Global Stock Market BLOG - Mike Burnick

Slower Growth – Elevated Inflation – Spell Trouble for U.S.

Last week, the U.S. Commerce Dept. released its preliminary figures on first quarter 2007 Gross Domestic Product (GDP) growth. Since GDP is the broadest national measure of our economic output, the number is widely followed by economists and market analysts alike. Last week’s data showed the U.S. economy still growing – but at the slowest pace in four years – at just 1.3%.

This anemic reading brings average growth over the past year down to just 2.1% -- among the slowest readings in the industrialized world. This data represents only a preliminary estimate from government statisticians, and is likely to be revised in coming months, possibly a bit higher.

However, it serves to underscore the magnitude of the slowdown currently underway in the U.S. – with many economists saying that a recession is unavoidable.

An interesting contrast in the data was the fact that even though the economy appears to be slowing sharply, inflation is still running at uncomfortably high levels. In fact, the GDP price index gained 4% -- the largest pace of increase in the past 16 years. Obviously, inflation has been the Fed’s biggest “official” concern, and the prime reason why the Fed raised rates so much since 2004, and has remained vigilant with the Fed funds rate still standing pat a 5.25%.

Inflation Remains Sticky

Core personal consumption expenditures – a measure that strips out volatile food and energy prices – rose only 2.2% according to the data. So it’s been argued that underlying inflation isn’t all that bad, although 2.2% PCE inflation is still above the Fed’s professed comfort zone. The fact is that all U.S. consumers require both food and energy – and with prices for both rising sharply – this can’t help but be a drag on consumer spending and output going forward.

The simple fact is that the U.S. is no longer in the position of global leadership at this phase of the economy cycle, as other developed nations in Europe, and Asia appear more promising. Tomorrow, I’ll be on the road again, heading south to Panama City, Panama for the Sovereign Society’s Total Wealth Symposium. Over the next several days my colleagues and I will be sharing our views on where in the world to invest today.

So which countries or regions look best positioned to grow strongly going forward? Well, with the U.S. fading fast we’ll be coming up with some interesting alternatives. Stay tuned.

The Shifting Sands of Global Growth Part II

Yesterday, in Part I of this post, I questioned the rationale behind surging global stock prices, when in fact the main engine of global growth – the U.S. economy – appears to be faltering.

And why has the Dow Jones Industrial Average (DJIA) surged this week to record highs above 13,000 for the first time – with U.S. GDP slowing in the first-quarter to the lowest levels in four years. In fact, several indicators are pointing to an increased probability of recession?

Well for one thing, most other global markets are performing much better than in the U.S.

In fact, so far this year the DJIA is up only 5% -- but the Dow Jones World Index (excluding U.S. stocks) has gained nearly 9% -- and Chinese mainland shares (still one of the hottest markets going) are up almost 40%!

You Can Also Go Global By Investing Local

But there’s another key factor behind the strength in U.S. stocks. Among the best performers in the DJIA recently have been big, multi-national firms like AT&T, GE, 3M, and Coca-Cola. All of these giants generate a significant amount of revenue and profits from overseas markets.

The sliding U.S. dollar helps boost the international sales and profits of these firms. In addition, these companies also benefit from stronger organic growth in foreign markets as well.

This is one very good reason why I expect large-cap U.S. growth stocks to perform well this year. In other words, if you must stay in the U.S. – stick with blue-chips!

Global Growth Keeps Rolling Along – Without the U.S. Engine

But for global investors, much better returns can perhaps be earned by venturing into other markets. International stocks are again leading the pack this year because economic and earnings growth are stronger overseas. In other words, international markets appear to be successfully decoupling from the U.S.

It would seem that the global economy depends less on American consumer spending than many people think. According to data from Morgan Stanley, “U.S. exports account for only about 2.9% of Japan's gross domestic product, compared with 4% of GDP in previous decades.”

For the European Union, which seems to be in a sustained uptrend in growth, exports to the U.S. amount to just 2.4% of GDP. Emerging nations too, “are increasingly selling commodities and other goods to China and India, lessening their historical dependence on the U.S. export market.”

Many nations throughout Asia and Latin America, even in Europe, are seeing an increase in demand for raw materials from China. Countries like Brazil, Chile, Russia, Singapore, Taiwan, Malaysia, Indonesia, even Japan – are benefiting from both growing trade with China – and increased wealth creation internally.

Where to Find the Best Emerging Growth Opportunites

Nations with relatively open and efficient financial markets, with stable currencies, low or falling debt, stable (or better yet declining) interest rates, and trade surpluses (unlike the U.S.) – are among those that look particularly attractive going forward.

From there it’s a matter of choosing the countries with the most attractive stock market valuations on a relative basis. This list includes several of those countries mentioned above.

The bottom line is that these shifting growth dynamics should help protect many international economies from a sharp slowdown in U.S. demand – as global trade marches on.

The Shifting Sands of Global Growth Part I

Global stock markets seem to be booming again. The Dow Jones Industrial Average (DJIA) of blue-chip U.S. stocks just hit a fresh all-time high – surpassing the 13,000 mark for the first time.

Many international markets are likewise trading at record highs. But the U.S. economy – the great engine of global growth – is slowing down substantially. So what gives?

Enter the New World Economic Order

What we may be witnessing is the highly sought-after and much debated “decoupling” in global growth. Call it the new world economic order that is no longer so U.S.-centric, but instead is more balanced, with growing contributions from both developed and emerging economies in Europe and Asia.

As U.S. growth slows – the rest of the world grows without a hitch.

Growth in the U.S. has slowed sharply in recent quarters – with the economy expanding just 1.3% in the first quarter. Some economists are forecasting growth to slow even further – and to remain anemic over the balance of this year.

Meanwhile, most of the growth numbers from the rest of the world have been surprising on the upside. Germany, the great engine of economic growth in the EU, is expanding at the fastest clip in six-years.

China just surprised (on the upside again) growing more than 11% in the first quarter – and in spite of several interest rate-hikes – shows no signs of a slowdown. And in Europe and Japan, economies are expanding at a 2.5%-plus clip – and are still accelerating.

Can International Markets Keep Booming if U.S. Hits Recession?

At the same time, the U.S. economy “just completed four straight quarters of annualized growth below 3%, which has never happened in 60 years without being followed by recession” according to a recent article in the Wall Street Journal.

According to the same article, the index of leading indicators for the U.S. economy has been falling for three months in a row. Based on analysis by Merrill Lynch, over the past 50 years, each time the leading indicators experienced such a decline, the U.S. economy has slipped into recession with only one exception (in 1967).

At first glance, this would seem to paint a pretty grim picture for the U.S. – so why break out the party-hats on Wall Street for the Dow’s milestone run above 13,000?

For more on these global developments, and my thoughts on where in the world to invest now, please tune in to tomorrow’s blog…

Wall Street High Roller Makes Bigger Bet on Vegas

High-profile initial public stock offerings and private equity deals apparently just don’t provide enough excitement for Wall Street’s best and brightest investment firms. Now they are increasingly moving into the Las Vegas casino gaming business to place their investment bets, according to a recent article in the Financial Times.

Venerable investment banker Goldman Sachs – one of the bluest of Wall Street blue-bloods is pressing its bets on the casino business by purchasing four casinos from Carl Icahn’s American Real Estate Properties for about $1.3 billion. The casinos in the deal include the flashy Stratosphere Casino Hotel & Tower located on the strip, and several other Las Vegas properties that cater to the fast-growing “locals” gaming business.

Goldman is just trying to keep up with Wall Street rival Morgan Stanlye which last year paid $74 million for an Atlantic City New Jersey Boardwalk casino. Morgan also has an 18% interest in Trump Entertainment Resorts, according to the article. And Goldman Sachs itself isn’t entirely new to the business, owning a piece of the Las Vegas Hilton.

In this deal, Goldman not only gets ownership of the Stratosphere tower and casino – with its signature rooftop roller coaster – but also takes control of 11 acres of undeveloped property surrounding the Stratosphere.

That could potentially be the biggest home-run of the deal, since the fast-pace of new casino development in town promises to shift the main attractions of the Las Vegas strip north toward the Stratosphere.

So after years of lending to casino operators, and underwriting their IPO’s, Wall Street is now taking a bigger piece of the action. Last year, the Las Vegas strip produced a record $6.7 billion in revenue – up 11% from a year before.

Facing the prospect of slower profit growth among U.S. public companies, and perhaps a slowing of business from its bread and butter Wall Street clientele, perhaps Goldman must view this purchase as a great way to hedge its bets for the future.

Chart of the Week: China’s Valuation Disconnect with Hong Kong

China’s mainland shares took a one-day 5% hit last week, but this time the sell off didn’t spill over much into global markets -- at least not yet.

Still, a curious divergence continues to exist between mainland shares listed in Shanghai, as represented by the Shanghai-Shenzhen 300 Index – and the Hang Seng China Enterprises Index – which includes many of the same companies, which also have shares listed in Hong Kong.

Since October 2006, the Shanghai index is up a remarkable 125%, while the China Enterprises list of Hong Kong listed mainland shares is trailing, with (still impressive) gains of about 37%.

The Divergence is even more striking since the beginning of 2007, with Shanghai up 54% -- while the Hang Seng China Enterprises index has actually fallen about 3% in value.

While these two indexes don’t contain the exact same list of stocks in the same proportion, many of the shares with the largest weighting are included in both. And while you might expect performance to be somewhat divergent – this appears to be a major disconnect in valuation that tells me -- sooner of later -- something’s got to give.

The Great MALL of China!

China boasts one of the world’s greatest wonders – the Great Wall – a structure so impressive that it can be seen from outer space. But China can also lay claim to a new wonder of the world – another impressive structure – of the retail variety.

In Dongguan, a city located north of Hong Kong – sits the South China Mall – the worlds largest retail shopping space. This mall swallows up 220 acres and boasts 9.6 million square feet of retail shopping space, according to a recent story in Bloomberg. By comparison, the South China Mall is more than twice the size of the largest U.S. shopping center – Minnesota’s Mall of America.

The South China Mall indeed must be a site to behold – reportedly including replicas of seven western tourist destinations including: Venice, Milan, Paris, and Hollywood. There’s even a 1.3 mile artificial river – on which visitors can lazily glide in replica Venetian Gondola rides. In fact, the mall’s marketing consultant’s bill it as “Disneyland and Las Vegas comes to China.”

Apparently this Mall Has it All… Except for Shoppers with Money to Spend

In fact, most of the South China Mall’s cavernous retail space sits idle, with many storefronts either abandoned – or never opened for business in the first place. The mall’s developers planned on attracting 100,000 visitors a day – but instead draw only about 10,000 on a good day – more than a year after opening its doors.

What’s the problem? The mall’s location can’t be entirely blamed. Dongguan is a thriving factory city of 6 million people, and it’s proximity to Hong Kong makes it “one of China's richest cities.”

Over building of mega real estate projects may be partly to blame too. In fact, China now has seven of the world’s top-twenty shopping malls – and no less than two mega-malls are located within 50 miles of the South China Mall.

But, the real problem seems to be frugality. Unfortunately, China seems to have far too many savers – and not enough spenders. This makes it a challenging market for mega-mall developers. The trouble with the Chinese retail sector is lack of robust domestic consumption.

A Surplus of Chinese Savings – But a Deficit in Retail Spending

China is growing rich by exporting cheap consumer goods to the U.S., Europe, and – well, pretty much the rest of the world too. But ironically, domestic Chinese consumers simply lack the wherewithal for regular shopping sprees at the local mall.

According to the Bloomberg story, “consumption in China, the world's most populous nation and the fourth-largest economy, accounts for just 35 percent of gross domestic product, about half the share in the U.S. and ‘quite possibly the lowest consumption share of any major economy in modern history,’ according to a report by Morgan Stanley.”

Typically, the Chinese save about half of their income, and after deducting basic living expenses, there’s little left over to spend at the Asian equivalent of The Gap or A&F. According to official government data as reported by Forbes, the per capita disposable income of China’s urban residents jumped 19.5% in the first-quarter of 2007 – but is still just 3,935 yuan (or about US$500).

Unbalanced Economy Needs More Domestic Spending

According to a recent statement by non other than China's Premier Wen Jiabao, the domestic economy is “unstable, imbalanced, uncoordinated and unsustainable.” That’s saying a mouthful.

But the reality is that unless and until China does more to re-balance its economy -- relying less on exports and more on domestic-led growth and consumption -- the retail trade may be difficult to pull off. Perhaps aspiring mall developers should try building casinos instead.

PS Not to be outdone in the “world’s largest” category, it was reported yesterday that Minnesota’s Mall of America has plans to more than double its size – adding another 5.5 million square feet of retail – at a cost of nearly $2 billion dollars.

But in typically American fashion, developers are seeking taxpayer’s money – in the form of sales tax exemptions – to finance the project. This may go a long way toward proving that hubris and foolishness are universally human traits -- shared equally around the world.

Russian Bear Puts Squeeze on Europe's Natural Gas Market

The Russian Bear used to use its military might to keep its European neighbors in check, but today Russia’s natural resources are being wielded by Moscow as the weapons of choice.

Europe has grown increasingly dependent on Russian oil – and especially natural gas – to power its economies. In fact, Russia really has a strangle-hold on fast-growing Eastern and Central European nations, with state-owned Gazprom holding all the cards.

According to a recent article in The Economist magazine, Poland Hungry, and the Czech Republic each depend on Mother Russia for more than 60% of their natural gas imports – while Bulgaria gets nearly ALL of its gas from Russia. In Western Europe, more than 40% of Germany’s gas imports come from Russia, while in Italy and France the figures are 30% and 20% respectively.

Calling the Shots in European Natural Gas

With its business largely controlled by the Kremlin, Gazprom generates $22 billion a year in profits from gas exports to European customers. By some estimates, nearly one-fourth of total global natural gas consumption is supplied by this company. The word “monopoly” just doesn’t do justice in describing the vast extent of Gazprom’s dominance over energy markets in the region.

Since almost 60% of the world's gas is concentrated in just three countries – Russia, Iran and Qatar – Gazprom is in position to control not only a majority of production – but also the flow of gas supplies (through its pipelines) from anywhere in Central Asia to customers throughout Europe.

Gazprom built this natural gas empire at the behest of – and with significant aid from – the Russian government. President Putin sees the company as a national crown jewel, even saying publicly that the company is a “powerful lever of economic and political influence in the world”.

Gazprom’s Bare-Knuckle Business Tactics

Gazprom has grown by acquisition, mainly through coercive tactics, by taking ownership stakes in other energy companies both inside and outside Russia’s borders. Making a series of offers that firms just can’t refuse, Gazprom has assumed nearly total control of the country’s natural gas production and distribution infrastructure.

One hapless independent energy firm in Siberia, Northgas, was persuaded to give up a 51% interest in its company to Gazprom in 2005, after repeated disputes with the company over pipelines. A company official is quoted by the Economist as saying “it’s better to have 49% of an enterprise that works, than 100% of one that doesn’t”, well said.

Around this time last year, Gazprom created quite a stir by turning off the supply of natural gas to Ukraine in a dispute over transmission fees for gas flowing through Russian pipelines across Ukrainian territory. These pipelines, most originally built by the former Soviet Union, crisscross Europe like the tentacles of an octopus – and now reach nearly every corner of the continent.

Controlling the Flow of Energy and Political Clout

Needless to say, whoever controls these pipelines controls the flow of energy to Europe and can pretty much dictate price – this economic AND political power rests ultimately in the hands of Gazprom.

The monopoly powers that Gazprom wields – not to mention its high-handed business tactics – are making customers in the west understandably nervous.

After forcing many of its domestic rivals to knuckle-under – Gazprom is now trying to muscle-in on the western energy sector – while it puts the screws to competitors on its own home turf. In fact, Gazprom has already purchased stakes in gas distributors in Germany and the Baltic states, and owns a 10% interest in an Anglo-Belgian pipeline.

But while Gazprom is busy consolidating the domestic energy sector –and buying up western assets – Russia is also turning a cold-shoulder to foreign companies investing in the country.

Gazprom’s Dealings Scare-off Western Investment and Expertise

Royal Dutch Shell and other firms were recently pressured into surrendering a controlling interest in the huge Sakhalin fields in far-eastern Russia, after pouring billions into the development of the project, just as large-scale production was beginning. BP Plc has also been hamstrung in its development of another large gas field in Siberia.

And recently, the Russian government turned an auction of energy assets from the bankrupt Yukos into a total farce. The bidding was in-effect “rigged” to insure that all the plumb-assets went to Rosneft, another state-owned energy firm, or to Gazprom itself through western intermediaries (An Inside Job in Russian Oil Auction). 

But these heavy-handed dealings with western firms, who bring not only capital but technological know-how to the table, may also backfire on the Kremlin.

Production at Gazprom’s three major gas fields are falling about 7% annually – a dilemma the company cannot afford – since these reserves account for 75% of its total output. And since it’s spending so much buying up European assets, Gazprom has less capital available to invest in exploration and production of newer reserves.

This declining production calls into question Gazprom’s grand strategy to become an even bigger supplier to global markets, since two-thirds of its production is already eaten up by Russian customers.

With domestic demand rising at a steady pace – European natural gas customers may be left out in the cold.

Global Shipping Boom Buoys Korean Shares

Soaring global trade has inevitably led investors into the fastest growing emerging economies – China with 10% GDP growth, and India growing at 8%, are obvious targets for global investors to pile-in.

Working more quietly behind the scenes of booming global trade, and grabbing fewer headlines, are South Korea companies. But many of this country’s industrial firms are enjoying robust profit growth – by supplying the vessels that facilitate international commerce.

South Korea is well known as the home of major multi-national manufacturers including: electronics giant Samsung, auto maker Hyundai, and Posco, the world’s third-largest steel producer (which has drawn investment interest from billionaire Warren Buffett).

World’s Largest Shipbuilder Grows Rich on International Trade

But what many investors may not know is that Korea is also the world’s largest shipbuilder. As such its shipyards are riding high right now on the rising tide of global trade -- and booking big profits in the process.

According to a recent Bloomberg news report, South Korea based “Hyundai Heavy Industries Co., the world's biggest shipbuilder, and its competitors will be able to keep charging record-high prices for at least two more years because rising demand has outpaced supply.”

Last year, worldwide orders for new ships totaled a record $105.5 billion – driven mainly by soaring imports of iron ore, copper and other raw materials to China – helping to fuel its booming economy.

Nearly half of those new orders were placed with South Korean shipyards. In fact, the country boasts the world’s two largest shipbuilders: #1 ranked Hyundai, followed by Samsung Heavy Industries at #2. Incoming orders received by these two industrial giants is enough to keep operations running full-tilt until at least 2010!

Soaring Orders Give Shipbuilders Pricing Power

Since almost 90% of global trade moves by sea – and with China so intent on supplying the world with cheap goods – freight rates on trans-oceanic routes have more than doubled in the past year. Orders for new oil tankers surged 37% last year – even though shipyards boosted prices by 67% for the largest tankers. Prices of bulk carriers that transport coal and iron ore jumped about 30%.

And still the contracts pour in. In fact, Hyundai Heavy snagged orders for 47 new vessels so far this year – which brings its total backlog to 270 ships valued at $26 billion – three years worth of production.

Korean Stocks Still Bargain-Priced Despite Booming Exports

To be sure, investors have noticed the booming business trends for Korean shipbuilders. In fact, Hyundai Heavy’s share price has gained 135% over the past 12-months.

Yet, South Korean stock prices in general still look like a bargain, with the benchmark Kospi Index selling at just 13 times earnings, cheaper than any Asian market but Thailand. By contrast, the Morgan Stanley Asia Index is valued at more than 18 times earnings.

Last year the Kospi rose just 4% in value, in spite of booming economic growth and corporate profits – since investors were busy dumping money into China’s mainland indexes. In the first quarter of this year, South Korean exports surged 15% from a year ago.

South Korea, which is growing rich by association with the China boom, appears to be a much better bargain for value-oriented global investors.

Investor Looking for the Latest Emerging Opportunities in Europe Should Look Farther East

The center of gravity in European emerging markets may be swiftly moving farther east. Poland, Romania and other Central and Eastern European nations have enjoyed rapid economic growth in recent years – leading to huge stock market gains.

Intrepid Investors Go East

But now, workers in these developing nations are demanding higher wages. And with other “social costs” on the rise in the region, investment capital and business outsourcing is beginning to look farther afield in Europe.

The countries that are located behind the former “Iron Curtain” have been seen as frontier emerging markets for many years. With 70 million potential consumers and access to a cheaper, but still well-educated work force – western investors have poured lots of money into this region.

But according to a recent article by the Associated Press, these nations may become victims of their own economic success. That's because with the cost of doing business in Central and Eastern Europe on the rise, investors are now looking farther east for their investment opportunities. In fact, countries such as Belarus and Ukraine – in the former Soviet Union – are fast becoming the preferred destination of business outsourcing and investment capital flows.

Wages, Other Costs, on the Rise in Eastern Europe

For example, in Poland wage growth is expected to outpace productivity growth for the first time, which means that it’s getting pricier to produce the same amount of goods or services in the country. Romania’s information technology sector has been an unparalleled success story in recent years, growing 35% last year to more than US$1.6 billion in size. But now salaries in some sectors of Romania are expanding 20% per year to attract new workers – which is pushing up the cost of doing business there. And Czech workers are already among the highest paid in Central Europe – with salaries up 6.5% last year alone.

It’s unlikely that western companies and investors will pull-up stakes and leave this important region altogether. In fact many multi-national firms such as Microsoft, Nokia, and Hyundai Motors of South Korea have extensive investments in the region or are expanding operations there. In fact, according to data from consultants at McKinsey, outsourcing activity in Central and Eastern Europe is expected to triple by the end of 2008 – adding 130,000 new jobs in the process.

But for intrepid investors looking for the next booming emerging markets in Europe – it might be best to set your sights farther east.

Venezuela’s Big Bond Deal - A Thinly Disguised Capital Flight

After months of spending vast sums on bread-and-circus style public works projects – plus massive amounts of oil revenue flooding the country – Venezuela finds itself beset with problems. Namely: too much cheap liquidity.

The country faces the twin deadly sins of any emerging market economy: #1 soaring inflation, and #2 a sinking currency.

What’s a socialist nation to do? In Hugo Chavez’s Venezuela they turn to western financial markets for a solution. Venezuela’s huge state-run energy monopoly PdVSA, just issued the largest corporate bond ever in Latin America – a jumbo $7.5 billion deal.

Could this mean that socialist President Hugo Chavez – a man bent on nationalizing nearly all of Venezuela’s key industries – is now embracing capitalism? Hardly…

Dialing for Dollars

Venezuela’s finance minister claims the big bond deal will help soak up excess liquidity as a result of all that government spending. But to me, it seems more like a government sanctioned currency flight of massive proportions.

Far from a business-friendly move, it appears to me the Venezuelan government is scrambling for ways to keep the lid from blowing off the country’s economy, by allowing citizens to exchange their rapidly depreciating bolivars – the sinking local currency – for cold-hard U.S. cash.

As reported by the Financial Times; “These dollar-denominated instruments (the PdVSA bonds) - which are bought in local currency and mostly sold straight on to the international market in return for dollars - are being used to drain the excess cash sloshing around the Venezuelan economy. They also feed the local demand for dollars, which has been strong since currency controls were imposed in 2003.”

Bashing the Bolivar and Surging Inflation – Not a Good Combination

Socialist-style currency controls introduced several years ago have had the usual effect – driving Venezuela’s currency much lower in black market dealings than the official exchange rate.

The official rate is set at 2,150 bolivars to the dollar – but the real rate charged in “un-official” currency dealings is more than twice that – at about 4,500 bolivars to the buck. And the black market rate has been weakening at an alarming pace this year, which indicates just how wary citizens are about accepting their own currency with inflation in Venezuela running at 17%.

But by buying the PdVSA bonds, analysts calculate that Venezuelan’s can acquire dollars at a rate of around 3,000 bolivars – a nice premium to the actual exchange rate – and a large window of opportunity to move massive amounts of sinking local currency into hard dollars.

Plenty of Extra Bolivars to Get Rid Of

As Venezuela’ finance minister quite accurately points out: “There are a great number of Venezuelans with lots of local currency to get rid of.” In fact, the bond sale was greeted with such high demand, that the issue was increased in size. More than 500,000 individual orders were placed, with much of it coming from non-institutional investors.

About 60% of those orders were for amounts below $100,000 each in size. Making the deal a more “complicated” transaction than usual, according to an official with ABN Amro, the banking firm that helped underwrite the bond offering.

Complex -- of course it is, since you must double-check the books to make certain all the government ministers in the Chavez administration received their fair-share of the hard currency allotment!

U.S. Business Investment: Where’s the Beef?

Most domestic investors are focused on the deteriorating state of the U.S. housing market and its associated drag on consumer spending – which has yet to materialize so far. But another area of the economy should perhaps be drawing more concern: a lack of U.S. business spending and investment.

As a recent research piece from Northern Trust points out, capital spending by American business declined at a 1.4% annual clip in the second quarter of 2006, then after rebounding in the third, business investment finished the year falling at a 4.8% clip in the fourth quarter.

This negative reading on business investment in two of the past three quarters is all the more striking since U.S. corporate profits and cash flows remain near record high levels. In fact, this budding downtrend in capital spending has even caught the Fed’s attention.

Corporate Capital Spending Trending Lower

When minutes from the January FOMC meeting were released, it revealed the following passage: “business fixed investment overall continued to be weaker than anticipated, suggesting some caution on the part of businesses.” 

And the deterioration in business investment is apparently continuing into 2007 as well. Shipments of non-defense capital goods—excluding aircraft, a widely followed proxy for business capital spending, has declined sharply in recent months – along with U.S. industrial production figures (see related graph on this page).

In fact current trends indicate a further slide in first-quarter 2007 capital spending even worse than the dismal Q4 2006 reading.

So the big question is, after 18 straight quarters of double-digit profit growth for the S&P 500 – the most robust run of corporate earnings gains in decades – exactly where is all this corporate cash flow going if not into productivity enhancing investment?

In other words: where’s the beef?

Instead of reinvesting all this excess cash in operational enhancements, U.S. corporations bought-back a record amount of their own stock last year – to the tune of more than a half-trillion dollars worth, according to Bloomberg news.

All this share buy-back activity certainly helps support U.S. stock prices, but it doesn’t do all that much to lay the investment groundwork necessary to enhance future profits. In other words, corporate execs just don’t see a very attractive environment in terms of return on investment at this time.

So rather than seeking to boost profits from the “core business”, firms are instead reducing shares outstanding to increase earning per share.

This kind of corporate shell game can work for awhile, perhaps until economic growth picks up again. But over the long-run, buybacks may prove a poor substitute for true organic profit growth.

The Next Big European Bourse

Global financial exchanges have been bitten with the urge to merge. The New York Stock Exchange just put the finishing touches on its union with Europe’s Euronext, and the London Stock Exchange only barely wiggled away from its suitor, Nasdaq. But consolidation in financial exchanges is likely to continue, as investors around the world clamor for true 24/7 trading on a global basis.

Meanwhile, behind the former Iron Curtain, another budding bourse has big designs of its own to become a major regional exchange. The Warsaw Stock Exchange (not to be confused with the Warsaw Pact) is quickly becoming Eastern Europe’s dominant equity market.

With a market value north of US$150 billion at the end of 2006, the Warsaw exchange is larger than those in Prague (Czech Republic) and Budapest (Hungary). Average daily trading volume is between 3 and 4 times that of its central European rivals as well. And all that liquidity is drawing IPO business to the Warsaw exchange – not just from Czech and Hungarian companies – but from firms all across the region that are looking to list their shares, according to Bloomberg news.

The Polish bourse is even angling to steal business away from the Vienna Stock exchange, which is considered one of the more modern Western European style exchanges in the region.

Business is booming for shareholders – the WIG20 Index (Poland’s version of the Dow Jones Industrial Average) has more than tripled just since the end of 2002 – that’s a 34% annual return.

Pension Cash Helps Lift Warsaw Share Prices

Part of the explanation for this enormous flow of capital - into the Polish financial capital - is a base of eager institutional investors. Laws passed in 1999 required pension funds there to invest 95% of their holdings in Polish stocks and bonds. Polish shareholders meanwhile can split their retirement funds between the state-controlled social security company and private investment managers.

After several years of 34% annual returns – it’s clear where a lot of these pension contributions are ending up. The Polish economy has also been expanding at a healthy clip, which is expected to continue, despite this nation having the highest unemployment rate in the European Union.

Pricey Market

Although some have expressed concern for excessive valuation in Polish stocks, compared to many of its eastern European neighbors, the Warsaw WIG 20 Index is closing in on new high ground near 3,500 presently.

According to statistics from Erste Bank in Austria, Poland’s economy has averaged about 10% growth in GDP over the past three years, while corporate profits jumped 15.5% last year, yet the WIG 20 Index trades at about 15 times earnings with a dividend yield of about 2% – which appears reasonable.

Going Public?

According to a recent article in the Financial Times, the Warsaw stock exchange is itself considering a public offering.  Unlike most major exchanges in Europe, the Warsaw Exchange is still 98.8% owned by the Polish government.

But now perhaps, the state sees a good opportunity to cash in on the rocket ride enjoyed by Polish stocks in recent years. The government is “mulling over selling a minority stake of about 40%, possibly later this year.”

Is this a case of well-timed selling by insiders after a nice run – or will shares in the Warsaw Stock Exchange be snapped up as fast as some of the IPOs this bourse has been listing? Stay tuned!

An Inside Job in Russian Oil Auction

In recent weeks an interesting drama -- masquerading as free enterprise -- has been playing out in Russia. Assets once belonging to a crown-jewel of the Russian energy sector, Yukos Oil (now bankrupt) are being auctioned off in something akin to the old Soviet style mock-trials that used to take please here.

Yukos was at one time a leading company in Russia's fast-growing energy sector, that is until its flamboyant CEO ran afoul of Russian President (and ex-KGB chief) Vladimir Putin. Today that CEO rots in a Siberian prison, billions in personal wealth confiscated, while Yukos' oil & gas properties get sold off piecemeal to other Russian state-controlled energy concerns.

BP's Straw-man Bid

BP Plc, the UK energy giant made a show-bid for some of these assets through its TNK-BP Russian energy venture. But it's doubtful whether they were serious in trying to actually acquire and Yukos assets. By Russian law, for an auction to proceed, there must be a minimum of two-bidders -- and so BP assumed the convenient role of straw-man bidder in this auction.

You see BP has bigger energy sector fish to fry in Russia, and wants to remain in Moscow's good graces, lest its Russian oil & gas assets end up, like Yukos, in state hands. TNK-BP faces the loss of its license to develop the giant Kovykta gas desposits in Siberia, which state owned Gazprom also has designs on. So playing this role in the Yukos auction was necessary to give another state controlled energy firm Roseneft an inside track in winning these assets at a favorable price.

But alas the best laid plans... As it turns out Roseneft wound up losing out on some valuable Yukos assets -- out maneuvered in a back room deal involving Russian's Gazprom and another foreign straw-bidder -- Italy's giant energy company Eni SpA Eni won a foothold in Russia's oil patch -- paying $5.8 billion for certain natural gas assets -- but only after agreeing to share these assets with state-run Gazprom -- the Russian gas giant. Gazprom immediately indicated that it would "exercise an option to buy control of the assets from Eni", according to Bloomberg news.

Such back-room inside deals would be enough to make America's 19th century robber-baron's blush. And these dealings make western investors more than a bit leary to invest heavily in Russia's key energy industry.

Energy Shares Perk Up!

According to a report out just yesterday, U.S. gasoline stockpiles plunged by more than 5 million barrels last week. And over the past eight-weeks alone, petroleum supplies have tumbled nearly 10% – and we haven’t even hit the peak driving season yet.

Crude oil prices have also been perking up recently. Following Iran’s recent grab of 15 British sailors and marines, the consensus view was that a “war premium” had crept back into the price of oil. But after news reports yesterday that Iran was willing to release its prisoners, crude oil was little change – and certainly didn’t fall as might be expected.

Energy Supply/Demand Balance Still Very Tight

The reason is simple; as indicated in yesterday’s U.S. gasoline inventory report, demand continues to outstrip supplies on a global basis. Strong global growth, especially in emerging nations such as China and India – whose economies are expanding 9% to 10% per year – should continue to strain global energy supplies. In fact, the International Energy Agency expects oil demand to rise by 1.6 million barrels a day over the rest of 2007 – that’s double the rate of demand increase last year.

Recent strength in energy quotes has been a harbinger of this steady demand growth. In fact, crude oil prices have remained remarkably firm over the past several weeks despite declining growth expectations for the U.S. economy.

Recent price action tells me that, after correcting by about one-third from its July 2006 high, the pull back in crude may be finished. Should worries about slowing economic growth begin to subside – it should trigger another sharp rally in energy stocks on a global basis.

Energy Stocks Have Come Down – and Valuation Looks Very Appealing

Plus, energy stocks have lagged behind other market sectors for many months, while energy-sector profits have continued to expand at a strong clip. This makes valuations in the oil-patch appear very attractive.

In expectation of a rebound in oil stocks sometime this year, in March I recommended a diversified international energy ETF to subscribers of our flagship publication, the Sovereign Individual (Vol. 10 No. 3).

So far, this innovative ETF that holds a nice mix of highly-profitable energy stocks is performing well. Now it looks as if this rebound in energy shares will come sooner rather than later in 2007.

Energy-Sector Investments of the Green Variety

When you hear the phrase “energy sector”, some of the thoughts that probably come to mind are: mature companies, that are slow-growing, and highly regulated. But when you say: “Green Energy” – nothing could be farther from the truth!

In fact, the enormous profit potential in the green energy sector today (aka alternative energy, clean energy) offers you similar upside potential to investing in personal computers, wireless telecom or the Internet during their prime growth years.

Granted, the issue of global warming is still fiercely debated; with some saying it isn’t a major concern, just part of the earth’s natural cycle. Environmentalists of course point to scientific evidence they believe shows that man-made pollutants as the root cause.

But setting aside the debate over “global warming” for just a moment – the reality is that there are increasing amounts of capital being poured into green energy technology today – which creates a number of outstanding profit opportunities in this emerging sector for the attentive investor.

Exceptional Growth in Green Energy

Total Revenue generated from all clean-energy technologies jumped 39% last year to $55.4 billion – and is expected to grow 300% to more than $226 billion by 2016 – less than ten-years from now, according to a recent report from Clean Edge Research.

The green energy industry can be broadly defined as any alternative fuel source that’s not a traditional fossil fuel. Also, companies that specialize in pollution reducing technologies applied to fossil fuel sources (like clean coal technology for instance) are also typically included in this sector.

In terms of alternative energy sources, the main categories are as follows:

* Wind energy
* Solar power
* Fuel Cell technology
* Hydro electric sources
* Bio-fuels

Private and Public Sector Pouring Money Into Green Energy

According to industry statistics, total world energy consumption is expected to increase by 40% to 50% by the year 2010 alone. As a result 22 states in the U.S. have recently passed laws governing CO2 emissions and mandatory targets for increased use of renewable resources for power generation.

For example, California which is the world’s 12th largest polluter in terms of carbon emissions, recently passed legislation that aims to cut CO2 emissions back to 50% of 1990 levels by the year 2020 – and targets an 80% reduction by 2050. Meanwhile, the European Union has even more ambitious green energy plans, directing that 22% of all electricity be generated by renewable energy sources within the next four-years.

Follow the Money… Into the Green Energy Sector

With the stepped up levels of regulation involved, the green energy industry is attracting lots of outside capital to invest in innovative new technologies – and this is creating quite a few attractive profit opportunities – if you know where to look.

Venture capital investments in green energy technology nearly tripled to $2.4 billion in 2006, up from $900 million in 2005. With growth numbers like that, the Green energy sector looks poised for the kind of explosive growth enjoyed in the 1990’s by high-tech stocks.

There are a number of companies, both large and small, involved in the green energy sector. But as with most emerging industries, the biggest winners will probably be firms you’ve never heard of. How many of us knew about Cisco Systems in 1990… or Google in 1999?

Without a crystal ball you may not find out who the biggest green energy winners will be in 10 years, but you don’t need to know. In my research, I’ve found a unique investment fund that focuses on the green energy sector with a diversified mix several-dozen different companies.

This investment gives you broad exposure to the industry in a single security. I’ll be following this fund closely, waiting for just the right time to pounce on this opportunity for subscribers to my service, Global Market Investor. Stay tuned!

Capital Markets Expanding Rapidly in Oil Rich Mid-East Region

As crude oil prices head into the high $60/ barrel range and gasoline prices on the rise again, financial markets in the Middle East are perking up again. After suffering a sharp correction over the past few months, stock markets in the region may begin to rebound with the price of oil. But it is fixed-income markets in the Persian Gulf that are stealing all the headlines – doing booming business these days.

New bond offerings in the six Gulf Co-operation Council (GCC) countries - Saudi Arabia, the United Arab Emirates, Qatar, Kuwait, Oman and Bahrain –surged to $40bn last year – up from just $13.5bn in 2005, according to the Moody’s bond rating agency. The majority of new bonds issued these days are from private companies in the region, as opposed to government debt offerings.

With economic growth booming in the Gulf region – thanks to sky-high crude oil prices – investors are turning to fixed income investments in the region, following stepped-up stock market volatility.

Total Gross Domestic Product in the GCC surged to $730 billion last year, more than double 2002 levels. Clamoring to get a piece of the action, its not just international investors who are buying up Mid-east bonds, domestic investors are lining up too.

About 25% of total bond issuance last year – more than $10 billion worth – was in Islamic bonds, which according to a Financial Times article, are structured to pay coupon profits instead of interest to stay in compliance with Arabic commercial laws.

According to Moody’s, GCC corporate bond issuance should double this year, with the United Arab Emirates and its business hub of Dubai leading the way. This is a great indicator that this wealthy emerging market region is expanding the breadth and depth of it’s capital market infrastructure – an important prerequisite for investors seeking to move money into these markets.