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Words from the (Investment) Wise for the Week That Was (May 4 - 10, 2009): Part II

Financial Times: Obama's offshore tax crackdown
"President Barack Obama prosposes tax code changes that would eliminate rules that allow businesses and wealthy individuals to defer paying taxes on onverseas profits."

Source: Financial Times, May 5, 2009.

BCA Research: Bonds - testing policymakers' resolve
"Regional bond allocation will likely be unexciting and provide little in the way of excess returns this year as central banks remain on hold at extremely low target rates. However, in the absence of the Fed and BoE targeting the government curve, the cyclical trend should be for these markets to underperform relative to bunds.

"The chart shows the sensitivity of the various regional bond markets to changes in global growth. Historically, the US, Australia, New Zealand and the UK have had the highest (negative) betas, causing these markets to underperform during periods of recovering global growth. In contrast, the euro area, Switzerland and Sweden are the least sensitive to swings in global growth and tend to outperform during recoveries.

"We had been wagering that this cycle would be different for the US and UK, given that these economies had the largest structural economic and financial sector problems and their central banks were willing to engage in quantitative easing to depress yields below where they otherwise would be. However, this call has not panned out over the past few weeks and further underperformance of Treasurys and gilts looms if the Fed and BoE do not step up their purchases of government bonds (especially given the longer-term issuance concerns for these markets).

"Thus, we recommend standing aside. We are booking profits on our long-standing overweight gilt position and moving back to neutral. Similarly, we are cutting our recent overweight Treasury allocation with a slight loss and upgrading euro area bonds to overweight."

Source: BCA Research, May 7, 2009.

BCA Research: US fixed income - maintain long duration but avoid Treasurys
"Investors should maintain long duration positions in non-government sectors, particularly in corporate bonds.

"Fed policymakers were confident enough with the outlook that they did not announce a new support program, expand an existing support program, or crank up the pace at which they are purchasing government or private sector securities after last week's FOMC meeting. The Fed's silence on the recent Treasury selloff was interpreted as a sign that policymakers are comfortable with higher yields, allowing the 10-year yield to break above 3%.

"Bond traders are likely to further test the Fed's tolerance in the coming weeks. The Fed will tolerate the backup in government yields as long as it does not interfere with the decline in private sector borrowing rates. Most non-government fixed-income sectors continued to rally last week in absolute terms, despite the jump in Treasury yields (i.e. spreads narrowed faster than Treasury yields rose). Non-government bond sectors have outperformed cash since we shifted our long duration position out of Treasurys and into spread product last December.

"Fed policymakers would likely become more aggressive in capping Treasury yields if the government bond selloff begins to push up private sector borrowing rates prematurely (i.e. before the economy can handle more expensive credit). The implication is that investors should avoid government bonds and express long duration positions in other fixed income sectors where value is still attractive."

Source: BCA Research, May 5, 2009.

Bill King (The King Report): Bonds breaking down
"... to say bonds are retreating due to economic growth is wrong, with the 80s as an example.

"The financial crisis to date is due to credit and solvency concerns. When people fear that an entity cannot meet interest payments or repay all or part of the principal, that piece of paper tanks. But debt without credit concerns remains buoyant; some debt increases in price on safe haven buying.

"But if bonds prices tumble, all debt gets marked down; and then there could be more derivative problems. If all debt instruments decline financial firms' balance sheets will deteriorate severely.

"One reason for the severity of the credit crisis is that too many Street denizens, including model makers, had not experienced a credit cycle turn. The last occurred in 1990.

"This bond bull market commenced in 1982. Few money managers have experienced the savagery that a bond bear market brings.

"Estimates have CDS at $40 to $50 trillion notion value. Estimates put interest rate related derivates over 50% of the $1.4 quadrillion derivative market. We don't have to elaborate about what might be triggered.

"If stocks tumbled on Thursday on concern about inflation and the bond market breakdown, the Fed is in deep stuff. Its intent has been to reflate financial asset prices. But declining bonds could trump the Fed.

"Ben is now chagrined because his effort to prop up bonds, possibly to appease China (after Hillary's trek there) by announcing a $300 billion monetization, has produced the opposite of the desired effect. Ben's scheme has inflamed inflation concern, as it should have and will continue to do so."

Source: Bill King, The King Report, May 8, 2009.

Bespoke: High-yield credit spreads significantly down
"... high yield credit spreads are down to their lowest levels in over six months. Based on data from the Merrill Lynch High Yield Master Index, junk bonds are currently yielding 1,308 basis points above comparable treasuries. These levels are by no means normal, but they are considerably better than the 2,100 basis point spread investors were dealing with in December. Additionally, they are also indication that the doomsday scenario markets priced in following the Lehman bankruptcy are being erased."

Source: Bespoke, May 6, 2009.

John Authers (Financial Times): Higher bond yields negative for equities
"If optimism remains intact, the trend in bond yields is clearly upwards. They could yet act as a brake on the stock market rally, and on the recovery."

Click here for the article.

Source: John Authers, Financial Times, May 6, 2009.

Bespoke: S&P 500 dividend yield drops 100 bps
"Since the March 9 low, the indicated dividend yield of the S&P 500 has dropped from 4.12% to 3.12%. At the same time, the yield on the 'risk-free' 10-year Treasury Note has risen from a low of just over 2% to its current level of 3.15%. The fact that the 10-year yield is now higher than the dividend yield of the S&P 500 makes equities less attractive."

Source: Bespoke, May 6, 2009.

Randall Forsyth (Barron's): Stress tests bring relief to markets
"We've all become so inured to numbers in the trillions that $75 billion no longer sounds daunting. Given the revival of the capital markets, raising that prodigious sum appears doable.

"Indeed, it's been the steady improvement in the equity, corporate debt and money markets that have instilled the confidence that banks could pass the stress tests.

"To be sure, the results of the tests, which were based on banks facing higher losses on business loans than during the Great Depression, helped further bolster optimism that these institutions could weather the worst conditions, with the addition of this additional capital.

"The stock market climbed the wall of worry posed by these what-if questions. But it has been boosted mainly by the provision of liquidity by the Federal Reserve through various innovative avenues that at least has credit flowing through the money market.

"Meanwhile, investors who have regained some measure of confidence, or have tired of earning virtually nothing on their growing stash of cash, have been putting it to work in the equity and debt markets. And woe be unto any professional money manager sitting on cash as the stock and corporate bond markets have been in rally mode.

"All of which has produced a huge advance from the March lows that has brought the major averages back to where they stood in January. But, according to Bank of America/Merrill Lynch chief North American economist David Rosenberg, that leaves the stock market in a much more precarious position now than 18 weeks ago.

"Professional investors appear to have covered their short sales, unwound their hedge positions and reduced their cash holdings in favor of getting back into the market, he writes in a research note. That makes the risk in the market much higher than when the averages stood at these levels around the beginning of the year - quite contrary to the view that the stress tests have lowered the risk level out there.

"With the 'smart money' now more fully invested, the stock market is more vulnerable to disappointments or reality checks, depending on your point of view. In which case, 'this is a bear market rally that has run its course', Rosenberg contends. Indeed, chances of a retest of the March lows are 'non-trivial', he adds.

"'The rally of the past nine weeks appears to be rooted in green shoots. While it may be the case that the pace of economic decline is no longer as negative as it was at the peak of the post-Lehman credit contraction, the reality is that employment, output, organic personal income and retail sales are still in a fundamental downtrend,' Rosenberg contends.

"Yet, stocks have rallied while Treasuries have backed up massively in yield, with the 10-year note up to 3.30%. That's analogous to mid-2207, when the benchmark note hit 5.35% while the stock market was hitting new highs, Rosenberg recalls. As was the case then, he says the trade now is to take profits in stocks and put the money in Treasury bonds.

"'Be careful about jumping into the stock market with both feet after this monumental rally. Consider whether or not it would be more appropriate to take advantage of the run-up to reduce equity exposure,' Rosenberg writes in what sounds like his valedictory report ahead of his previously announced departure from Bank of America/Merrill Lynch.

"'Our preference is to stick with fixed-income securities, which we believe will work much better from a total return standpoint, as they did for years after the economy hit bottom back in the early 1930s. When we are finally coming out of this epic credit collapse and asset deflation, we should expect that the trauma exerted on household balance sheets will have triggered a long wave of attitudinal shifts toward consumer discretionary spending, homeownership and credit. The markets have a long way to go in terms of discounting that prospect.'"

Source: Randall Forsyth, Barron's, May 8, 2009.

Financial Times: Russell Napier - "cataclysmic bear market"
"Russell Napier, author of Anatomy of the Bear, tells John Authers that a rise in Treasury yields will cause a 'cataclysmic bear market' within two years."

Source: Financial Mail, May 7, 2009.

Barry Ritholtz (The Big Picture): Sentiment reading - neutral
"One of the refrains we have heard lately is that 'Everyone is too bullish'.

"Looking at the data, we find that the sentiment is decidely mixed - perhaps the best word is neutral. Consider the various data points:

• Investor Intelligence Newsletter Survey has Bulls 40.4 versus Bears 31.5 - this is the lowest level for the bears since June 2008. (See chart below). Overall, this is in neutral territory. It is neither excessively bullish (see October 2007) or excessively Bearish (see October 2008).

• The % of NYSE Stocks above their 200-day moving averages was deeply oversold at just 1% in March - its now just under 40%.

• Consumer confidence has been extremely low, and is now moving off of those levels.

• Earnings expectations have also been quite low - possibly too low. For the first time since the bear market began, earnings on the SPX are beating consensus.

• Money market cash as a percentage of total market value peaked in March at ~44%; Its down to 38% as of the end of April, significantly above historic levels.

• Cash in individual investor portfolios remains significantly above the 21.5 year mean of 25%; Its down from 44%, but remains elevated at 34%.

"The bottom line: Sentiment data is off of the extreme levels we saw at the lows in March; however, it has not yet reached levels that are associated with excessive bullishness."

Source: Barry Ritholtz, The Big Picture, May 6, 2009.

Bespoke: Past years most correlated with 2009
"With the market dropping big in the first two months of the year and then rallying big over the last two months, investors are wondering where we go from here. We have a cool file here at Bespoke that looks at the market's pattern in the current year and finds prior years with the most similar patterns. The file looks at the correlation between the year-to-date returns of the Dow at any point in the current year with all historical years.

"Since 1900, there have been two years that have a correlation with this year (as of May 5) of more than 0.75 (1 is perfectly correlated). These two years are 1982 and 2000.

"As shown in the chart below, the chart patterns through May 5 have been very similar for all three years, although the moves this year have been more extreme. The current year is most correlated with 1982 at this point, and as shown below, the Dow actually topped out in May of that year and went on to make a new low, only to post huge gains in the last quarter of the year to finish up 20%. If the rest of 2009 plays out anything like 1982, it will be painful at first but sweet in the end.

"In 2000, we had a similar decline through early March, saw a big rally into the Spring, and then traded sideways for the rest of the year to finish down 6%."

Source: Bespoke, May 5, 2009.

Bespoke: Keep an eye on technology & financial sector relative strength
"The chart below shows the relative strength of the Technology and Financial sectors versus the S&P 500. In each chart, a rising line indicates that the sector is outperforming the S&P 500 while a declining line indicates underperformance. We have also included dots showing each time the Fed cut rates (red) and left rates unchanged (black dots).

"After a strong run of outperformance since late November, technology stocks have steadily outperformed the overall market. In fact, on Monday the tech heavy Nasdaq became the first major index to trade above its 200-day moving average. Since then, however, tech stocks have faltered and on each of the last three days, the sector has underperformed the S&P 500 by a wide margin.

"In terms of relative strength, Financials have yet to run into the problems that the tech sector has encountered. However, while the sector has had what can only be classified as an extraordinary rally, it has a ways to go before it even tests its downtrend in relative strength that has been in place over the last year."

Source: Bespoke, May 7, 2009.

Bespoke: Breadth by the 50-day moving averages
"As the market continues to rally, the percentage of companies now trading above their 50-day moving averages also continues to rise. As shown below, 92% of the stocks in the S&P 500 are now trading above their 50-days. This is by far the highest reading since mid-2006, and it is indicative of extremely strong market breadth.

"Every sector except Health Care and Consumer Staples has a >50-DMA reading of more than 90%. The Consumer Staples sector is at 88%, and Health Care is at 75%. Telecom only has 9 stocks in the sector, and all of them are trading above their 50-days. The Industrials sector ranks second at 98%, followed by Energy and Utilities at 97%. While still high, Financials and Consumer Discretionary have actually seen a decline in the percentage of stocks above their 50-days over the last week. The indicator maxes out at 100%, so there isn't currently much upside room from a breadth perspective. A pullback in these extraordinary numbers would be neither surprising nor unhealthy."

Source: Bespoke, May 5, 2009.

NDTV: Mark Mobius - load up on growth stocks
"The rally has caught many by surprise, particularly the retail investors who have mostly missed a ride. But there is a lot for them to look forward to, if one goes by the optimism of Mark Mobius, executive chairman at Templeton Asset Management.

"'India has broken out of the downturn. It is a matter of building a base now. The Indian markets will move up and down before dramatically moving up,' he said.

"He said that emerging markets will move first once the global recovery process kicks in, given that these markets are better prepared with high reserves and low debt, both at the country and company levels.

"He suggests investors to be aggressive on the markets and look particularly at growth stocks, which will do well over a five-year time frame.

"On the current rally, Mobius said, 'We are building the base for the next bull market and the markets are saying that one year down the line the economies of the world will recover.'"

Source: NDTV, May 5, 2009.

Sanjiv Duggal (Halbis): Indian election weighs on equities in short term
"The near-term outlook for Indian stocks is unfavourable in spite of a strong rally because of uncertainty about the outcome of the country's election, according to Sanjiv Duggal, head of Indian equities at HSBC's Halbis investment arm.

"In dollar terms, he says, the broad BSE 200 has in just 32 days surged more than 50% from its March low, the fastest short-term rally.

"'Equity raising and placements are likely to shoot up given this pre-election rally, partially meeting this sudden greed for stocks,' Mr Duggal says.

"'The amount of hot money coming through derivative holdings has increased while small and mid-cap stocks have recently outperformed large caps. These tend to be initial warning signs that speculative and retail participation is back.'

"He expects volatility to pick up ahead of and after the election results. None of the three main coalitions is likely to gain a majority.

"Mr Duggal is positive longer term.

"'We expect the broad market to deliver a compound annual growth rate of about 15% over the next decade.'

"He says that the market does not appreciate the full magnitude of the government's stimulus measures and that growth will be further supported by aggressive monetary easing during the past six months.

"'Although the journey will be volatile, these factors should ultimately drive share prices higher,' he says."

Source: Sanjiv Duggal, Halbis (via Financial Times), May 7, 2009.

Bespoke: Bespoke's commodity snapshot
"Below we provide the year to date change of ten major commodities. As shown, copper is up the most in 2009 at 54.3%, followed by orange juice (21.81%), oil (18.61%) and platinum (17.71%). While platinum is up 17.71%, gold is up just 0.84%. Last year, platinum traded down to a 1 to 1 ratio with gold, even though the metal is much rarer than gold. So far this year, however, platinum is diverging from gold on the upside once again. Natural gas continues to be the big loser with a decline of 37.23% year to date."

"Below we provide our trading range charts of some of the commodities highlighted above. The green shading represents between 2 standard deviations above and below the commodity's 50-day moving average. When the price moves outside of this green shading, the commodity is considered overbought or oversold.

"Oil is pretty close to the top of its trading range, and the last time it moved above the green shading, it pulled back pretty quickly. Natural gas is the closest to oversold territory and continues to trend downward. Gold, silver, and platinum have broken their uptrends recently and are approaching the bottom of their trading ranges. Copper, corn, wheat, orange juice, and coffee are closer to the top of their range than the bottom."

Source: Bespoke, May 4, 2009.

Commodity Online: Jim Rogers - gold prices may go to a bottom
"Will the International Monetary Fund's (IMF) decision to sell 403 metric tons of gold drive down gold prices? Yes, gold prices will plunge to $700 or below that if and when IMF really sells its gold reserves, says legendary global commodities investor Jim Rogers.

"Rogers, who left the United States to settle down in Singapore last year, and who is regarded as a commodities guru globally said he will hold on to his gold and is waiting to buy more gold because he expects gold prices to considerably come down when IMF sells its gold holdings.

"'The fact is that IMF is trying to get permission from everybody to sell gold. I don't know it will succeed or not. But if and when IMF sells its gold, gold prices may go to a bottom. Who knows? It may go down to US$700. IMF has got a lot of gold to sell. If it does, I hope I'm brave enough and smart enough to buy more,' Rogers told Bloomberg Radio in an interview.

"Rogers who is hot on China has been investing heavily into Chinese investment and agricultural funds in the last year. According to Rogers, three billion people living in Asia, most of them in India and China, will account for a major portion of the total demand for commodities in the coming years.

"In an interview to Commodity Online Rogers said recently: 'China is a fascinating place to invest in. China is on the rise, like America 100 years ago, and the problems the Asian giant is encountering right now in certain, mainly export-driven, sectors of its economy will not alter the country's long-term trajectory.'"

Source: Commodity Online, May 3, 2009.

John Authers (Financial Times): Putting faith in China
"Rallying markets think the Chinese economy has made a V-shaped recovery, but its is difficult to tell to what extent we can trust the encouraging economic data coming out of Beijing."

Click here for the article.

Source: John Authers, Financial Times, Mei 4, 2009.

Financial Times: ECB cuts rates to combat recession
"European central banks on Thursday intensified their efforts to combat the continent's severe recession by unveiling bolder-than-expected moves to buy assets and boost growth through historically-low interest rates.

"The European Central Bank cut its main interest rate by a quarter percentage point to 1%, the lowest yet, and announced plans to buy €60 billion of covered bonds, which are backed by mortgage or public sector loans.

"Separately, the Bank of England said it would pump a further £50 billion into the UK economy through its programme of 'quantitative easing'.

"Signalling significantly greater flexibility, Jean-Claude Trichet, ECB president, said official eurozone borrowing costs could fall again.

"Several ECB governing council members had previously publicly opposed cutting rates below 1%, and Mr Trichet had warned of the dangers of letting rates fall to zero.

"The announcements reflected increased ECB gloom over the economic outlook for the 16-country eurozone, which is expected to be hit worse this year by the global slowdown than the US or UK."

Source: Ralph Atkins, Chris Giles and David Oakley, Financial Times, May 7 2009.

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