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Thursday, 31 July 2008

Recession-Proof Your Portfolio--By Wading Into Stocks

By Bill Bergman

History informs decisions with future consequences. Looking backward to anticipate the future can seem like a contradiction, but we're all human, and history is one the tools we have.

OK, if we are in a recession today, what does history tell us about the wisdom of buying stocks during a recession?

History says it's time to load up.

If you had put a dollar into the S&P 500 every month since 1950, those 703 dollars would be worth about $9,300 today. But if you had been lucky, smart, and disciplined enough to only invest in each of the nine months that the NBER Business Cycle Dating Committee has deemed as the onset of the nine recessions we've had since 1950--in other words, investing equal chunks of the 703 dollars ($78.11) in each of those nine months--you would have $11,600 today, or 24% more than the amount you would have had by buying into the S&P 500 every month.

Correlation is not causation, but there's some common sense behind this. The S&P 500 is in the index of leading economic indicators because it tends to go down before recessions start and rise before recessions are over. Recessions are to be feared, to be sure, but fear sparks bravery and productivity, and our business arrangements tend to evolve for the better when the cold splash of recession arrives.

Granted, calling recessions ahead of time is no mean feat. But if you had broken those 703 dollars not into nine equal pieces, but into 93 equal pieces of about $7.55 apiece--for each of the 93 months in which the NBER has deemed the U.S. economy to be in a recession since 1950--you would have an even higher return than you would have if you had been investing only at the onsets of recessions. Conversely, if you only bought into the S&P 500 in each of the nine months in which our nine recessions ended, you would have less money today than if you had bought at the onsets of or during those recessions.

Recession investing has beaten continuous investing in either nominal or real terms, to the extent that the consumer price index is to be trusted as an inflation measure.

This brings us to another qualifier lately. Inflation has been on the rise, but that's history, not the future. History suggests that we don't let our monetary authorities pull the rug out from under us for long. We shouldn't let them get away with it now, and we probably won't. Some would say that we bear some resemblances to the latter stages of the Roman Empire, and it wasn't a good time to be buying into that program back then either! But for all the worthy cynicism, the bottom line is that there are just too many good people--and good companies--to lose faith in our basic productivity.

Ring the bell! Discretion is the better part of valor, of course, but the time is ripe to seek out great companies at good prices--and wade into them.

Friday, 25 July 2008

When Pessimism Prevails, It's Time to Get Rich

by Robert Kiyosaki

If you're serious about getting rich, now is the time. We've entered a period of mass-produced pessimism, when bad news is everywhere, and the best time to invest is when optimists become pessimists.

The Weird Turn Pro

Journalist Hunter S. Thompson used to say, "When the going gets weird, the weird turn pro." That's true in investing, too: At the height of every market boom, the weird turn into professional investors. In 2000, millions of people became professional day traders or investors in dotcom companies. Mutual funds had a record net inflow of $309 billion that year, too.

In an earlier column, I stated that it was time to sell all nonperforming real estate. My market indicator? A checkout girl at the local supermarket, who handed me her real estate agent card. She was quitting her job to become a real estate professional.

As a bull market turns into a bear market, the new pros turn into optimists, hoping and praying the bear market will become a bull and save them. But as the market remains bearish, the optimists become pessimists, quit the profession, and return to their day jobs. This is when the real professional investors re-enter the market. That's what's happening now.

Pessimism vs. Realism

In 1987, the United States experienced one of the biggest stock market crashes in history. The savings and loan industry was wiped out. Real estate crashed and a federal bailout entity known as the Resolution Trust Corporation, or the RTC, was formed. The RTC took from the financially foolish and gave to the financially smart.

Right on schedule 20 years later, Dow Industrials and Transports struck their last highs together in July 2007. Since then, nothing but bad news has emerged. In August 2007 a new word surfaced in the world's vocabulary: subprime. That October, I appeared on a number of television shows and was asked when the market would turn and head back up. My reply was, "This is a bad one. The worst is yet to come."

Many of the optimistic TV hosts got angry with me, asking me why I was so pessimistic. I told them, "The difference between an optimist and a pessimist is that a pessimist is a realist. I'm just being realistic."

As we all know, things only got worse in early 2008, with the demise of Bear Stearns and the Federal Reserve stepping in to save investment bankers. In February, many of those optimistic TV (and print) reporters became pessimists -- and when journalists become pessimists, the public follows. By March, mutual funds had a net outflow of $45 billion as investors fled the market.

Surviving the Bad Times

Back in 1987, as savings and loans closed and investors' stock and real estate portfolios were wiped out, my wife, Kim, and I were living in Portland, Ore. Many people were depressed and hiding from the truth. The following year, I said to Kim, "Now is the time for you to begin investing."

In 1989, she purchased a two-bedroom, one-bathroom house for $45,000, putting $5,000 down and earning $25 a month in positive cash flow. Today, she owns over 1,400 units and -- because more people are renting than buying -- she earns hundreds of thousands a year in positive cash flow.

The period from 1987 to 1995 was a rough one, even for the rich. In his book "The Art of the Comeback," my friend Donald Trump writes about being a billion dollars down at the time. Rather than give up, he kept on fighting to survive. He and I often talk about how that period was great for character development.

Two-Year Warning

I believe we're through the worst of the current bust. I know there will be more aftershocks, and the news will continue to be pessimistic for at least two more years, possibly until the summer of 2010.

But the upside to this is that it gives us at least two years to do our market research and find the next big stock or real estate bargain. Before buying, I strongly suggest you study, read books, and take courses on your asset of choice. If your choice is stocks, take a course on stocks or options. If it's real estate, take a course on real estate. Now is the time to learn; not only will you know more than the average person and be in a good position when the market turns, but you'll also meet people with a similar mindset.

You have about two years to get into position. Opportunities this big don't come along often, so this is your time to get rich.

Climbing Bulls, Flying Bears

Am I optimistic for the long-term? Absolutely not. I still believe we're due for the mother of all market crashes, and that the U.S. economy is running on borrowed time -- and I do mean borrowed. I think most baby boomers are in serious financial trouble, and that oil will climb above $200 a barrel. Inflation will also increase, causing more pain for the poor and middle class.

The Fed is flooding the market with nearly a trillion dollars of liquidity, which is why I believe gold under $1,200 an ounce and silver under $30 an ounce are bargains. Gold and silver should peak and decline before 2020, completing two 20-year cycles. My exit is to sell silver around 2015. I plan to hold onto gold, income-producing real estate, oil wells, and stocks.

Most of us know the bull climbs slowly up the stairs, but the bear jumps out the window. I believe the bull is still climbing the stairs, and the bear hasn't jumped yet. But rest assured that it will.
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Wednesday, 16 July 2008

Downturn gains steam as inflation roars ahead

By Martin Crutsinger and Jeannine Aversa, AP Economics Writers

Inflation rises at fastest pace since early 1980s as Fed chair warns of more trouble

WASHINGTON (AP) -- The U.S. economic downturn gained steam Tuesday, with a report of the highest inflation since the early 1980s, more bad news for banks and automakers and a suggestion by the Federal Reserve chief that worse days are ahead.

President Bush sought to bolster confidence by declaring that the financial system was "basically sound," but he conceded: "It's been a difficult time for many American families."

The Labor Department said wholesale inflation, driven by skyrocketing gas and food costs, rose by 9.2 percent for the 12 months ending in June -- the fastest pace since the summer of 1981, during another energy crunch.

At the same time, consumers hit the brakes hard despite a massive infusion of government stimulus checks. Retail sales turned in their poorest showing in four months.

Federal Reserve Chairman Ben Bernanke delivered a somber midyear outlook to Congress, saying the U.S. faces "numerous difficulties" despite the Fed's interest rate-cutting campaign, which began last September in hopes of preventing a recession.

Bernanke said the Fed expected the economy to grow for the rest of this year "appreciably below its trend rate." He cautioned inflation was likely to move "temporarily higher" in the near future.

That puts the Fed in a bind: Rising inflation hamstrings the Fed from cutting interest rates to jump-start the economy. The Fed had already signaled last month the rate cuts were probably at an end.

Outside Washington, there was plenty more bad news. On Wall Street, the Dow Jones industrials closed below 11,000 for the first time in two years, and shares of troubled mortgage giants Fannie Mae and Freddie Mac tumbled again. Fannie shed 27.3 percent and Freddie lost 26 percent.

In Los Angeles, police had to order people lined up outside an IndyMac Bank branch to remain calm or face arrest as they tried to pull out their money on the second day of the failed institution's federal takeover.

An analyst downgraded Wachovia Corp. and said the outlook for its shareholders is "bleak." Its already-battered stock sank about 7.7 percent further, to $9.08. U.S. Bancorp posted an 18 percent drop in second-quarter profit and tripled its provision for credit losses.

General Motors said Tuesday it plans to lay off salaried workers, cut truck production and suspend its stock dividend, all in an effort to raise $15 billion to help turn around its North American operations.

The dollar hit a new low against the euro. And even good news came with a dark side: Oil prices fell by more than $6 per barrel -- the biggest single-day drop in 17 years -- as traders fretted that the slowing U.S. economy would dampen demand for crude.

"The country is in a bad spot right now, squeezed by high and accelerating inflation and a very weak economy and struggling to overcome a very severe financial shock," said Mark Zandi, chief economist at Moody's Economy.com.

Wholesale prices for goods before they reach consumers rose by 1.8 percent in June from a year earlier and at 9.2 percent for the 12 months ending in June. Core inflation, which excludes food and energy, was better behaved, rising by just 0.2 percent in June, slightly lower than expected.

Food costs were up 1.5 percent, the biggest increase since January, led by steep gains in the cost of vegetables and eggs. Even pet food jumped by 6 percent, the largest monthly increase on record.

Wholesale energy prices shot up 6 percent. The price of unleaded regular gas surged 9 percent in June on top of a similar increase in May. Home heating oil, natural gas and liquefied petroleum gas also took big jumps.

Retail sales were up just 0.1 percent in June, the worst showing since February. That figure reflected a huge drop in auto sales and would have been even worse had it not been for a big jump in gas sales -- reflecting higher prices, not demand.

Analysts were particularly alarmed by the retail sales report because consumer spending accounts for two thirds of total economic growth. The weak sales came as the government was pumping out $28 billion in economic stimulus checks, bringing the total payments to $78 billion by the end of June.

Those same analysts worried what will happen after the government finishes mailing out the bulk of the checks this month.

"Clearly the economy is on the ropes with weak employment market conditions, declining home and equity prices and surging gasoline prices inducing the consumer to pull back," said Brian Bethune, chief U.S. financial economist at Global Insight.

Despite tough talk on inflation from Bernanke, many analysts predicted that the Fed will keep interest rates unchanged for the rest of the year to give the financial system some breathing room to deal with a tidal wave of mortgage defaults. Those have already resulted in an estimated $400 billion in losses at financial institutions.

Treasury Secretary Henry Paulson, appearing with Bernanke before the Senate Banking Committee, came under a barrage of tough questions about an emergency plan to bolster Fannie and Freddie, which between them hold or guarantee more than $5 trillion in mortgage debt -- nearly half of the nation's mortgage debt.

The plan would have Congress authorize billions of dollars of government help should the two giant institutions come under increased pressure because of the surge in mortgage loan losses. As a last resort, the government could also invest directly in Fannie and Freddie.

But both Democrats and Republicans on the committee questioned why the administration was seeking what critics term a bailout for two big corporations, with taxpayers left holding the bag in the event of severe losses.

Paulson insisted taxpayers were being protected and said the offer of government help should be enough to calm jittery markets.

In a Tough Economy, Timing Is Everything

by Suze Orman

Sharply falling stock market and home values have created an extremely treacherous period. It's in just this sort of tough economic environment that your future financial security is won or lost.

How you handle your money in these tough times is going to play a huge role in whether you reach your long-term financial goals. Unfortunately, I'm seeing far too many people focused on making moves that might bring some short-term relief without fully recognizing the long-term damage they're doing to their bottom line.

It's Too Early to Hibernate

The stock market has officially fallen into bear market territory, with the Dow Jones Industrial Average sinking 20 percent below its October 2007 high. Watching your portfolio take a big hit probably has you seriously considering making a beeline for the nearest exit, but please slow down and think this through.

Emotionally, it makes perfect sense to want to bail on the stock market. But emotions are what keep individuals from making smart investing decisions. Look no further than the ever-growing cadre of behavioral economists who make a living by studying how we cheat ourselves with misguided money moves.

Heading into investing hibernation right now is one of those moves. I'm not predicting that the market has absolutely bottomed, but to bail out now puts you at odds with the immutable law of successful investing: Buy low, sell high.

Many Unhappy Returns

Selling now also plays right into the timing trap that's thwarted so many individual investors. We need to look no further than the data provided by Dalbar Inc., which takes a look at how fund investors have historically fared when compared to the performance of the S&P 500 stock index.

It's not a pretty picture. For the 20 years from 1987 through 2007, the S&P 500 gained an annualized 11.8 percent. The returns for investors in mutual funds over that period were just 4.4 percent.

What gives? Really bad market timing. In that period, individual investors had a knack for getting in and out of stocks at just the wrong time; if they'd just sat tight they would've pocketed more than twice -- actually close to three times -- the gains they actually earned.

History Rewards the Long-Term Investor

That brings us back to today. If you're a long-term investor -- that is, if you expect to leave your money invested for at least 10 years -- the evidence is pretty clear that sticking it out as a buy-and-hold investor is going to be your best (non-) move. That's especially true if you're investing via a 401(k).

Your money buys you more shares today -- given lower stock values -- than it would if you bought at higher valuations. Invest $250 per paycheck in your 401(k) in funds that have a share price of $25 and you get 10 shares. Invest when those shares fall to $20 and your $250 buys you 12.5 shares. Fast-forward 10 years and the shares that have bobbed both up and down but are now worth, say, $30. If you had 10 shares your account is worth $300. With 12.5 shares you have $375.

Of course, this assumes that over long periods of time the market gains more than it loses. That might be hard to imagine right now, but we all know that over time -- decades of history -- the stock market has a long-term bias to trend up, not down. Folding now makes no sense if you're investing for a long-term goal.

What are your alternatives anyway? Don't tell me the 3 percent or so you can get at the bank or the 4 percent in a Treasury bond is a good, safe investment. There's nothing safe about having money you need to grow earn a guaranteed rate of return that's well below the rate of inflation.

Homing in on Reality

The slide in home values is creating another "timing" issue for many individuals. In addition to the few million homeowners who are already in or close to foreclosure, some economists are now projecting that another 2 to 3 million could find themselves in serious trouble over the coming year or so if home values continue to falter and a weak economy causes unemployment rate to rise.

The typical response to being in mortgage stress is to pull out all the financial stops to stay in the home. That includes raiding retirement savings, running up huge credit card debt, and borrowing from any and every family member or friend to come up with the cash to cover their rising mortgage costs. Again, emotionally this makes perfect sense -- the desire to stay in homes we ostensibly "own" is profound. But if the only way you can afford your home is to ruin the rest of your financial life, what have you really achieved?

It's very sad to say, but I think many homeowners need to seriously consider "folding" if the reality is that they have no way of being able to afford the higher mortgage payments in the long term. In fact, the latest round of housing aid being discussed by Congress would limit federal assistance to homeowners who could afford the cost of a 30-year mortgage. That's Washington's line in the sand: Help will be limited only to those homeowners who are able to make a go of it at a real market rate.

Know When to Fold 'Em

It should be your litmus test, too. Run the numbers using this Yahoo! Finance calculator: Plug in 6 percent for the interest rate and 360 for the term of the loan (that's 360 months, which is the full term for a traditional 30-year mortgage: 30 years x 12 months=360.) Then take a look at that monthly mortgage amount. Can you afford it today, without running your savings dry and your credit cards into the stratosphere?

If the answer is no, then you need to look at the big picture. It makes little sense to throw good money (what savings you have) at a bad situation you know you can't afford long-term. As painful as it is to consider selling, or going through foreclosure now, it can be the smarter move than trying to "hold on" for another six months, or year, or two years, until you have no more money to raid.

There are no miracle bailouts on the way. If Congress does step up to the plate, it looks like any assistance at this point is going to be very limited. Nor should you cross your fingers that housing values seriously bounce back in the near term and give you enough equity to easily refinance. And with the economy struggling, the chance of getting a big raise doesn't seem too likely. The bottom line: Keep your retirement savings intact and put away that credit card. It's time to consider folding -- hopefully through a sale and not foreclosure -- so you can get your financial house back in order.

Analysts Say More Banks Will Fail

By LOUISE STORY

As home prices continue to decline and loan defaults mount, federal regulators are bracing for dozens of American banks to fail over the next year.

But after a large mortgage lender in California collapsed late Friday, Wall Street analysts began posing two crucial questions: Just how many banks might falter? And, more urgently, which one could be next?

The nation’s banks are in far less danger than they were in the late 1980s and early 1990s, when more than 1,000 federally insured institutions went under during the savings-and-loan crisis. The debacle, the greatest collapse of American financial institutions since the Depression, prompted a government bailout that cost taxpayers about $125 billion.

But the troubles are growing so rapidly at some small and midsize banks that as many as 150 out of the 7,500 banks nationwide could fail over the next 12 to 18 months, analysts say. Other lenders are likely to shut branches or seek mergers.

“Everybody is drawing up lists, trying to figure out who the next bank is, No. 1, and No. 2, how many of them are there,” said Richard X. Bove, the banking analyst with Ladenburg Thalmann, who released a list of troubled banks over the weekend. “And No. 3, from the standpoint of Washington, how badly is it going to affect the economy?”

Many investors are on edge after federal regulators seized the California lender, IndyMac Bank, one of the nation’s largest savings and loans, last week. With $32 billion in assets, IndyMac, a spinoff of the Countrywide Financial Corporation, was the biggest American lender to fail in more than two decades.

Now, as the Bush administration grapples with the crisis at the nation’s two largest mortgage finance companies, Fannie Mae and Freddie Mac, a rush of earnings reports in the coming days and weeks from some of the nation’s largest financial companies are likely to provide more gloomy reminders about the sorry state of the industry.

The future of Fannie Mae and Freddie Mac is vital to the banks, savings and loans and credit unions, which own $1.3 trillion of securities issued or guaranteed by the two mortgage companies. If the mortgage giants ever defaulted on those obligations, banks might be forced to raise billions of dollars in additional capital.

The large institutions set to report results this week, including Citigroup and Merrill Lynch, are in no danger of failing, but some are expected to report more multibillion-dollar write-offs.

But time may be running out for some small and midsize lenders. They vary in size and location, but their common woe is the collapsed real estate market and souring mortgage loans. Most of these banks are far smaller than the industry giants that have drawn so much scrutiny from regulators and investors.

Still, only six lenders have failed so far this year, including IndyMac. In 1994, the Federal Deposit Insurance Corporation listed 575 banks that it considered to be troubled. As of this spring, the agency was worried about just 90 banks. That number may go up in August, when the government releases an updated list.

“Failed banks are a lagging indicator, not a leading indicator,” said William Isaac, who was chairman of the F.D.I.C. in the early 1980s and is now the chairman of the Secura Group, a finance consulting firm in Virginia. “So you will see more troubled, more failed banks this year.”

And yet IndyMac, one of the nation’s largest mortgage lenders, was not on the government’s troubled bank list this spring — an indication that other troubled banks may be below the radar.

The F.D.I.C. has $53 billion set aside to reimburse consumers for deposits lost at failed banks. IndyMac will eat up $4 billion to $8 billion of that fund, the agency estimates, and that could force it to raise more money from the banks that it insures.

The agency does not disclose which banks it thinks are troubled. But analysts are circulating their own lists, and short sellers — investors who bet against stocks — are piling on. In recent weeks, the share prices of some regional banks, like the BankUnited Financial Corporation, in Florida, and the Downey Financial Corporation, in California, have stumbled hard amid concern about their financial health. A BankUnited spokeswoman said the lender had largely avoided risky subprime loans.

In his “Who Is Next?” report over the weekend, Mr. Bove listed the fraction of loans at banks that are nonperforming, meaning, for example, that the assets have been foreclosed on or that payments are 90 days past due. He came up with what he called a danger zone, which was a percentage above 5 percent. Seven banks fell in this category.

An important issue for the regional and community banks will be whether they have managed to sell their riskiest loans to Wall Street firms.

And the government may have fewer failures than in the past because private investment funds might buy some troubled lenders. Regulators are considering rule changes that would allow private equity firms to buy larger shares of banks, and several prominent investors, like Wilbur Ross, have raised funds to leap in.

Bernanke warily lifts US growth outlook, warns on inflation

WASHINGTON - THE US economy is growing a bit faster than expected and could avert recession, Federal Reserve chairman Ben Bernanke indicated on Tuesday, while citing a 'critical' need to keep inflation expectations in check.

Mr Bernanke also said a 'top priority' of the central bank would be to keep financial markets functioning, and that the Fed was paying close attention to the troubles of mortgage giants Fannie Mae and Freddie Mac.

The Fed chairman, delivering his semiannual forecast to Congress, indicated that his outlook for better growth and cooling inflation remained subject to a 'high degree of uncertainty'.

The central bank called for 2008 growth in a range of 1.0 to 1.6 per cent, up from an April projection of 0.3 to 1.2 per cent.

The inflation outlook was hotter at 3.8 to 4.2 per cent for overall prices but the outlook for 'core' inflation excluding food and energy was unchanged at 2.2 to 2.4 per cent. -- AFP

Tuesday, 15 July 2008

Analysts Say More Banks Will Fail

by Louise Story

As home prices continue to decline and loan defaults mount, federal regulators are bracing for dozens of American banks to fail over the next year.

But after a large mortgage lender in California collapsed late Friday, Wall Street analysts began posing two crucial questions: Just how many banks might falter? And, more urgently, which one could be next?

The nation’s banks are in far less danger than they were in the late 1980s and early 1990s, when more than 1,000 federally insured institutions went under during the savings-and-loan crisis. The debacle, the greatest collapse of American financial institutions since the Depression, prompted a government bailout that cost taxpayers about $125 billion.

But the troubles are growing so rapidly at some small and midsize banks that as many as 150 out of the 7,500 banks nationwide could fail over the next 12 to 18 months, analysts say. Other lenders are likely to shut branches or seek mergers.

“Everybody is drawing up lists, trying to figure out who the next bank is, No. 1, and No. 2, how many of them are there,” said Richard X. Bove, the banking analyst with Ladenburg Thalmann, who released a list of troubled banks over the weekend. “And No. 3, from the standpoint of Washington, how badly is it going to affect the economy?”

Many investors are on edge after federal regulators seized the California lender, IndyMac Bank, one of the nation’s largest savings and loans, last week. With $32 billion in assets, IndyMac, a spinoff of the Countrywide Financial Corporation, was the biggest American lender to fail in more than two decades.

Now, as the Bush administration grapples with the crisis at the nation’s two largest mortgage finance companies, Fannie Mae and Freddie Mac, a rush of earnings reports in the coming days and weeks from some of the nation’s largest financial companies are likely to provide more gloomy reminders about the sorry state of the industry.

The future of Fannie Mae and Freddie Mac is vital to the banks, savings and loans and credit unions, which own $1.3 trillion of securities issued or guaranteed by the two mortgage companies. If the mortgage giants ever defaulted on those obligations, banks might be forced to raise billions of dollars in additional capital.

The large institutions set to report results this week, including Citigroup and Merrill Lynch, are in no danger of failing, but some are expected to report more multibillion-dollar write-offs.

But time may be running out for some small and midsize lenders. They vary in size and location, but their common woe is the collapsed real estate market and souring mortgage loans. Most of these banks are far smaller than the industry giants that have drawn so much scrutiny from regulators and investors.

Still, only six lenders have failed so far this year, including IndyMac. In 1994, the Federal Deposit Insurance Corporation listed 575 banks that it considered to be troubled. As of this spring, the agency was worried about just 90 banks. That number may go up in August, when the government releases an updated list.

“Failed banks are a lagging indicator, not a leading indicator,” said William Isaac, who was chairman of the F.D.I.C. in the early 1980s and is now the chairman of the Secura Group, a finance consulting firm in Virginia. “So you will see more troubled, more failed banks this year.”

And yet IndyMac, one of the nation’s largest mortgage lenders, was not on the government’s troubled bank list this spring — an indication that other troubled banks may be below the radar.

The F.D.I.C. has $53 billion set aside to reimburse consumers for deposits lost at failed banks. IndyMac will eat up $4 billion to $8 billion of that fund, the agency estimates, and that could force it to raise more money from the banks that it insures.

The agency does not disclose which banks it thinks are troubled. But analysts are circulating their own lists, and short sellers — investors who bet against stocks — are piling on. In recent weeks, the share prices of some regional banks, like the BankUnited Financial Corporation, in Florida, and the Downey Financial Corporation, in California, have stumbled hard amid concern about their financial health. A BankUnited spokeswoman said the lender had largely avoided risky subprime loans.

In his “Who Is Next?” report over the weekend, Mr. Bove listed the fraction of loans at banks that are nonperforming, meaning, for example, that the assets have been foreclosed on or that payments are 90 days past due. He came up with what he called a danger zone, which was a percentage above 5 percent. Seven banks fell in this category.

An important issue for the regional and community banks will be whether they have managed to sell their riskiest loans to Wall Street firms.

And the government may have fewer failures than in the past because private investment funds might buy some troubled lenders. Regulators are considering rule changes that would allow private equity firms to buy larger shares of banks, and several prominent investors, like Wilbur Ross, have raised funds to leap in.

Eric Dash contributed reporting.

Thursday, 10 July 2008

IMF gloomy on growth, warns on inflation

By Alan Wheatley, China Economics Editor

TOYAKO, Japan (Reuters) - It is hard to know how far the global financial crisis still has to run, with the extent of further credit losses hinging on what happens to the U.S. housing sector, IMF chief Dominique Strauss-Kahn said on Wednesday.

"What is sure is that the consequences for the real (economy) sector of the financial crisis are still in front of us," Strauss-Kahn, the International Monetary Fund's managing director, said in an interview.

With sky-high food and oil prices adding to the economic pain caused by financial strains, Strauss-Kahn said the IMF was fairly pessimistic about global growth prospects this year and, especially, in 2009.

But he told a news conference later that softening growth was less of a threat than inflation, which he said was rampant in some countries.

"In developed countries, central banks have taken it into account and have the correct monetary policy stance. In emerging countries and some low-income countries, in some of them at least, inflation is out of control. That means monetary policy probably has to be tightened in coming weeks or coming months."

Strauss-Kahn said the lesson from the 1970s and 1980s was that inflation can last for years, or even decades, if central banks and governments choose the wrong policy settings.

"That's why it's very important today, and that's what the IMF is doing, to draw attention to this question," he said.

DOLLAR NEAR FAIR VALUE, YUAN TOO CHEAP

In the interview, Strauss-Kahn reaffirmed the IMF's view that the dollar is close to its medium-term equilibrium value when adjusted for inflation and measured against a basket of currencies of America's trading partners.

"The euro is probably slightly on the strong side, while other currencies like the renminbi are obviously undervalued," he said.

Although the United States needs to boost net exports to offset weakening domestic demand, Strauss-Kahn said a competitive exchange rate was not the only driver of exports.

"Prices are important, of course, but quality, service and other things that go with exports are more and more important," he said. "It's not only a simple mechanical question of the exchange rate."

Ties between the IMF and China have been strained since the fund introduced new currency surveillance rules in June 2007 that make it easier for it to determine whether a country is keeping its exchange rate fundamentally misaligned to boost exports.

Beijing objected to the rulebook, regarding it as a ploy by the United States to enlist the fund in its campaign for a stronger yuan. The dispute delayed completion of the IMF's 2007 report on China under Article 4 of the Fund's charter.

Strauss-Kahn said the 2007 review would be folded into this year's, which would be debated by the IMF's board of directors in late August or early September.

"I have repeatedly said that the renminbi was significantly undervalued, and the board is going to give its own comment on this during the Article Four in six, seven weeks from now.

"The discussions are taking place and we will see -- but I won't tell you know -- what exactly the IMF staff is going to write and how the board of the IMF is going to react," he said.

Beijing is worried that an IMF finding that the yuan is fundamentally misaligned could expose it to trade sanctions.

The yuan, also known as the renminbi, has risen more than 20 percent against the dollar since Beijing scrapped its peg to the dollar in July 2005 and let the currency float in managed bands.

But it has risen much less against other major currencies.

Strauss-Kahn said the IMF's discussions with China revolved around how fast the yuan should appreciate.

"The Chinese authorities are quite aware of the fact that it is in their own interest to move the exchange rate -- to revalue the real exchange rate. They are facing a high level of inflation and they also have other undesirable consequences of this undervalued exchange rate.

"But of course it's not easy to do. We all have to understand that the move has to take place but to take place progressively."

(Reporting by Alan Wheatley and Yoko Nishikawa; Editing by Hugh Lawson)

Hedge funds stumble in first half of '08

By David Ellis, CNNMoney.com staff writer

Hedge funds delivered their worst performance on record during the first half of 2008, revealing that the industry has not been immune to the broader market turmoil.

As a group, hedge funds declined 0.68% through the end of June, and are down 0.75% so far this year, according to numbers published this week by industry tracker Hedge Fund Research.

The figures represent the worst first-half of the year performance for the industry since the research group began tracking returns in 1990.

While hedge funds' sluggish performance is troubling for an industry known for delivering sky-high returns year in, year out, the decline is far better than the broader market has fared.

During the first half of the year, the 30-stock Dow Jones industrial average tumbled 14.4%, while the broader S&P 500 declined 12.8%, as stocks have fallen ill on a dangerous brew of mortgage woes, soaring commodity prices, a declining dollar and weakness in the broader U.S. economy.

Despite the difficult market climate, hedge funds were still alluring to investors. During the first three months of the year, hedge funds attracted $16.4 billion in net assets. That's down both from the same period a year ago, when the industry attracted $60.22 billion, and the fourth quarter of 2007 when net asset flows reached $30.46 billion.

Still, if the market conditions persist, the hedge fund industry could endure more liquidations. During the first quarter, 170 funds folded. Right now, Hedge Fund Research anticipates that number to climb to 679 by year end.

Why This Housing Bust Is Worst Ever: The American Dream Ends

The current housing downturn isn't over and is "much much worse" than past downturns, says Barbara Corcoran, who built The Corcoran Group into a multi-billion firm during the real estate busts of the mid-1970s, 1980s and early 1990s.

This downturn is "grossly different" than those past cycles because homeowners are much more willing to "walk away" from homes, says Corcoran, who sold her namesake firm in 2001 for a reported $66 million and is now an author and widely cited real estate guru.

Just a few foreclosures - which Treasury Secretary Paulson says are unavoidable - can "put a pall on an entire neighborhood" by putting downward pressure on all local prices, she says.

The good news is that there's a "Macy's Day sale" in housing right now and buyers are starting to step in. But there aren't enough "brave souls" to stem the decline which Corcoran says will take prices down another 5%-to-10% nationally and end next Spring - in a best case scenario.

Would-be bankers set for bruising ride

FRANKFURT/LONDON - BEFORE they even start working 80-hour weeks, graduates sense tougher times in investment banking, and either by choice or necessity, some are already planning careers elsewhere.

Financial companies have slashed at least 70,000 jobs in the United States and Europe as a result of the credit crisis, making students uneasy as they face the reality of a sector which looks more bruising and less lucrative than a year ago.

Banking has been a popular choice among graduates in recent years. Five of the top 30 most desirable recruiters in Europe are banks, with Deutsche Bank leading the pack, according to a 2007 survey of some 40,000 students by Berlin-based research firm Trendence.

Although there is no evidence to suggest graduates are turning away en masse, universities are concerned for next year's intake and, with banks such as Citigroup and Bear Stearns cutting jobs, some students are less keen.

'The more I met people from the investment banking sector, the less I liked what I saw,' said 21-year-old Ms Marion Deneuville, a London School of Economics student who investigated jobs with large investment banks such as Goldman Sachs, JPMorgan and Merrill Lynch.

'You used to be able to move up to the next level in a bank after three to five years, but that's not guaranteed now, they are letting people go.

'It's always been incredibly competitive and now it's even harder. The perks, like big expense accounts to balance out the 80-hour weeks, are gone.' Instead, she has opted for a consultancy job.

Another student at a top European school is back on the job market after having a job offer from Bear Stearns withdrawn in the middle of exams.

'You would have thought there would be some loyalty to the individual, but it really isn't the case in this sector,' said the student, speaking on condition of anonymity to protect their employment prospects. 'No one went out of their way to let us know what was going on.' Investment bankers are an elite corps who can reap huge fees by helping clients raise money via issues of stocks and debt and advising on mergers and acquisitions.

'There is no possible career, with the exception perhaps of private equity and hedge funds ... where you can make as much money as you can on the Wall Street,' said author and former investment banker Bill Cohan at a discussion on compensation in financial firms earlier this year.

But with financial institutions suffering at least US$300 billion (S$409 billion) of write-downs, losses and credit provisions since mid-2007, they are now cutting back on the perks.

Some have reduced cell phone subsidies or car vouchers and banned business class travel for some divisions. Many in banking expect pay packages will also fall.

Young Blood
Students determined to go into banking are hoping the turmoil on financial markets won't hurt their careers in the long run.

'There is this 'hire and fire' mentality in investment banking where tomorrow I could have no job. Students are seeking reassurance and are asking questions,' said Mr Christian Marx, head of the student council at the Frankfurt School of Finance and Management, a feeder institution for large banks.

Universities say most banks have promised to honour this year's job offers because most were made over a year ago, before the full extent of the subprime fallout was known.

They say banks have learnt from the last downturn when they froze graduate recruitment and were left with a skills shortage.

Selling their product, the universities and business schools also point out that graduates are good value for money.

'It's more cost-effective to lay off the more experienced members of the workforce and take on cheap, eager graduates who will work an 120-hour week,' said Rolf Tilmes, professor at Germany's European Business School whose graduates are often sponsored by big banks.

'It's always good to have young blood,' he added.

The supply is there - Morgan Stanley says applications made in 2007/08 for its European analyst programmes were up more than 40 per cent on the previous year.

'One trend we are seeing is that students are now attracted to a wider range of roles, such as sales and trading, asset management, private wealth management and technology, as well as the traditional investment banking and M&A positions,' said Ms Stephanie Ahrens, head of EMEA Graduate Recruitment at the bank.

Banks are also seeking more specialist skills, such as foreign languages and physics, engineering or maths qualifications combined with computing, as they build expanding divisions in emerging markets or high-tech black box trading.

When Morgan Stanley went to Cambridge University last month, it was seeking candidates for quantitative finance.

Mature students are also opting to go into less risky areas, swapping investment banking for private banking, according to Beat Bernet, professor at Switzerland's University of St. Gallen, which counts CEOs of major banks among its graduates.

'This (change) definitely has to do with uncertainty in the investment banking sector,' he said.

And universities say they are worried about next year's intake. Merrill Lynch, JP Morgan and Goldman Sachs declined to give details on their graduate recruitment, and other large banks did not reply to requests for figures.

Universities are advising students to look at alternatives, such as working in the finance departments of the multinationals which regularly fish for graduates but which fell out of favour with graduates in the boom of investment banking.

Nonetheless, students with sophisticated skills hope that in a weaker job market, they will be more in demand.

'Obviously the job market has changed, these are tense times now,' said 21-year-old Mr Konstantin Kraus, who skipped a year at school and has trained with Deutsche Bank through his studies at the Frankfurt School.

'The problem with some of these financial products is that people did not understand what was behind them - banks will be looking for people who do.' -- REUTERS

Entrepreneurial spirit drives Taiwan

TAIPEI - COMPUTER salesman Ke Teh An quit his job with a major Taiwan computer manufacturer to open an American-style diner that he hopes will make him rich.

Such stories are not unusual in Taiwan, which has one of the largest pools of entrepreneurs in the region.

Becoming an entrepreneur is a way of life in Taiwan where go-it-alone businessmen are driven by a desire to become their own boss as well as to make their fortune.

'It's tough, that's for sure, but it's a dream,' Mr Ke said as he worked in his Taipei diner which employs four people and serves an average of 250 customers per day.

'It's a mess out there. Everyone wants to be his own boss,' remarked Mr Ke, who has added a second diner to his burgeoning chain and is already saving up for his third outlet.

Running a business is so popular in Taiwan that more people are employed in small businesses than in Thailand, which has almost three times the population.

'It's a cultural thing,' said Mr Cheng Cheng Mount, an economist with Citigroup in Taipei. 'Among ethnic Chinese, you don't want to be the employee. You want to be the employer.' The entrepreneurial streak in Taiwan dates back to as early as the 1940s, when many of the Chinese businessmen and refugees fleeing the Communists on the China mainland opened shops on the island as there was no major industrial base to provide jobs.

Easily available business permits and government micro-loans keep the entrepreneurial spirit alive today, while poor working conditions and a do-it-yourself spirit also contribute to the desire of many in Taiwan to open their own business.

About 70 per cent of Taiwan companies are listed by the government as 'small-to-mid-sized,' which means they have fewer than 200 employees. Taiwan's 1.24 million small-to-medium-sized firms employed around 7.8 million of the island's 23 million people in 2006 and contributed about 30 per cent of the income generated in Taiwan.

The large number of small businesses in Taiwan has helped cultivate a versatile economy that has been more resilient than it might have been in the face of poor economic performance over the past few years characterised by inflation, wage stagnation and employment barricades, economists say.

'It's basically a good thing, because if a business is more nimble, it can pounce on any opportunity that comes its way,' said Mr Vishnu Varathan, a regional economist with Forecast Ltd. in Singapore.

'They (small businesses) tend to have a bit more ability to react faster than big companies,' he said, adding that Taiwan's wealth of small businesses help 'squeeze more out of the economy'.

Finding a niche
As entrepreneurs scramble to find a niche, Taiwan residents benefit from a wide range of choices and inventive ideas.

Seaweed cakes from Taiwan's north coast, party balloons shaped as giant animals and miniature paper houses for burning at traditional Taiwan funerals are among the one-of-a-kind products that have spawned small, successful Taiwan businesses.

'Price is not necessarily the most important thing,' said Mr Robert Lai, small business director at the economics ministry.

'Specialty is key.' Oddball businesses often prosper most in low-tech fields that require less expertise and capital to start up, Mr Lai said.

Mr Ke's LaGuardia, for example, offers New York bagel sandwiches and burgers alongside traditional Chinese food. Mr Ke started the business even though he had no previous restaurant experience.

The large number of small businesses in Taiwan was apparent at the 2008 Computex Taipei in July, a five-day international computer show, which showcased many of the small businesses plying home-grown products from gadgets to software.

'We're not a big factory, but if you can provide personal service, that helps,' said Mr Jacky Chen, owner of Items Technology Co. Ltd., a Taipei computerised TV equipment exporter with 50 employees and annual revenues of T$400 million (S$17.95 million).

Down the street from Ke's diner, 19-year-old tea entrepreneur Mr Lin Wo Sheng competes with other tea vendors selling tea gift products in bulk to overseas importers, mostly from China and Japan.

Margins are thin, says Mr Lin, but he enjoys the freedom to set his own hours even though that often means working 11 hour days.

'Some people envy me,' Mr Lin says, grinning at he sits on a plush executive chair. 'But some wouldn't do it'. -- REUTERS

Bad credit mars Wall St bankers' summer break

WASHINGTON - JULY is usually a quieter month for busy Wall Street bankers, spent lounging poolside at the Hamptons or on a Caribbean beach, but a nagging credit crunch has cast a dark cloud over such vacations.

Major US banks, including Citigroup, Bank of America, JPMorgan Chase and Merrill Lynch, are due to unveil their second quarter earnings in coming weeks, and analysts say some results will not be pretty.

America's finance houses are weathering one of the worst market downturns in decades as a two-year long housing market slump and a credit squeeze, which erupted last summer, continue to roil balance sheets.

Some bankers believed at the start of the year that Wall Street would ride out the credit storm by the summer, but such predictions have proved premature.

Lehman Brothers announced a net loss of US$2.8 billion (S$3.81 billion) for its fiscal second quarter on June 16, and America's seventh largest savings and loan bank, IndyMac Bancorp, said on Monday it was struggling to raise fresh capital while announcing some 3,800 job cuts.

'It's tough to say exactly when things are going to turn, it really comes down to when the broader economy and the housing markets start to stabilise. When that happens, the operating environment for the banks will start to get a little bit better,' said Mr Ryan Lentell, a senior equity analyst at Morningstar.

Banking analysts at Goldman Sachs expect Citigroup and Merrill Lynch to unveil further quarterly losses this month. Merrill is due to post its earnings on July 17 followed by Citigroup, one of America's biggest financial institutions, a day later.

Media reports have suggested Merrill may sell its respective stakes in the BlackRock investment firm and Bloomberg, the financial information group, to raise fresh funds to help shore up its balance sheet.

A Merrill spokesperson declined to comment on the rumours.

Merrill posted a first quarter loss of almost two billion dollars, but it is still chasing deals. It reached an accord last month to acquire the Chilean brokerage firm Ureta y Bianchi for an undisclosed sum.

Some firms are riding out the credit squeeze, which has forced banks to tighten lending as they seek to stem losses tied to ailing mortgage investments, relatively well.

Goldman Sachs reported an 11 per cent slide in its latest quarterly earnings on June US$17 billion to US$2.1 billion, but its earnings were better-than-expected and were looked on with envy by rivals.

Analysts say JPMorgan Chase, which took over the ailing investment bank Bear Stearns in March, has also escaped the credit crunch relatively unscathed.

JPMorgan Chase is due to unveil its results on July 17.

Aside from mortgage losses, the credit woes have also been fuelled by a sharp downturn in corporate mergers and acquisitions, and initial public offerings (IPOs), from which investment banks reap fat fees.

A hefty slide in US stock markets, the leading Dow Jones Industrial Average has tumbled over 14 per cent so far this year, has meanwhile dented profits from share trading.

And analysts say they are now seeing evidence that banks are being pinched by delinquent home equity and car loans, suggesting some consumers are buckling from the economic slowdown.

The credit storm has been reflected in bank stock prices.

Citigroup's stock had slumped 40 per cent from the start of the year to US$17.39 on Tuesday while Merrill's stock has tumbled 38 per cent to 32.77.

Top regulators have signalled they are keeping a close eye on the health of America's biggest banks.

'The financial turmoil is ongoing, and our efforts today are concentrated on helping the financial system return to more normal functioning,' Federal Reserve chairman Mr Ben Bernanke told a forum this week.

Mr Bernanke spoke a day after the central bank and the Securities and Exchange Commission announced they had agreed to deepen ties to better monitor cash-strapped banks.

The credit squeeze has triggered wider global repercussions and European bankers will also take subdued holidays this summer.

Two large Swiss banks, UBS and Credit Suisse, have posted billions of dollars in losses tied to soured US mortgage bets, and a British bank, Bradford & Bingley, has seen its shares hammered as it vies to right its stricken finances. -- AFP

JPMorgan's Dimon says credit crisis could worJPMorgan's Dimon says credit crisis could worsensen

ARLINGTON (Virginia) - JPMORGAN Chase Chief Executive Jamie Dimon said some problems in the credit markets have been resolved, but that does not mean market conditions will not deteriorate further.

'I do think we have some very serious issues to face,' Mr Dimon said on Tuesday at a mortgage lending forum sponsored by the Federal Deposit Insurance. 'Things could actually get worse.'

Wall Street investment banks should not be considered too big to fail, he said, adding the United States regulatory response to the credit crisis has been appropriate.

Mr Dimon, whose bank is widely expected to acquire a regional bank, said an accounting rule requiring banks to mark assets to their current market value is a deterrent to mergers.

FAS 157, as the rule is known, would force an acquirer to write down the value of assets from a target bank - even if the loans and securities were sound - to reflect current depressed market values. In some cases, Mr Dimon said, a target bank could emerge with negative value under this mark-to-market accounting, forcing an acquirer to raise more capital.

With more short-term suffering ahead for the economy, Mr Dimon said US commercial banks, regional banks and jobs will be the next areas to experience significant stress. Banks must get more realistic about the risk with some products, he said.

'Capital requirements go too low in certain products,' he said. 'You have to try to be as conservative as possible.'

Receivership for investment banks
Regarding the US regulatory response to the credit crisis, Mr Dimon said the top officials have done well within their legislative limitations.

'I think the government is taking proper, in my opinion, monetary and fiscal policy at this point,' he said.

In March, the Federal Reserve helped engineer a takeover of Bear Stearns by JPMorgan and guaranteed a US$29 billion (S$40 billion) loan to facilitate the transaction, out of concern that a Bear Stearns bankruptcy could trigger a financial panic.

The Fed also started making emergency loans to investment banks for the first time since the Great Depression. That measure expires in September, but Fed Chairman Ben Bernanke said on Tuesday the emergency lending facility may stay open past the year end to help restore market stability.

Long term, the US government needs a mechanism to let it act as a receiver for a failing investment bank and set up a so-called bridge bank for an orderly liquidation, Mr Dimon said.

That model now exists for US commercial banks. Treasury Secretary Henry Paulson has called for a similar approach with investment banks.

'The government can take over the institution, wipe out the equity holders and then deal with secured debt in a way that's appropriate,' Mr Dimon said, referring to a receivership mechanism. 'It's complicated, but we need that option. They're not too big to fail.'

Saving the golden goose
He also urged Congress to overhaul the patchwork system of financial services regulation.

'One day we have to stop saying it's not politically feasible,' Mr Dimon said. 'If we don't, we'll never have policies.'

Democrat Barney Frank, chairman of the House Financial Services Committee, will launch a series of hearings on Thursday laying the groundwork for financial services reform legislation in 2009 after a new administration takes over.

Mr Frank has proposed giving the Fed or another agency power to monitor all risk in the financial system. US Treasury Secretary Paulson has said the Fed should be given permanent authority as a 'market stability regulator'.

'I hope things like that start to become serious policy down the road,' Mr Dimon said.

But he also said the financial services industry should be wary of excessive regulation that could limit their activities and drive business overseas.

'We have to worry about the unintended consequences of regulation,' he said. 'Let's not kill the golden goose here.' -- REUTERS

Guard against a second round of inflation: Tharman

By Goh Chin Lian

SINGAPORE must guard against a second round of inflation. The latter could come about if wages are pushed up just to keep pace with price increases.

Finance Minister Tharman Shanmugaratnam issued the warning on Wednesday, noting that Singapore prefers to fight inflation by having a strong Singapore dollar to ward off imported inflation.

The Government will also give help directly to those who most need it, instead of trying to bring inflation down for every one as a whole, he said to a gathering of 500 unionists.

Mr Tharman's call for restraint comes at a time when workers - especially those in manufacturing, transport and administrative jobs - see inflation eroding their wages, and could press for more pay.

Despite wages rising by close to 11 per cent in the first three months of this year, real wages in some sectors fell after accounting for inflation that has reached beyond 6 per cent, according to a recent Manpower Ministry report.

Inflation is forecast to slide later this year, but meanwhile imported food prices have risen 10 per cent compared to a year ago, and petroleum products are 64 per cent higher, noted Mr Tharman.

Still, upping wages to offset inflation was no cure as it would simply cause employers to pass the costs on to consumers as well as dent Singapore?s competitiveness, he said.

In a separate interview with The Straits Times, Manpower Minister Gan Kim Yong said: 'We have learnt from our experience in the 1970s and 80s.'

When wages rose in response to inflation, bosses upped prices, leading to a wage-price spiral then.

Wednesday, 9 July 2008

Credit, housing concerns wipe $1.3 trillion from S&P 500's companies in 2008

NEW YORK - UNITED States financial companies have lost more than US$1 trillion (S$1.4 trillion) in value this year, and yet another decline on Monday shows concerns aren't going away soon.

Banks and brokerages began the week lower on the same fears that have been proven toxic since last summer in the ongoing credit crisis. The financial sector was hit with a confluence of troubles on Monday: cautious remarks from a Federal Reserve official and new capital concerns at Freddie Mac and Fannie Mae.

The drop in names like Lehman Brothers, Morgan Stanley and Merrill Lynch caused the financial section of the Standard & Poor's 500 index to lose almost US$150 billion in value on Monday, according to the rating agency. That means S&P 500's 85 financial components have lost some US$1.3 trillion since the sector reached a high last October.

Even more startling is that shares of 35 of the companies, which include insurers, have lost more than half their value so far this year. The financial sector used to be the index's main driver, and many economists believe that the broader market will rise or fall on their health.

'Some would argue that perhaps the sell-off in financials is overdone, but at the same time there is just much uncertainty out there about write-offs, loan losses, and how bad the housing market is,' said Mr Jim Herrick, a director of equity trading at Baird.

'For a period of time the pain was in the big money centre banks, but now it's spreading.'

Fannie and Freddie fell sharply after Lehman Brothers analyst Bruce Harting said the two government-backed lenders might need to raise billions of dollars in new capital. Both are facing a proposed change to accounting standards that would require financial services firms move bonds backed by pools of loans, also known as securitisations, off their balance sheets.

If this rule is passed, it would end Freddie and Fannie's primary source of generating new revenue. Mr Harting said Fannie Mae would need to raise US$46 billion in cash to meet capital requirements, while Freddie Mac would need US$29 billion.

The broader financial sector was hurt after San Francisco Federal Reserve President Janet Yellen said problems in the housing market and banking system could get even worse before the economy recovers.

Global banks and brokerages have lost nearly US$300 billion from investments in mortgage-backed securities and other risky investments since the credit crisis began one year ago.

And there are fresh signs that Wall Street's biggest investment houses are having trouble navigating through volatile markets.

Goldman Sachs Group, the world's biggest investment bank, disclosed in a regulatory filing that it lost at least US$100 million on nine trading days during the second quarter. Goldman reported that total trading revenue in the second quarter fell 17 per cent to US$4.87 billion, according to the filing.

The firm, known for aggressive trading tactics that can cause big swings from week to week, still far surpassed many of its rivals on the Street. That has put more focus on Merrill Lynch, which will report its quarterly results next Thursday.

Mr John Thain, Merrill's CEO, is said to be examining the sale of stakes the brokerage has in asset manager BlackRock and in Bloomberg. Money raised would be used to offset big write-downs expected at the brokerage.

A spokesman declined to comment about numerous media reports.

However, Mr Thain in the past has said he is open to selling the stakes if Merrill can fetch a good price.

Mr Howard Silverblatt, S&P's senior index analyst, said financial stocks will likely continue to be hurt until some signs develop that show banks and brokerages have a better grip on credit problems.

Merrill's earnings next week could provide that.

'There's still lots of uncertainty out there,' he said. 'And, the financials need to turn around if the whole index wants to recover.' -- AP

Subprime fallout could last two years: Singapore bank head

SINGAPORE, July 8, 2008 (AFP) - The global fallout from the US subprime mortgage crisis could last another two years, the chairman of Singapore-based United Overseas Bank said in a newspaper report Tuesday.

"I hope I am wrong, but my view is that this crisis will take one to two years to stabilise," Wee Cho Yaw, a banker for almost 50 years, told a university commencement ceremony, The Straits Times reported.

A bank spokeswoman confirmed the quotes when contacted by AFP.

The default crisis in the US subprime -- or higher risk -- mortgage sector ballooned into a world credit squeeze as banks tightened lending criteria. The crisis has also battered financial markets.

"What worries me is that no one seems to know the full amount of off-balance sheet securities circulating in the financial markets," Wee was quoted as saying.

The subprime homeloans were repackaged into securities and sold to investors around the world. The wave of defaults led to billions of dollars in losses on those securities, damaging the balance sheets of major international banks.

"And this is what frightens me most -- no one can tell me how much more will be written off...," The Straits Times quoted Wee as saying.

Wee said regulators will need to ensure closer supervision of financial institutions and the "exotic trades" that have arisen over the past decade, the newspaper reported.

UOB has a regional presence, including subsidiaries in Malaysia, Indonesia, China and Thailand.

Monday, 7 July 2008

Stocks: More Doldrums Ahead

Rising unemployment and inflation have market watchers taking back predictions of a second-half rally

News July 2, 2008, 9:59PM EST
by Matthew Goldstein, Ben Steverman and Ben Levisohn

The first six months of 2008 ended with U.S. stock markets in the dumps. Now, with the major indexes in or near bear market territory after touching highs in October, hopes for a happier second half are fading fast.

A toxic brew of sluggish economic growth, rising unemployment, and spiking inflation—otherwise known as stagflation—is prompting market watchers to backpedal furiously on earlier predictions of a rally later this year. Noticeably absent from the discussion are the traditional stock market drivers of strong earnings and interest-rate cuts, neither of which seem to be on the horizon. Economists, meanwhile, are beginning to tamp down expectations for global growth not only for the rest of this year but for 2009 as well—especially with oil surging to new heights.

All of which is leaving traders tossing around adjectives like "tired," "nervous," and "depressed" to describe the mood heading into the slow July-August months. "The market is in for a rough summer," says Gary Wolfer, chief economist with Univest's (UVSP) Wealth Management & Trust Group, who has been dialing down his once-optimistic outlook for corporate profits. Some pros are even seeking refuge in newfangled instruments known as absolute return barrier notes, designed to protect principal first and allow for capital gains second. In this environment, one can't be too safe.

If history is any guide, investors might need to hunker down for a while. James Swanson, chief investment strategist for mutual fund firm MFS Investment Management, notes that the average bear market lasts 406 days, during which stocks fall 31%, on average. Using that benchmark, we're only halfway through the pain.

Unhappy Anniversary
Much of the malaise, of course, stems from the credit crunch, which will soon mark its one-year anniversary. Banks are expected to notch an additional $600 billion in losses in coming quarters from the mortgage mess and the resulting economic troubles, bringing the total to $1 trillion. They're still ducking for cover: In a recent Federal Reserve survey, 70% of banks had tightened their lending standards for home equity loans.

Whether it's technically a recession or not, it certainly feels like one for many individuals and businesses. Credit-card delinquencies are on the rise, meaning banks will have to set aside money to cover a new round of losses from troubled loans. American Express (AXP), for example, issued a sobering statement on June 25, noting that the business environment in the U.S. continues to weaken as "credit indicators deteriorate beyond our expectations."

That's bad news for the broader stock market. Usually, financials and consumer discretionary stocks lead the way in a recovery, but both sectors are heading south now. The Philadelphia KBW Bank Index, which tracks banking stocks, was down 34% in the first half of 2008, compared with 12.8% for the Standard & Poor's (MHP) 500-stock index. And consumer-related companies from Starbucks (SBUX) to Kohl's (KSS) are reeling.

In fact, few sectors are showing signs of life. Technology-industry analysts are fretting about a slowdown in corporate spending, while health-care stocks are being pummeled on fears of policy changes in Washington after the 2008 election. On July 2, for example, medical insurer UnitedHealth Group (UNH) cut its profit outlook for the year. The lone bright spot: energy, especially coal stocks and oil drillers.

Meanwhile, the continued weakness in the financial sector is fueling speculation that another big bank or two will suffer the same fate as Bear ­Stearns. The sharks are already circling Lehman Brothers (LEH), the smallest of the major Wall Street firms. Skeptics say the investment bank can't remain independent, since its new risk-averse posture will make it hard to earn the fat profits the Street demands. On June 30, Lehman's stock plunged to an eight-year low of 20 on talk of a "take-under," in which a larger rival would buy the firm at a price below its market value. The stock later rallied after management agreed to give employees a bigger stake in the company.

Bargain Basement
It doesn't help matters that every time a cash-starved bank seeks a handout from a deep-pocketed investor such as a sovereign wealth fund or a private equity firm, the investment is priced at a deep discount. The twin pressures of more shares at lower prices are weighing heavily on financials in particular and the rest of the market in general. Now banks are feeling motivated to dump noncore assets and businesses to raise capital without hurting shareholders any further. Some analysts think Merrill Lynch (MER) could sell off part of its 49% stake in money-management firm BlackRock (BLK) to bolster its balance sheet. Of course, dumping profitable holdings like BlackRock in a weak environment may only extend the recovery time for companies. A Merrill spokeswoman declined to comment.

With so much uncertainty swirling, some money managers are pushing instruments designed to limit investors' exposure to volatility. Absolute return barrier notes tie up a wealthy client's money for 18 months. If a specific benchmark, such as the Dow Jones industrial average, stays within a certain range over that period the notes pay a hefty interest rate. Should the index deviate from the target range, the investor in these sophisticated products doesn't collect the yield, but the principal remains intact. "It's an opportunity to get an above-market return with protection," says Keith Styrcula, chairman of the Structured Products Assn. "You either get everything or nothing but your principal." Given the way the market has been performing, just treading water may be enough for many investors.

'This financial crisis is far from over'

Business Times - 05 Jul 2008

THERE would be few people who have seen banking and financial turmoil as close up, and from as many angles, as Shaukat Aziz. In his 30-year-long career at Citibank alone, he had first hand experience of several banking crises. In particular, during the early 1990s, he was in the thick of the action when Citibank got into deep trouble after vast amounts of its loans to Latin America, as well as domestic real estate loans, went sour. At that time, he played a key role in convincing Saudi Prince Alwaleed bin Talal - his one-time client - to invest some US$600 million equity into Citi - an equity injection which many observers believe helped save the bank.

Then, as Pakistani finance minister from 1999 to 2007, Mr Aziz was the architect of the economy's dramatic turnaround from near-bankruptcy.

Given his experience, it seems irresistible to ask him for his take on the global financial crisis now unfolding and the lessons he would draw.

It is clearly something he has been watching closely; 'I was hoping you would ask that,' he says.

Mr Aziz points out that the crisis started with securitisation, mainly of US mortgages. 'People who packaged and originated these securities were not carrying the risk,' he notes. 'The whole focus was originating the mortgages, packaging them, having them rated and then selling them to investors.'

'Nothing wrong with that if you do it right. But as the appetite for more securitised paper grew, people who were originating the mortgages put more pressure on their sales forces to generate more paper.'

'So one lesson here - and we're still learning - is that anybody who originates and packages securitised products must hold a certain percentage of the risk. They should not be allowed to trade out 100 per cent. If they were to keep say, 20 per cent, they would monitor the value of the assets. And the rating agencies should not be the primary entities (involved in rating assets). They should be secondary.'

There was also a serious failure of risk management, according to Mr Aziz. 'This should have never been abdicated,' he says. 'Institutions holding the paper must at all times track what the risks are. That didn't happen. Perhaps there was an over-reliance on rating agencies. But when you have a dynamic portfolio where markets are changing, the environment is changing and risk parameters are changing, ratings can get outdated pretty fast. So the risk management department must always have its finger on the pulse and not abdicate its responsibilities to other institutions.'

Finally, there was greed, he says, coupled with faulty incentives: 'Financial institutions face pressures to grow, to show high earnings and pay high compensation to the individuals involved. But compensation should be tied to the maturity of the securities sold - maybe higher compensation initially, but there should always be a direct link to maturity.'

All that, in essence, created the huge capital shortages we now see in large American and European financial institutions.

Mr Aziz sees sovereign wealth funds (SWFs) - government entities with large pools of investment capital, such as the Government Investment Corporation of Singapore - as key players in repairing the capital positions of troubled institutions.

'SWFs are probably the best investors available,' he points out. 'They are not intrusive, they do not look for board seats, they are mature and long term investors. And history shows that if you bet on the right institutions you end up making a lot of money.'

From the regulatory standpoint at least, now is a good time for SWFs to invest, he adds. 'When you enter a market or an institution in a crisis mode, the regulatory environment is favourable and the signals tend to be green. But when you go in during normal times, you will see many amber signals and some red signals. If you enter when the country receiving the money feels they don't need it, there will be barriers. Those barriers drop during an environment of crisis.'

'But this crisis is far from over,' he says. While the financial sector's woes are well-known, the knock-on effects on the real economy are still to play out. 'I am not sure the ripple effects are fully understood. You will see a softness in real estate prices in the US and elsewhere. And as the real economy slows, unemployment will increase and income levels will go down - so there may be more pain to come. The full impact will unfold only in the future. And I think financial institutions may see more pressure on their asset quality, depending on how the real economy reacts.'

I ask him what challenges he sees for Citibank, which he knows so well and which is among the worst-hit financial institutions in this crisis.

'The challenge for Citi is to get all the different parts of the institution working complementary to each other,' he suggests. 'They have done it in the past, they can do it again. Naturally, individual businesses have to be looked at for returns and if they don't make sense, they have to be spun off. The core competencies of an institution like Citi, in my view, are an ability to work in diverse markets and have diverse business products, complementing each other and not conflicting with each other.'

Finally, he cautions that Asian economies cannot but be affected by the crisis and will not 'decouple' from those in the west, as some optimists suppose.

'I don't believe in decoupling,' he says. 'It's a flawed concept. I believe in globalisation. In this day and age, we must believe in the globality of markets and in linkages.'

'Of course the impact will vary and not everybody will be affected to the same degree. But no economy can isolate itself.'

Asia's exporters suffering as global demand weakens

Sat Jul 5, 2008 10:07pm EDT
By Alison Leung - Analysis

HONG KONG (Reuters) - Cliff Sun is hurting.

The 54-year-old chief executive of Kin Hip Metal Plastics had spent much of the past year grappling with rising labor and material costs in China and a strengthening yuan.

Now that the U.S. consumer juggernaut is slowing, he's throwing in the towel and relocating inland from coastal southern China.

"If we don't cut margins or even take small losses these days, we're just not able to get the same level of orders," said the former chairman of the Hong Kong Exporters' Association.

"We're facing a bitter, cold winter ahead."

Sun and others that collectively make up Asia's mighty export engine face a difficult second half with Asia's central banks now ready to sacrifice growth to combat food- and oil-based inflation and with Europe no longer taking up the slack amid downward-spiraling U.S. consumption.

The worst is yet to come. Exports make up 10 percent of China's gross domestic product and up to 30 percent for externally vulnerable economies like Hong Kong and Singapore.

Asia -- much of which had remained resilient in the face of the U.S. downturn -- and China are expected to decelerate with interest rates on the rise, inflation mounting and oil at $145 a barrel.

Toyota Motor (7203.T: Quote, Profile, Research, Stock Buzz), the world's top carmaker, said it could fall short of its U.S. sales target this year as high gasoline prices and a sluggish economy cut into demand.

Deutsche Bank estimates some 20 percent of China's low-end exporters will go belly-up this year.

Foxconn (2038.HK: Quote, Profile, Research, Stock Buzz), the world's top contract manufacturer of cellphones for Motorola (MOT.N: Quote, Profile, Research, Stock Buzz) and Nokia (NOK1V.HE: Quote, Profile, Research, Stock Buzz), lost two-fifths of its value in the past two months on fears that slowing global demand will hit its earnings.

And Japanese exports to the United States fell for a ninth straight month in May, while shipments to the European Union -- which had been holding up well -- recorded their first annual drop in more than two years.

"The Euro area and Japan are decelerating and that's really bad news for Asian exporters," said David Fernandez, Head of Economic and Sovereign Research at JP Morgan.

Hong Kong's exports to the United States -- much of which originates in China, the world's workshop -- fell 1.5 percent year on year in the first 5 months. Exports to the United States from South Korea shrank 0.3 percent in January to May.

"By the year's end and early next year, Asian demand should start to slow," said Daiwa economist Kevin Lai.

WHAT TO BUY?

Analysts and fund managers reckon firms with established brands, which own technology higher up the value chain or enjoy large cash balances -- such as Samsung Electronics (005930.KS: Quote, Profile, Research, Stock Buzz) or Taiwan Semiconductor Manufacturing Corp (2330.TW: Quote, Profile, Research, Stock Buzz) (TSM.N: Quote, Profile, Research, Stock Buzz) -- will fare better in this environment.

"Slowdowns are sometimes a double-edged sword that can benefit outsourcing. So for Taiwan tech this year, export growth is still in the double digits and the fundamentals remain quite solid," said Kevin Chang, an analyst at Yuantai Securities.

Old-economy exporters that need intensive labor, energy or raw materials, such as garment, car and cellphone makers, are more vulnerable to inflating costs and shrinking demand.

Other firms, far from fighting a holding action, might spot an opportunity to expand through acquisitions in a down market.

"If the company has net cash or low debt, they've got flexibility and will not be forced into making any foolish business decisions," said Hugh Young, Managing Director at Aberdeen Asset Management, which has $40 billion in Asian equities.

They "might have a golden opportunity to buy one of its competitors at rock-bottom price."

Energy-saving devices maker Computime Group Ltd (0320.HK: Quote, Profile, Research, Stock Buzz), which ships about half its goods U.S.-ward, has stepped up efforts to enhance technology with automation and by slashing staff.

"We'll focus on our brand and outsource to Vietnam, Mexico and east Europe," said chief executive Bernard Auyang.

SHARES

Weak U.S. sentiment has knocked down many top Asian exporters in the past three months with U.S.-focused trading firm Li & Fung (0494.HK: Quote, Profile, Research, Stock Buzz) plunging 23 percent. LG Electronics (066570.KS: Quote, Profile, Research, Stock Buzz) dropped 16 percent and TSMC fell 8 percent in the same period.

But there's hope yet. Some economists say Asian countries are still posting good growth, surprising the market on the upside.

China, which became the top exporter to the United States alongside Canada in 2007, accounts for 8.8 percent of world exports. Its total exports rose 28 percent in May, beating forecasts of 20 percent.

But the question is how bad it will get.

Toyota expects U.S. vehicle sales, which plunged to a 15-year low in June, to bottom and foresees a modest recovery in 2009.

JP Morgan sees Euro zone growth sliding to under 1 percent by mid-year from 3.2 percent in the first quarter and Japan easing to 1 percent, with downside risk, in the second half.

And China, whose appetite for everything from oil to electronics has bolstered many Asian exporters, could hike rates several times more to curb inflation at a decade's high.

"I believe one-third or even half of the manufacturers in Guangdong will either close or relocate in the next few years to lower cost areas," said Kin Hip's Sun, who claims his "Kinox" brand can be found on 70 percent of U.S. coffee containers.

India's Economy Hits the Wall

Growth is slipping, stocks are down 40%, and foreign stock market investors are fleeing. Business blames the ruling coalition for failing to make reforms

Economics
July 1, 2008, 7:28AM EST
by Manjeet Kripalani

Just six months ago, India was looking good. Annual growth was 9%, corporate profits were surging 20%, the stock market had risen 50% in 2007, consumer demand was huge, local companies were making ambitious international acquisitions, and foreign investment was growing. Nothing, it seemed, could stop the forward march of this Asian nation.

But stop it has. In the past month, India has joined the list of the wounded. The country is reeling from 11.4% inflation, large government deficits, and rising interest rates. Foreign investment in India's stock market is fleeing, the rupee is falling, and the stock market is down over 40% from the year's highs. Most economic forecasts expect growth to slow to 7%—a big drop for a country that needs to accelerate growth, not reduce it. "India has gone from hero to zero in six months," says Andrew Holland, head of proprietary trading at Merrill Lynch India (MER) in Mumbai. Many in India worry that the country's hard-earned investment-grade rating will soon be lost and that the gilded growth story has come to an end.

Global circumstances—soaring oil prices and the subprime crisis that dried up the flow of foreign funds—are certainly to blame. But so is New Delhi. Much of the crisis India faces today could have been avoided by skillful planning. India imports 75% of its oil to meet demand, which have grown exponentially as its economy expands. The government also subsidizes 60% of the price of such fuels as diesel. In 2007, when inflation was a low 3%, economists such as Standard & Poor's Subir Gokarn urged New Delhi to start cutting subsidies. Instead, the populist ruling Congress government spent $25 billion on waiving loans made to farmers and hiking bureaucrats' salaries.

Botched Opportunities
Now those expenditures, plus an additional $25 billion on upcoming fertilizer subsidies, is adding $100 billion a year—or 10% of India's gross domestic product, or equivalent to the country's entire collection of income taxes—to the national bill. This at a time when India needs urgently to spend $500 billion on new infrastructure and more on upgrading education and health-care facilities. The government's official debt, which dropped below 6% of gross domestic product last year, will now be closer to 10% this year. "Starting last year, the government missed key opportunities" to fix the economy, says Gokarn. In fact, he adds, "there has been no significant reform done at all in the past four years"—the time the Congress coalition has been in power.

Even the most bullish on India are hard-pressed to recall any significant economic reforms made in the recent past. A plan to build 30 Special Economic Zones is virtually suspended because New Delhi has not sorted out how to acquire the necessary land, a major issue in both urban and rural India, without a major social and political upheaval. Agriculture, distorted by fertilizer subsidies and technologically laggard, is woefully unproductive. Simple and nonpolitical reforms, like strengthening the legal system and adding more judges to the courtrooms, have been ignored.

A June 16 report by Goldman Sachs' (GS) Jim O'Neill and Tushar Poddar, Ten Things for India to Achieve Its 2050 Potential, is a grim reminder that India has fallen to the bottom of the four BRIC nations (Brazil, Russia, India, and China) in its growth scores, due largely to government inertia. The report states that India's rice yields are a third those of China and half of Vietnam's. While 60% of the country's labor force is employed in agriculture, farming contributes less than 1% to overall growth. The report urges India to improve governance, raise educational achievement, and control inflation. It also advises reining in profligate expenditures, liberalizing its financial markets, increasing agricultural productivity, and improving infrastructure, the environment, and energy use. "The will to implement all these needs leadership," points out Poddar. "We have a government in New Delhi with the best brains, the dream team," he says, referring to Oxford-educated Prime Minister Manmohan Singh and Harvard-educated Finance Minister P. Chidambaram. "If they don't deliver, then what?"

Disillusioned Business
More worried than most are India's businessmen, who have turned in stellar performances with their investment and entrepreneurial drive and begun to look like multinational players. For them, there's plenty at stake. But lack of infrastructure, from new ports to roads, along with an undeveloped corporate bond market and high prices for real estate, commodities, and talent, are causing them to hit "choke points and structural impediments all over. We will lose years," says Bombay investor Chetan Parikh of of Jeetay Investments.

Sanjay Kirloskar, chief executive of Kirloskar Brothers (KRBR.BO), a premier $470 million maker of water pumps, already has $100 million in overseas contracts. Yet few infrastructure contracts have come from New Delhi. Kirloskar had hoped to be part of a grand project linking India's rivers, but those plans have been on hold for four years. "The infrastructure growth we had hoped for has not come about," he says. "Instead, we will now expand overseas more than in India."

Such constraints on growth at home will have an impact. Corporate earnings growth is likely to dip, says Merrill Lynch's Holland, who now predicts just 10% growth, instead of the previous year's 20%. That slowdown makes it less attractive for foreigners to invest in India's stock market. Already this year, foreigners have taken $5.5 billion out of the market, compared with the $19 billion they invested last year. Gagan Banga, chief executive of India Bulls Financial Services, an emerging finance and real estate giant, points admiringly to China's ability to maintain its growth momentum for a decade, while India's has not been able to hold up for even three years. "Serious companies are going to grow at a much slower pace, and some may even de-grow this year," he says. Unless major policy decisions are made by New Delhi immediately to keep the economy on the growth path, he says, "India will slow down even further."

New Delhi defends its four year reign in India. "We've had 9% growth for four years in a row," says Sanjaya Baru, media adviser to Prime Minister Singh. "That is unprecedented." He attributes it to the increasing rate of investment, up from 28% of GDP to 35% currently, "close to most ASEAN economies," though he admits that a large part is from the private sector. "Yes, there is a fiscal problem, but there's a price to be paid for coalition politics," adds Baru. So having growth drop "from 9% to 7% is not grim."

Social Backlash?
Chetan Modi, head of Moody's India, says the increasingly high cost of doing business in India may force global investors who had set up base in India—especially financial-services players—to move to more affordable and efficient hubs, such as Singapore and Hong Kong. If the economy slows and inflation continues to accelerate, says Sherman Chan, economist at Moody's Economy.com, "social unrest is possible."

In fact, India is becoming a dangerous social cauldron. The wealth harvested by the reforms of previous governments has made itself evident in the luxury cars and apartments in India's big cities, leaving much of India full of aspirations but few means to achieve them. There is a severe shortage of colleges, yet a plan to build 1,500 universities gathers dust. The Communists in the ruling coalition are against both globalization and industrialization, so without new factories being built, employment growth has been almost stagnant, rising to just 2%—a disappointing rate in a country where an estimated 14 million youths enter the workforce every year, but just 1 million get jobs in the regulated, above-ground economy.

Meanwhile, few expect any bold moves New Delhi, especially with national elections due in 2009 and five important state elections scheduled before the end of this year. Thus far, the ruling Congress party's record has been poor; it has lost almost every state election this year and is likely to lose all five of the upcoming ones.

The big hope for a return to the course of reform in India, businessmen hope, will be a new government in New Delhi next year. The gravest danger is that India's messy coalition politics will bring into power another indecisive alliance that will keep the country in policy limbo for another five years. If so, says S&P's Gokarn, it's a meltdown scenario: growth slipping below 6.5%, accelerating the chances of India reverting to its 1991 status when it was plunged into a balance-of-payments crisis.

Why Are Oil Prices Rising?

By: James Kingsdalec
Saturday, July 05, 2008 4:11 PM

June was a good month for energy stocks and for the EIS portfolio but the broad market tanked. The impact of high energy prices on both inflation and consumer discretionary spending is being reflected in stock prices. Energy pressures present a special risk to economic stability by coming on top of the twin collapses in the credit and real estate markets.

So far Mr. Market seems able to distinguish between the very healthy energy sector and the tenuous economy. I fear that at some point we’ll get a sustained - 1930’s style - bear market in all stocks which will take down the energy stocks along with everything else. In fact we’ve seen a few days like that already, generally followed by big pops in energy stocks later.

That fear is why I have a commodity strategy included in the EIS portfolio. It is insurance against the collapse of energy stocks as part of a general market collapse. I implement it with options on long dated crude and natural gas futures contracts. If you do not use a futures account and depend only on stocks but want to be invested in physical oil or gas, you can use an ETF like USO or OIL for oil or UNG for gas.

Despite the S&P’s 8.8% drop in June, stocks in the EIS portfolio were up 4.2% for the month which beat the broad oil ETF, IYE, but was slightly under the oil service sector’s sterling 5% gain as represented by OIH. My shipping stocks held the portfolio back. Apparently the stock market thinks the China boom is peaking. I doubt that.

My commodities strategy was up only slightly in June despite large gains in the commodity prices due to heavy-handed meddling by yours truly. Total EIS performance including the commodity strategy was up 4.4% for the month of June and the year-to-date gain of 32.9% has to be considered attractive given the 12.5% S & P loss since 1/1/08. I guess outperformance by 45.4% for the first half of the year should make my stockholders happy. I’ll go ask my wife.

What’s the Lesson Here?

June’s lesson, I think, is the value of Tsunami Investing so I’m going to spend a little time reviewing it.

Oil and gas are a perfect investment Tsunami. Oil scarcity is increasing and will be with us for at least another ten years. Natural gas will also soon become scarce. (It’s price has actually risen faster than oil so far this year.) So the short version of my advice to myself is don’t try to be clever. Keep the investment posture simple in terms of both stocks and commodities. Don’t try to trade it. Be there when oil becomes truly scarce after 2010.

A Review of Tsunami Investing

If a major trend - an economic Tsunami - is unfolding why not be invested in the companies that will be lifted by it? In fact one might dare ask why be invested anywhere else if you can stand the volatility associated with a concentrated portfolio. Why not let the vast bulk of investors who are pushed by a trained army of brokers, advisors, and lawyers to be “diversified” buy all those stocks that together by definition yield an average return?

Is Tsunami Investing Really That Easy?

Well, no. In addition to buying Tsunami stocks you have to do one other thing. You must hold on. Don’t sell when you think the stocks have become temporarily overpriced. You could be wrong about the timing. And even if you are right, the payback in trading turns out to be small compared with a buy-and-hold strategy.

There are a few other Tsunami rules also:

1. It must be a real Tsunami not just a macro-trend.

2. You must identify the Tsunami early enough in its life-cycle to benefit from it.

3. You must pick stocks that are central to the Tsunami, not peripheral.

Tsunamis vs. Long Term Trends

Long term trends are what create growth stocks and there are a lot of growth stock managers. It is a fine strategy. You pick a trend like the aging population or the growth of China or biotechnology or the internet. Then choose some companies that are benefiting from whatever trend you’ve identified.

That is not Tsunami investing. The difference between a long term trend and a Tsunami is that the Tsunami is (as the name implies) very concentrated and very powerful. It will be over within one or, at most, two decades. It is easy to identify exactly which companies are part of it and all of those companies will be successful so long as the Tsunami is gaining momentum.

Long term trends, on the other hand, are identifiable but not as strong. They contain many more companies, most of them are only indirectly affected, and some of them will not be winners. A successful growth stock manager must know his companies very well to be sure that he picks a Dell and not a Gateway, for example. You want a Genentech or Biogen, not an EntreMed.

When I was building a cable TV business in the ’70’s and ’80’s the right answer to any cable property acquisition opportunity was “yes”. It did not pay to be clever. It did not matter which company you bought. And if you were an equity investor in the stock market, it also did not matter which cable company’s stock you bought. The only thing you had to do was just buy it! Oh, and hold on to it too. The same thing held true for cellular companies in the ’90’s and also for real estate investment trusts in the ’90’s and the first part of this decade.

The same thing is pretty much true for today’s energy Tsunami. Companies that are central to the long term production of oil and gas will all win. It does not matter if you choose Encana or Devon or XTO. It only matters how well whatever companies you pick are able to secure oil and gas. That’s why my favorites are the oil sands plays; they have enough oil to last well beyond anyone’s investment horizon, so they are the most central to the energy shortage Tsunami.

Tsunamis Gain Speed, Then Peak, Then Lose It

Unlike a long term trend that may extend at roughly the same rate of growth for many decades, a Tsunami is like a bell shaped curve. So timing is important for the Tsunami investor. If you bought into cable in the late 90’s you were wrong. If you bought any time before the mid- to late ’80’s you were right, and the earlier the better.

By the same token, you would not have gained much if you waited until the year 2000 to figure out that cell phones were going to be the future of telephony. It was too late. You should have seen that coming by, say, 1995, when there was still enough time to make good money. Better would have been 1992. I began attending investment seminars on cellular in 1988.

What about the oil and gas Tsunami? It started in 2004. Probably it will peak some time in the 2015 - 2025 time frame. So using the cellular time frame, now may be roughly the equivalent of 1993 for oil. There is certainly still time for major gains in oil and gas stocks despite the fact that a lot of the money already has been made.

One thing about the oil Tsunami that is different from other Tsunamis is that it’s power is so enormous that it could have a destructive impact on society’s financial infrastructure similar to a real tsunami’s impact on the place where it lands. The cresting of the oil Tsunami in the 2010 - 2018 time frame could destroy stocks, including even energy stocks. That is why a position in the physical commodity seems like a necessary aspect to a strategy concentrating in energy investments.

Beware of False Profits

You also need to pick stocks central to the Tsunami, not ones that are a mini-trend or a sub-wave related to the Tsunami but not inherently part of it. For example, in the energy world today there are a lot of companies making photo-voltaic electricity generators. Some have been good investments, some not, depending a lot on when you bought the stock and which company. But PV solar is only indirectly connected to peak oil and the related demise of the age of petroleum; not all PV companies will be successful.

Tsunami companies tend be acquired as the industry matures. No matter how “expensive” a cable stock or a cellular stock seemed to be at any given time, none of those companies ended up selling out at any price other than near the highest price they had ever sold for. Granted, a few of them such Comcast and Time Warner made the mistake of buying late in the game when they should have been selling, just as the Tsunami was peaking. But the other 98% of the cable companies sold out at their peak price.

On the other hand, I managed to find some ill-fated investments that were related to cable and cellular but were not right at the center of the Tsunami. One was a “Chinese cellular” company. Back in the early 90’s China was a different animal than it is today in terms of its business and financial practices. That company went under. Why I felt it necessary to go to China to invest in cellular when there were fine opportunities right here is not clear.

Similarly, there was a television distribution technology like cable in some ways called “MDS”. Companies that chose to “bypass cable” by using MDS did not end happily, nor did their stockholders. There were “specialized cable companies” too that served sub-markets like hotels. Some of them ended badly.

Similarly there are “false profits” in the energy space today. Most of them are part of the “alternative energy” universe. Some are involved in battery technology and other aspects of electric cars (which might become another Tsunami at some point). Some, like ethanol have already fallen on their swords.

The heart of the energy Tsunami is the production of oil and, secondarily, natural gas. The companies with the largest reserves and the greatest proven ability to increase reserves of oil and gas will grow in value the most. Close to the heart of the Tsunami are those drilling and service companies that enable the production of oil and natural gas.

Sometimes I think that the smartest thing an investor can do these days is put everything into Canadian Oil Sands Trust. With a nearly 8% dividend and more oil reserves than they have even bothered to prove, what could go wrong? Well, politics for one. And the possibility that they will get bought out requiring a tax payment and reinvestment program. Plus something will change if/when the Canadian taxes on trusts are revised. So some diversification of corporate vehicles is a good idea. That’s the least a Tsunami investor can do to earn his keep.

On the other hand ,and as a final note on investing in the energy Tsunami, the S.E.C. is currently revising its rules for reporting by oil and gas companies. The revision will allow them to count oil sands as reserves which could unleash a massive oil sands acquisition program by the oil majors. Best to own these stocks before Exxon starts writing checks.

Oh, and India is another rumored buyer of oil sands properties, but because they need the oil, as discussed below.

Why Are Oil Prices Rising? “The Answer” Comes into Focus

Recent information and analysis has clarified the dimensions of the energy Tsunami - what is causing the price to rise and how future prices and supplies will behave. The distinguishing characteristic of the picture is complexity. People want simple answers which is why so few of them understand oil. The oil world is huge and its behavior is multifaceted. Understanding it takes more than a simple minded idea like “blame the speculators.”

The reality is that the oil market is undergoing a sort of “perfect storm” of many different factors, including:

1. A group of countries that together produce 13% of the world’s oil are mismanaged or infested with political violence causing them to produce far less oil than they could if they had a stable government and market economy. The underproduction could be as much as 5 to even 10 mb/d.

2. Russian oil production is declining. That fact has dire implications for the amount of oil available to future export markets, as discussed in the link. When you combine declines in Russia with those of Mexico and the North Sea, the extent to which non-OPEC supply could decline in coming periods becomes significant.

3 Within OPEC it is uncertain as to whether Iran and Nigeria will increase or decrease their oil exports in future years. Saudi Arabia, Angola, and Libya are the only OPEC countries likely to increase oil production near term. Iraq is a potential bright spot starting in a few years at best.

4. Old oil fields produce less oil each year, which is called the decline rate and the amount by which they decline must be made up by production from new fields. Global decline is estimated to be about 3.5 - 4 mb/d per year, a much greater number than additional oil demand that is estimated to range from 1 - 2 mb/d per year.

Decline rates for existing fields have been rising and will probably continue to rise as more extreme methods of recovery are applied to old wells. The geological rule is that as efforts to increase the output of a field by extraordinary pressurization and drilling efforts becomes greater, the field will decline much more rapidly once the decline starts. For that reason, there is a a risk that the largest Saudi fields - and others such as Russian fields - may decline more rapidly than currently is projected and such increased declines could start to happen fairly soon.

An additional important fact regarding decline is that newer fields tend to be offshore and offshore fields exhibit much higher decline rates than land based fields. Offshore fields often decline by 8% - 15% per year compared with 5% - 8% for land fields.

5. Megaproject analysis indicates oil supplies coming from new oil fields will substantially drop after 2010 and will drop even more steeply after 2013. Some projects scheduled for the next few years could face substantial delays. If so, some of the projects now projected to start up in 2008 - 20010 will be delayed into the 2011 - 2015 time frame. That will add to price pressures in the near term. The megaprojects work is the most tangible evidence of a coming oil supply crisis.

6. New oil fields are located in increasingly difficult environments such as deep offshore or difficult fields like Kashagan. Costs of oil recovery in these fields are much higher. Higher costs are partly due to the fact that it takes more energy to recover the oil from these fields, so the Energy Return on Investment is declining.

This means the amount of net oil recovered after oil expended in the process of recovery is lower in these new, more expensive fields. If you project this trend into the future, at some point there would be no net gain at all from the process of extracting oil from new fields. At that point, which is well out into the future, there could be no more oil available at all.

7. In addition to the real historical phenomena discussed above, oil prices reflect to some degree whatever fears there may be that future political events may reduce oil supplies. The most important risk today is clearly the possibility that military action will be undertaken to keep Iran from having nuclear weapons. There are clearly no good choices for the West. An Iranian bomb would be a very clear and present danger to the security of the developed world but a military attack would clearly bring immediate instability and the risk of even greater future conflicts.

8. At the same time that all the above factors are influencing oil prices, higher oil prices are moderating demand somewhat, particularly in OECD countries. But while demand is declining in developed countries it is continuing to increase from developing countries, particularly in oil-exporting countries where fuel prices are subsidized and therefore market mechanisms do not impact consumer oil demand. The enormous - almost unimaginable - new wealth of oil exporting countries is being used by many of them to develop new industrial bases, which growth adds to their enhanced consumer demand to yield huge increases in their own use of their oil and thus decreases in their ability to export it.

It is not clear that the reduction in subsidies in developing countries that do not export oil such as China will reduce demand. In fact it could have the perverse impact of increasing usage in developing countries if higher prices cause an increase in the supply of fuel available to their consumers.

9. One way to sum up the outlook for the oil supply available to importing countries is to look at all the countries which produce more than one million barrels per day and which together supply 88.4% of world oil. An analysis of these countries that accounts for the projected internal use of their own oil production projects that their exports (which is not the same thing as production) are likely to decline going forward from today. If true, that would account for an increasing price of oil.

I’m sorry this discussion was so long. Unfortunately, there are simply a great many influences on the price of oil. It is quite wonderful that all this complexity gets boiled down into a single price that changes minute-to-minute. Oh well, blame the speculator.

Goldman Sachs Information, Comments, Opinions and Facts