Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Financial Armageddon Postponed

There’s no doubt that the long-term fortunes of the American economy and the dollar are heading down the dustbin. At some point over the next several years or sooner, the dollar will come under severe attack as a buyer’s strike materializes in the face of gargantuan debt levels, extended conflicts blasting U.S. budgets and ultimately, sharply higher interest rates to attract foreign lenders. But it’s a big mistake to believe this scenario, coined “Financial Armageddon,” has arrived courtesy of the sub-prime crisis in 2007.

I still view this as a long overdue correction in asset values. In my eyes, it’s a great buying opportunity for stocks, especially foreign markets.

Like previous crises, the United States Federal Reserve and other central banks around the world have grown extremely proactive over the last 20 years. Through all sorts of financial gimmicks and policy initiatives, the central banks have repeatedly arrested financial bleeding, including stock-market crashes, credit collapses, hedge fund failures that threatened the financial system and currency crises, including a plunging dollar in the 1980s and the European Exchange Rate Mechanism blow-up in 1992.

The massive credit bubble has yet to fully deflate. From 2003 until July 2007, the world witnessed an incredible inflation in riskier credit, leveraged to the hilt with yen carry-trades and cheap bank loans. I’d compare this financial crisis to the technology bubble of the late 1990s and the real estate craze in the United States, which has already deflated; other real estate bubbles in England and especially the Mediterranean sun-belt, have yet to collapse. Like all bubbles, they’ll also hemorrhage eventually.

But this credit cycle, however damaged and discredited, will continue on life-support as private equity and hedge fund vultures eventually mop-up excesses with the help of the Federal Reserve as bank credit is expanded. I also expect the United States to allow Fannie Mae and Freddie Mac, quasi-government agencies, to delve into the sub-prime mortgage market and buy distressed mortgages to further alleviate the crisis. Both mortgage agencies are already a house of cards; allowing these entities to own more garbage won’t make a difference in the big scheme of residential real estate.

Yes, there’s something really wrong with capitalism if we continue to bail-out the reckless individuals and institutions that ultimately cripple the global economy. And make no mistake about it; sub-prime, like future crises, won’t be a local phenomenon. Today, financial panics are global, and therefore a systemic event that can mushroom into a massive financial collapse. At some point in the future, this will happen. I believe that day of reckoning will materialize with Asia and the United States at odds of over trade and dollar-based Treasury financing. Economic conflicts of this sort historically result in military confrontations as the balance of economic power ultimately shifts. Again, this won’t happen in 2007 or 2008.

For now, this is a correction. I’m betting on successful central bank reflation and over the next few weeks, will buy emerging market stocks and more commodities, including gold. These two asset classes should respond quickly as governments flush the financial system with credit.

As Richard Russell, the dean of Dow Theory has espoused, it’s definitely “print or die” for the Fed.

Have a great long weekend. See you Tuesday.

U.S. Insiders Dive into Bank Stocks at Distressed Levels

Despite the worst credit crunch since 1998, many American financial services executives are aggressively accumulating company shares this month. According to Bloomberg, stock purchases by directors at U.S. banks, consumer lenders and insurers in the S&P 500 Index soared this month to their highest levels since 1995. That’s an amazing statistic considering the financial services sector has been mauled this year and continues to rank as one of the worst-performing indices in 2007 after the home-builder stocks (see below).

Insiders thus far have purchased $26.9 million dollars’ worth of company shares this month as of August 15. I reckon that figure is even higher following the mini-crash on August 16 that sent global markets reeling following more sub-prime defaults and closures.

Insiders are obliged by U.S. securities laws to report company purchases and sales within two business days in filings with the U.S. Securities and Exchange Commission (SEC).

Although data from Insiders is widely followed by investors, the strategy is not full-proof by any means. In my research since 1992, I’ve discovered that riding insiders’ purchases is far more lucrative than following their sales, which can be misleading. For example, insider sales hit the sky in 2003, despite a huge rally that began that same year following a treacherous 3-year bear market from 2000 to 2002. Insiders can sell stocks for a variety of reasons that have no direct bearing on their future earnings forecasts – typically for personal reasons (purchase of a home, second home, endowment, charity, etc). In my view, insider purchases, especially with cash proceeds, can usually result in big gains. That’s probably the case right now amid the biggest concentration of net purchases by financial services officers and directors in 12 years.

One group largely absent from insider buying this month, however, is the investment banking sector, riddled with scores of asset write-downs because of huge hedge fund closures or trading losses. But overall, you’ve got to wonder if a bear market has started in U.S. equities with an army of company executives accumulating large swaths of their stock. The odds are highly unlikely.

The Trouble with Money-market Funds: Part II

With more troubles affecting retail and institutional mutual funds in the mortgage-backed market this month, it’s time for a another post on this important subject.

My first comment on money-market funds earlier this month elicited a wave of responses from my daily readers, legitimately concerned that liquid assets parked in mutual fund money-market funds might be vulnerable to a collapse or liquidation. It’s a very significant concern as waves of cash stashed in money-market funds and even brokerage accounts have piled into the safety of U.S. Treasury bills this month. I was so concerned that I advised my U.S. clients to move the bulk of their brokerage liquidity into a short-term Treasury bond ETF two weeks ago. Many other investors have done the same thing, explaining why the yield on ultra-safe T-bills has plunged.

Though it’s highly unlikely that a money-market fund might collapse without the parent company bailing-out its investors, there’s no guarantee, or FDIC deposit protection insurance governing your money-market fund assets. Remember, the government won’t bail you out if your money-market fund or mutual fund complex fails, however unlikely.

The only money-market funds I would own, if you can access these, are U.S. Treasury-bill funds offered by some of the larger fund complexes like Vanguard. Apart from these, I strongly suggest taking most of your money out of money-market funds and placing these assets into T-bills or exchange-traded-funds backed by U.S. Treasury securities, including SHV, SHY and BIL -- all U.S.-listed securities.

Yesterday, State Street, a very large and respectable Boston-based asset manager, announced that its institutional State Street Limited Duration Bond Fund plunged 37% the first three weeks of August. Other funds with seemingly passive names like “Limited Maturity” or Short-term High Income,” for example, have also been clobbered this month. In my eyes, fund titles like these are very misleading.

This crisis is about to climax as we conclude August trading on Friday. To be sure, there’s more peripheral damage coming our way in September, but increasingly, I’m growing bullish on stocks. Tomorrow, I’ll comment on what corporate insiders are doing with their millions of dollars. The results might surprise you.

Will the Fed Actually Tighten?

I received an interesting email this morning from a TSI member who believes the Federal Reserve will actually surprise the market with an interest rate increase this year or next. In a very rational argument, this member, who enjoys reading my daily blog, adamantly subscribes to the view that Ben Bernanke, the Fed Chairman, will fight to protect the U.S. dollar.

Though I’m grateful for this member’s feedback, I think he’s dead-wrong about the Fed and higher interest rates.

If the Fed raises interest rates over the next several months, the economy, housing and credit will collapse. The only reason why the Fed would raise interest rates is because credit has stabilized, unemployment is falling and housing prices have bottomed. I think the odds are greater that a spaceship from Mars will attack Earth; there’s no way the Fed is going to tighten.

Another premise is that the Bernanke Fed will not rescue those idiots that caused this mortgage-backed crisis by expanding bank credit. The argument here is that if you “live by the sword, then you must die by the sword.” I couldn’t agree more; but if the Fed doesn’t become more proactive, then the entire economy is at risk of hemorrhaging because sub-prime is big enough to send the country into recession. In Germany, several small Landesbanks have collapsed or had to be rescued by their larger parents last week. It’s no joke that some countries and their respective banks are denying credit to German borrowers. Yes, this is spilling over.

There’s no doubt that Bernanke, unlike Greespan, has not been quick to print credit in the worst credit crunch since the Great Depression. By now, Greenspan probably would have cut rates (the Federal Funds rate) by at least 50 basis points; instead, Bernanke has reduced the Discount Rate, a symbolic monetary tool more than anything else.

The credit crunch, defined as eligible or prime borrowers being denied credit, is still very much alive. Housing values continue to plunge (not decline), the supply of homes is at a 16-year high, mortgage refinancing activity has stalled and deflation, not inflation, has arisen from the ashes for the first time since 2001. The Fed will not tighten monetary policy over the next 12 months because the United States is teetering on the brink of recession. Once the unemployment rate begins to rise over the next few months, which is almost a certainty, the Fed will have a “green light” to unload credit or expand the money-supply.

Bernanke wrote numerous essays as an economist before becoming Fed Chairman. One of these research papers studied the causal effects of the Great Depression and how the Federal Reserve mishandled the economy. I find it hard to believe that the Fed today, amid a credit crisis and housing bear market, would be stupid enough to tighten.

Twelve months from now, the Federal Funds rate will be lower, stocks will be higher and bond markets in the midst of their best rally since 2003. As for the 8,000 hedge funds, I expect about 20% of them to close as margins disappear along with their investors.

Stocks Greater Bargains Now, but Remain Hostage to Widening Credit Spreads, T-Bill Volatility

Compared to just four weeks ago, stocks around the world are much cheaper. For value investors, that’s great news. Nibbling at lower prices or dollar-cost-averaging into your favorite stocks and mutual funds is a prudent strategy now. But don’t go on a buying spree just yet as the credit markets continue to gyrate, applying more downside pressure on equities.

Credit spreads, or the difference in yield between risk-free U.S. Treasury bonds and riskier fixed-income securities remain at historically low levels (see chart below). Despite the credit squeeze since July, spreads have barely widened for securities like junk bonds and emerging market debt. The markets have not yet fully adjusted to this new paradigm where the pricing of riskier assets has not reached levels that compensate borrowers to assume positions that bear greater risk. Previous credit shocks, most recently in 2000 and 2001, resulted in far higher credit spreads; this correction is just the beginning of what I would term a “normalization” of this process, implying more downside volatility still lies ahead for equity investors.

Since 2003, credit spreads have reached historically low levels as the appetite for risk grew exponentially along with leverage and margin. That combination, lethally profitable amid a declining interest rate environment, resulted in the universal application of the now infamous Japanese yen “carry-trade,” or borrowing funds in cheap yen and converting those proceeds into higher-yielding foreign assets, including commodities and emerging markets. But now, that process is unwinding and will continue to unwind as the financial system de-leverages. The credit crunch since late July has not ended.

Another sector of the yield curve that continues to trade nervously is the Treasury bill market where yields remain well below the Federal Funds rate. This suggests that investors are still edgy, and not totally committed to returning en masse to riskier assets. The extreme volatility of T-bills is a strong indication that investors are afraid of the commercial paper market – pounded in recent weeks by fears of a liquidity crunch for many issuers.

As longer-dated credit spreads continue to widen over the next 12 months and adjust to normal levels, markets will remain hostage to further volatility. I’m not expecting a quick V-shaped recovery for stocks, either. Markets won’t recover lost ground in a quick rebound this fall because many banks have yet to disclose their sub-prime and other mortgage-backed losses on their books. Investment banks are especially vulnerable, laced with exposure across derivative-infested investments that remain largely illiquid or plagued by steep losses over the last several weeks. Despite the rally in stocks since August 20, most investors have yet to recover their losses from the markets’ peak on July 19th.

Indeed, although the selling climax has probably peaked in the sub-prime crisis, other sectors of the market and economy are subjected to spillover, including financial company earnings, consumer spending and housing-related industries. The market has not fully adjusted to a slowing economy over the second half of this year and another round of selling is likely to occur over the next few weeks. But as the Federal Reserve finally cuts the Federal Funds rate on September 18th, coupled by other rate cuts later this fall, markets should eventually form a bottom as liquidity and bank credit expands. This will be a gradual process as investor confidence is slowly regained.

One of the best hedges in a credit crunch therefore remains the Japanese yen, the prime beneficiary of the carry-trade unwinding.

It’s okay to bargain-hunt now for some amazing values, especially in the insurance sector, diversified conglomerates and select international REITs. Market-timing is impossible on a regular basis. In that spirit, buying quality assets at lower prices now is a sound strategy for long-term equity investors. Just keep some powder dry.

From Market Darlings to Market Dogs: U.S. and British REITs

It’s amazing how in just a very short period of time an asset class can swing from excessive bullish sentiment to excessive bearishness. But that’s the case now with many REITs.

Massive selling, fresh multi-year lows, big dividends and insider buying are compelling factors supporting some of the best-managed U.S. and British real estate investment trusts (REITs) this summer. Plus, it doesn’t hurt that several of these large REITs also trade at big discounts to their net asset value.

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As a value investor I love buying an asset below its intrinsic worth, or at a discount to net asset value. It’s your maximum margin of safety in any market.

That’s the case with distressed REITs in the United States and in the United Kingdom, home to huge bull market gains from 2000 to 2006. In fact, both industries rallied to incredible heights since 2000, sporting excessive valuations and shrinking dividend yields as a result of that rapid appreciation. My alarm bells went off earlier in 2006 as it became clear to me that gains could not continue at the same rate with market values far exceeding REIT book values. American and British REITs clearly exhibited classic signs of a “bubble.” And where there’s a bubble, there’s trouble -- eventually.

But in the span of just eight months, REITs on both sides of the Atlantic have been mauled. Literally, they’ve gone from market “darlings” to “dogs.” Many of these companies now sell below their book-value and are prime beneficiaries of heavy insider buying.

I’ve already assembled a “buy list” since last week and in next month’s Sovereign Individual, I’ll be plugging one of the largest British REITs just above its 52-week low, paying a fat dividend, trading 28% below its book-value and home to a flurry of insider buying since July.

If I loathed most U.S. and U.K. REITs last year, I’m starting to love them now.

Have a good weekend.

Catch Mike Burnick on CNBC.com

On Friday morning, my colleague, Mike Burnick, was on the air at 7:00am EST on CNBC's Squawk Box.  Click here to watch his segment, on demand.

The Boom Continues in Scandinavia

I’ve been coming to Denmark and the rest of Scandinavia regularly since 1996 on business. Denmark is especially unique. It’s still one of my favorite countries in the world with a courteous and friendly populace, diversified export-based economy and home to the world’s leading shipping concern (Maersk), one of the largest beer companies (Carlsberg) and a leading wind turbine manufacturer (Vestas).

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Compared to a decade ago, the entire Nordic region is undergoing a major economic revolution with booming exports, low unemployment and bulging trade surpluses. Norway, in particular, is home to one of the largest trade surpluses in Europe, mainly because of high-flying oil exports this decade. Ports across the region are bustling; I visited Copenhagen harbor yesterday and it’s absolutely jammed with vessels. It’s no wonder the Baltic Dry Index, a key international gauge for shipping rates, continues to hit all-time highs this year.

Sweden, of course, is the region’s largest economy and also home to brand-name companies like Ericsson, Volvo, Ikea and many others. Like Denmark and Norway, Sweden is also booming in 2007.

The region’s economic transformation is even more compelling when compared to 1990-1991 when the entire area was immersed in a major recession causing all sorts of dislocations across Scandinavia. Several Nordic banks failed in the early 1990s amid a bust in real estate and business conditions. Currencies also declined sharply in value while plunging commodities prices torpedoed the region’s finances, namely in Sweden and Norway.

Today, the bull market in natural resources combined with record-high shipping rates is transforming Scandinavia into an economic powerhouse driven by its massive export base. Germany is the largest source of this region’s exports followed by major international trade routes in the United States and Asia.

The Sovereign Society has strong links in Scandinavia with private banking contacts in Denmark, and now, Sweden. We’re also bullish on alternative energy this decade and beyond; our recommendation last winter to buy Vestas has resulted in a fat double-digit gain thus far combined with foreign currency appreciation of the Danish krone versus the dollar.

Provided interest rates stay low and commodities prices continue to rise, as I expect them to, the incredible economic renaissance in Scandinavia will continue.

Food Inflation Bullish for Agricultural Commodities

While the majority of commodities investors are glued to crude oil and base metals prices over the last few years, food inflation has embarked on a bull market of its own. Buying a slice of the agricultural bull market is vital the latter part of this decade as prices offer a negative correlation to common stocks and bonds; over time, foodstuffs are poised to soar from booming demand in Asia and global bio-fuel production.

Everything from milk, cereal, coffee, cocoa, butter and other constituents of the Breakfast Club has already soared over the last 12 months with the grains now participating in a secular long-term rally since last fall as crop yields decline, particularly for soybeans and wheat. Only orange juice and sugar remain depressed in 2007.

Soybean Prices are Soaring since 2006

Input costs for global food conglomerates, including giants like Nestle and Unilever, has increased markedly since 2005. And with the surge in bio-fuel production, created by a combination of corn, sugar and vegetable oils, prices are being squeezed by demand on all fronts.

The problem for the retail investor is a lack of direct access to play this exciting long-term theme. Fortunately, there are a few avenues available, if you know where to look.
In my Commodity Trend Alert signature investment service, we’re currently long two diversified grain and sugar indices since last winter. But despite the heady gains for some soft commodities this year, the grains have stumbled since hitting a high in February with corn prices down by almost a third on bullish 2007 crop forecasts. Still, the trend remains favorable as global crop yields continue to decline amid rapid population growth in Asia coupled with rising incomes that demand richer, healthier diets.

Investing in soft agricultural commodities requires patience if you choose the indexing route. For the majority of investors, including myself, indexing this tremendous long-term theme is far safer using diversified benchmarks than riding individual wheat futures or sugar futures options contracts – not my sort of game.

In September, I’ll also be plugging a publicly-traded mining company that recently ditched its metal inventory in favor of investing in soft commodities. This company now trades at a 15% discount to its net asset value and is definitely making the right bull market asset allocation.

The consolidation in grain prices since last February is drawing to an end. One of the next big bull markets is unfolding, quietly, while most investors are still fixated on emerging market stocks or small company stocks. Think Breakfast. Think profits.

Christmas Comes Early: Time to go Selectively Shopping for Stock Bargains

Stock-market panics and corrections are incredibly frightening. They can also test an investors’ resolve, tempted at exactly the wrong time to sell stocks amid market hysteria. That’s what happened last week in global markets as the selling climax hit hard on August 16 – the day before the Federal Reserve cut the discount rate.

But amid the carnage, the worst sell-off for global equities in over a year, stocks have gone from being fairly priced or expensive six weeks ago to undervalued compared to future earnings and lower interest rates, as everything under the sun was indiscriminately sold since late July. If I had difficulty isolating cheap stocks in July – the majority of which traded near their highs and paid below-average dividends, it’s the opposite right now with hundreds of good companies at their 52-week lows and paying fat dividends, especially in Europe.

And judging by the VIX Index, or the Chicago Board Options Equity Volatility Index, which hit a multi-year high last Thursday, stocks are very oversold and poised to rebound. Also, the CBOE equity puts-to-call ratio, which measures the number of investors betting on declining stock prices, also hit a multi-year high last week – a contrarian signal. But perhaps one of the most bullish buy signals is the level of corporate insiders in the United States purchasing company stock – the highest since 2002.

I would suggest shopping now with the intention of buying again later this fall as markets eventually stabilize. Since market-timing is almost impossible, consider buying half of your investments now at these low prices and the other half later in October or November.

Risks Remain to Growth Outlook

A real estate bear market is accelerating in the United States. The risks are growing that the economy might tip into recession the second half of this year.

Consumption growth in the United States is expected to continue to slow this year while the unemployment rate is showing signs of rising. Retail sales have been anemic at best with Wal-Mart Stores and Home Depot reporting poor results and lower earnings projections for the remainder of the year. The odds of an economic recession continue to rise, unless the Fed is more vigilant recognizing the consumption-led slowdown. We need lower interest rates now.

In my eyes, the Fed will do the right thing and provide the financial markets with more liquidity so that mortgage-backed stress can ultimately be relieved. That liquidity or expansion of bank credit should also find its way into capital markets, particularly stocks. Lower rates imply the dollar will be sacrificed for economic growth as monetary policy eases heading into 2008. Though corporate earnings will slow as a result of this debacle since late July, I’m still optimistic for the next 12 months as lower interest rates spur consumption and hopefully, arrest the real estate bear market.

Make no mistake about it; we’re not out of the sub-prime mess, yet. Over $500 billion dollars’ worth of adjustable-rate-mortgages must be reset next year, threatening lenders and borrowers. But the Fed’s admission of the problem and a concerted effort by banks to prioritize this crisis should allow for more stable markets over time. I don’t believe the sub-prime crisis will cause a recession.

Meanwhile, I’m finding huge bargains just about everywhere. In a slowing economic environment, I’d be looking to buy food conglomerates, select pharmaceuticals, insurance companies and gold-mining stocks. Also, global multinationals are attractive, especially U.S. large-caps, which should benefit from a weak dollar and stronger economic growth abroad. I’d still, however, avoid most banks since a blizzard of asset write-downs (hedge fund losses, sub-prime) lies ahead of us over the next six months.

Big Yields in Europe

Investors can find big dividends in the European insurance sector – in excess of 3.5% to 4%, slightly less than benchmark ten-year government bond yields in Germany. Most of these companies don’t have significant sub-prime exposure on their books and have been mauled since July 19. Provided the hurricane season, now in earnest, doesn’t result in huge claims, insurance stocks should be much higher by mid-2008 on the heels of stable-to-lower global interest rates and attractive valuations. Swiss, German and Dutch carriers look especially appealing at these levels.

Though we should avoid a recession in the United States this year, the Fed is late coming to the rescue, resulting in more volatility before stocks ultimately form a bottom later this fall. With interest rates headed lower and global central banks now tackling the commercial mortgage-backed crisis, stock prices will be higher 12 months from now. Equities, despite the fear factor inflicting damage portfolios worldwide, offer healthier entry points compared to just eight weeks ago.