Global Stock Market BLOG - Mike Burnick

The Long and Short of Exchange-Traded Funds

Global stock markets were down once again pretty much across the board on Wednesday, as worries persist about slowing economic growth worldwide. Most major exchanges in Europe, the Americas, and Asia fell in unison – although Russian and Shanghai shares both gained.

The selling, though nothing dramatic, extends a lackluster week for global equity investors. A heightened sense of uncertainty has crept into financial markets – and the growing sense of doubt among investors is palpable.

So at times like this, what can you do to help safeguard your global investment portfolio? How about an inverse ETF?

Correction Protection Made Easy with ETFs

In my service, Global Market Investor, I specialize in showing you how to tap into emerging opportunities with explosive profit potential in financial markets all around the world.

One of the best ways to invest in many of these opportunities is through global exchange-traded funds (ETFs). There’s a very wide-range of ETFs available today that give you diverse investment choices.

There are a growing number of ETFs that track alternative investments, such as private equity, commodities and real estate – and you can invest in them all using a standard brokerage account. What’s more, these diverse investment options are easily accessible, just as close as your discount broker’s website.

But there’s a new class of ETFs that really provides a unique twist on traditional investing: inverse ETFs.

Inverse ETFs, similar to inverse mutual funds, give you the opportunity to profit when financial markets decline. Rydex Funds and ProFunds were among the early pioneers of inverse mutual funds, and now ProShares (an affiliate of ProFunds) has branched out into ETFs with this same concpt.

Last year, ProShare launched a series of ETFs that basically let you sell-short popular U.S. stock market indexes in order to hedge against – and profit from – a stock market correction.

How To Profit with Inverse ETFs  

Let’s say you’re bearish on the Nasdaq 100 Index, thinking tech-stocks may be headed for a fall. You can purchase the ProShares Short QQQ ETF (symbol: PSQ) and if the Nasdaq 100 falls 10% in value, your ETF should rise about 10% – delivering opposite (or inverse) returns to the market.

And if you’re a perma-bear, and really think the U.S. stock market is in trouble, ProShares has a set of ETFs that give you double the inverse performance of the market. So if for example, the Nasdaq 100 index falls 10% – the ProShares Ultra Short QQQ ETF (symbol: QID) would be expected to gain 20% in value – talk about doubling-down!

ProShares also offers ETFs that upside leverage to several leading stock indexes, so you can catch the market’s rebound too. For instance, the ProShares Ultra QQQ ETF (symbol: QLD) aims for twice the upside return of the Nasdaq 100 Index.

I’m certainly not advocating that you should begin day-trading these innovative ETFs, trying to catch ever twist and turn in the markets. But as a smart way to hedge your other stock or mutual fund holdings against a potential market decline, these inverse ETFs add a versatile tool to your investment arsenal – call it correction protection for your portfolio!

Why Constitutional Reforms in Mexico Should be a Windfall for its Energy Sector

Mexico’s legislature took some very hopeful steps recently toward economic reform, which promises to help defuse a looming pension crisis that’s been hanging over the country for years.

What’s up next up the legislature’s agenda? Hopefully, they’ll tackle constitutional reforms, which could bring a windfall of foreign investment into Mexico’s key energy sector.

Following soon after populist legislation to help curb skyrocketing Tortilla prices (see: Signs of Creeping Inflation … in Popcorn and Taco Prices, January 23, 2007), Mexico’s lower house of Congress – the Chamber of Deputies – recently tackled more serious issues; passing a bill that would set up individual pension accounts for public-sector workers in Mexico.

Pension Reform is a Good Sign That Mexico is Serious about Tackling Tough Issues

The plan, vaguely reminiscent of Social Security reform proposals circulating north of the border would provide a more secure safety net for Mexico’s working class, in exchange for extending the typical retirement age by ten years.

According to a report in the Financial Times, this is “the first serious attempt at economic reform under the new government of (President) Felipe Calderón.” This important piece of legislation now moves on to the Mexican Senate, where prospects for passage are very good, since both major political parties in Mexico’s Congress are squarely behind the reform legislation.

This is a refreshing sign of Mexican bi-partisanship and increases the probability that the government may be able to tackle still more ambitious reforms: specifically, a constitutional amendment that could bring about much needed fiscal reforms to stimulate investment in Mexico’s energy sector.

Constitution Holds Key to Mexico’s Energy Future

As conditions exist today south of the border, the state owned energy giant Pemex is faced with declining oil output amid a global energy boom.  What’s the reason? Mexico’s constitution presently prohibits foreign private companies from investing dircetly in Pemex in any sort of production-sharing arrangement.

This is of course a holdover from a previous generation of Mexican authorities, always wary of gringo-exploitation of the nation’s crown-jewels – namely Mexico’s rich oil and natural gas reserves.

But the unintended consequence of this constitutional restriction on free enterprise has been decades of underinvestment in modern oil-well production technology in Mexico, which has led to a precipitous decline in oil and gas output at Pemex. 

In fact, the giant Cantarell complex, the world’s second-largest – and source of 60% of Mexican oil reserves – experienced a 13% fall off in output last year – and oil production could decline another 15% this year, according to the Financial Times.

Pemex Posts Losses, Despite Surging Crude – and All of Mexico Suffers as a Result

In spite of record high crude oil prices during 2006, Pemex actually suffered a net loss of about $7 billion last year due to declining oil and gas output and other ineficiencies.
And since the Mexican government counts on this oil revenue to supply more than one-third of its total national income, this isn’t good news for the country as a whole.

Pemex needs to invest billions to modernize Mexico’s energy infrastructure, which is money the firm just doesn’t have in its coffers. The answer is for global oil companies outside of Mexico to invest in Pemex, but right now they’re unable to do so – due to Mexico’s constitutional prohibition.

Another huge energy producing country in the region, Venezuela faces this same sort of capital investment drought, but for different reasons. It’s Hugo Chavez and his zeal for nationalizing Venezuela’s energy assets that has frightened away western investors, and for very good reason.

So this is a golden opportunity for Mexico to cast a vote in favor of free enterprise-minded reforms. That can pay huge dividends for the country and its energy sector – a true win-win situation

Mexico’s government has an important – even historic – opportunity to address this issue with a few constitutional reforms. And in the process send a clear message to global investors that Pemex is open for business. Let’s hope Mexico finds the political will – and economic foresight – necessary to do just that.

Banking on China’s Mainland Stocks

Chinese stocks have bounced right back from February’s sell off. In fact, after rising 121% last year, fueled by a rush of retail investors clamoring to invest, the Shanghai and Shenzhen 300 Index is up about 20% so far this year – notwithstanding sharp drops of about 12%, and 10% in the past two months.

With the index of China mainland shares once again flirting with new highs, it’s worth taking a look at the valuation in this market.

As my contact at DBS Bank Ltd in Hong Kong tells me, the Shanghai and Shenzhen 300 Index is valued at more than 30 times earnings presently – compared to about 15 times earnings for the Morgan Stanley Emerging Markets Index as a whole. This makes Shanghai shares one of the most expensive markets in the world right now.

But one sector in particular, although also richly valued at the moment, may benefit over the long run by recent changes to China’s corporate tax laws.

China’s Banks Get A Boost form Tax Cuts

The National People’s Congress, China’s main legislature, recently made changes in China’s tax laws that eliminates favorable tax breaks for foreign companies doing business in China. Some of the provisions in the new law however, may end up giving a big boost to Chinese banks.

The new statutory tax rate for all Chinese corporations falls to a single 25% bracket, down from 33% previously, but the big winners will be China’s large banks, according to analysts at JP Morgan. That’s because under the old system, banks paid both income and revenue taxes, which together accounted for almost 50% of all pre-tax profits earned by China’s banks.

The new law, which goes into effect next year, promises to be a double-bonus for mainland banks. Not only will they see a reduction in the statutory tax rate – but the revenue tax will also be gradually phased out as well.

This is potentially a very profitable change for Chinese banks. According to estimates by JP Morgan, a 1% cut in income tax should lift the fair market value of China’s banks by 3%. What’s more, a 1% reduction in the revenue tax should raise bank values by 7%! That’s good news for investors in Chinese banks.

Now for the Bad News…

China’s banks should benefit down the road from this tax-reform, and they’re going to need this boost in value too. That’s because Chinese banks are pretty richly values right now.

There’s been a lot of hype surrounding Chinese banking stocks lately. In fact, just last year Industrial & Commercial Bank of China Ltd., raised $22 billion in the world's biggest initial public stock offering. Since its’ IPO, ICBC shares have gone through the roof.

This frenzy for Chinese banking shares has driven the group to trade at a premium valuation of more than 3 times forecast book value, compared to an average of just 2 times book value for other emerging market banks. In fact two stocks, Shenzhen Development Bank and Shanghai Pudong Development Bank, each trade at more than 4 times book.

Banks Finance Shanghai Stock Speculation

Recently, Chinese authorities announced the creation of a task force to clamp down on illegal lending practices at Chinese banks. Over the past year, an estimated 300 billion to 500 billion yuan of bank loans may have financed stock market speculation, according to the Chinese Academy of Social Sciences' Institute of Finance & Banking.

So there may be a bit of “froth” in China’s bank stocks at the moment, making them poor investments in the near term. But over the long haul, these are companies that investors can probably bank big gains on. 

The Fed Blinks – Or So Wall Street Seems to Think

The facilitators of global liquidity – aka the U.S. Federal Reserve – gathered once again in Washington this week to decide the fate of U.S. monetary policy. To no one’s surprise – the Fed left overnight lending rates unchanged at 5.25%.

Considerably more interesting, the Fed apparently inched a bit closer toward a true neutral policy stance but Wall Street acted more like a rate cut was already in the bag.

While maintaining its belief that risks of inflation are the main concern, the Fed nevertheless dropped its reference to additional rate hikes perhaps being needed. Instead, the Fed adopted a softer, gentler tone stating, “future policy adjustments” (implying either rate increases OR decreases) will depend on the economic outlook going forward.

Is the Fed Already Too Restrictive?

With a policy rate currently above 5%, some have accused the Fed of already being too restrictive considering the growing evidence of a slowing economy.

But others believe the Fed has a greater responsibility to reign in loose credit to prevent any errant “asset bubbles” from growing to destabilizing proportions in financial markets.

So Ben Bernanke and the Fed continue to walk a tightrope, trying as best they can to please all investors all of the time. For some Wall Street types, those who never met an asset bubble they didn’t like, there’s a growing belief the Fed should move to cut rates by mid year, and perhaps several times before year-end.

Of course hopes of Fed rate cuts have periodically been built up before on Wall Street, only to be dashed subsequently by the Bernanke Fed. But given growing evidence of slower growth in the U.S. economy, and in corporate profits, maybe this time Wall Street has got it right.

Hope Springs Eternal for Lower Rates by Mid-Summer Amid Clearly Slowing Growth

According to analysis by www.briefing.com, first quarter GDP growth, the broadest measure of U.S. economic output, is expected to fall to a rate of just 2.5%. That’s well off the above-trend pace of 5.6% GDP growth achieved this time last year.

Also, profits at America’s largest public companies seem to be taking a nosedive.

Following 14 straight quarters of double-digit year over year earnings growth, profits for companies in the S&P 500 Index are expected to inch ahead just 4.3%, according to data compiled by First Call. That’s only about half the growth rate forecast by Wall Street just two-months ago – and well behind the blistering 15% earnings growth rate posted in the first-quarter of 2006.

There’s little doubt that the economy is slowing. The real questions now are: how much, how fast, and how long? The Fed may be able to help provide some answers depending on the future course of monetary policy.

Wall Street is betting on rate cuts ahead – and perhaps this time they’re correct – but they should also be careful what they wish for.

Opening China’s Financial System – Wall Street Style

U.S. Treasury Secretary Hank Paulson traveled to China recently, delivering the message that China’s protected financial sector would do well to accelerate reforms, and more fully open up its banking system.

Apparently, Mr. Paulson thinks China’s financial sector could benefit by operating more like … Wall Street!

Last year, China took steps to liberalize the banking system, lifting some legal restrictions. But Beijing still limits foreign ownership in its equity markets, and excludes overseas companies from holding controlling interests in China’s banks, brokers, and asset managers. The government even dictates interest rates earned on bank deposits as well as the rates charged for loans.

The point is China’s banking sector isn’t really open just yet to foreign competition. For example, if a Chinese citizen wants to open an account at say, a Citibank branch in Beijing, a minimum deposit of about US$120,000 would be required – which effectively eliminates all but a slim minority of China’s population from banking with Citibank.

Wall Street’s China Agenda

But I doubt Mr. Paulson’s real agenda is to get Citibank ATMs on every street corner in Shanghai – that’s a low-end business for most banks. No, what Mr. Paulson, and American financial institutions are really after is fuller access to much more lucrative businesses, such as investment banking, trading, commercial lending and asset management.

Trouble is, China’s existing banks, which have been troubled by indiscreet lending practices leading to massive non-performing loan losses, probably aren’t ready for the impact of full competition at this point.

So far Beijing has preferred internal reform, trying to reign in loose lending practices through centralized regulation, and a series of rate increases, rather than using the hard medicine of open competition to accomplish this task.

Stability vs. Innovation in China’s Financial Sector

The great fear in Beijing is that too sudden a shift in deregulating the financial sector could result in instability - of both the economic and social variety.

But Paulson, an alumnus of the premier American investment bank Goldman Sachs, did his best to lobby China on behalf of his U.S. financial service constituency, insisting that “a broader base of institutional investors and asset managers will lead to a wider array of market strategies, reducing volatility and the risk of ‘herd mentalities.’”

Wall Street types like Paulson know all about herd mentalities.

Another thing they’re good at is creating unique investment products and services - then inventing a perceived need in order to sell these products – earning big fees and commissions in the process.

Paulson went on to tell the Chinese “institutional investors are the most rigorous in their analysis and innovative in developing new securities and investment strategies.”

Perhaps Goldman Sachs has an innovative sub-prime lending strategy it would like to roll out to eager Chinese borrowers. After all, this innovative and rigorously tested product works so well in promoting financial stability in American markets.

Will Sub-prime Woes Sink Financial Markets?

There has been much written about US housing market woes and the likely impact this sector will have on overall growth. I won’t get into all the gory details once again, except to say that investor sentiment in this sector sure looks about as ugly as it gets.

When the CEO of a prominent homebuilder remarks on an open conference call to Wall Street analysts and institutional investors alike that the outlook “sucks” – you know industry conditions are at a pretty low ebb.

Sub-prime Mortgage Market “Sucks” Too

Last week, investors were presented with a fresh housing-related disaster to consider. It seems that sub-prime mortgage loans are defaulting at an accelerating rate. Never mind that overall growth in the economy is in the midst of a pretty swift deceleration of its own, and that it's not particularly uncommon for high risk loans to go bad in such an environment.

A closer look at the hard data seems to indicate that while mortgage loans gone bad are certainly on the rise – conditions could get much worse – indeed they have in past housing recessions – before the bears should think about hitting the panic-button.

According to data from the Federal Reserve, total outstanding mortgage debt stood at $9.676 trillion at the end of last year. The latest report from the Mortgage Bankers Association showed the delinquency rate for mortgage loans had risen to 4.95% up from 4.8% this time last year. In fact, delinquency rates for sub prime borrowers – the segment of this market that’s currently being pilloried –are no higher now than in 2002.

Of these past due loans, just 1.19% were technically in foreclosure as of the end of 2006. This represents a potential total loss of about $115 billion to the nation’s lenders, based on the latest numbers for total mortgage debt outstanding. But in reality, even in worst case foreclosure proceedings, banks typically recoup about 50% of the outstanding loan value.

This further reduces the potential hit on bank loan portfolio write-offs to about $58 billion -- that's assuming that 100% of today's "delinquents" decide to throw the front-door keys in the mail-box and walk away.

Much Ado About Mounting Mortgage Delinquencies

Interestingly, this same Fed report also said American’s household net worth rose to a record high of $55.6 trillion at the close of 2006, or 575% of disposable income – indicating that perhaps our personal balance-sheets are not yet as upside-down as some would have us believe. I didn't see much mention of the record net worth figure in the press; probably squeezed out by all the juicy sub-prime news.

Rising delinquency rates in the sub-prime market, or even in prime mortgage loans, are only to be expected as the economy downshifts to a slower rate of growth. But at less than one-tenth of one-percent of total household not worth – bad mortgage debts would really have to snowball much more from here to create much in the way of a legitimate issue for the banking system.

There’s certainly not enough evidence yet to be warning about a potential credit-crunch in the making.  To the contrary, the Mortgage Bankers Association recently reported that home loan applications rose 19.1% from a year ago!

Investors Wary of Baltic-Bucks amid Rumors of Devaluation

Low volatility in global financial markets have been accompanied by terrific gains in recent years, but it has also bred an unhealthy degree of complacency among investors who assume the global “Goldilocks” scenario can carry asset prices higher forever – growth as far as the eye can see - with little in the way of downside risk.

My colleague Jack Crooks has been warning Sovereign Society Members about the potential of risk getting priced back into global financial markets, and the likely consequences (Don't Get Fooled Again: More Risk May Return to the Market!). At the margins we are beginning to see more and more signs of just this sort of potential trouble ahead. Case in point: Latvia.

Currency Concerns Knock the Lat Lower

Recently, the Latvian currency (the lat) fell to an all-time low; the reason … too much of a good thing. Economies in the Baltic states of Latvia, Estonia and Lithuania have been going gangbusters – as has been the case in many emerging Eastern European economies.

Gross domestic product (GDP) growth in Latvia was clocked at nearly 12% last year, fueled by soaring domestic consumption. The trouble is there hasn’t been enough domestic production to balance out all this conspicuous consumption – and Latvia's trade picture has deteriorated alarmingly as a result.

In fact, Latvia's current-account deficit amounted to a staggering 24% of GDP in the third quarter – with imports jumping nearly twice as fast as exports. What's more, Latvia’s strong GDP growth – the highest in the EU last year – has also been accompanied by an unwanted byproduct: accelerating inflation, which at more than 7% now is also the highest in Europe, according to the Financial Times.

Soaring Trade Deficits Spell Trouble Ahead for Latvia

The growing trade deficit in Latvia, just as here in the U.S. is being financed by the kindness of foreign creditors, as evidenced by the fact that Latvia’s net foreign debt has grown sevenfold since 2000, according to Bloomberg. This adds more uncertainty to Latvia's financial stability.

The easiest way out of this structural imbalance is for the lat to fall in value, since a lower currency would quickly shrink Latvia’s growing trade deficit. And in spite of “official” central bank assurances to the contrary, rumors have been swirling that Latvia may be forced to devalue as the easiest way out.

The trouble with currency devaluations however, is that they are notoriously difficult to keep contained.

Asian Contagion All Over Again?

Latvia’s toxic mix of large current account deficit, rising inflation and break-neck credit growth, looks a lot like Thailand in 1997 – just before it devalued its currency – sparking the “Asian Contagion” financial crisis; a domino effect of competitive devaluation that hit several fast growing Asian Tiger economies that year.

Like Southeast Asia then, Eastern Europe now shows eerily similar imbalances – not just in Latvia – but in many fast-growing nations throughout the region. In fact, many eastern European economies have a similar story: fast GDP growth, rising inflation, wide current account deficits, and easy credit.

Current account deficits total about 10% of total GDP in six out of ten Eastern European “Tigers”, according to Danske Bank in Denmark. And credit is expanding at a rate of 50% annually in Latvia, Lithuania and Romania – which only makes the situation more unstable.

Governments that maintain fixed exchange rates are especially vulnerable to financial instability, because deep-pocketed currency speculators can often outgun smaller central banks – just ask George Soros. The three Baltic currencies all maintain a fixed currency peg to the euro, and so does Bulgaria. Many other countries in the region manage their currencies in a trading band against the euro. This is very similar to the way Asian currencies were managed before speculators helped force widespread devaluations in Asia two-decades ago.

Emerging Eastern Europe in the “Danger Zone”

Back in Latvia, the central bank has pledged to defend the lat to the last by selling euro if necessary. Trouble is, the bank has only about $4.4 billion in foreign currency reserves, according to Bloomberg, which amounts to just 4-months worth of imports.

That’s not much in the way of fire-power to defend against a run on the lat by determined speculators. By contrast Russia maintains about $300 billion in reserves, amounting to 2-years worth of imports.

Danske Bank, the Danish firm that warned about Latvia’s plight in a recent report, says that among the 10 east European EU members, Latvia, Estonia, Lithuania, Romania and Bulgaria are all in the “danger zone” for financial instability and potential currency devaluation. Danske Bank analysts say they are “concerned about the state of economies in central and eastern Europe in general”, because several nations in the region “could become more vulnerable with the ending of easy monetary conditions globally.”

So emerging market investors should keep a close watch on the way this situation develops, because an ongoing global liquidity drain might just lead to a squeal of the 1987 Asian Contagion taking place 20-years later – call it the Baltic Blight 2007!

Mr. Bush Goes to Brazil – Practicing Sweet Energy Diplomacy!

President George W. Bush concluded his Latin America “Friendship” tour in Mexico today, discussing the politics of immigration reform – and the miles of border fencing Mr. Bush feels is necessary to control it. For his part, Mexico’s President Felipe Calderón took the visit warily in stride – as did nearly all the heads of state on Bush’s road trip south of the border.

To say that the U.S. President was about as welcomed in these Latin American states as an IMF loan collector, would be a vast understatement. According to recent poll results from the BBC “most Mexicans consider US influence in the world to be negative”.  There’s a news flash for you!

A story in Newsweek magazine reveals just how surreal, and costly this road-trip was from the point of view of a reporter “embedded” with the President as part of the “press pool” that followed Bush's traveling road show.

In Brazil for instance, Bush’s motorcade reportedly included no less than 40 vehicles – most of them bullet-proof no doubt – plus several helicopters overhead. A brief photo-op at a Sao Paulo community center, where Bush mugged with “common Brazilians” for the nightly-news was a case in point. The setting for this stage show was in actuality a locked down and sealed off compound – completely ringed in with riot fencing and razor wire - to keep huge crowds of angry Brazilian protesters at bay and out of earshot.

Bush’s Latin America Diplomacy Falls on Deaf Ears

In Bogota, Columbia, which was labeled by the Secret Service as the “most significant threat environment” to Bush on the entire trip, security forces went so far as to dispatch a dummy motorcade from Air Force One – prior to Bush actually deplaning – in order to foil any roadside attempts to bushwhack the President. On the road out of Bogota, Bush’s armored motorcade had grown to more than 70 vehicles.

It’s hard to blame these Latin American leaders, much less their people – for tuning out this made for TV spectacle. Far from cultivating deeper trade ties with our neighbors to the south, the Bush Administration has done almost nothing in six-years to strengthen ties with the region.

In fact, Latin America has been so ignored that big economies including Brazil, Chile and Argentina, not to mention Venezuela have instead cultivated advanced trade relations with China – more than 10,000 miles across the Pacific. Today, South America is largely pursuing its own economic – and some say political – agenda through its home grown Mercosur trading bloc.

The Ethanol Import Tariff

Bush's stop in Brazil clearly points out how the U.S. is stealing defeat from the jaws of victory in terms of Latin American trade relations, where the thorny issue of ethanol trade came up.

One of the very few issues that Mr. Bush and Congress (now in the hands of Democrats) can agree on is the need to pursue alternative energy strategies, to lessen America’s dependence on imported oil. Bush has repeatedly made this policy a centerpiece of his administration – at least in the form of repeated lip-service. And when Democrates recently took hold of Congress, they too made alternative energy a top priority, at least in rhetoric.

But if this is truly a “unifying issue” in Washington, then why does the U.S. maintain anti-free-trade tariffs against the importation of Brazilian Ethanol?

On the road in Brazil, Bush visited an ethanol plant in Sao Paolo Brazil. This well orchestrated photo-op provided a great backdrop for a joint U.S. Brazilian biofuel technology sharing agreement. Meanwhile, U.S. trade tariff tack on 54-cents a gallon to ethanol fuel shipped to the U.S. Since Brazil is the largest Ethanol exporter in the world, this anti-free trade stance on the part of the U.S. is costing Brazil millions.

So if pursing alternative energy, in hopes of lowering fuel costs for U.S. consumers is such a high priority, then why the tariffs?

The Politics of Ethanol

Well, the tariffs help protect America’s amber waves of grain – particularly corn which is the main source of U.S. ethanol production. Never mind that it’s much less fuel efficient and more expensive to squeeze gas from corn.  In Brazil, sugar cane serves as ethanol’s raw material, which also happens to be a much cheaper and more efficient source of ethanol production than corn.

But the U.S. maintains its tariff on imported ethanol to help protect U.S. corn farmers in key Midwest “swing states” – there is an election year coming up after all.

At the same time it charges Brazil more for imported ethanol produced from sugar, in a kind of Twilight Zone free trade policy. The U.S. government also maintains price supports for domestic sugar growers. As a result, they refuse to switch their cash crop to ethanol production instead – because of the artificially high price of sugar – propped up by Uncle Sam.

I have no idea about the raw numbers involved, and I doubt anyone in Washington really does either. But it just might be possible for the U.S. to eliminate ethanol tariffs, AND price supports for both corn and sugar – pay a few thousand farmers a one-time lump sum that provides for a comfortable retirement – and in just a few years the U.S. would be both better off financially AND more energy self-sufficient at the same time.

Just a crazy thought that might actually help solve the problem, but don’t count on it – as I said – 2008 IS an election year!

China's Legal-Eagles Take A Step In The Right Direction

Chinese government authorities took a big step in the right direction this week, announcing key measures to help protect private property in the world’s fastest growing economy.

The National People’s Congress, China’s main legislature, met this week in Beijing to debate new decrees. Of course much of the juicy details of the NPC’s deliberations are anti-climactic – with most of the important decisions having been made previously and behind closed doors. In fact, a commentator in The Standard (China’s Hong Kong based business newspaper) was quoted as saying the NPC is the “World’s Biggest Rubber Stamp.”

China’s Rubber Stamp Congress Puts Teeth in Property Laws

Be that as it may, the newly revealed Property Law is expected to be approved next week by the NPC, and promises to bring the rule of law to property speculation – and reign in outright thievery – in Chinese land deals. NPC vice president Wang Zhaoguo says that the new Property Law “will be conducive to consolidating and developing the economic sector of public ownership and will serve to define the scope of private property and protect private property in accordance with the law.”

The new legislation is a stark recognition on the part of pragmatic Chinese leaders that wild-west style land-grabs by public party officials in recent years need to be stopped, if nothing else than to stifle growing protests from its own people.

China has not substantially reformed its property laws since 1949. And in recent years well-connected officials did a well, land-office business exploiting loopholes in the current laws to enrich themselves – often at the people’s expense. 

These heavy-handed real estate swindles have resulted in growing unrest in rural areas of China in recent years. So the new legislation appears to be both badly needed, and long overdue.

Protection for the People’s Property Rights

Mr. Wang, the high-ranking NPC official, noted, “a clear-cut definition of property and fair competition are the basic requirements for developing the socialist market economy.” He went on to say that the people “urgently require effective protection of their own lawful property accumulated through hard work.”

Of course some critics point out that the new laws merely legitimizes past indiscretions and fraudulent transfer of state property, but China’s got to start somewhere.

Still, others say that the new Property Law will stop corruption and plug some of those loopholes. Mr. Wang further points out that this legislation not only “strengthens the protection of state-owned property” but also is part of a broader legislative agenda on the part of the NPC that seeks to set up a "Chinese-style socialist legal system by 2012."

Overhaul of China’s Inefficient Judicial System Needed

And that’s a good thing too; because China’s judicial system is presently in a state of “crisis”, according to James Rose the editor of www.corporategovernance-asia.com. Struggling to keep up with China’s rapid economic modernization, Chinese courts are clogged and overworked, with courthouses often run by corrupt officials.

And China doesn’t offer much in the way of a properly functioning public defender's office either. In fact, in spite of “thousands of legal aid branches” located in China, some 70% of all cases heard in Chinese courts do not have benefit of defense counsel.

The new Property Law is certainly a step in the right direction for China – so kudos to the NPC for passing it. 

But rather than new legislative initiatives adding even more statutes to the books – the essential priority for China’s leadership today seems to be enforcement of existing statutes – by overhauling the judicial system.

Only then will a well-functioning rule of law exist in China that is capable of fully protecting the private property rights of its citizens.

And that’s a process that can’t simply be rubber-stamped, through the National People’s Congress.

Italian Government Almost Gets Booted

Italians tried to give Prime Minister Romano Prodi the “boot” recently – although he narrowly survived a vote of no confidence in Parliament – and that’s a good thing for investors in Italy.

Since winning office last year by a narrow margin, Mr. Prodi has attempted to drag Italy – kicking and screaming – into the 21st Century, with a program focused on deregulating the nation’s economy, paying down government debt, and boosting productivity.

These measures should ultimately pay-off with faster growth in Europe’s third-largest economy. And from what I can see, the reforms are overdue.

After serving just nine-months in office, Prime Minister Prodi offered to quit his post last month, after losing an important foreign policy vote in Italy’s Senate – where Prodi’s ruling coalition government holds a very slim majority. Fortunately for investors in Italy, cooler heads prevailed during the brief leadership crisis, and Prodi was able to rally support, and win a confidence vote last week to remain in charge.

Italy’s Revolving-Door Political System

Part of the problem is Italy’s fractious multi-party political system. If you think Washington gridlock is bad with our dual-party system splitting executive and legislative duties – imagine the chaos that prevails in a nine-party coalition government – as is the case right now in Italy.

There has been a growing chorus in Italy from those who wish to reform the electoral process in hopes of streamlining the political process, but that will be difficult to accomplish, since changes to Italy’s constitution are required.

However, another type of reform – the economic variety – should now be free to keep moving forward in Italy, thanks to new found confidence in Mr. Prodi. And this should prove to be a very good thing for Italian financial markets.

Ironically, it was some of these very reforms that contributed to a sharp decline in popularity for the government in the first place.

Economic Reform Promises to Boost Italian Growth

Under Mr. Prodi’s leadership, the government has been concentrating its efforts on improving the economy. Reform and deregulation are top priorities for the Italian economy, which is often derided for its bureaucratic inefficiencies. 

In fact, Italy’s GDP growth has lagged behind average growth rates in the European Union (EU) for more than a decade. But when Prodi first met with his uneasy coalition government early this year, he declared the “meeting is dedicated to growth.”

And according to Italy’s finance minister, boosting production, improving education and eliminating government red tape – could potentially double Italy’s growth rate within five years.

These measures appear necessary to help Italy’s economy accelerate, and better compete on the world stage, not to mention within the EU itself.

But it has stirred resentment among Italian voters who see government deregulation as nothing more than an unwanted intrusion into the privileged life that professionals and service providers in Italy have long grown accustomed to.

An excellent Financial Times article (Italy’s bastions of protection and privilege resist liberal assault)recently detailed some of the changes – and the potential impact on once protected Italian enterprises.

For instance, gas station operators in Italy are up in arms about government rule changes that allow supermarket chains to sell gasoline for the first time. Hairdressers are in a tizzy about the fact their salons are now allowed to remain open on Mondays – therefore potentially lengthening the workweek for Italy’s stylists. And Italian banks are no longer allowed to hit customers with steep fees for paying off mortgage loans early – heaven forbid – this could lead to lower mortgage rates and higher home prices!

Apparently, Italian trade groups are “masters of the art of keeping prices high and blocking others from competing with them”, according to the FT article. But a little free market reform, like a little revolution, is a good thing from time to time.

In the long run, Italy’s economy should be better off for these reforms – with a payoff likely in faster economic growth and better job opportunities – even if Italian workers don’t quite see it that way at present.

For the good of Italy’s economic future – investors should rejoice the government-sponsored deregulation program – and they’d better hope Mr. Prodi’s nine-party political union holds up under the stress of the needed reforms.

Shanghai Surprise – the View from the Mainland

Nearly a week after the one-day 9% plunge in the Shanghai Stock Market, the largest bourse for mainland Chinese shares, thoughts turn to how well local investors are holding up considering the increased volatility.

So far it seems they’re coping pretty well and taking the correction in stride!

China’s domestic listed A share markets enjoyed spectacular gains of about 130% in 2006. But so far this year, things are off to an uneven start. For one thing, volatility has increased dramatically on domestic exchanges.

Prior to last week’s big decline, stocks had already displayed  unusual volatility, with the Shanghai index notching one-day drops of nearly 5% and 4% already this year - before recovering to hit new highs.

But according to a sampling of Chinese retail investor sentiment, as captured by a recent article in the New York Times Chinese Shrug Off Losses as Market Swings Back, a bullish ( some might say complacent) mood still prevails.

One mainland investor perhaps best reflects the upbeat attitude on Chinese stocks. Li Ruichang, a retired engineer compares the Shanghai market to a “casino, or perhaps even a government-regulated slot machine. But you can still make money betting on the market here”, according to the article.

Echoing this same view of the Shanghai stock exchange as a sort of government-run casino operation, 37 year old shoe salesman turned day-trader, Qin Changhai says “this is what we go through every day. It’s just like I’m gambling with the government.”

It’s difficult to take issue with this view of China’s mainland markets; in fact the locals have got it just about right. As I pointed out previously China Investment Strategy: How to Bet Your Home on the Stock Market!, the Chinese government is the biggest player in the domestic stock market, closely watching the trading activity on the Shanghai and Shenzen exchanges. The vast majority of listed companies on these bourses are state-owned and controlled – and the largest shareholder is the Chinese Communist Party itself.

The government also runs the stock brokers and institutional fund management firms – imagine if you will that Uncle Sam owned a controlling interest in Merrill Lynch, Charles Schwab, and Fidelity Investments – not to mention General Motors, General Electric, and Microsoft.

So it’s no surprise that the Chinese government has a vested interest in keeping the whole game going – to try and prevent disruptive market declines – which could lead to unrest among its citizens not to mention steep losses on all those shares held by the government.

But if it ever wants to truly open its financial markets to global investors, a step that must happen sooner or later, China also understands that it must keep the game from getting out of hand in the other direction too. That’s because too much speculative money driving stocks well above reasonable valuation will only have to be painfully unwound at some point.

The Chinese government may have taken just such a step last week. In looking for possible explanations for the big sell off in Shanghai shares, there were several rumors of government intervention.

Apparently last Tuesday, February 27, information became public that holding companies tied to China’s State-owned Assets and Supervision Administration Commission have been busy selling shares in about 15 large listed companies, according to Morgan Stanley analysts in China.

These “insider” stock sales were reportedly close to the annual limit of 5% of total shares outstanding.

With these insiders perhaps acting on explicit government orders, and dumping so many shares on the market at one time, it goes a long way toward explaining the 9% correction in Shanghai.

But the speculative fever gripping China’s retail investors continues to boil. Our man in Hong Kong, Ushe Koh a VP in the Private Banking Division of DBS Bank Limited, was kind enough to send me the following analysis last week, the emphasis is mine;

“Shares of Ping An Insurance jumped 38% on their debut in Shanghai, bucking a slump in Chinese equities after the world's biggest stock sale by an insurer drew near-record bids from investors. The stock rose to 46.79 yuan from its offer price of 33.80 yuan, closing at a 38% premium to its Hong Kong shares.”

This spectacular debut for the latest China mainland IPO came in spite of the fact that the Shanghai and Shenzhen 300 Index fell nearly 3% that day. And yet the buying frenzy among mainland investors is still strong enough to drive Ping An Insurance to a nearly 40% premium over its identical shares listed in Hong Kong -- same company mind you -- but trading at an inflated value in Shanghai.

This tells me that in spite of China’s correction, the speculative fever among domestic investors has still not cooled much from overheated “bubble-like” proportions. Millions of new investors are pouring their money into mainland Chinese shares, with as many as 90,000 new brokerage accounts established every day in recent weeks.

Don’t get me wrong, I firmly believe that China will be one of the best places on the planet to invest in coming years, and I’m always on the look-out for good buying opportunities. The fact that Chinese citizens are flush with cash, with about $2 trillion in savings sitting idly in bank deposits, tells me there's lots of pent up buying-power to eventually send shares much higher.

But after the big run-up in share prices we’ve seen recently, prospects for finding true bargains in China are rather scarce right now.

So perhaps we will see more downside ahead in Chinese stocks, which may be exactly what’s needed to purge more of the excess from this market – and create more attractive opportunities ahead.

Or perhaps the big drop last week in Shanghai will soon be forgotten like other setbacks, as stocks once again zoom to fresh record highs – propelled by all those day-trading Chinese gamblers who can’t seem to get enough of this government-sponsored casino action.

The wheels are spinning round and round – place your bets folks!

Goldilocks Gets Thrown a Curve

As much as those in the mainstream financial media would like to make a connection between this week’s plunge in Chinese stocks being a root cause of the pull back in U.S. share prices; the fact of the matter is that there’s been plenty of downbeat news on the American economy to account for this rout all by itself.

In fact, recently released data on the economy, and more sobering views on U.S. corporate profits going forward may have just thrown “Goldilocks” a sharp breaking curve ball.

Economic Outlook Dims

> On Tuesday morning, the U.S. commerce department reported that durable goods orders plunged 8% last month – much worse than forecast – while business investment fell 6%. Such a sudden fall off in demand for big-ticket items like computers, appliances and industrial machinery may mean that the U.S. manufacturing sector is already in recession – swing and a miss strike one!

> Another worrying sign is the fact that the housing sector is not getting any better – and much worse – now seems to be dragging down the subprime lending sector of the all-important financial industry along with it. On Wednesday, it was reported that new home sales slumped almost 17% in January – strike two!

> Fed fund rate futures now indicate better than 75% chance of a quarter-point rate cut before the Federal Reserve’s July meeting, a clear sign of weaker growth ahead. And far from the soft-landing scenario many had envisioned for the economy, the probability of recession in the U.S. has now risen to a bit more than 40% -- thanks in no small part to comments made Monday by former Fed chief Alan Greenspan who suggested this possibility – strike three!

So it spite of the fact that many pundits were quick to blame it all on China – the global market correction this week may have had more to do with a growing perception of weakness on this side of the Pacific.

More evidence in favor of this view can be found by taking a closer look at just how the global market sell off unfolded in real time.

Did Shanghai Really Shock Global Markets?

When Shanghai stocks were plunging 9% late Tuesday evening and early Wednesday New York time, other Asian markets fell in sympathy, as you would expect.

But theses declines were nowhere near the magnitude felt in Chinese A shares. For instance; Hong Kong fell only 1.8%, and Japan declined just half a percent on the same day. The reaction from other stock markets in the region including: Singapore, Australia, New Zealand – even India, was similarly muted.

These Asian markets didn’t really get caught up in this first wave of selling emanating from China. It was not until European markets dropped early Wednesday – and even more so following larger losses in New York -- that the other shoe dropped on stock investors in the rest of Southeast Asia.

This apparent timing disconnect is actually quite reasonable when you stop to consider that, perhaps global investors weren’t reacting so much to what’s happening in China’s mainland markets – as much as they are afraid of what might be happening to the U.S. economy – the great engine of world-wide growth in recent years.

U.S. Consumption Could be the Key to Rising Global Risks

If the U.S. economy does indeed slow more than most economists and analysts expect, then consumption will surely suffer. And should American’s finally stop shopping, then at the margin, this is sure to hit Chinese and Japanese manufacturers the hardest.

If China then falters, due to a downshift in exports, this would be quickly followed by weakness in economies throughout South East Asia that do a lot of business with China.

Of course the next domino to fall would be countries rich in mineral wealth, and dependent on selling these natural resources to China and the rest of Asia. This list of potential victims includes: Australia, New Zealand, Brazil, Russia, etc.

Make no mistake, China is doing a wonderful job transforming itself from an export-dependent economy, to one in which internal consumption will play an increasingly important role. Evidence of this can be seen in the fact that so many newly rich Chinese have the wherewithal to speculate in Shanghai stocks all day.

But the time has not yet come when China is insulated from weakness in the U.S. economy – and that day may not arrive for sometime to come. So before blaming Beijing for the global market correction – investors should perhaps look a bit closer to home for the real reasons.

Trading Carbon Credits for Fun and Profit!

Ten years after the Koyoto Protocol kicked off global efforts to limit greenhouse gas emissions, the American free enterprise system – allied with state governments throughout the land – is finally making global warming a top priority.

And why not … after all there’s a lot of money to be made.

We have seen a seismic shift in the U.S. lately, in favor of cutting carbon dioxide gas emissions, and other made-made pollutants, that are suspected of causing global climate changes.

In fact, three major energy industry groups have recently done a complete about-face -- from fighting mandatory federal limits on greenhouse gas emissions – to now supporting legislation that may put federal regulation in place sooner than most thought possible.

The Wall Street Journal reported this week that the Edison Electric Institute, a powerful lobby for the electric utility industry in the U.S. – has joined the American Gas Association, and the Electric Power Supply Association, in supporting federal government regulations on its industry members.

This is a significant shift on the part of American industry, which for years pooh-poohed the very idea that carbon dioxide even caused global warming. It reminds me of the good ‘ole days, when the American tobacco industry vigorously denied scientific evidence – now universally accepted – that smoking causes lung cancer. But of course, there’s a profit motive behind the industry’s change of heart.

Utility Industry Gets a Wake-Up Call

Firms that belong to the Edison Electric Institute generate 60% of electricity in the U.S., according to the Wall Street Journal. And the good folks at the EPSA represent the interests of 22 firms that sell electricity on wholesale markets across the country.

Together, these two organizations represent a very big block consisting of the biggest carbon dioxide emitters in the U.S. In fact, about 50% of America’s electricity needs are provided by coal-fired power plants – the fossil fuel with the highest carbon content.

But why the sudden change of heart? For one thing, the change in control of Congress last fall was no doubt a wake-up call for the utility industry. Former vice President Al Gore’s well-received documentary “An Inconvenient Truth” has helped galvanize public opinion in favor of environmental protection.

There’s now a growing probability that Congress acts to pass some sort of emissions controls in the run-up to next year’s election. And Paul Wilkinson, vice president of the American Gas Association, perhaps said it best: “We want to be at the table during the debate” – in other words, to help steer the debate as much as possible in the industry’s favor – it’s the American way.

U.S. States Hop Aboard the Carbon Credit Bus

The impetus in favor of legislation to limit greenhouse gas emissions was already underway in state legislatures across the country. Last year, the State of California – the world’s 12th largest carbon dioxide emitter -- passed the Global Warming Solutions Act that aims to cut greenhouse gasses 25% by 2020.

Oregon, New Mexico, Arizona and Washington state have joined forces with California  to propose a cap-and-trade program that would allocate carbon emission credits among companies operating in these western states.

The idea is modeled after an emission-credit trading program in place among eight states in the northeast, including nearly all of New England states, New York, New Jersey, and Delaware. So now the time seems ripe for a federal carbon credit-trading program -- to spell out nationwide rules for limiting greenhouse gasses.

There are a number of different schemes being considered by Congress, so it’s too early to say what the final version will look like. But the basic idea is a carrot and stick approach – with a free market twist.

Birth of Carbon-Credit Trading

Companies like electric utilities and manufacturers that produce carbon-based fuels or emissions, would require government permits for each ton of carbon they release into the environment. Firms could then trade these carbon-credits amongst each other, so that a company that upgrades its operations to reduce emissions might wind up with surplus credits.

These extra credits may then be sold to less “environmentally friendly” firms in need of more carbon credits to cover their excess emissions of greenhouse gases – or else pay steep penalties to the federal government. This creates a potential profit incentive for American industry to clean up its act.

Obviously, it also creates a vast new medium of exchange – with carbon credits as the currency. And wherever there’s a new medium of exchange, you can rest assured that someone will figure out a way to trade them on the open market to earn an extra buck or two.

Enter Wall Street

Of course, Wall Street Investment Bankers will have a field day. They are no doubt salivating as we speak, at the chance to figure out new ways to securitize carbon credits so they can be traded on financial exchanges around the world.

Think of all the millions … even billions of dollars at stake. Global investors will have lots of new products in which to stash their hard earned cash, in search of incrementally higher investment returns.

In fact, the Chicago Climate Exchange (CCX), which began operations in late 2003, bills itself as North America’s only, and the world’s first, greenhouse gas emission registry, reduction and trading system. CCX recently announced plans for a new exchange traded fund in based on carbon credits, potentially allowing individual investors to profit from this new market.

And we’re going to need new profit opportunities, because one sure thing that’s coming out of this is higher utility costs to consumers.

In fact, the Wall Street Journal reports that one environmental group is forecasting an increase of anywhere from 3.5% to as much as 35% in the nation’s electric prices, depending on the shape and scope of the government plan that’s finally adopted.

But what’s a few bucks more in monthly utility costs when we’re helping save the environment from poisonous greenhouse gases.

Besides, you can always offset your higher electric bill with a few well-timed carbon credit day-trades in your IRA!