Donald Coxe

Donald Coxe, Chief Investment Strategist, BMO Capital Markets has just released his latest instalment of Basic Points, “Capitalism Faces its Greatest Challenge” for November, 2008.

Mr. Coxe is best known for his highly read monthly newsletter, “Basic Points,” as well as his bi-weekly conference calls. His convictions that we are in the midst of the biggest long-term commodities bull market have been severely tested during the most recent months since this past summer, when he launched the Coxe Commodity Strategy Fund, but he remains convinced that the thematic fundamentals are in tact.

Here, we summarize his November 14, 2008 recommendations:

Its too late to sell losing stocks, and too soon to do more than nibble at bargains. This is a time for investors to be opportunistic about investing, and stocks are available at prices that will look incredibly cheap in a couple years’ time.

When conditions resume for rebuilding equity positions, buy banks and diversified financial sector stocks.In a global recovery, these should perform well, considering the mostly new management teams.

Buy commodity oriented stocks. They have been totally oversold beyond all expectations. When there is a global recovery, they will be the winning asset group.

During the waiting period, start accumulating convertible bonds of quality corporations. A sharp contraction in the near-record yield spread between investment grade companies’ bonds and comparable treasuries, could trigger a major equity rally.

Buy Emerging Market bonds from China, India, and Brazil, whose economies are fundamentally sound. Avoid Eastern European bonds.

Business-oriented tech-stocks should also be included when once again accumulating stocks as these will participate in the global recovery. comparatively, consumer-oriented tech stocks may take quite a while.

Railroad stocks benefit from lower energy costs and the savings may offset the reduction in top-line revenues during the recession. Upon exiting the recession, these should be core investments.

Gold has been disappointing. Though it has outperformed stocks since the peak in the S&P 500, this has not yet been reason enough to own it. As deflation fears diminish, it will once again regain its lustre.

You can download the complete report here.

Source: Donald Coxe, BMO Capital Markets, Basic Points, “Capitalism Faces its Greatest Challenge,” November 14, 2008

In all, the price of oil has dropped more than 61% since the July peak, and likely to break lower given the ongoing conditions in the market.

Chart: Bespoke Investment Group

Look at Russia; although most folks aren’t interested (but should be) Russia is not only off by -64.5%, its valuations have compressed to 4.3 times trailing earnings. China stocks are down -64.3% is fetching 14.55 times trailing earnings. India stocks are down -48.1% and priced at 10.7 times. Canada’s TSX 60 is down 29.4% and PE has contracted to 10.9 times earnings.

Oddly, US Stocks, down -36.4% year-to-date, have experienced a slight expansion in P/E from 20.11 times to 20.54 times. Hmmm? Does this suggest that there is more downside in US stocks, given that there has been no compression in valuation? Tunisia, Bahrain, and Switzerland are the only countries out of 84 to join the US in this phenomenon of rising P/E. For the US, it appears that earnings have gone down in lockstep with the stock market, perhaps more than stock prices themselves.

click to enlarge

For those countries whose P/E ratios have gone down the most in this tumultuous year-to-date, high P/E compression suggests relatively strong earnings fundamentals versus very poor technical considerations.

Only three countries, Ghana, Tunisia, and Ecuador, out of 84, have had positive results this year.

Below are the comparisons of China stocks vs. US stocks, and China P/E vs US P/E. China’s market has had a much larger correction than the S&P 500, but look at the valuations. Chinese stocks are now far less expensive than US stocks. China’s earnings are in tact, while its stock market has been liquidated as a result of deleveraging.

Charts: Bespoke Investment Group

Here is a summary of some of Hendry’s thoughts:

• the present environment is all about the return of your capital, not return on capital.
• he is intrigued by government bonds and bets that interest rates will be cut further than people anticipate at the present time.
• interest rates will come down to unprecendented levels but it won’t make a difference.
• monetary policymakers will be pushing on a string.
• Hendry has been investing in long term US treasuries
• he is profoundly bearish on commodities, for now
• He believes that gold will drop further to below $600 as a result of the deflationary pressure that we are facing from the fixing of the system, then as a result of all the stimulus, we will face profound inflation. When long-term bond yields drop to around 2.5% that’s when you want to own commodities. That’s when he’ll back the truck up for gold, the big 16 oz. bars.
• For now Hendry will place his bets on deflation and falling long term interest rates.

If being leveraged means shorting cash, then deleveraging means buying cash, and he’s afraid the deleveraging is far, far, from over, because debt levels are still very high at this point. That means the dollar will continue to rally on the resultant repurchasing or short covering of the dollar. The rallying dollar, and ongoing asset liquidation is deflationary for now.

Hendry’s case and outlook is deeply compelling and worth taking seriously.

The second part of Dominic Frisby’s interview is with Dr. Francis Claessens of Peers, who tells us what the super rich have been doing with their money. Claessens leads WealthPeerGroup.com, a peer group that meets on a monthly basis to discuss financial issues. Minimum entry to this group is investable assets of £5-million ($8-million). This too is very interesting, i.e. if you’re interested in what’s worrying the very HNW investor these days.

Listen to the entire interview here:

The announced sum of four trillion yuan represents about 16% of China’s economic output last year, and is roughly equal to the total of all central and local government spending in 2006. New spending of even half that amount would be substantial next to China’s six trillion yuan annual budget for this year.

The plan includes spending in housing, infrastructure, agriculture, health care and social welfare, and features a tax deduction for capital spending by companies. China’s economy won’t be able to absorb so much spending immediately: Economists expect one or two more quarters of slowing growth at a minimum before a rebound could take hold.

With the announcement, China will enter a meeting Saturday of the Group of 20 largest economies with a plan that would dwarf stimulus measures by others in the group, which is convening in Washington to discuss ways to stem a global slowdown in growth.

…

In the new stimulus package, total new investment could be less than the headline figure of four trillion yuan, since the plan does appear, for instance, to incorporate rebuilding programs for the areas affected by May’s massive earthquake. Those have already been allocated one trillion yuan in funds.

Although Chinese officials have been meeting daily on the financial crisis, most observers hadn’t expected leaders to reach final consensus on a stimulus plan until an annual economic-policy meeting scheduled for the end of this month. The rapidity of the response underscored the government’s concern about the growing risks of a real downturn.

A stimulus this large comes once in a generation, or two, as does the opportunity, especially when the margin of safety is this high. As of Friday November 7, 2008, the Shanghai Stock Exchange Index was down 72% from October 16, 2007 peak closing of 6,092 points, having closed at 1,747 points, and roughly 44% below its 200-day moving average of 3,120 points.

Other packages have been relatively in the same ballpark, but set to span much longer periods of time, like ten years. A few years ago, for example, China earmarked 2.7-trillion Yuan ($300-billion) towards augmenting the country’s railroads, a sum to be invested over ten years.

Giving details of the package, Xinhua said China would invest an additional 100 billion yuan in national construction this quarter and would earmark an extra 20 billion yuan next year for reconstruction in areas hit by major natural disasters.

Sectors that will benefit from the extra spending include affordable housing, rural infrastructure, transport networks, environmental protection and technical innovation, Xinhua said.

The cabinet also confirmed a long-awaited reform to the way value added tax is calculated. The result will be to reduce companies’ tax bill by 120 billion yuan a year, the agency added.

This sum, a grand total of 4-trillion Yuan ($586-billion) is set to be dispensed over 2 years. You do the math…this is enormous.

Click for the complete WSJ.com article here [PDF]

Sources: Reuters

WSJ, China Sets Big Stimulus Plan In Bid to Jump-Start Growth

http://online.wsj.com/article/SB122623724868611327.html

Here are a few excerpts from the must read interview, “Feed the World - and Boost Returns.”

How should investors approach today’s stock market?

If you aren’t deeply in the equity market, this is not a time to be committing large amounts of money. Stocks are cheap but they can get cheaper; we know that. We got back to the Dow having a multiple of 5.9 in December of ‘74, which was the foundation of Warren Buffett’s wealth because he started buying at that level. The Dow isn’t anywhere near 5.9 [its multiple last week was 11], but some of my favorite stocks are trading at lower P/Es than that. I can tell you they are the fertilizer, oil and agricultural companies.

…

Tell us some more about those industries.

The core investment concept of our time is that we are living through the greatest simultaneous effervescence of personal economic liberty in history. When people go from abject poverty to dwellings with indoor plumbing, electricity, basic appliances and access to motorized transportation, they have more economic liberty than 99% of humanity enjoys and we are adding 50 to 150 million people a year to that list. The gigantic investment returns are all going to be tied to companies that meet real human needs and do it better than other companies. What a great time to be an investor, because it is not just about the dwellings and the transportation, it is about the high-protein diet. When I came back from a trip two years ago, I said the biggest commodity story is going to be food, bigger than the other ones. It is high-protein food. The way to play that is through the fertilizer stocks, the genetically modified seed stocks and the farm-equipment stocks.

Which commodity groups do you like best?

Agriculture is first. We will need more fertilizer. There are only three farm-equipment companies of any size in the world. Terms of entry are difficult. You have to have dealerships. CNH Global [ticker: CNH] is one of the top three companies in the world in the field. It’s a subsidiary of Fiat and its stock has collapsed, but earnings haven’t collapsed. In May it sold for $45 a share. It’s $17 now. The next group has to be gold stocks. A period of massive reflation always leads to a good move in gold.

To read the entire interview click here.

Source: Barron’s, Feed the World — Boost Your Returns, November 10, 2008

Donald Coxe, Global Portfolio Strategist, BMO Financial Group

- Obama’s victory will lead to a “feel-good” attitude within America at a time when gloom and sourness have become excessive. That favours financial assets generally at a time that fall is moving into winter.

- Obama’s spending plans will be seen as economy-favourable with the nation in recession. Stocks should benefit near-term.

- Obama is fully committed to continuation of all the ethanol subsidies and tariffs that McCain opposed. That is good news for the reeling ethanol stocks that have been buffeted by falling oil prices and still-high corn prices.

- Obama has threatened to impose carbon taxes on coal-fired electrical generating plants.

- None of the candidates promised significant revisions to the extremely favourable royalty structure for mining on federally-owned properties, mostly in the West. That is important for Canadian gold miners operating in Nevada.

- He famously said that on his first day in the White House he would “call up the President of Canada to announce he was tearing up NAFTA.” We believe he won’t do that.

- Worldwide, the election of a new U.S. President with a change agenda  will be greeted favourably. This should facilitate America’s dealings with other nations on such hot topics as Russian expansionism and response to Iranian nuclear weapons development.

Andrew Busch, BMO Capital Markets, Global FX Market Strategist

- Expect a U.S. stimulus package of $150 billion to be enacted and checks out the door by March with an impact on consumer spending by late April and May.

- Expect very expensive bond deals issuance to be done over the next three months with those issuing likely to only be high quality to get done and with high spreads to Treasuries. This should mean they get snapped up.

- There is going to be massive government bond issuance in 2009 across the globe to pay for bailouts, stimulus packages, and social spending. This means we should see a further steepening of the yield curve in 2009, but it won’t necessarily point to a big economic recovery like it has in the past.

Jack Ablin, Chief Investment Officer, Harris Private Bank

- Both an Obama victory and a Democrat-controlled Congress are currently factored into markets.

- When looking at Europe vs. U.S. price-to-sales comparisons, one can see the U.S. is beginning to trade like a “nationalized” country.

- Tax rates are expected to increase which will give an edge to municipal bonds.

- A move towards socialized medicine appears to be already discounted. In examining the valuation of U.S. vs. European pharmaceutical stocks, the U.S. valuation already incorporates nationalized health care.

- Large cap is set to outperform as small cap moves back to normal valuation.

Paul Taylor, Chief Investment Officer, BMO Harris Private Banking

- We are a long way away from a sustainable equity market rally. A sustainable equity market rally will only occur when it is clear that the spectre of a protracted, significant U.S. economic recession is not in sight.

- Leading economic indicators signal a meaningful U.S. and global economic recession. This will cause policymakers in Washington to focus attention on the economy as the number one priority.

- Investors should have a defensive strategy, with an overweight in Consumer Staples, Telecom, Utilities and underweight in Energy, Materials and Technology. This will be more appropriate until the spectre of recession is past.

- With Fed Funds at 1.0%, monetary policy will be impotent moving forward.

- A global economic recession is bearish for commodity based currencies (Canadian and Australian dollars) and is bullish for other currencies. The current “crisis of confidence” is bullish for the U.S. dollar due to its position of reserve currency.

Source: PR Newswire

Now you can listen to the Investment Outlook and Commentary from Bill Gross (PIMCO), Vanguard Funds’ Portfolio Managers, and others on GreenLightAdvisor.com’s Audio Resources page.

This month, Bill Gross presents his latest investment outlook, Kenneth Volpert from Vanguard discusses the Credit Crisis, and Dominic Frisby, from MoneyWeek interviews Hugh Hendry of Eclectica Asset Management.

Enjoy!

These prices were much higher a few weeks ago, before TARP kicked in.

The chart below shows yesterday’s loss of -5.05%, was indeed, the worst day for the Dow, following the election of a new president. Reports cited the market’s reaction to the ADP report, and not the election results.

Our sense is that the real reason markets are liquidating is due to the unwinding of carry trades as a result of rate cuts out of the UK and the Euro. They cause destabilization in the global currency balance and that forces markets to unravel further. This kind of activity is not likely to subside until currencies come back into balance i.e. when Euro and Sterling (UK) rates and thus currency valuations fall to lower levels against the dollar. Furthermore you’d also have to see the Yen back above 100/dollar (USDJPY).

The Yen is an excellent negatively correlated barometer for global markets. When the Yen weakens, markets gain, and vice versa.

Table: Bespoke Investment Group

The following chart shows how as a result of high commodity prices the daily cost of living rose incrementally to a high of an additional cost per capita of $4.77. While the turmoil in commodity market has been terrible for investors, the turn has been beneficial to comsumers, who are now enjoying a $2.58 dividend off the resultant cheaper cost of living.

In the above chart we calculated the ‘08 price change of the major food and energy commodities in the CRB index (Corn, Soy, Wheat, Cattle, Hogs, Oil and Natural Gas) and multiplied the changes by the annual per capita consumption of each item.  While this method may oversimplify the actual costs, it provides a good idea of how changes in commodity prices have impacted consumers wallets this year. (Bespoke)

Volatility in commodities is sure to continue and their prices have still a long way to go before the upper limit of the current downtrend line is broken. Under present circumstances, if you consider the economic growth numbers for the US economy continue to show up in the negative GDP growth and the credit market volatility continues to reign on the markets’ parade, commodity prices could face more downward pressure. 

Charts: Bespoke Investment Group

Chart: Bespoke Investment Group

Hendry has been one of the harshest critics of the lack of regulation in credit markets.

The three segments total about 15 mins. Its a must see:

Hugh Hendry, Part 1, Dispatches: Don’t Bank on the Bailout

Hugh Hendry, Part 2, Dispatches: Don’t Bank on the Bailout

Hugh Hendry, Part 3, Dispatches: Don’t Bank on the Bailout

Click image for video

Ken Heebner, CGM Funds, and Frank Holmes, US Global Investors, discuss emerging markets in the context of the Fed’s 50 bps rate cut last week. Both their remarks on the rate cut and emerging markets are noteworthy.

Ken Heebner, CGM Funds: “Well, the emerging market economies are going to continue to have long-term growth. Those are the markets down the most, they’re down 50, in some places 60 percent and long term they have a bright future. Even Jeremy Grantham, the mega… the bear, is saying they’re almost cheap enough for him to buy. … When he’s ready to buy something, it’s going to go up.”

Frank Holmes, US Global Investors: “Well, I do like the emerging markets and I think if you look at energy names like PetroChina, it’s been just devastated here in stock price and it has a huge upside to get back to basically a healthier equilibrium and P/E ratios. But remember that most of these emerging markets, unlike 10 years ago Erin, they have, like China has $2 trillion of U.S. dollars…so they have a huge (foreign reserve) surpluses to be able to reinvigorate their economies. …I totally agree with Ken, this is where growth opportunities lie.”

The current issue of The Economist features an excellent article about the forced selling that has been the key feature of this bear market, caused by the violent trading days that have come in the wake of the deleveraging of many banks and hedge funds as they need to get their balance sheets in order.

Here are some excerpts:

… the speed of market movements suggests another factor has been even more important. When investors are in trouble, they sell what they can, not what they would like to. It looks as if they have been dumping a whole range of assets.

Emerging stockmarkets, for example, have lost more than half their value this year, while emerging-government bonds were yielding more than eight percentage points above Treasury bonds, at least until a rally on October 28th. Leveraged loans (debts to finance management buy-outs) are trading at just 70 cents on the dollar.

… Who is being forced to sell? One obvious answer is banks that have ended up owning far more risky assets than they would like. Barclays Capital put $970 million of leveraged loans up for sale in October; in the face of disappointing offers, it ended up selling just 30% of the lot. Other banks have been winding down their trading, a big source of revenue earlier this decade, in an attempt to reduce risk.

Another group of sellers is the hedge funds. After a disappointing performance this year, many are facing calls for redemptions from clients and are having to sell assets to raise cash. But their problems also stem from their use of leverage, or borrowed money.

Lascelles points to several key areas:

• A peek at the latest sovereign credit default swap data reveals that Canada is now regarded as quite possibly the world’s safest sovereign country in terms of the solvency of the country’s government.
• On the surface, this seems surprising given how closely Canada is linked into the U.S. economy and into commodity prices, and how both of those two erstwhile pillars have recently crumbled.
• But a closer look reveals that there may be some method to the market’s madness - Canada is indeed in a remarkably good position by several metrics, which we pursue in this piece. 

• We should begin by noting that we believe Canadian bonds should continue to underperform the U.S. because sovereign debt concerns have not played a major role in the market to date, and because Canada’s economic prospects are somewhat better than in the U.S. and so less rate cutting will be needed.
• However, should the market begin to differentiate between countries based upon their debt-to-GDP ratios and other measures of fiscal pressure, Canadian bonds would ultimately be a winner in that contest. At present, there is little evidence that this is happening - case in point, both Japanese and U.S. debt continue to be happily purchased, yet the Japanese debt burden is extremely high and the U.S. debt burden is growing quickly. Nor do we necessarily expect this to change. But should the market grow more fickle about what it buys, there could be a quick reversal and this would prompt us to favour Canada over the U.S. in bonds.
• Third, throughout the credit crunch, Canadian bonds have been less volatile than in the U.S., and this speaks in no small part to the relatively more stable fiscal and economic foundations in Canada. We expect this trend of relative stability to continue.

The Teflon Maple Leaf, October 31, 2008, Eric Lascelles, TD Securities Inc.

Why the Banks Have Most Likely Not Hit Bottom
• Corporate earnings from most sectors will be weak and capex programs will be slashed.
• Hedge funds will continue to be tortured by redemptions and their interplay with banks was
incestuous.
• The effect of hedge funds pulling out of the market will chill many sources of corporate
finance - Redemptions are massive.
• Counterparty risk in the CDS market will remain a bit of a mystery.
> CDS was equally as bad at the plate as equity and debt players
> The governments infusion of equity collapsed the CDS spreads
• CDS payments and failures at levels that are unfathomable - watch Lehman reconciliations on
Tuesday, Oct. 21st.
• The housing market will remain anemic.
• Insurance companies, automakers, airlines and shippers are all in trouble.
• State and municipalities are also Fed borrowers.
• Corporate refinancings at $150 billion a quarter with no one to refinance.
• Massive margin calls on the titans of America which will cause collapse in the corporate
equities they own.
• Forced liquidations.
• LBO restructurings and covenant violations.
• No DIP financing for bankruptcies, only liquidations.

Long-term Consequences

The good news is that all we care about at the moment is SURVIVAL. We need to fight every day to monitor and steward the best deals we can find — the ones we own. However, eventually we will need to examine the long-term effects of our triage.

• Huge inflationary pressures. Inevitable higher interest rates and taxes.
• Massive national debt and budget deficits.
• Are we deferring the pain like Japan did?
• $11.3 trillion national debt is really $55 trillion due to OBL (off balance-sheet liabilities).
• Implications of investment losses for pension funds and endowments?

Bottom Line

The game is afoot and not over. Don’t panic and don’t be euphoric. The discoveries will be constant and unsettling. Fortunately, the world powers have committed to win it. Now we all have to figure out what exactly that means. Based upon our past experience at implementing bank takeovers and “distressed asset” management and dispositions, we suggest that we all buckle our seatbelts for a longer ride with lots of ups and downs before we arrive to safety.

From Bloomberg, October 10, 2008:

“For once, it will be better to be late rather than early,” Barrack said in a four-page letter to investors on Oct. 8, a copy of which was obtained by Bloomberg News. “There is no bottom because no one believes the messenger.’

“As all markets come to the realization that we are now in a worldwide systemic recession — not just a credit crunch — things may get worse,” the Los Angeles-based Barrack, 61, wrote in the letter, titled “In God We Trust — But Not Counterparties.”

“The massive restructurings, refinancings and re-pricings that will now take place, cascading from the financial world to the industrial world, will be legend. The complexities, repercussions and consequences to all parties are indeterminate.”

From Donald Trump’s Blog, the Donald quotes his good friend’s (Thomas Barrack Jr.) newsletter:

Why Can’t Anybody Find the Bottom?

It all boils down to trust! The mantra of the country is “In God We Trust–but not counterparties.” No buyer trusts any seller, banker, insurer or intermediary. No investor trusts any depository, insurer, broker-dealer or advisor. No Main Street citizen trusts Wall Street, and neither Main Street or Wall Street trusts the government. No counterparty in any transaction has confidence in the other. Values at every level have been artificially adjusted and when the air comes out of the “speculative hope certificates” everyone is pointing fingers at each other for fault and retribution.

The Worst is in Front of Us

Counterparties are renegotiating, borrowers are violating covenants, banks are finding any excuse not to fund existing commitments, insurers are negating liability, and renegotiations of  responsibility and liability are being conducted at every level of the capital structure across the spectrum of companies.

There is no bottom because no one believes the messenger. With trillions of dollars of re-pricing occurring in these markets there is no hurry to catch the falling knife. There will be ample time once that last “dead cat bounce” has bounced and the government launches a coherent and consistent program. For once it will be better to be late rather than early.

Bottom Line: This is Not the Bottom.

Thomas J. Barrack Jr., “Is the World Going To ELE?”, October 14, 2008

Source: NakedShorts.com, Colony Capital

Arthur Laffer

The Age of Prosperity is Over, October 27, 2008. This is a must read.

Seymour Schulich provides a foreword to this article:

“This piece from an American friend gives a clear picture of where the U.S. is heading and the price to be paid for allowing unregulated hedge funds and derivative activity.

The next commodity boom will set new price records. It is galling to see the u.s. dollar sell at a huge premium. I think our Canadian dollar is the best buy in the world today.”

Best Regards, Seymour Schulich

Here are some excerpts:

When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.

No one likes to see people lose their homes when housing prices fall and they can’t afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house’s value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple.

Regarding past Presidents and central bankers:

The stock market is forward looking, reflecting the current value of future expected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well as higher employment, higher wages, more productivity and more output. Just look at the era beginning with President Reagan’s tax cuts, Paul Volcker’s sound money, and all the other pro-growth, supply-side policies.

Bill Clinton and Alan Greenspan added their efforts to strengthen what had begun under President Reagan. President Clinton signed into law welfare reform, so people actually have to look for a job before being eligible for welfare. He ended the “retirement test” for Social Security benefits (a huge tax cut for elderly workers), pushed the North American Free Trade Agreement through Congress against his union supporters and many of his own party members, signed the largest capital gains tax cut ever (which exempted owner-occupied homes from capital gains taxes), and finally reduced government spending as a share of GDP by an amazing three percentage points (more than the next four best presidents combined). The stock market loved Mr. Clinton as it had loved Reagan, and for good reasons.

Hat Tip: John Budden, BeEarly.com

The Age of Prosperity is Over, Wall Street Journal, October 27, 2008.

Patelis points out that close to 90% of global GDP growth will come from emerging markets economies in 2009, and goes one step further saying that he would not be surprised if global growth would come exclusively from emerging markets. They are underlevered, strong domestic economies, where consumption growth is being fuelled by income growth, and strong savings rates. In particular, he favours China and India.

Click image to watch video

We have covered this topic on several occasions during this year:

• The Carry Trade and Markets? What is the relationship?,
• Resurgent Yen is Scary News,
• Why the selloff in commodities and emerging markets?,
• More Carry-Trade commentary
• More volatility coming and more ETF options
• Yen’s Strength [has been] profoundly negative for global markets

From the Economic Times, The Group of Seven issued warnings on Monday the yen’s wild swings are threatening financial stability, fanning speculation central banks may intervene to halt a rally in the currency driven by a Japanese exodus from emerging markets.

The yen was the only currency mentioned in a brief G7 statement as it rallied to 13-year high against the dollar, not only threatening Japanese exports as the world’s second-largest economy tumbles toward recession amid the worst global financial crisis in 80 years, but leading to a destabilization of currency related transactions that need to be unwound.

As a matter of background building, we provide below a summary of milestones in the yen’s history:

1871 - The yen became Japan’s currency as part of the Meiji Restoration, which marked the start of Japan’s modernization and opening to the rest of the world. Japan adopted the gold standard.

1949 - After World War Two the dollar’s fixed rate is set at 360 yen via the Bretton Woods system, partly to help stabilize prices in the Japanese economy.

1959 - The dollar/yen exchange rate is liberalized and the margin of fluctuation is set at 0.5 percent on either side of its dollar parity.

1963 - The margin of fluctuation is widened to 0.75 percent. 1971 - United States abandons gold standard, bringing an end to the Bretton Woods system of fixed exchange rates and forcing a realignment of world currencies.

December 1971 - Under the Smithsonian Agreement, the dollar/yen exchange rate is set at 308 yen and is allowed to fluctuate in a wider band between 301.07 yen and 314.93 yen.

1973 - Japanese monetary authorities decide to let the yen float freely against the dollar, and the yen appreciates as far as 263 to the dollar.

1978 - The yen pushes through 200 to the dollar for the first time, strengthening as far as 177.

1980 to 1985 - The yen’s appreciation halts and partially reverses despite Japan’s big trade surpluses. Higher interest rates in the United States prompt Japanese investors to put money in dollar assets.

1985 - The Group of Five industrial nations, the predecessor to the G7, sign the Plaza Accord in which they agree the dollar is overvalued and to weaken it. The yen climbs from its pre-accord level of around 240 to 211 in October and 200 in November, a 20 percent rise in just a few months.

1986 - The U.S. currency falls further to around 190 yen in January, 167 yen in April and 153 yen in August.

1987 - In February, six of the G7 nations sign the Louvre Accord, which aims to stabilize currencies and halt the dollar’s broad decline. The dollar still falls from near 153 to 137 in April and 120.80 by the end of the year.

1988 - On January 4, the dollar falls to a post-war low of 120.45 yen in Tokyo trade, a level that holds as the low for more than five years. The Bank of Japan intervenes to buy dollars and sell yen that day on behalf of the Ministry of Finance.

August 17, 1993 - The dollar declines to a new post-war low of 100.40 yen in Tokyo.

June 21, 1994 - The dollar falls through the key 100 yen level and touches a record postwar low of 99.85 yen in New York trade before finishing at 100.30 yen.

April 19, 1995 - The dollar hits a record post-war low at 79.75 yen after U.S.-Japanese trade frictions spark heavy selling. By the end of the year it is near 103.40.

June 17, 1998 - As the dollar shoots above 144 yen, U.S. authorities join the Bank of Japan to buy yen, spending $833 million. By August the dollar rises to near 148 yen, partly due to yen carry trades in which investors borrow yen funds at Japan’s near zero interest rates to buy higher-yielding currencies.

1998 - After the global financial market strains from the near collapse of hedge fund Long-Term Capital Management, carry trades are unwound quickly. In one week alone in October, the dollar tumbles from near 136 yen to a low around 111.50 yen.

1999 - The yen strengthens further despite repeated intervention, reaching 102 in November.

2001 - Following the Sept 11 attacks, Bank of Japan intervenes to sell yen for dollars.

2003 - The MOF begins massive intervention to halt the yen’s rise against the dollar, partly to shield Japanese exporters as the economy remains stuck in its post-bubble slump and deflation. The MOF spends 20.4 trillion yen ($200 billion) over the year, nearly all of it to buy dollars and sell yen.

2004 - The MOF spends 14.8 trillion yen ($145 billion) intervening in the first quarter of the year, including 1.67 trillion yen buying dollars on January 9 alone. But the MOF ceases intervention in March and has never since resumed.

2005 - The yen reaches a high of 101.67 yen in January but then starts to fall, hitting 121.40 in December. Yen carry trades and Japanese investors shifting funds into foreign assets drive the slide.

June 2007 - The dollar hits a 4-1/2-year high of 124.14 yen. July 2007 - The yen’s broad depreciation takes it to a 22-year low on a real effective exchange rate basis. Since January 2005 the yen has lost 25 percent of its value on a REER basis.

August 2007 - Strains in financial markets from the U.S. subprime mortgage crisis spark an unwind of yen carry trades.

The dollar falls from near 120 yen to 111.60 yen. The high-yielding Australian and New Zealand dollars tumble nearly 10 percent.

March 13, 2008 - The yen hits an 12-year high of 99.77.

October 24, 2008 - Yen hits 13-year high of 90.87 versus the dollar, while setting an all-time high against the Australian dollar of 55.11, with the Aussie losing almost a third of its value in just a month on a massive unwind of carry trades.

October 27, 2008 - The yen’s surge to 13-year highs prompts the G7 to issue statement to single out the yen in warning on currency market volatility.

The yen has surged nearly 20 percent so far in October on a trade weighted basis, more than twice as big as any month going back to 1970, including the carry trade collapse in October 1998 and the Plaza Accord to weaken the dollar in 1985.

(Sources: Reuters, Bank of Japan, Bank of England)

Included here are excerpts from a report by CLSA’s macro strategist Andy Rothman regarding China’s recent decision to stimulate its housing sector.

Beijing is cutting mortgage rates to as low as 5.23 percent, reducing required down payments to buy a home from 30 percent to 20 percent for first-time buyers, comparatively still far above what most Americans have put up to purchase a house, and also lowering some taxes and fees.

CLSA views the government’s action as a move to get people to invest their wealth in real estate, which will serve to shrink an overbuilt housing inventory and help keep the broader economy from slowing down further.

“Beijing had succeeded in cooling off price growth, taking it from 25 percent year over year last fall to about zero year over year today. And, having achieved the objective of avoiding a bubble, the last thing the Communist Party wanted to do was crash the property market.

“(This week’s) policy changes will have two effects:

“First, they make home-buying more affordable, with a combination of lower interest rates, lower down payments and lower transaction fees.

“But the second effect is most important, as affordability has never been the big problem in China. (The) measures represent the government reversing its anti-property stance adopted one year ago. Back then, Beijing said, in effect, ‘we will do our best to depress prices and discourage home-buying.’ Consumers responded rationally by delaying purchases.

“Now, the government is saying, (my words), ‘we encourage home-buying and you should anticipate that property prices will start rising again.’

“With affordability good, household debt almost non-existent, and banks ready to lend (they are all controlled by the Party), homebuyers will return to the market in response to Beijing’s message.

“(The) move can be considered part of an overall effort to give a light stimulus to the economy, but in my view is primarily focused on the real estate sector. These changes also illustrate that the Party is capable of taking proactive steps to deal with a changing economic environment.”

In a webcast interview with Times Online UK, Mark Mobius discusses why he believes Brazil will lead the recovery in Emerging Markets.

Press Play to listen here:

Download audio file (markmobius.mp3)

Jeremy Grantham

Part 1, “Reaping the Whirlwind,” published 2 weeks ago:

“At under 1,000 on the S&P 500, US stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10 prices, but even more so. History warns, though, that new lows are more likely than not.

“Fixed income has wide areas of very attractive, aberrant pricing.

“The dollar and the yen look okay for now, but the pound does not.

“Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry!

“Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows.

“As for us in asset allocation, we have made our choice: hesitant and careful buying at these prices and lower. Good luck with your decisions.”

You can read ”Reaping the Whirlwind,” in its entirety by clicking here where Grantham has published his views on the fallout from the financial crisis and the investment opportunities he sees.

Part 2, ”Silver Linings and Lessons Learned”, published early this week:

“When asked by Barron’s on October 13 if we would learn anything from this ongoing crisis, I answered, ‘We will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term. That would be the historical precedent.’

“That is unfortunately likely to be the case. But over the next several years at least, there are many silver linings and valuable lessons to be learned.

“Chief among the many benefits of this crisis are unprecedented opportunities for investing in some fixed income areas where some spreads are so wide as to reflect severe market dysfunctionality.

“As of October 18, we also have moderately cheap US and global equities for the first time in 20 years. Probably quite soon, global equities too will offer exceptional opportunities after the additional pain that is likely to occur in the next year.

“We are reconciled to buying too soon, but we recognize that our fair value estimate of 975 on the S&P 500 is, from historical precedent, likely to overrun on the downside by 20% to 40%, giving a range of 585 to 780 on the S&P as a probable low.

“The world faces unavoidable declines in economic activity and profit margins, so this overrun is unlikely to be much less painful than average, although you never know your luck.”

You can read ”Silver Linings and Lessons Learned,” in its entirety by clicking here where Grantham has published his comments on lessons learned from the credit crisis, as well as his proposed strategy.

Source: Jeremy Grantham, GMO, October 2008.

Courtesy: Prieur du Plessis, Investment Postcards

Jeff DeGraaf, ISI head of technical analysis says Tuesday’s rally is far more credible than the past rally a couple weeks ago.

“This is the 6^th best rally in the S&P since 1925,” he says. “If you look at volume and breadth it makes me more bullish than I’ve been in quite a while.”

With sentiment so bearish, “we have a condition that would set itself up for some type of mean reversion probably to 1100,” he says.

Short assets vs. assets shows that there is far more money betting the market down than up, and today’s rally is more reliable than the most recent one.

As a result, “the best market strategy right now is a call spread on the S&P selling the upside around 1100,” he concludes.

What’s the bottom line? Sell the rip!

To see DeGraaf’s entire analysis please watch the video.