Roubini on mother of all carry trades

From FT Mother of all carry trades faces an inevitable bust:

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed.

Market commentary from Art Cashin

GR reports Q3 2009 results

Here is the market action before and after the pre-market October 22 results. The results were mixed. From MSN money Goodrich cuts 2009 sales outlook:

Goodrich lowered its 2009 sales outlook, to $6.7 billion, compared with a forecast of $6.9 billion in July. The company said its estimate includes unfavorable sales impacts of about $154 million related to foreign currency exchange rate fluctuations and lower sales of about $125 million related to the formation of a joint venture.

The Charlotte company said it still expects to post a profit of $4.60 to $4.75 per share for 2009.

Analysts surveyed by Thomson Reuters, on average, expect a 2009 profit of $4.58 per share on $6.82 billion in sales.

For 2010, Goodrich said it expects to post a profit of between $4.15 and $4.40 per share on sales of about $7 billion. The company said 2010 should be a year of "modest recovery which should allow us to grow our commercial aftermarket sales." It expects the recovery will take hold toward the middle of next year. Its shares gained $1.81, or 3.3 percent, to $56.46 in morning trading.

Analysts, on average, expect a 2010 profit of $4.59 per share on $6.89 billion in sales.

Goodrich also said its third-quarter profit fell 14 percent, as the weak economy continued to depress sales.

From the Economist Denial or acceptance:

At their most panicky investors shunned all but the safest and most liquid assets: American Treasuries were a favoured comfort blanket. That demand for safe assets prompted a rally in the dollar in the months after the collapse of Lehman Brothers last September.

Headache for countries with floating exchange rates has prompted three responses: direct measures to stop currencies rising; attempts to talk them down; or acceptance of a weak dollar as a fact of life.

Brazil has gone for the direct approach. Foreign capital has flooded in, attracted by the healthy prospects for economic growth and high short-term interest rates. That has pushed up local stock prices, as well as the real, Brazil’s currency. To stem the tide, the government this week reintroduced a tax on foreign purchases of equities and bonds.

Others have resorted to talking their currencies down. In a statement released after its monetary-policy meeting on October 20th, Canada’s central bank said the strength of the Canadian dollar would more than offset all the good news on the economy in the past three months.

Other euro-zone countries are less rattled. “A strong euro reflects the strength of the European economy,” shrugged Walter Bos, the Dutch finance minister. Germany, Europe’s export powerhouse, feels that its firms can just about live with a euro worth $1.50. Its exporters still flourished when the euro last surged to that level, because demand from Asia and the Middle East for its specialist capital goods proved insensitive to price. France, however, struggled. Other euro-area countries such as Greece, Ireland, Italy and Spain have at least benefited from the recent revival of risk appetite through lower premiums on their debt.

Ghosn's electric car gamble

From the Economist Mr Ghosn bets the company:

Mr Ghosn believes that by 2020 purely electric, zero-emission vehicles will take 10% of the global car market. What is more, he wants such vehicles to account for 20% of Renault-Nissan’s sales by then.

In urbanised western Europe, 80% of journeys are below 60km, and 20% of cars in Europe—about 20m vehicles—never go any further. Battery technology is undergoing a revolution, with more than 20 big companies worldwide competing to produce smaller, tougher and more powerful batteries. One reason for Renault’s leasing model is to allow vehicle owners to upgrade their batteries as and when the technology improves.

Renault’s commitment and attention to every detail is impressive, but Mr Ghosn’s bet depends on three things working in his favour that he cannot control: the eager co-operation of governments; a rising oil price; and the willingness of drivers to change their habits. It is the last of these that is hardest to predict.

Dollar weakness - long TBT?

From the Economist Down with the dollar:

The recession, which reduced America’s imports as consumers tightened their belts, has improved its trade imbalance, shrinking its current-account deficit. But ironically this has been accompanied by renewed weakness for the dollar.

The simplest explanation for the currency’s decline is based on risk aversion. On the days when risky assets fall, the dollar tends to go up. When risky assets rise, the dollar falls. The dollar has fallen fairly steadily since March, a period which has seen stockmarkets enjoy a phenomenal rally. Domestic American investors may be driving the relationship, repatriating funds in 2008 when they were nervous about the state of financial markets and sending the money abroad again this summer because of a perception that the global economy is reviving.

But although risk aversion may be a factor, describing the dollar as a “safe haven” seems dubious. Indeed, the weakness of American fundamentals has revived the longstanding bearish case against the currency. Some cite the American budget deficit, expected to be 13.5% of GDP this year.

But if foreign investors are so concerned, why is the dollar’s decline not accompanied by a sharp rise in bond yields? One reason may be that the Federal Reserve has been buying so much of the year’s debt issuance, as part of its quantitative easing programme. That has helped to keep yields down.

A simple dynamic may be at work: supply and demand. Last year the market was short of dollars because investors needed the American currency to meet their liquidity needs. This year QE is creating a surplus of dollars (and pounds) and is thus driving both currencies down.

The use of QE also creates a problem for central banks as they contemplate their exit strategies. An early abandonment of the approach could cause bond yields to rise sharply, unless there is an unexpectedly dramatic improvement in the fiscal position. But continuing QE could cause further currency weakness.

It is hard to see what the American authorities could do to bolster their currency even if they wanted to. Low yields offer little support to the dollar.

A country heavily in debt to foreigners, with a government deficit it is making little headway at controlling, is creating vast amounts of additional currency. Yet it is allowed to get away with very low interest rates. Eventually such an arrangement must surely break down.

Cloud computing: Battle of the clouds

From the Economist Battle of the clouds:

The idea is that computing will increasingly be delivered as a service, over the internet, from vast warehouses of shared machines. Documents, e-mails and other data will be stored online, or “in the cloud”, making them accessible from any PC or mobile device. Many things work this way already, from e-mail and photo albums to calendars and shared documents.

This represents a big shift. If you store more and more things online, and access more and more software through an ordinary web browser, it suddenly matters much less what sort of computer you have, and what kind of software it is running.

By switching to cloud-based e-mail, accounting and customer-tracking systems, firms can reduce complexity and maintenance costs, because everything runs inside a web browser. Providers of cloud services, meanwhile, can benefit from economies of scale. Why should every company or university set up and maintain its own mail server, when Google or Microsoft can do it more efficiently? Companies are already happy to rely on utilities to provide electrical power, after all. Cloud computing will do the same for computing power.

The ability to summon computing capacity from the cloud when needed will also give the software industry a shot in the arm. During the dotcom boom, the first thing a start-up had to do was raise the money to buy a room full of servers. If a website experienced a sudden surge in popularity, more servers were needed to meet demand. Today a capacity can be rented as needed, allowing cloud services to scale up smoothly. This lowers barriers to entry and promotes innovation and competition.

From the Economist Clash of the clouds:

Windows 7 is not just a sizeable step for Microsoft. It is also likely to mark the end of one era in information technology and the start of another. Much of computing will no longer be done on personal computers in homes and offices, but in the “cloud”: huge data centres housing vast storage systems and hundreds of thousands of servers, the powerful machines that dish up data over the internet. Web-based e-mail, social networking and online games are all examples of what are increasingly called cloud services, and are accessible through browsers, smart-phones or other “client” devices.

The rise of cloud computing is not just shifting Microsoft’s centre of gravity. It is changing the nature of competition within the computer industry. Technological developments have hitherto pushed computing power away from central hubs: first from mainframes to minicomputers, and then to PCs. Now a combination of ever cheaper and more powerful processors, and ever faster and more ubiquitous networks, is pushing power back to the centre in some respects, and even further away in others. The cloud’s data centres are, in effect, outsize public mainframes. At the same time, the PC is being pushed aside by a host of smaller, often wireless devices, such as smart-phones, netbooks (small laptops) and, perhaps soon, tablets (touch-screen computers the size of books).

Apple is also secretive about the way it conducts its internal R&D. Mr Jobs clearly calls most of the shots. But insiders say that there is a system of teams that pitch projects to him.

EnerNOC: an interesting business model

From the Economist Wiser wires:

For applications that run on smart grids, it is still early days. EnerNOC gives a hint of things to come. The speciality of this American firm, whose share price has more than quadrupled in the past 12 months despite the crisis, is demand response. It promises utilities to supply them if they need additional power and is paid as if it were keeping physical plants ready. In fact it has agreements with many firms, which it pays for the privilege of being allowed to shut down their non-essential gear if need be, thus freeing up capacity. As of June 2,400 customers, from steel plants to grocery stores, had signed up. They represent 3,150MW, the output of about 30 peak-power plants. But EnerNOC also wants to use the equipment it has installed and the data it collects to offer something called “continuous commissioning”: making sure that big buildings, for instance, do not start to waste energy.

Smart grid developments

From the Economist Wiser wires:

A global movement is afoot to make grids “smart”. This means adding all kinds of information technology, such as sensors, digital meters and a communications network akin to the internet, to the dumb wires.

Governments have earmarked parts of their stimulus packages for smart grids. Utilities have started to spend serious money. In recent years American venture capitalists have put more than $1 billion into smart-grid start-ups, even if investment this year has not matched the heights of 2008. Two of these start-ups, GridPoint and Silver Spring Networks, raised $220m and $170m respectively.

Outages cost the American economy $150 billion a year.

A more resilient grid, however, is the less important half of the story. Just as the original grid facilitated the industrial innovations of the 20th century, the smart grid should support the green advances of the 21st.

More intelligence in the grid would also help integrate renewable sources of electricity, such as solar panels or wind turbines. As things stand, the trouble is that their output, being hostage to the weather, is highly variable. A standard grid becomes hard to manage if too many of them are connected to it; supply and demand on electricity-transmission systems must always be in balance. A smart grid could turn on appliances should, for instance, the wind blow more strongly.

Within the smart-grid market, there are three different strata of technologies, known as “stacks”.

The first stack is called “advanced metering infrastructure”, or AMI. It is at the heart of every smart grid and is the most vibrant part of the market so far, which is good news for makers of smart meters, such as General Electric, Itron, based in Washington state, and Landis+Gyr, from Switzerland. Their products are rather like smart-phones: they have a powerful chip and a display, and are connected to a communications network. More than 76m will have been installed worldwide by the end of this year, forecasts ABI Research, a market-research firm. By 2013 the number will rise to 155m.

The main task of a metering system is to get information reliably into and out of meters—for example, how much power is being used, when and at what price. The best approach is to use wireless mesh networks, in which data are handed from one meter to the next.

Such networks, which automatically reconfigure themselves when new meters are added, are at the core of the wares sold by Silver Spring Networks and Trilliant Networks, both based in Silicon Valley. Yet as well as providing the communications infrastructure of a smart grid, they also want to offer its software foundation. So far Silver Spring is the more successful of the two, having several American utilities on its customer list, PG&E among them. But Cisco is likely to enter this market, probably through acquisition.

The other two technology stacks of a smart grid are more straightforward, but no less promising. One is all the technology a utility needs to manage the usage data, combine it with other information and set rates depending on demand. The leading start-up in this area is eMeter, from Silicon Valley, but Oracle, a database giant, offers similar software. IBM helps utilities connect their disparate systems, build applications for smart grids and analyse the huge amount of data they produce.

The third stack is the “home area network” (HAN)—industry-speak for all the smart-grid technology in the home, behind the meter. There is general agreement that it will include things such as wireless displays that show the household’s power consumption at that instant, thermostats that are connected to the meter and smart appliances that can be switched on and off remotely. The big question is how all these devices will be connected and controlled. Will the HAN be dedicated to regulating electricity consumptions, for instance, or will it also control home security or stream music through the rooms?

Given the infantry of start-ups and the artillery of corporate giants, you might think it cannot be long before smart grids are widely deployed, at least in the rich world. Alas, things are more complicated, for three main reasons. The first of these is that the technology is not ready yet. Granted, most of it exists in some form (with the notable exception of ways to store energy efficiently when demand is low). But many products are not widely available or still need honing. Smart grids are also said to be vulnerable to cyber criminals. At a recent conference, a security consultant showed how a large number of meters could be hacked and shut down.

What is more, many standards have yet to emerge and the technology is still in flux. Understandably, utilities are hesitant to make big bets on products that could soon be obsolete.

That does not mean that smart grids will never be widespread. But just like other new technologies, they will first go through what Gartner, a market-research firm, calls the “hype cycle”. After a peak of inflated expectations, there comes a “trough of disillusionment” before the technology reaches the “slope of enlightenment”. And perhaps more than with other technologies, how steep this slope turns out to be will largely depend on what people, from politicians to business leaders to consumers, make of it.

A weak dollar explains the rising price of gold?

Inquiring minds are reading the Economist article Bullion bulls:

Gold was once the linchpin of the global monetary system and is still seen by many as a hedge against inflation. But if investors are really frightened of price rises, it is hard to see evidence in the government bond market. There has been a modest increase in inflation expectations (measured by the difference between the yield on inflation-linked bonds from that on conventional bonds). But the Treasury bond market is only pointing to average inflation of 1.9% over the next 20 years.

Conventional explanations of supply and demand do not work, either. Mining production is slightly up year on year; jewellery demand is down by 13.8%. The main demand has been led by investment. Retail and institutional investors have been buying gold through exchange-traded funds, which allow them to have a pooled stake in bullion.

But blaming the rise on ETF purchases does not answer the fundamental question; why do investors want exposure to gold at all? The dollar is the prime suspect. Gold’s rise coincided with a fall in the greenback on a report (since denied) that oil-producing countries were talking about replacing the dollar as the pricing currency. When the dollar falls, as it has since March, risk-averse investors tend to buy gold.

David Malpass's view on the U.S. dollar

Inquiring minds are reading the WSJ article The Weak-Dollar Threat to Prosperity:

If you want to know why the dollar has been falling this week and gold hit a new high, look no further than the weak jobs numbers last Friday and the weak communique issued over the weekend at the G-7 meeting in Istanbul.

Asked whether low interest rates will weaken the dollar, Bill Gross said: "I think that's part of the administration's plan. It's obviously not announced—the 'strong dollar' is always the policy, so to speak. One of the ways a country gets out from under its debt burden is to devalue."

Corporations play this game for bigger stakes, borrowing billions in dollars to expand their foreign businesses. As the pound slid in the 1950s and '60s and the British Empire crumbled, the corporations that prospered were the ones that borrowed pounds aggressively in order to expand abroad. Though British equities rose in pound terms, they generally underperformed gold and foreign equities.

Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create.

The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity.

The value is migrating from firms that run networks and make hardware to those that make software and offer services

Inquiring minds are reading the Economist's Cleverly simple and Copycats:

Sales of smart-phones were up by nearly 15% in the 2Q of 2009, according to IDC, a market-research firm. The market for smart-phones is expected to grow so quickly in part because they are changing. Expensive pocket computers such as the iPhone and BlackBerry are giving way to new models that come with popular services built in, but are less versatile or run on open-source operating systems, and are often cheaper. All this reflects a broader trend in the industry, where value is migrating from firms that run networks and make hardware to those that make software and offer services.

New handsets from Motorola, an industry veteran, and INQ, a rising star, illustrate these changes. They both feature built-in support for online services, including popular social-networking sites such as Facebook and Twitter.

INQ and Motorola are also both betting on Android, an open-source operating system developed by Google. Although the internet giant’s operating system only has a small piece of the market, it is clearly gaining momentum.

Android will also accelerate the third trend. Prices are now on a downward spiral, says Ben Wood of CCS Insight, a research firm. Several other handset-makers are already offering cheap smart-phone-like devices. Android allows cut-price Chinese firms such as Huawei and ZTE to enter the smart-phone market, which they had previously stayed out of for lack of the necessary software.

But if pared-down smart-phones become the norm, handset-makers risk becoming sellers of commodity hardware while operators face a future as dumb pipes for data. Hence the recent rush into services.

Xerox’s move follows Dell’s recent $3.9 billion offer for Perot Systems, another services company. Both bidders are betting that profits from their targets, which boast fat margins and multi-year contracts with customers, will offset shrinking returns from the increasingly commoditised hardware business. They hope the deals will help them sell more photocopiers, computers and other gear too. The combined firms will compete with behemoths such as IBM, which now gets more than half of its revenues from services, as well as Indian rivals such as Infosys and Wipro.

Splicing hardware and services firms together can pay off handsomely. Witness the experience of HP, which last year forked out $13.9 billion for EDS, a services giant. (On September 23rd HP renamed the business HP Enterprise Services.) After a difficult integration process involving thousands of job losses, HP’s operating margin in services has hit a ten-year high of 15.2% and it now has deals involving $4 billion-worth of HP equipment in the pipeline. Before the acquisition, EDS mainly touted kit from HP’s rivals. Dell and Xerox must be hoping that this success can be copied.

Some great daily market analysis

From Zero Hedge - Wall Street "Animal Spirits" Stampede Across the River

Anyone see 60 Minutes last night? The story about the animal migration across the Mara River in Kenya? All the Wall Street particpants were there. And this morning they were stampeding back into the "inflation" and "re-risking" trade once again.

Despite the warnings from Nouriel Roubini, despite the crash warnings from the survivalists who have suddenly become expert market technicians, etc., the market was ramped up on a Goldman Sachs upgrade of a few bank stocks, and that was enough to get the "Animal Spirits" going.

Here's a picture of the Wall Street Herd crossing the river called the 50-day EMA:

And here are some of the participants:

Fidelity, Vanguard, Schwab, Barclay's, etc.

TIAA-CREF, Harvard Endowment, Gates Foundation, CalPERS, etc.

Myriad Hedge Funds, Bucket Shop Players, etc.

Various 19-year old enterprising speculators, daytraders, action junkies, etc.

Goldman Sachs Prop Desk Traders lying in wait:

As soon as it was evident that the oft-predicted October Crash was not going to happen just yet, and the 50-day was not going to be broken today, the herd immediately jumped in and wildly bought stocks....

Meanwhile, here's a hapless retail daytrader who was caught on the wrong side of the river, overmargined with a short position, being devoured by a Goldman Sachs Prop Trader:

Just another day in the jungle, buying the worst stocks possible.

Like Select Comfort Mattress:

Las Vegas Sands:

Nordstrom's

Robert Reich thinks government debt is not an issue, creating jobs is more important

From Robert Reich's blog:

Let me say this as clearly and forcefully as I can: The federal government should be spending even more than it already is on roads and bridges and schools and parks and everything else we need. It should make up for cutbacks at the state level, and then some. This is the only way to put Americans back to work. We did it during the Depression. It was called the WPA.

Yes, I know. Our government is already deep in debt. But let me tell you something: When one out of six Americans is unemployed or underemployed, this is no time to worry about the debt.

When I was a small boy my father told me that I and my kids and my grand-kids would be paying down the debt created by Franklin D. Roosevelt during the Depression and World War II. I didn’t even know what a debt was, but it kept me up at night.

My father was right about a lot of things, but he was wrong about this. America paid down FDR’s debt in the 1950s, when Americans went back to work, when the economy was growing again, and when our incomes grew, too. We paid taxes, and in a few years that FDR debt had shrunk to almost nothing.

You see? The most important thing right now is getting the jobs back, and getting the economy growing again.

People who now obsess about government debt have it backwards. The problem isn’t the debt. The problem is just the opposite. It’s that at a time like this, when consumers and businesses and exports can’t do it, government has to spend more to get Americans back to work and recharge the economy. Then – after people are working and the economy is growing – we can pay down that debt.

But if government doesn’t spend more right now and get Americans back to work, we could be out of work for years. And the debt will be with us even longer. And politics could get much uglier.

h/t Zero Hedge

Some companies are investing their way out of recession

Inquiring minds are reading the Economist's Thriving on adversity:

Bain & Company discovered that twice as many firms made the leap from “laggards” to “leaders” (ie, from the bottom quartile of companies in their industry to the top quartile) during the recession of 1991-92 than during non-recessionary times. McKinsey discovered that one-third of banks and two-fifths of big American industrial companies dropped out of the first quartile of their industries in the recession of 2001-02.

What about the current recession? The most obvious winners are established giants: market leaders that entered the recession with cash in their pockets and sound management systems under their belts. These companies are reaping rewards from investors who are skittish about shakier rivals. They are also using their corporate muscle to squeeze their costs (for example, by negotiating cheap rates for advertising) and so win market share from their competitors. BCG, another consultancy, notes that 58% of companies that were among the top three in their industry had rising profits in 2008 and only 30% saw their profits decline. In contrast, only 21% of companies outside the top three had rising profits, and 61% had falling profits.

McDonald’s is simultaneously sharpening its appeal to its core customers, even introducing computer systems that allow its outlets to adjust their prices to local economic circumstances, and moving upmarket with lattes and salads. Asda, a British supermarket chain, is building 14 new stores and hiring 7,000 new workers. PepsiCo has taken direct control of two of its biggest bottling companies, at a cost of $6 billion.

Despite seeing its revenues fall by 23% in the last quarter of 2008 compared with the last quarter of 2007, Intel is continuing to invest heavily in innovation. Craig Barrett, the company’s former boss, insists, “You can’t save your way out of a recession; you have to invest your way out.” P&G is launching its biggest expansion in its 170 years, opening 19 new factories around the world and investing heavily in new ideas, despite disappointing recent results. IBM is holding a series of “innovation jams” designed to squeeze ideas out of its employees.

Cisco is speeding up its transformation from a backroom network plumber into a much more versatile internet giant, using its cash reserves to snap up start-ups in new fields and expand its business portfolio. Repositioning is a strategy that has paid off dramatically in the past. When the Soviet Union collapsed, plunging Finland into economic turmoil, Nokia’s response was to abandon 90% of its businesses to concentrate on telecoms, particularly mobile phones.

Russia's sickly car market and some "smart" predictions

Inquiring minds are reading The Economist's Russia's sickly car market:

A year ago Russia’s market for new cars was one of the fastest growing in the world. It had gone from annual sales of less than 1.5m in 2005 to nearly 3m and was poised to overtake Germany as the fourth-biggest car market in the world. Ernst & Young, a consultancy, forecast sales of 5m by 2012. Credit Suisse confidently predicted that sales would grow by at least 12% a year until 2012 and that by then the foreign car firms that had rushed to build factories in Russia would be producing more than 1.5m cars a year. How wrong they were.

There is no mystery about why Russia’s car market is reeling. Credit, which was used to finance the purchase of about half of all new cars, disappeared almost instantly because Russian banks were unusually dependent on shuttered wholesale markets. Thanks to the economy’s reliance on exports of oil and gas, slumping energy prices immediately hit both earnings and the rouble. The tumbling rouble also meant that foreign car brands suddenly became much less affordable, including those made in Russia, because most of their components are still imported. “We had to force through several price increases in a weakening market,” says Nigel Brackenbury, Ford’s senior executive in Russia.

“The market will come back—the wealth has not disappeared,” says Christian Estève, who runs Renault’s operations in Russia. Pointing to car-ownership levels that are still less than a third of Western Europe’s and the age of the Russian fleet, Mr Brackenbury agrees: “We still believe the market will eventually get back to 3m-4m a year.” However, neither expects a rapid bounce.

Mr Putin wants both AvtoVAZ and Gaz to survive, so they probably will. But although Russia’s car market will eventually recover, the same cannot confidently be said of its native carmakers.

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Economic outlook from Paolo Pellegrini

From Bloomberg's Pellegrini 80% Return Proves Paulson Protege No Fluke at Fund:

Today, Pellegrini’s economic outlook for the next 5 to 10 years is a sobering one. He says the U.S. economy will groan under the weight of budget deficits, increased regulation and household debt. Europe will perform only slightly better, and Asian economic growth will outstrip that of the developed world. “There are going to be huge shifts in wealth around the globe,” he says. “I want to invest in that.”

Pellegrini says the U.S. stock market is likely to generate negative returns when adjusted for inflation. And the U.S. dollar will flag as an unrestrained Federal Reserve dispenses more money.

“In the U.S., there is limited interest among those in power in the stability of the dollar,” he says.

Meanwhile, the price of scarce commodities such as oil will surge as global competition for them heats up, Pellegrini says. Accordingly, he expects U.S. Treasuries to fall in price in the long term, and he’s buying oil futures. In September, he owned Norwegian kroner and said he believed the Australian dollar would benefit from that resource-rich country’s geographic proximity to Asia.

From Zero Hedge - John Paulson's ABX Oracle Paolo Pellegrini Discusses Anemic Real Stock Returns, Blasts Federal Reserve:

• Stay away from US fixed income asset: he is short USTs and Agencies
• Much more demand for commodities, specifically oil: "these are the real assets you want to be in"
• US Equities: "trend growth will be much less than in the past and that affects equity valuations" - there will be less efficiency, less activity, less real growth, which will affect stock valuation. "You will have anemic real returns on stocks."
• What should the Fed be doing? "We should focus on market based way of reducing household liabilities, basically restructure mortgages one by one and whoever made the mortgages should bear the brunt of the losses"
  
• "Long-term let's change the mission of the Federal Reserve: let's codify something that prevents it from running amok, like it did for the past ten years"

h/t Zero Hedge

Success story: Paolo Pellegrini of PSQR - John Paulson's protege and ABX oracle

Inquiring minds are reading Bloomberg's article Pellegrini 80% Return Proves Paulson Protege No Fluke at Fund:

Paolo Pellegrini has a nose for trouble. He saw it in rising housing prices in early 2006, when he cranked through decades of home price data and concluded the bubble was poised to burst. Pellegrini then helped engineer a massive bet against subprime mortgages that catapulted Paulson & Co. hedge funds to 2007 gains of as much as 590 percent -- and firmwide profits of more than $3.5 billion.

Pellegrini says his fund’s name, PSQR, is a play on his own: Paolo or Pellegrini Squared. It’s also an anagram of SPQR, the initials of the ancient Roman Republic that stand for Senatus Populusque Romanus, or the Senate and the People of Rome. The four letters are still emblazoned on monuments and signs around the city, where Pellegrini was born and spent his first five years amid the cobblestoned alleys of the Trastevere district.

The identity of the Zero Hedge founder has been revealed

Inquiring mind are reading The Dow Zero Insurgency:

As it happens, the founder is a 30-year-old Bulgarian immigrant banned from working in the brokerage business for insider trading. A former hedge-fund analyst, he’s also a zealous believer in a sweeping conspiracy that casts the alumni of Goldman Sachs as a powerful cabal at the helm of U.S. policy, with the Treasury and the Federal Reserve colluding to preserve the status quo. His antidote? A purifying market crash that leads to the elimination of the big banks altogether and the reinstatement of genuine free-market capitalism.

h/t Zero Hedge

Scepticism is quite important in finance

Inquiring minds are reading the Economist's The pedagogy of the privileged:

History courses aside, business schools need to change their tone more than their syllabuses. In particular, they should foster the twin virtues of scepticism and cynicism. Graduates in recent years, for example, seem to have accepted far too readily the notion that clever financial engineering could somehow abolish risk and uncertainty, when it probably made things worse. It is worth noting that such scepticism is second nature to the giants of financial economics, as opposed to the more junior propellerheads. Andrew Lo, of MIT’s Sloan School of Management, was fond of pointing out that in the physical sciences three laws can explain 99% of behaviour, whereas in finance 99 laws can explain at best 3% of behaviour.

The rally in financial markets is driven primarily by liquidity provided by governments

Inquiring mind are reading Investors are betting on a vibrant recovery:

Equity and corporate-bond markets have also been boosted by quantitative easing (QE), the process whereby central banks create money to purchase (mostly government) bonds. That has helped keep the lid on Treasury-bond yields. In June the ten-year bond yielded almost 4%; it is currently around 3.5%, pretty low by historical standards even though governments are issuing record amounts of debt. The fear is that if QE stops, yields may rise sharply, driving up borrowing costs for everyone. “At some point the quantitative easing will come to an end but until it does this bull market is sponsored by [governments] and everyone should enjoy it,” Crispin Odey, a hedge-fund manager based in London, recently urged his clients.

Yet the stockmarket seems to assume a robust economic recovery. The S&P 500 index is trading on a price-earnings ratio of around 20, based on 2009 forecasts for operating earnings. A more cautious approach, using earnings reported under official accounting standards, puts the multiple at 27. Both numbers are well above the historical average. According to Smithers & Co, the American market is 37% overvalued on the best long-term measure, the cyclically-adjusted price-earnings ratio (which averages profits over ten years).

As a result, the markets look vulnerable to a setback. As strategists at UBS remarked in a recent research note: “Liquidity has been a much bigger driver of this market than fundamentals. Liquidity-driven rallies have a habit of reversing violently without warning.”

h/t The Economist

Art Cashin on the end-of-the-day selling

88 week moving average - some voodoo indicator?

Nic Lenoir of ICAP likes to remind us of this 88 week moving average:

The fundamental framework is simple: we are experiencing (experienced?) a bounce in industrial production and it led markets up, while they were at the same time being supported by many incentives produced by the government to invest in distressed securities. Given the amount of shorts the bounce also became a squeeze, and in turn it appears that the positive sentiment has spread. Bear in mind the consumer is sensitive to a turn around by 50% in equity markets, and it can help her/him forget partly his precarious situation, or at least give him hope. Hope was also made more affordable by the "hope anything" programs in place, and the "cash to buy a car you don't need" incentives, not to mention tax rebates. This created an explosive cocktail, and while I think markets have gone way to far on the upside, and very little has been done to solve the real issues, one must recognize the move could potentially go a lot higher. Unlike rates which can hardly go much lower than zero, stocks can go just about anywhere from these levels.

That's why it's key to watch the markets and see what indication they give us that we may, or may not, be turning soon. First we tested the 88 week moving average, and like it or not, it has been your best friend over the past 20 years to trade stocks on a big macro picture. Some ask why 88? Well, that's because it corresponds well to the pace of the long term dynamics for the S&P market. Envelop theory states that to call a change of trend in a bull market for example, one need to find the moving average that best covers all the lows, and if there is one with a great fit, wait for a break to be confirmed, but in doubt buy every test of this support (and conversely for bear markets). Knowing that and looking at the 88 week moving average, it's pretty clear...

h/t ZeroHedge

"Many private equity firms are hoping that daylight doesn’t shine on the corpses of their companies"

Inquiring minds are reading an article by Andrew Ross Sorkin of the New York Times A Financier Peels Back the Curtain:

“We all had too much money. It was just too easy.”

That’s the unvarnished appraisal of the private equity business by Guy Hands, perhaps best known for his unfortunate $4.73 billion purchase of the record company EMI in March 2007, the peak of the buyout boom — a bet that will almost certainly lose his investors and his firm, Terra Firma, a fortune.

That ill-timed acquisition aside, Mr. Hands’s surprisingly candid assessment of the private equity industry is worth sharing. He was in the midst of the industry’s growth to dizzying heights during the debt-fueled boom, and he is now having to deal with the aftermath of its shopping spree. Like others, he is desperately trying to keep businesses afloat and pay off the equivalent of huge monthly mortgage payments to the banks that financed them.

The problem, he said, was that the funds had grown so big that the 2 percent became just as important as the 20 percent.

“Clearly a large number of P.E. firms were totally overpaid at the peak of the market,” he said. “The fees were an entirely unwarranted windfall, as the managers did not use the excess fees to invest in resources to grow the skill base of their funds.”

He estimated that the private equity firms’ “net earnings will decline a minimum of 80 percent from the peak in 2007.”

Success had less to do with performance or risk management, he said, and more to do with bulking up. “It is time for investors to see through the elaborate marketing machines created by the industry,” he said.

Between sips of his mint tea, he said that during the boom, investors had thrown so much money at so many private equity firms — some of which formed consortiums to buy businesses from one another — that they were “really investing in the same thing so their capital was competing against itself, driving up prices.”

He also argued that private equity firms formed consortiums not to spread risk, but because, ultimately, it was easier than going “through the pain of gaining internal consensus to do something contrarian.” The big firms would counter that consortiums allowed them to buy bigger companies and to spread the risk.

With banks still holding back on loans, some on Wall Street have suggested that the private equity industry is dead. Others argue that the biggest firms — the Blackstone Group, Fortress Investments, Kohlberg Kravis Roberts & Company, which is planning to go public — will survive, albeit in a different form. Last year, Stephen A. Schwarzman, the co-founder of Blackstone, said, “The people rooting for the collapse of private equity are going to be disappointed.”

Mr. Hands is not rooting for the industry’s demise, but he is predicting it will wither. The firms still have funds big enough to last them at least a decade, as they provide steady fees. “Right now, the big firms have a tower of fees,” he said. “But the tower starts to collapse over time.”

As the funds dry up, Mr. Hands expects the firms will struggle to raise enough new money to support the hundreds of employees they now employ. His prediction has a precedent — that’s what happened to venture capital after the late 1990s. The industry shrank sharply after it became clear that too much money was chasing too few deals.

But the pattern may play out in slower motion for private equity. “Neither the banks nor P.E. want to come clean about mistakes,” he wrote in his notes. “Hence companies will live as zombies unable to grow their businesses or make long-term commitments. Meanwhile banks will try to suck out as much money as they can in fees and postpone recognizing the full extent of the losses of their underwriting decisions.”

In the end, he said, “Many P.E. firms are hoping that daylight doesn’t shine on the corpses of their companies, so they are reluctant to restructure too quickly.”

Of course, it’s possible that some firms will make terrific bets now, in the depressed economy, and will come out even stronger when things improve.

h/t ZeroHedge

Some private equity wisdom

Inquiring minds are reading Interview with David Bonderman, the founding partner of Texas Pacific Group ("TPG") and an alumni of Harvard Law School, on what it takes to be a successful private equity investor:

Harbus: What do you think makes a good private equity investor?

DB: Being a good private equity investor is more complicated than it seems. I would say that there are a few characteristics that are important. If you look at the skill set that you need to ultimately be a successful private equity investor, at least at the senior level, you have to be, in this business, a good investor. You have to be able to help companies perform and you have to have judgment around exiting investments. If you look at the skill sets there, they include some things you can teach and some that you can't.

One of them, of course, is being a person who has good judgment about businesses. A second is someone who's pretty analytical and understands how to deal with numbers. A third one is personality, because in the private equity business, there's no deal unless you can persuade somebody to sell you their company. And as you say, there are many competitive situations here. So if many of us are all out there competing, and people like you and they don't like me, they're probably going to be interested in selling their company to you, and not me. So, you have to have a mix of those talents.

In addition, a very important characteristic is having a nose for value.

That's why some of the very best private equity people, in my experience, are people who start out as stock pickers - people who really understood value, how to take a company's financials apart and couple that with good judgment about businesses, macro trends, and where things are going.

It's a complicated skill set, and probably no one is perfect at all of them.

The more you start out with the right kind of personality, the right kind of smarts and the better the training you get, the more successful you're likely to be.

Harbus: Mr. Bonderman, you've obviously had a very successful career in private equity. What do you enjoy most about your job? What has been the most challenging aspect of your career path?

DB: Let me answer those in different ways. For me, one of the highlights of being in the private equity world is that you need to learn a lot and very quickly about different businesses. So it's always a continuing learning experience where you can apply what you know, of course, by way of judgment and by way of numerical analysis. You're always investing in new businesses, which is a learning experience in itself. I think that is a wonderful thing and I think it makes for intellectual challenge and for continued personal growth. That, for me, is the highlight of this job.

You have a challenge every day in figuring out what's happening in the markets, where your next deal is coming from and so forth. So there is always a continuing challenge - but this is a financial services business, it's not brain surgery. The challenges are all about getting it right, but in the scheme of things, there is plenty of latitude to get it wrong.

h/t ZeroHedge

Insiders are selling

Inquiring minds are reading Corporate insiders continue to increase the pace of their selling

The bravest face you can put on corporate-insider behavior right now is to point out that they're often early -- anticipating market moves by as much as 12 months in advance.

But otherwise the message from the insiders is rather sobering: They are selling a whole lot more of their companies' stock than they are buying. The net difference is even larger than it was two months ago, when I noted that insiders were already selling at a greater pace than at any time since the top of the bull market in the fall of 2007.

Consider the latest data from the Vickers Weekly Insider Report, published by Argus Research. For the week ended last Friday, according to Vickers, insiders sold 6.31 shares for every one than they bought. The comparable ratio two months ago was 4.16-to-1, and at the March lows the ratio was 0.34-to-1.

As Vickers editor David Coleman puts it in the latest issue of his newsletter: "Given the dramatic decline in our sell/buy ratios over a relatively short period of time and the robust rally we have seen in the broad market averages, we expect the overall markets to trade flat to downward in the intermediate term -- and with increasing volatility. Overall insider sentiment is bearish by nearly all metrics we track."

Mish writes:

As Hulbert mentioned, insiders are not always right. Moreover one should not use insiders buys and sells as a timing device but rather a gauge of sentiment, and that sentiment is as extreme as it gets.

h/t Mish

Flash trading is no big deal?

From themistrading.com

So, how could Cramer say that flash is no big deal. The CNBC website couldn’t even believe that Cramer was in favor of Flash trading. They wrote , “Believe it or not, Cramer said, “This is actually a part of the market that’s working.” http://www.cnbc.com/id/32915415

So, Cramer says milliseconds don’t matter for the average retail investor. But those milliseconds have contributed to a multibillion dollar high frequency trading industry. This money is not created out of thin air (sorry, Ben Bernanke not in this part of the business). Somebody is losing here. And, the retail investor is one of the losers. Lets look at an example of how they lose that somehow Cramer seems to have failed to mention:

1-The market on XYZ is 21.05 bid for 500 shares, 500 shares offered at 21.08.

2- Say you want to buy 500 shares of XYZ at 21.08. You place a buy order with a $21.08 limit through your online broker .

3- Your broker routes to a market center which utilizes the flash method. Before your order gets routed to the market center which has the $21.08 offer, it is flashed to a subset of market participants.

4- A flash subscriber see this buy order coming and decides to trade in front of it and buy the 500 shares at $21.08 for their own account.

5-You get nothing done and 500 shares trades at $21.08.

6- It is very possible now that another market participant sees this trade and then bids $21.09 for stock. The buyer who took your stock then offers it at $21.10.

7- You are frustrated that you got nothing done and then change your limit to $21.10 and buy the stock.

Some people may say that it is only 2 cents and shouldn’t make a difference. Well, maybe 2 cents isn’t a big deal for this one trade. But do this thousands of time a day and it adds up to real money that is being siphoned away from retail investors.

h/t ZeroHedge

Sideline cash debate

Mish writes:

Anyone advising clients to "buy the dip" based on sideline cash shows a fundamental lack of knowledge about how markets work.

For every buyer of securities there is a seller except at IPO time, secondary offerings, ect. Thus, it is virtually impossible for money to come into the market in normal day-to-day trading transactions.

For example: If one firm invests $100,000 in equities, then another firm will be selling $100,000 in securities. The end result of the transaction is "sideline cash" moves from firm A to firm B.

Furthermore, because of monetary printing, one should expect the amount of "sideline cash" to rise over time. Sideline cash is higher than it was 10 years ago and will be higher 10 years from now barring a huge number of IPOs or secondary offerings that would suck up some of that sideline cash or a period of heavy monetary draining by the Fed.

h/t Mish

Leading economic indicators rise for for the 5th straight month

The Conference Board said Monday, September 21, the Leading Economic Index (LEI) for the U.S. increased 0.6 percent in August, following a 0.9 percent gain in July, and a 0.8 percent rise in June.

Bill King of Ramsey Securities says

LEI, which has increased for five straight months, is heavily weighted to monetary indicators and the stock market. Its predictive value for the stock market has been poor due to over-used monetary stimulus.

Barry Ritholtz says

The LEI trended lower from 1997 to 2000 as US stocks bubbled. It declined from 2004 to 2008 as the monetary medication carried a diminishing effect on the real economy.

h/t The Big Picture

Art Cashin on Dow 10,000

Bob Janjuah is changing his trader hat to investor hat.

Bob Janjuah, chief credit strategist at Royal Bank of Scotland, is back with his market missive.

View on currencies:

With this hat on, it is clear to me that, as we get into Q4 09, and probably for the next 12/18/24 months, I DO NOT want to own 'risk' (credit - esp. HY, equity), I DO NOT want to own USDs and GBPs on a long term basis, and I DO want to look at owning assets in EUROs (and maybe also JPY and AUD). In particular, because the ECB is by far the most credible central bank left when the choice is between the Fed, the ECB and the BoE, it appears to me that the Eurozone will drop into the debt deflation zone sooner rather than later and will by-pass the the MONETARY inflation risks so prevalent in the UK and US, thus on a decent investment horizon, I want to own very long dd govt debt issued from core-Europe, esp. of course Germany and France. I think getting a 4%+ carry on a multi-yr basis on German sovereign risk and ECB prudence makes an awful lot of sense at a time where not much else really has ANY VALUE left.

Market outlook:

Anyway, let me say 1st up that even though its all been pretty marginal, the RISK here is that over the next month or so we see risk assets go even better. This is a TACTICAL call and is NOT a change in the 3/6mth secular call, which REMAINS BEARISH. Andy Chaytor set some levels last week which I am comfortable with - there is a 60/40 chance that S&P trades up to 1120ish by end Sept/early Oct. I think the next month will be volatile and NOT straight line, but on balance the risk is that by month end/early Oct, risk assets will be better. And YES, I know that Sept is seasonally one of the weakest months, that we are already 5% off the Aug highs, and that 'everyone' - even the bulls - think we need a period of pullback/consolidation, but for me the perfect head fake will be a strong (but volatile) Sept.

I do however think that we are VERY MUCH in the tail end of the correction of the Oct 07 to Mar 09 bear move, where S&P lost nearly 60% from peak to trough, and where the correction from the Mar low would, at 1120, represent the 50% retrace. Once what I assume is a bear mrkt correction finishes, over the next month or so, I expect the Bear to return with vengeance and I retain my call for NEW LOWS in equities. That's 550 S&P!!

Of course if I am wrong then additional Stop Losses are critical. For me, the next stop loss is at 4 consecutive S&P closes above 1120. I recognise that the weight of opinion/mood is against me, and that it would be far EASIER for me to roll over, get with the herd, and move to the bull camp. But I have yet to see anything that convinces me otherwise - the ISM going back up to 50 was what Kevin told me in Jan/Feb we'd see, by around August time - and critical here is the call on whether balance sheet health & sustainability matters or not. Until I see hard evidence telling me otherwise, I will run the risk of being labelled unpopular/a perma-bear/blind/stupid - take your pick, I have been called much worse...by my wife!

h/t ZeroHedge

Vuitton never puts its stuff on sale. The company would rather destroy products.

Inquiring minds are reading LVMH in the recession:

... It is the only leather-goods firm, for instance, which never puts its products on
sale at a discount. It destroys stock instead, keeping a close eye on the proportion it ends up scrapping (which it calls the “destruction margin”).

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