same time, our model has shifted to a positive posture on long term US treasuries and the US dollar. These shifts are based on short to intermediate time frames measured in weeks and maybe a couple of months. Until proven otherwise, we view these developments as counter trend.

When making allocation and investment decisions, our process in deciding whether to try to sidestep or hedge a counter trend move is based on the potential size of a “correction”. At present, our matrix of research and indicators suggest that the risks of a sizable correction are significant enough for us to have shifted our portfolio strategy to a more defensive stance.

We’ve moved progressively over the month of June to reduce portfolio risks and we continued that process this week. While we remain bullish on precious metals stocks over the long term, we decided to reduce our exposure to the industry over the past couple of weeks. Due to our sizable investment in the industry last fall and the significant appreciation since, these positions had grown to be a higher percentage of client portfolios than we are comfortable with given our concerns about a potential correction. By reducing exposure, we reduce risk and create enough room in portfolios to proactively re-buy exposure in the industry if a larger correction does emerge.

Along with the reduction in precious metals exposure, we also boosted our portfolio hedges again this week. With these latest moves, we believe client portfolios are well positioned to weather a potential correction of significance. Markets are likely to be choppy as we approach the end of the calendar quarter on Tuesday next week

Humor for the Weekend

2009-06-22T06:23:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: June 19th, 2009

Provided by TEAM Financial Services

"For shameful deeds are taught by shameful deeds."
- Sophocles

Items for Discussion

One of the major financial news stories this week centered on the Obama administration’s proposed changes to the financial regulatory system. We honestly do not derive enjoyment out of being chronically cynical, but the establishment continues to defy even our most basic level of “smell test”. At the core of the proposed reform is an expansion of the Federal Reserve’s powers and responsibilities. We find this to be so ridiculous that we could laugh if we weren’t dealing with such a serious issue.

The Federal Reserve Bank was established in 1913 largely due to a consortium of large banks lobbying the US government to provide a bailout process for them following the banking crisis of 1906. The Fed is actually a rather unique entity, as it is privately owned by many of the big banks but also plays a public role. The Fed has been charged with a relatively few number of mandates legislatively. They are supposed to target “price stability and full employment” using monetary policy. Secondly, they are supposed to serve as a regulator of the banking system. We would give the Fed a sold “F” grade in both roles over the past 15 years.

It is amazing to us how abject failure is so often rewarded by politicians. We believe the Federal Reserve under Alan Greenspan chronically set short term interest rates too low and helped inflate the stock market, housing and credit bubbles of the late 1990’s and early 2000’s. While this horrendous error was bad enough, they also effectively provided a blank slate for the large banks to engage in all kinds of off balance sheet leveraged entities and derivatives deals. The Greenspan Fed abdicated its regulatory responsibility, in our opinion. This powerful blend of chronically low interest rates with banks allowed to run amuck with crazy leverage (40x or more) was at the center of the credit bubble and our current systemic problems.

It is our opinion that the Federal Reserve is an inherently conflicted organization whose primary role is to serve its largest interest group – the big banks. We believe that the interests of the political establishment place as a close second to the large banks, with the supposed well being of the US monetary system coming in as a distant third. Since its inception in 1913, the purchasing power of the US dollar has declined by over 95% - hardly a track record of which to be proud.

Given this long and distinguished track record, it is only reasonable to empower this institution with still more power and responsibility…..right? Wrong! Fortunately, there is a blossoming movement in the house and senate to try and force the currently secretive Fed to disclose what it is up too. TEAM suspects they wish to remain secretive because the Fed’s balance sheet would likely makes Bear Stearns and Lehman Brothers look pedestrian by comparison. The Fed has a relatively small sliver of capital supporting trillions of dollars in assets it has acquired in its series of bailouts.

Congressman Ron Paul introduced HR 1207 to try and legislatively mandate more disclosure from the Federal Reserve Bank. The bill now has well over 200 co-sponsors, though one never knows what back room dealing could do to such a potentially controversial bill. If disclosure is finally required, we suspect that those pushing for further Fed regulatory control may regret that support. Regardless, TEAM regrets to say that we see very little to be encouraged about as relates to “regulatory reform”. It seems to us that the fox is not only being retained to watch the hen house, but may be given the key to get inside.

Market/Economic Climate

The Weekly Leading Index from ECRI reached a 34 week high this week, while its growth rate hit an 18 month high. This continues to reinforce our view that a cyclical economic recovery is likely to emerge in the US and much of Asia and the emerging markets during the 2nd half of this year. However, we believe the recovery is likely to be very uneven, as the global industrial sector appears poised to recovery rapidly, while industries related to US, European and Japanese consumers are likely to struggle. The structural debt imbalances, the potential for a “jobless recovery” and the likely stagnation in wages, make it unlikely for the consumer to resume anything close to his/her spending binge of the past 5+ years.

Despite our optimistic (who us?) outlook for overall economic growth over the next year, we’ve grown very cautious on a tactical basis regarding the financial markets. We see increasing signs of vulnerability across the favored investment themes of the past three months. The “green shoots” and cyclical recovery trade has driven many to seek risk exposure to things like technology stocks, basic material stocks, energy stocks and commodities in general. TEAM remains very positive on the materials, energy and commodity themes over the long term, but we’ve taken significant measures in the past two weeks to reduce client risk exposure to these areas tactically.

We largely eliminated energy stock exposure late last week, which proved to be timely, as the sector lead the market lower this week with a decline of nearly 10%. We took additional measures Thursday this week to aggressively hedge client commodity exposure by purchasing an Exchange Traded Note (ETN) that is designed to go up in price on a 2 to 1 basis when crude oil prices go down. For example, crude oil was down about 2.5% on Friday and this ETN was up about 5%. This kind of move allows us to retain our core long term investment in a diversified basket of commodities, while protecting client portfolios against a short to intermediate term correction in commodities. Our focus on using crude oil as a hedging vehicle is due to our expectation that it is particularly vulnerable to a sharp correction.

As an example, despite a typical client allocation of 16-17% in commodity linked vehicles and the broad commodity indexes declining almost 2% on Friday, our “anti-oil” hedge and allocations to agriculture and livestock resulted in a net gain in our commodity positions in client portfolios Friday.

Obviously, this is just a single day and the strategy is not assured of success over our anticipated time frame of 1 to 4 weeks. We hope this simply provides some context and rationale for clients to better understand what we are buying and why. Client portfolios are now positioned with a significant amount of defensive positions designed to weather a significant correction in the more aggressive stock sectors and industrial commodities. TEAM would welcome such a correction as an opportunity to shed much of our defensive positions and renew positions in energy and other opportunities that we believe are poised to benefit from a global industrial recovery.

Outrage of the Weekend

It was reported this week that senior executives at several banks that received tax payer funded bailouts were using corporate jets to visit personal vacation homes in Europe and various resort areas in North America. There was a time in this country that the public shame of such an act would make such conduct unthinkable. Apparently receiving hundreds of millions of dollars in compensation to drive their companies to the brink of disaster isn't enough for some - fleecing the taxpayer to ensure their aristocratic lifestyles is shameful.

2009-06-14T07:50:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: June 12th, 2009

Provided by TEAM Financial Services

"A government that robs Peter to pay Paul can always depend on the support of Paul."
- George Bernard Shaw

Items for Discussion

As we’ll expand upon in the second section of this week’s commentary, a durable cyclical economic recovery is very likely to emerge during the 2nd half of 2009 in the US and most of Asia. However, such a cyclical recovery will not resolve two important factors TEAM continues to focus upon. First, the major long term fundamental problem with the US economy is that much of the post 1995 growth in the economy has been fueled by an explosion in debt. As the following chart displays, debt at all levels of our economy (government, corporate, consumer, etc.) continued to growth during the 1st quarter of 2009. A contraction in consumer and corporate debt was more than offset by and explosion in government debt, as federal deficits reach record levels.

The federal government is allowed to issue endless amounts of debt, at least in theory, as it has a monopoly on our currency and printing press. State and local governments do not have this “luxury”. The fiscal state of many of our nation’s state and local government entities is in shambles. California is in the news as being the poster child for being in a fiscal crisis, but TEAM believes it is just a large tip of the iceberg. In fact, we believe there is a significant chance that bailing out state and local governments may be the next crisis addressed by the federal governments over active printing press.

Along with what we believe to be an approaching state/municipal crisis, the US consumer remains heavily indebted and scraping to get by. Of course, these large macro numbers are averages and there are many households in excellent fiscal condition. Unfortunately, this cuts both ways, as statistically these healthy households mask the truly desperate conditions that a large number of US households are suffering. Many households have been living beyond their financial means and financing the imbalance via credit cards, home equity loans, mortgage refinancing, etc. The financial sector is finally awaking to the fact that lending money to over indebted consumers is perhaps not the best business over the long term. The irony is that the government is now trying to force distressed financial firms to lend even more money to households who really shouldn’t be borrowing anymore.

TEAM believes that the last 2 years are just the early stages of what is likely to be a 10 plus year process of restructuring the average American household’s balance sheet. Debt will be repaid and defaulted upon, and savings will increase. This long term trend will certainly include ebbs and flows, so the current cyclical recovery in the US economy could provide a temporary reprieve for some. However, TEAM believes that the cyclical recovery is extremely unlikely to be extended or the type that creates significant amounts of new jobs. Unfortunately, we believe that the overhang of excess debt is likely to dramatically reduce the long term growth potential for the US economy until the imbalance is resolved. We see no signs from policy makers that there is a political will to deal with this reality.

The cyclical recovery we now forecast for the US is likely to be within the context of a very disjointed global backdrop. The US and Asia ex-Japan appear poised for cyclical recovery during the 2nd half of 2009, while Europe and Japan remain stagnant with no tangible signs yet of recovery. Such a recovery is likely to limit global growth and keep the US economy very vulnerable to a relatively brief expansion prior to a second recession emerging.

Market/Economic Climate

As far as financial markets are concerned, TEAM believes that a peak of some significance may have been reached this past week. We took significant measures Thursday to reduce client portfolio risk. While we remain extremely positive on commodity prices over the long term, we believe that a correction in many commodities is possible. We trimmed portfolio exposure to energy companies, as crude oil prices reached an upside price target we’ve maintained. In addition, we believe the higher volatility segments of the stock market are poised to do very poorly relative to more defensive stocks, such as pharmaceutical and large telecom stocks.

Many of the large pharmaceutical stocks are trading at price to earnings multiples of 7 to 9 with dividend yields around 6%. The large telecom providers are similarly valued. Both market segments offer reasonable growth prospects with a high degree of dependability – i.e. the profits are more predictable than those of a more cyclical business like an industrial company. There are certainly political risks in play for the pharma companies, as healthcare reform takes center stage in Washington D.C. this summer. However, we believe the stocks are already priced for a horrible outcome and that the political realities on the ground could surprise many as to how the pharma companies could emerge from “reform” relatively unscathed and winners relative to doctors, insurers and hospitals.

As of Thursday this week, client portfolios are positioned more defensively than they have been since early October last year. While we have been worrying for two months that a correction of some significance could emerge at any time, our concern has grown to be significant and acute due to how our model and research have developed over the past two weeks

Humor for the Weekend

2009-06-07T03:03:00.000-07:00

NEWS-9 COMMENTRY ON BANGALORE'S INFRASTRUCTURE WOES

On news-9 (June 4th 2009) commenting on the Bangalore's infrastructure woes and why the BBMP is unprepared even after years of experience that monsoons and rains severely affect roads, drains and activity in Bangalore.

I AM URGING ALL BANGALOREANS TO GO ONLINE AND SIGN THIS PETITION TO BE SENT TO THE BBMP. GO ONLINE, READ THE PETITION AND SIGN IT: CLICK HERE

ONLINE LINK TO THE PETITION: http://www.PetitionOnline.com/BBMP2009/petition.html

THE MORE PEOPLE THAT SIGN THE PETITION, THE MORE POWERFUL THE MESSAGE. LET IT BE DIFFERENT THIS TIME, AND LET US ALL TAKE A FEW MINUTES OUT OF OUR BUSY SCHEDULES AND FORWARD THIS PETITION LINK TO PEACE LOVING BANGALOREANS SO THAT OUR VOICE IS HERD LOUD AND CLEAR. SO PLEASE FORWARD THIS LINK TO MORE CONCERNED BANGALOREANS TO SEND A CLEAR MESSAGE TO THE BBMP.

Dont forget to add your comments!

2009-06-07T03:00:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: June 5th, 2009

Provided by TEAM Financial Services

"Anyway, no drug, not even alcohol, causes the fundamental ills of society. If we're looking for the source of our troubles, we shouldn't test people for drugs, we should test them for stupidity, ignorance, greed and love of power."
- PJ O'Rourke

Market/Economic Climate

There is an old saying many successful investors/traders we know live by: it isn’t the news that is important, but the reaction to the news. What does this mean? Monitoring how financial markets react to both positive and negative news can be instructive as to how market participants are positioned in aggregate. For example, market bottoms are often put in when horrible news is announced and the market rallies anyway. The rally continues to defy bad news and investors grow frustrated as the rally “doesn’t make sense”. This is what we call “crawling the wall of worry”.

After a period of time, the wall of worry slowly transitions as the news back drop begins to improve. Investors begin to convert from worrying about losing money to concern that the train may be leaving the station without them. Among professional investors, what we call the “viagra effect”, begins to kick in – portfolio managers begin to buy more volatile stocks due to performance anxiety, as their performance lags major stock market averages. This manifests itself in a narrowing of market leadership among what are called higher beta, or more volatile, stocks.

Such behavior serves to create a significant momentum in markets, which can often last longer than many can expect. TEAM has certainly been guilty of this error in recent weeks, as the stock market’s persistence to the upside has been unrelenting. We’ve chronicled in recent weeks the various chinks in the market’s armor as it has marched higher. For example, the increase in prices of late has been driven by an absence of selling rather than a continuation of intense demand. From the data we have seen, short sellers have largely exited the game for now, which lifts a natural source of supply.

This week brought with it several more signs of concern. First and perhaps most importantly, the market reacted poorly to good news. The monthly employment report was announced on Friday morning, and job losses came in dramatically below the consensus forecast. TEAM has a long and consistent history of criticizing these ridiculous exercises in statistical fantasy and Friday’s employment figure didn’t disappoint in this regard. The infamous birth/death adjustment the government uses to try and guess how many jobs were created or lost by small business added 220,000 jobs for the month. Such an assumption is just flat out ridiculous in our opinion.

Despite the goofy nature of the number, the markets reaction to it was instructive. After initially bouncing sharply when the figure was announced, the market exhausted to the upside and reversed to end the day down marginally. The market had been down a good more earlier in the day, but the recent trend of investors buying any and all dips was at play once again.

Another data point that crossed our desk this week that is concerning has been the explosion in speculative trading in OTC stocks in recent weeks. As reported by Sentimentrader.com, the share volume of penny stocks has exploded in recent weeks. This has historically been a sign of excessive speculation in the past and has often occurred prior to market corrections.

With sellers being very weary, even modest levels of demand can result in significant short term market support. We remain nervously constructive on the markets over the intermediate term, but would stress the word “nervous” at this point. The market has not yet done anything of significance to warrant major concern, but we continue to retain a modest amount of defensive hedges for some protection. Historically, markets being driven higher by an absence of sellers often reverse violently when/if sellers return. After a very large run higher in commodity prices during May, clients should be prepared for portfolio volatility in the coming weeks.

Humor for the Weekend

This graphic comes via www.theonion.com

2009-06-02T06:19:00.000-07:00

COMMENTRY ON NEWS-9: THE DILAPIDATING STATE OF BANGALORE'S INFRUSTRUCTURE

I was on News-9 today (June 2nd 2009) commenting on the dilapidating state of infrastructure in Bangalore. Recently rains captured the life of 6 year old Abhishek, which was extremely tragic and absolutely unacceptable. The BBMP, or the primary organization responsible for this lapse was caught napping at the wheel. Their top officials were not even ready to appear in front of the media to apologize. Here are some points that I made.

1. LACK OF PLANNING: Unfortunately Bangalore (and many metros in India) do not even have updated underground maps of drains and sewage systems, which is very disappointing. It's the responsibility Bruhat Bengaluru Mahanagara Palike or BBMP to get on this job immediately so that search and rescue operations can go on smoothly in times of emergency.

2. NO EXCLUSIVE SEARCH AND RESUCE TEAMS FOR EMERGENCIES: The BBMP has no team who is assigned solely to emergencies like this, which is again very sad. It's the duty of organizations like BBMP is to have top quality search and rescue teams with world class equipment, after all they are using our tax money!

3. BBMP recently took out half page and quarter page ads boasting how they had record tax collection --- WHERE'S ALL THAT MONEY GOING IF THEY CANNOT PROVIDE THE CITIZENS OF BANGALORE SOME BASIC AMENITIES!

I AM URGING ALL BANGALOREANS TO GO ONLINE AND SIGN THIS PETITION TO BE SENT TO THE BBMP. GO ONLINE, READ THE PETITION AND SIGN IT: CLICK HERE

ONLINE LINK TO THE PETITION: http://www.PetitionOnline.com/BBMP2009/petition.html

THE MORE PEOPLE THAT SIGN THE PETITION, THE MORE POWERFUL THE MESSAGE. LET IT BE DIFFERENT THIS TIME, AND LET US ALL TAKE A FEW MINUTES OUT OF YOUR BUSY SCHEDULE AND FORWARD THIS PETITION LINK TO PEACE LOVING BANGALOREANS SO THAT THEIR VOICE IS HERD LOUD AND CLEAR. SO PLEASE FORWARD THIS LINK TO MORE CONCERNED BANGALOREANS TO SEND A CLEAR MESSAGE TO THE BBMP.

Don't forget to add your comments!

From Public Gallery

2009-05-30T11:54:00.001-07:00

Where is GOLD headed, and WHAT DETERMINES its direction?

Gold has been inching up quietly in the last few weeks, and not many are taking notice because there haven't been any monster moves. But the way it's shaping up on the charts, we could see some huge movements coming in the next few weeks. Coincidently, gold has been in an uptrend ever since November of 2008 (click on the chart below for a bigger picture in a new window), when the financial crisis was unfolding at a rapid pace. It' has formed higher bottoms, has never reached the November 2008 lows and is approaching the previous tops made in Aug-08 and March-09, which are all pretty bullish signs. Here are some things to watch out for when trying to forecast gold's future movements.

1. The continued weakness of the US dollar is contributing heavily to the rise in gold. If the dollar continues to depreciate against major currencies, the uptrend in gold might continue.

2. Gold is comfortably above two critical moving averages (the 50 day and 200 day moving averages) which is a very bullish sign on for commodity traders.

3. The technical formation on gold is very bullish as volume has also been picking up slightly in the last 2 weeks.

4. Gold has massive resistance between $1000-$1020 which is a very critical band. If gold consolidates there and lacks strength as it reaches that price, it can correct back to the $900 levels. The other scenario which is more likely is that gold will shoot through this resistance with good volume and reach $1100-$1120 very soon.

5. Fundamentally speaking, if the, "green shoots," sprouting in different economies turn out to be weeds, i.e. a false signs of recovery, then gold is the safe haven that everyone will rush to, which should send the price of the yellow metal up another 15-20 percent.

6. Many countries are slowly and silently divesting tiny portions of their US treasury holdings in their foreign exchange reserves and funneling them towards gold. In fact, if the dollar crashes gold prices will SURGE so this acts as a small hedge in many cases.

7. If the commodity bull market resumes and initiates its second leg, then gold might see historical levels very soon.

NOTE THAT THE CHART BELOW IS FOR THE GOLD ETF GLD. THIS ETF APPROXIMATELY REFLECTS 1/10TH THE PRICE OF AN ACTUAL OUNCE OF GOLD. CLICK ON THE CHART BELOW FOR A CLEAR PICTURE.

Dont forget to leave a comment!

2009-05-30T06:59:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: May 29th, 2009

Provided by TEAM Financial Services

"A dollar saved is a quarter earned."
- John Ciardi

Items for Discussion

There were rumblings this week in Washington about the potential for implementing a consumptions/sales tax at the Federal level, comparable to the VAT tax you may have encountered for those who have traveled to Europe. Philosophically, I personally believe that consumption taxes are the fairest and most economically efficient way to raise government revenues, as taxing labor, savings and investment is tantamount to biting off one’s nose to spite one’s face. However, the very fact that such a discussion is occurring, and apparently in a serious way, speaks to the epic nature of the budget crisis the US faces. The recent plunge in the US dollar and sharp increase in long term US Treasury rates only highlights this issue.

After a brief flirtation with political ideology during my college years, I quickly shifted to a far more pragmatic view of political policy. As investors, we’ve found that it pays to maintain an analytical bent to things and try not to allow personal bias to sway our analysis. For example, many on the right of the political spectrum are reactionary about high tax rates and believe it would reap economic calamity. Many on the left believe that the golden goose has an endless ability to pay ever higher taxes to pay for social programs. We believe reality is far more complicated.

The 1950’s was perhaps the best economic decade of our nation’s history. This occurred as marginal tax rates were at extremely punitive levels – as high as 90%. One need only watch a documentary on the great boxer Joe Louis to get a sense of how punitive the tax rates were. Yet, our nation was able to enjoy a period of immense prosperity and growth. How could this be? In our opinion, it was largely because the government was relatively wise in allocating the resources it was confiscating via punitive taxes. Our nation’s infrastructure was enhanced exponentially with the construction of the interstate highway system. Such investment in productive infrastructure increases societal productivity and can result in a huge return on the money spent. The GI bill offered to “the Greatest Generation” after WWII and Korea produced a generation of well educated engineers and scientists that provided the expertise that allowed the infrastructure to be built well and technological innovation. It helped our country put men on the moon and was the seed planted that allowed the computer to blossom. .

Unfortunately, we see little signs of a similar wisdom being displayed presently by either political party in Washington. The current deficits are not being incurred to invest in productive infrastructure, even as our infrastructure crumbles – sometimes literally. Our electrical grid is terribly outdated and ill equipped to handle the future demands of an increasingly digital society. Water and sewer pipes are corroding. Airports are a wreck. Bridges are in dire need of repair. Yet, a frighteningly small amount of “stimulus” passed in Washington is dedicated to these issues, which would not only create employment in the near term, but also provide long term productivity benefits to our economy.

Instead, we have widespread political paybacks. We have bankers being bailed out by taxpayers, with no real “heads rolling”. Want a $100 million job that is secure even if you drive your company to the edge of insolvency and the entire banking system to the brink of disaster? Just become a large bank executive! We have 200 years of contract law being undermined by an administration that is strong arming (I could use a far more terse term) investors to hand over large industrial companies to unions.

The massive amount of debt our country is assuming COULD provide a way out of the long term economic crisis we face, but only if the resources are used in a productive fashion. We see just the opposite occurring. So while a cyclical economic recovery is likely to emerge over the next six months, TEAM has actually grown more concerned about the long term economic outlook in the US.

Market/Economic Climate

As we’ve expressed in recent weeks, our major concern for 2009 has been that the US funding crisis could emerge during the year, and described that a dramatically weaker US dollar combined with a spike higher in US long term interest rates would be an indication that the crisis may have arrived. We believe a crisis is likely to be something that unfolds in many phases, and we may very well be towards the end of the first phase.

Our models indicate that a temporary exhaustion may have been reached for long term interest rates, though the US dollar still has another few percent of downside until it reaches our initial target for its decline – around 76.50 on the US dollar index versus Friday’s level around 79+.

Interestingly, stock investors have not been overly concerned with the dislocations in the dollar and interest rates - yet. The hottest stock market sectors in recent days have been those related to higher commodity prices, as commodity prices have marched significantly higher as the US dollar plunges. The past eight months have been remarkable for precious metals stocks, as they have rallied, as a group, over 150% from their mid October 2008 nadir. Of course, the stocks still remain well below their March 2008 peaks, which is indicative of how horrific the 70% decline from March of 2008 to October 2008 had been.

Our intermediate term indicators for the stock market remain tenuous, but the stock market's resiliency continues to impress. We fear there may be a trap door approaching, so maintaining some defensive measures remains a focus. Should long term rates drop significantly and the US dollar stabilize for a period, our significantly appreciated positions in commodities and related stocks could be vulnerable to a sharp correction.

Humor for the Weekend

2009-05-23T04:53:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: May 22nd, 2009

Provided by TEAM Financial Services

"Although no sculptured marble should rise to their memory, nor engraved stone bear record of their deeds, yet will their remembrance be as lasting as the land they honored."
- Daniel Webster

Items for Discussion

After a period of 2 plus months in which seemingly all news was viewed as good news, it appears that a more skeptical cloud has descended on the broad investor psyche. The rally from the early March low has been epic and historical in scope, but there has never been a market to goes straight up forever. The weekly unemployment figures were worse than expected this week, which shifted some to question their prior certitude that an economic recovery was imminent. There appears to have been a subtle shift in investor psyche, in which data points on the margin are taken negatively and create selling pressure. This development fits with our expectation that at least a temporary market correction in the 10-20% range over a 3-8 week time frame was possible, if not likely.

As is typical in this weekly commentary, we try to highlight market activity in those areas that the average person may not be monitoring closely. This week brought about violent activity in the US Treasury bond and currency markets, as long term interest rates spiked higher and the US dollar declined significantly versus most major currencies. The UK’s sovereign credit rating was compromised, which increased speculation that the US could be next in line to be “downgraded”. TEAM believes such an outcome is a matter of “when” rather than “if”, and is at the center of the 3rd phase of the 3 headed monster we’ve been discussing over the past year.

First there was the financial crisis, then the economic crisis and now the US funding crisis – at least potentially. The latter of the three is what we are most concerned with at present, as we believe the policy initiatives being implemented in Washington DC are not likely to help the long term economic challenges we face. On the contrary, we believe they are likely to make matters worse and introduce new and possibly more dangerous risks to the economy and that average American’s standard of living. The national debt is exploding higher and the resources are being squandered on politically motivated initiatives rather than tangibly productive ventures.

For example, much of the US’s infrastructure is in dire need of modernization, yet the recent stimulus bill included a very small amount to this badly needed investment. Whether it is bridges, airports, mass transit or the electricity grid, the US is falling in to the category of “developing nation”. The key to overcoming our fiscal imbalances is the position the economy to grow via savings and investment in productive assets that will increase productivity – that is the formula to raise living standards. On the contrary, we view current policy as likely to stunt growth by punishing savings and investment, with political priorities driving the allocation of resources. This is not meant to be a partisan statement – the prior administration’s war in Iraq could be criticized in a similar fashion.

Ultimately, the US is doubling down on our level of debt hoping that the economy will grow fast enough to bail out this imbalance. Such a bet could be successful if the resources were allocated productively, but we see little signs for optimism in this regard. We unfortunately see a dramatically increased probability of 50%+ marginal tax rates, higher interest rates, a weaker US dollar and a prolonged period of elevated inflation in commodities driving the standard of living of most Americans lower. Happy holiday weekend!

Market/Economic Climate

TEAM’s portfolio strategy remains modestly hedged with significant exposure to commodity prices and related company stocks. The recent weakness in the US dollar has helped drive the vast majority of client portfolios (those at TEAM for any significant period of time) to new all time high valuations. We remained concerned that a deeper correction/retracement of the March-May rally is possible which is why we continue to maintain a significant allocation to hedging vehicles.

If a significant stock market correction does develop, our current plan is to use such a move to more aggressively position client portfolios to better take advantage of the global industrial economic recovery, even if it proves to be “only” cyclical and temporary. Our commodity and related stock investments are already geared for such an outcome, and we hope to augment those positions with increased exposure to basic materials and/or industrial positions.

Weekend Remembrance

2009-05-18T12:23:00.000-07:00

PERILOUS STATE OF THE US DOLLAR

By, Adhvith Dhuddu

As appeared in the Business Line Hindu.

The US dollar is bearing the brunt of the blame as critics reemerge to vilify its position as the world’s reserve currency. Concerns about many aspects of the US economy have resurfaced following the unprecedented financial commitments made by the Obama Administration to pull the economy out of a deep recession. US debtholders are becoming increasingly apprehensive about this and the trillions of dollars in long-term liabilities that the US government is saddled with .

Although this is nothing new, the momentum to give the world an option of another global reserve currency is picking up as more economists and central bankers come to this consensus, as the Chinese realise the $2 trillion quandary they’re entangled in, and as the US continues to print its way out of this recession simultaneously devaluing the dollar.

STEEP STRENGTHENING

As the crisis was unfolding at lightning speed, the dollar did strengthen considerably. This was primarily due to two reasons: The lack of another option as a safe haven currency and the forced asset sales all over the world to meet rising capital requirements in the US. So the quick and steep strengthening of the dollar immediately after the crisis should not be mistaken as a sign of long-term resilience. There are several other issues that have plagued the currency which will contribute to its steady decline.

Short-term liabilities skyrocketed to inconceivable heights as the US government committed $3.5-4 trillion in bailouts, guarantees and assurances to various institutions since September last year. Although a lot of this was required to prevent financial Armageddon, the numbers are mind-boggling as you realise that the total amount committed was 30-35 per cent of its GDP.

What’s more alarming are the long-term liabilities that the government is burdened with in the next few decades. Tens of trillions of dollars in entitlement spending towards social security and medicare are not only unavoidable but are rising steadily as average life expectancy rises, healthcare costs surge and inefficiencies in the system persist. There are some signs of hope as this Administration strives to modernise healthcare, and tackle long-term entitlement spending.

But here’s how the situation stacks up currently: China holds close to $2 trillion in US debt and has expressed concerns about the US government putting the printing presses on overtime. In some way this subtly implies that China will not purchase US treasuries at a rapid pace. This is where the dilemma arises, as the US issues treasuries at an unprecedented rate to finance its ever-expanding liabilities. If China either sells current treasuries it holds, or slows the pace of gobbling up newly issued treasuries, interest rates in the US will rise significantly; only to prolong the recession.

CHINA'S DILEMMA

In an efficient marketplace, all artificially priced assets eventually get valued at the appropriate levels. This is where China’s dilemma arises. The primary reason its currency is artificially undervalued is because of its unabated appetite for US treasuries. In a way, the Chinese don’t have a choice but to aggressively continue purchasing US treasuries if they want to keep their currency undervalued. So the consequences for the Chinese if they sell US treasuries or slow down their purchases will be paramount as their currency will surge to choke export growth.

The Chinese government and central bank face an uphill task as they confront this complex challenge. With the limited amount of funds they posses, they have to simultaneously perform three critical activities:

They need to keep their currency undervalued to support their massive export industry;

Continued support for their internal growth through their ambitious stimulus plan is critical in assuaging any social uprisings in the rural and semi-urban areas; and

They need to continue purchasing US treasuries to prevent any drastic fall in the dollar’s value.

Clearly, the Chinese are in a multi-trillion dollar quandary as they appear stuck with US treasuries which are depreciating steadily. The US was able to finance its liabilities for years, and successfully bought cheap goods from the Chinese with cheap credit via US treasuries (which it sold to the Chinese), and is now actively pursuing to devalue the dollar as the Federal Reserve and US Treasury realise that’s the only way out. It increasingly looks like the US might have its cake and eat it too.

IF NOT THE DOLLAR...

But a few larger questions arise here: How can the dollar be a universally accepted global reserve currency when two countries, the US and China could potentially derail the currency? If the US was analysed as US Inc., would any banker lend it money after glancing through its balance-sheet?

The counterargument for all these questions is often the same: If not the dollar, then what else? It’s not a legitimate question, because, true there is no other currency that is as powerful as the dollar, but if an alternative is presented to the world, if a choice is given to nations, then the true resilience of the dollar will be discovered, because then there will be a choice.

This might not be an appropriate time as nations recover from this historic meltdown, but a clear roadmap must be drawn out in the next one year so that countries can finally choose in which form they want to keep their reserve funds.

The Stone Age did not end due to a lack of stones, similarly the petroleum age will end long before the world runs out of oil and the dollar’s status as the world’s reserve currency will end not due to a lack of dollars but because individuals, central banks, governments and nations will realise the increasingly perilous state of the dollar as the country’s liabilities get compounded with the passage of time.

(The author is a professional trader and asset manager in the US and India.)

Online link to this article: Click here

2009-05-16T22:05:00.000-07:00

TV 9 INTERVIEW: COMMENTING ON THE IT SECTOR SLOWDOWN IN INDIA

I was recently interviewed by TV9 news (a local news channel) and gave my opinion on the slowdown in the IT sector, and how it's interrelated with the slump in the US economy. The main points discussed are breifly given here.

1. The main sectors affected in the US during this recession are: financial services, insurance, brokerage and banking. Companies in these sectors outsource a significant amount of activities to Indian and other IT companies. Therefore the slowdown has affected their IT spending numbers leading to depressed revenues and profits.

2. IT budgets in many mutli-national companies like Citi, JP Morgan, etc. have been slashed leading to lower IT capital spending. This again affects Indian IT firms. In FY 2009, tech spend in the US declined by 9 percent and in FY 2010, the outlook is not very sanguine either, as tech spend might stay the same or decrease marginally.

3. IT budgets in Indian companies too have taken a hit. They grew at a healthy pace by 13-14 percent in FY 2008, and might grow only at 4-5 percent in FY 2009. IT budgets in the coming financial year might either stay constant or just grow marginally.

4. IT spending is usually divided into essentail and non-essential IT spending. Essential IT spend usually consists of 60-70 percent of the IT budget, which has been steady. It's the non-essential IT spend that had declined.

5. As a result, many Indian IT firms are accepting contracts at a lesser price.Projects that were usually done at a certian price, are being accepted at 10-15 percent less.

From Public Gallery

2009-05-16T22:00:00.000-07:00

WEEKLY ECONOMIC ANALYSIS: May 15th, 2009

Provided by TEAM Financial Services

"Don’t look back. Something might be gaining on you."
- Satchel Paige

Items for Discussion

One of the themes we have discussed in the commentary over the past year has been our long term bullishness on commodity prices, with agricultural commodities being near the top of our list for the next few years. This bullishness is based on our assessment of global supply and demand fundamentals, but we are very worried about these fundamentals and what impact higher prices may have.

Global inventories for many major agricultural products are at multi-decade lows. The world has “enjoyed” a period over the past few years of relatively minor supply disruptions courtesy of Mother Nature. The last time the world reached similar supply/demand fundamentals was in the early and mid 1970’s. Grain and soft commodities experienced rolling parabolic moves higher, with most taking a turn at moving higher by several hundred percent in a relatively short period – 12 to 24 months. So far, we are suffering similar supply and demand fundamentals, only this time prices have not yet responded significantly. In addition, there is a major difference between that period and the present. Namely, the period in the 1970’s occurred with a closed communist China and Soviet Union excluding billions of people from the demand side of the equation.

Global population continues to expand at around 80,000,000 people per year. Historically, arable land has been developed (i.e. lost of rain forest etc.) to meet the increased food demand. Advances in fertilizer, irrigation and seed technology dramatically increased crop yields per acre or hectare. Unfortunately, these forces appear to be losing ground in their relative ability to increase supplies compared to the combination of population growth and the progression of millions of people out of subsistence living standards in the developing world. One of the first things people do when their income rises is to consume more food in general and introduce more proteins into their diets. This increases demand for agricultural products via direct grain demand, but also via the high demand for grains to raise livestock.

TEAM is extremely concerned that the world is poised to suffer a combination of a food and water crisis in the next few years. China, in particular, has significant problems in both regards. The country simply does not have the internal resources required to meet the long term demands from their population for food and water.

Social and political volatility has spiked significantly in the past during periods of significantly higher food prices. Famine and increased poverty is likely for those most vulnerable should prices head much higher. This development would be horrible for the world and it is certainly not something we are hoping to occur. Unfortunately, it is something that we believe is not only possible but probable.

One agriculture segment we believe is particularly vulnerable to higher prices over the next 12-24 months is livestock. Herds were reduced significantly in 2007 and 2008 when grain/feed prices had risen sharply, while hog and cattle prices remained stagnant or fell. Along with herds being reduced significantly, land which had previously been utilized for livestock was converted to farm land to “follow the money”.

Livestock inventory is not something that is increased rapidly when pricing incentivizes such a move. Cattle and hogs do not grow as quickly as a crop in corn or wheat. Some agricultural commodities have longer cycles, such as livestock and coffee (coffee trees take several years to reach a point of being productive). This compares to rapid cycle commodities like corn, wheat and soybeans. At present, TEAM believes there is a critical state in livestock prices – like snow building up on a mountain. At some point their will be a “small noise” or catalyst that will start the avalanche of higher prices. We certainly don’t know when it will occur, but if you have a freezer large enough you may want to buy your steaks summer grilling soon!

Market/Economic Climate

TEAM believes that the stock market finally launched into a correction or retracement of the explosive rally off the March low. If our base case premise is operative, then a decline of significance would take place and last between 3 to 6 weeks, which is a typical rule of thumb for such a decline. As we’ve stated in the past couple of weeks, we’ve increased hedging and defensive measures in client portfolios with the intent of weathering such a move.

ECRI’s leading economic indicators now suggest that the US economy should begin a cyclical economic recovery sometime this summer – i.e. the economy should emerge from recession. Such a development would not suggest that the many long term structural problems we’ve chronicled over time have been addressed or solved. On the contrary, TEAM believes that the policy actions pursued over the past two years have likely compounded those long term problems and created new ones.

The trillions of dollars in stimulus being created throughout the world are likely to have at least a temporary impact and get the economy moving. TEAM is anxious to utilize any significant correction/retracement in the stock market to continue our shift to assets we believe are poised to benefit from the recovery – even if it proves to be temporary and fleeting.

Humor for the Weekend

This graphic comes via the Big Picture Blog authored by Barry Ritholtz.