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

Templeton’s Mobius Predicts another Crash

Tønsberg, Norway

Mark Mobius, who runs the emerging markets team at Templeton Asset Management, warned that a new financial crisis will develop from the failure to effectively regulate derivatives and the extra global liquidity from stimulus spending.

Mobius is an old hand in the emerging markets. He’s led the emerging markets group at Templeton since 1987 and recently forecast a big recovery for the asset class earlier this year amid a financial crisis in the major economies. To-date, the MSCI Emerging Markets Index has surged more than 35%.

But the seeds of another market meltdown are currently being sown, according to Mobius: “Political pressure from investment banks and all the people that make money in derivatives” will prevent adequate regulation, said Mobius, who oversees $25 billion dollars as executive chairman of Templeton in Singapore.

“Definitely we’re going to have another crisis coming down. Banks make so much money with these things that they don’t want transparency because the spreads are so generous when there’s no transparency,” he said in a Bloomberg interview on July 15.

A “very bad” crisis may emerge within five to seven years as stimulus money adds to financial volatility, Mobius said. Governments have pledged about $2 trillion dollars in stimulus spending. Mobius also thinks stocks can plunge 15% to 20% rather quickly as investors grow nervous again.

The United States is just throwing bundles of money at the financial crisis rather than effectively letting banks and other companies fail – despite the severe consequences of job losses that would entail.

From a portfolio management risk perspective investors are playing a game of “chicken” chasing the stock market amid the worst destruction of credit values since the 1930s and soaring unemployment. Latest data from the Bank Credit Analyst shows that U.S. bank lending is not growing in 2009, despite TARP.

Investors have also bet the ranch on government spending to bail-out the market and the economy from the near depths of Great Depression II. In my book, that’s the wrong way to invest. Buying stocks and a host of risky assets now might seems like a smart trade as stocks recover since March but fiscal stimulus won’t indefinitely supplant organic consumer spending – now clearly in savings mode since late 2008.

My exposure to stocks remains the lowest in 18 years. My European managed accounts are actually net short again since July 1 while my U.S. accounts are about neutral or barely long in equities.

The biggest equity-linked exposure I maintain since March is through convertible bonds, which were hammered last fall as stocks and credit crashed. But the premiums on convertible bonds have risen markedly since April and I wouldn’t buy these securities now.

This is a very uncertain economic environment. Previous crashes marked or triggered by a deep financial crisis over the last 150 years have clearly resulted in a sluggish and uneven economic recovery thereafter. This won’t be your typical post-WW II recovery because financial intermediation has been almost wiped-out while bank credit expansion is virtually nil. Without domestic consumption and bank credit growth any economic recovery will be frail at best and ultimately, will collapse or head for a double-dip recession assuming the economy grows this quarter.

You don’t need equity risk to make money in the market.

Investors have lost money in stocks since 1996 and while the prospects look better for stocks than T-bonds over the next 12 months after a major crash in 2008, I suspect the risk-to-reward obtaining those returns is too high and fraught with great uncertainty. Instead, look to buying convertibles and high quality corporate bonds following a correction this summer or fall and adding to gold stocks, gold and silver. Also, reverse indexing looks compelling for stocks, T-bonds and junk bonds – all expensive relative to this economic cycle.

Stocks aren’t the only game in town.

Norway Home to Morningstar 5-Star Managers

Tønsberg, Norway

I’m back in Norway this week spending time with my girlfriend and checking out the annual Slottsfgell Festival or Castle Mountain Festival here in beautiful Tønsberg – about 75 kilometers south of Oslo. Over 10,000 guests are expected for this event, including rock concerts and open bars. Drinking gets started at 2pm on Thursday – not exactly my thing but definitely a big part of this bash.

Norway, of course, has been a growing feature in my investment portfolios since May because increasingly, I’m convinced the Norwegian kroner is undervalued vis-à-vis most currencies.

Norway has a budget surplus-to-GDP ratio of 10.5% -- the highest in Europe and one of the world’s largest state pension funds valued north of $300 billion dollars. The country is rich in oil and gas and is now making a big push into renewable energy to supplement its declining annual oil and gas production.

But Norway is also home to two tremendous mutual funds denominated in Norwegian kroner.

A few years ago – prior to the credit crisis -- I recommended the Skagen Global Fund in The Sovereign Individual – the best performing global fund in Scandinavia and among the most profitable in Europe. The Fund has gained 9.3% per annum in kroner since 1999 or more than 11% in U.S. dollars. That compares to an annualized loss of 2.9% for the MSCI World Index over the last ten years. Skagen, like all non-U.S. registered funds, is not available directly to U.S. investors.

Another superb fund is the Storebrand Verdi Fund managed by Norway’s best stock-picker, Alf Inge Gjerde. I met Mr. Gjerde in Oslo in May and his track record is superb. This Fund is a Norwegian growth and value fund, unlike Skagen Global Fund. Though highly aggressive because of big stock specific bets and heavy concentration in energy, the Storebrand Verdi Fund has gained a cumulative 161% in kroner since 1997 versus 106% for the Oslo All-Share Index. Storebrand is Norway’s second-largest insurance company and manages over $80 billion in assets.

Americans can’t directly buy offshore mutual funds because of potentially onerous tax implications. However, they can defer the tax on these products through an offshore IRA or an offshore variable annuity (NMG in Zurich or Isle of Man Assusrance). Otherwise, investors outside of these tax-deferred vehicles will have to pay taxes each year on undistributed gains (assuming you have any gains) from a separate source of income; most offshore funds don’t pay year-end distributions and don’t issue a K-1 to U.S. investors.

Costa del Sol a BUY after Spanish Bust

Marbella, Spain

This marks my second holiday in the Spanish Riviera since 2005. Four years ago, Marbella and neighboring towns were littered with cranes; not anymore.

The last time I visited Marbella the Costa del Sol region was in the throes of a major real estate boom that saw prices extend as far as the eye can see; now the property market has crashed and bargains beckon in Spain.

If you’re looking for an affordable condominium in the Spanish Riviera then now is the time to make a purchase following a 15% to 40% bust since prices peaked in 2006.

According to Banco Bilbao Vizcaya Argentaria there’s about 800,000 to 1.4 million unsold homes scattered across Spain, including Costa del Sol. The bank estimates it’ll take about two years to absorb this supply but I think it’s looking more like three years or more. There isn’t a week that goes by whereby banks aren’t repossessing residential property.

Along the stretch that’s between Puerto Bañus (ritzy high-end jet-set enclave) and Marbella (coined the “Golden Mile”) the majority of properties are considered “high end;” they’ve declined anywhere between 15% to 25%. But throughout the “ritzy” coast many more affordable areas have declined sharply with homes or condos in the €700,000 range down at least 20% since the market peaked about three years ago.

Basically, if you’re looking to buy a summer residential dwelling in southern Europe, than come to Spain. The weather is unbeatable, the food is terrific and the Spanish are very warm and friendly. Compared to 25 years ago, Spain is highly modernized and offers a first-class infrastructure of highways and roads. Malaga Airport is just a 35minute drive from Marbella.

I just spent a week on holiday with my girlfriend at the Hotel Puente Romano – what an experience! If I was in my late 50s or early 60s and looking to settle down amid retirement then I would certainly be buying in Costa del Sol right now. The price is right.

For more information check out Panorama or Marbella’s oldest real estate agency at www.panorama.es

Texas and the Dakotas Best Municipal Bond Bets amid Funding Crisis

Montreal, Canada.

It’s not a pretty site for state finances.

California, the world’s ninth-largest economy -- is bankrupt once again. The state issued its first batch of IOUs yesterday as its coffers ran dry. Though extreme, California is certainly not alone this year as many other states grapple with a bear market in revenues, rising unemployment and increasingly grow dependent on Washington to fund state and municipal operations.

States face a cumulative shortfall of $230 billion dollars from now until 2011 as revenues plunge since 2007. In 2009 alone, the cumulative budget gap for states is $121 billion dollars, according to the National Conference of State Legislatures. Thus far, 42 U.S. states have slashed enacted budgets to cope with rising demand for services and sharply declining revenues, according to the National Governors Association.

State and local sales-tax revenues fell more sharply in Q4 2008 than at any time over the past fifty years. For the first two months of 2009, 41 states that reported tax revenues saw total receipts fall 12.8% compared to 12 months ago.

Of the $787 billion dollars recently legislated by Congress to boost economic growth, about $246 billion has already been deployed to states. In early June, Treasury issued $25 billion dollars in bond authority available to state and local governments under the Recovery Zone Bonds program.

The bad news, however, is that all of this money is now in the process of being spent by states and by next year more government assistance will be required because state revenues are still declining. This has created a dangerous cycle of government interdependence for the most fiscally challenged states – including California, which by all intents and purposes is basically broke in 2009.

I don’t like buying or owning an investment that relies on government support. We all know the rules can change suddenly in uncertain times and depending on government to secure your retirement or long-term investment goals is the wrong way to invest.

If you own a bunch of municipal bonds then I would carefully review your portfolio to ensure the following:

• Is your state solvent without federal aid? You can obtain this information at your state’s budget survey online or at www.sunshinereview.org;

• If not, consider several top-rated national municipal bond funds as ranked by Morningstar to ensure proper diversification and risk allocation;

• Make sure your municipal bonds or bond funds are liquid. If you have to sell your bonds then ensure there’s no liquidity issue. You shouldn’t have to wait more than 24-hours;

• Limit your portfolio duration to a maximum of 5 years. Duration measures interest rate sensitivity. Though rates will stay low for the foreseeable future, make sure you don’t own long-term bonds with maturities extending beyond 2015;

• States with the best balance sheets include Texas and The Dakotas.

Despite the compelling tax savings, I’m very cautious about most municipal bonds because I’m in the camp this economic expansion will be sluggish for the next few years. Consumers are not spending, the unemployment rate is still rising (at 9.5%) and the housing market has not bottomed. This will NOT be a typical post-WW II expansion because bank credit is not expanding and borrowers are largely absent.

Texas is currently only one of six states not facing a budget deficit. The same goes for North and South Dakota and several others.

In Texas, state revenues are projected to decline 10.5% in 2009 compared to 2008, the state has apportioned some money for emergency funding or a Rainy Day Fund. The Rainy Day Fund was established in 1987 following a severe economic downturn and a sharp decline in oil and gas prices. The fund is expected to reach about $9.1 billion in assets by 2011.

Texas, of course, relies heavily on oil and gas revenues to boost its balance sheet. The state continues to benefit from strong oil prices – which have doubled since February – and will shortly receive $11.4 billion from Washington’s Economic Recovery and Reinvestment Act or the $787 billion dollar stimulus bill. That will further cushion Texas’s coffers.

I like the prospects for Texas longer term. That’s because I’m an oil and gas bull and believe she’ll continue to benefit from the trend in rising energy prices and Peak Oil, or a global phenomenon tied to declining oil production coupled by rising consumption mostly in the emerging markets. You could say Texas is in a “sweet spot.”

Also, Texas, though taking federal assistance – like all states – can live without it. The state is one of the few in the Union to balance its books.

If you must own municipal bonds to reduce your effective tax rate, then be especially careful now. These are not normal economic times. The wrong way to invest for the future is to depend on government to bail-out your state -- which means that in the absence of federal aid your state might possibly default on its debt. Though unlikely, this is a growing possibility in the post-2007 credit crisis.

I’m off next week to Spain for a summer break. I’ll be back blogging on Tuesday, July 14 from Tonsberg, Norway. Until then, Happy July 4th and Happy Canada Day!

Bear Market in U.S. Housing to Last Years

Montreal, Canada

The prospect for a quick residential real estate recovery continues to look dim in 2009 as the market struggles to wind down a 12-month supply glut.

Recent housing data point to a gradual improvement in some areas of the battered U.S. real estate market. To be sure, existing house sales have edged higher this spring and prices in some regions have begun to stabilize. But we’re still a long way off from a new bull market – probably years away as a lethal combination of rising unemployment, soaring foreclosures, ARM resets and a supply glut weigh on recovery prospects.

U.S. home prices eased their dizzy slide in April, according to the latest report by the Standard & Poor’s/Case-Shiller Index. Thirteen cities reported price gains in April as Dallas, Denver and Cleveland led the way with a 1% gain compared to a month earlier.

But the big picture for this index continues to look grim with home prices down 18% compared to 12 months ago and almost 33% off their all-time high in mid-2006.

Unlike previous bear markets in housing – most recently in the late 1980s – this recession is unique because of the extent of damage inflicted by a crash in credit, leveraged borrowing and domestic consumption since 2008. A sharp recovery is almost impossible over the next few years because employment trends remain dire and consumer confidence is near a multi-decade low; more importantly, there’s a huge overhang of unsold homes or too much inventory that will take years to wind down.

Probably the most worrisome short-term concern for residential housing is the surge in U.S. foreclosures recently coupled by a plunge in refinancing activity. The Fed’s ambitious plans to purchase up to $300 billion dollars’ worth of mortgage-backed securities since last November has failed to contain long-term fixed-rate mortgages this year. The recent spike in mortgage rates – though moderating since late June – remains elevated in a market that’s still lacking credit. Many jumbo mortgages are also being turned down as banks refrain from real estate lending in a declining market.

I’ve argued all along this year that we are in the midst of a long recovery process whereby credit markets are still largely dysfunctional and still dependent on Federal Reserve intervention to an extent. Interest rates are indeed super low but they’re also at these levels for a good reason. The demand for credit or funds is anemic and banks are still hoarding cash.

The stock market rally is now overdone because corporate earnings won’t recover beyond this fall, if at all. Basically, the government is providing a huge slop of short-term credit financing that’s ballooning asset values over the last three months. Worse, near zero percent interest rates is forcing depositors and other conservative investors back into the market because they’re desperate for yield. To interpret this economic recovery as a typical post-WW II expansion is dangerously futile. At some point over the next 6-12 months I suspect Mr. Market will need another injection of government stimulus and that’s when we’ll take-out the March 9 lows.

The majority of investors, traders and money-managers continue to underestimate a credit depression. Nobody alive has ever witnessed such a monster collapse of credit values. To believe that we’re on the road to riches again is just nonsense.

For now, the trend is your friend.

Homebuilders, Regional Banks and Transports Flashing Red

As the third quarter gets underway, U.S. stocks posted their best quarterly gains since Q4 1998 following the Long Term Capital Management crisis. June, however, did witness some important price divergences for several sectors of the market suggesting this bear market rally is nothing more than a dead-cat bounce since March 9.

As pointed out almost daily by my favorite market maven, Richard Russell (Dow Theory Letters), the divergence between the Dow Jones Industrials and the Dow Jones Transportation Average was confirmed earlier in May and has failed to solidify this post-March uptrend. The Transports have recently broken down below important support levels. According to Dow Theory, both averages must hit new highs in order to confirm a new bull market; that hasn’t been the case over the last few months as the Transports remain down 8.6% this year. Rails, trucks, shipping and airlines usually precede a bull market – yet that’s not occurring in this rally.

Another important indicator failing to sustain a rally is the regional banks.

While the largest banks have successfully raised more than $50 billion dollars since April to boost their still battered balance sheets, the smaller banks in the United States, including many regional banks, have topped-out. The smallest lenders have tumbled 26% since hitting a four-month high on May 8. Many smaller banks don’t have sufficient capital to feel confident enough to boost lending while many others have returned TARP funds because of government restrictions tied to borrowing capital.

Then you’ve got the homebuilders – one of the worst casualties of this credit crash. Homebuilding stocks posted huge gains off the March lows but have since tanked 26% since hitting their highest levels since last October on May 4.

Concern that mortgage rates, credit losses and foreclosures are increasing spurred retreats in the companies forecast to be among the biggest beneficiaries of $12.8 trillion dollars in government stimulus spending. Despite massive government injections into housing and tax incentives, you can’t force someone to buy a home or refinance if job losses are mounting and foreclosures are rising.

Inflation worries – which typically accompany a cyclical economic recovery – are premature at this stage. The United States and the global economy are mired in a deep contraction in demand; virtually no company has pricing power since last year and margins are mostly being improved through aggressive company cost-cutting.

Major inflation gauges like gold and TIPS have indeed climbed in 2009 but remain well below their March 2008 and July 2008 highs, respectively. This price action doesn’t suggest an inflation panic anytime soon. The same is true for Dow Transportation Average – a highly cyclical barometer.