Global Stock Market BLOG - Mike Burnick

Is a Home-Grown Housing Crisis Brewing… in Europe?

At the conference I’m attending near Paris, the participants have gathered from far and wide, including many Europeans – from Spain, Germany, France, Ireland and the U.K. And one of the main questions on everyone’s mind is… just how much will the U.S. housing recession and sub-prime mess impact the European economy and housing markets?

They should also be considering the possibility of a housing slump and credit crunch closer to home.

Europe has been enjoying very a welcomed resurgence in economic growth over the past few years, there’s no doubt. Industrial production is expanding nicely, exports are booming, and housing prices inflating. In fact, most European countries – particularly the U.K. and Spain – have enjoyed booming property markets -- similar to what was experienced in the U.S. – up until recently.

That’s really the nagging question on the minds of many European’s I spoke with over the weekend: are home values in Europe destined to begin a downward spiral similar to what America is experiencing now.

Housing “Affordability” is a Big Issue Here Too

According to several of the people I talked to, housing affordability is at or near record lows in both Spain and the U.K., not to mention other EU member states – with the exception of Germany where home prices have been rather flat for years. However, sharply rising home values in most EU countries and in the U.K.; combined with slowly growing wages have conspired to price many first-time European home buyers out of the market.

In Spain for instance, housing prices have inflated at an average rate of 15% per year since 2002. In France, home price appreciation has averaged nearly 14% annually over the same period. Many faster growing EU nations like Greece and Ireland have seen similar or even bigger increases in property values. By many accounts home prices in the U.K., especially in and around London have jumped even faster in recent years.

Will the Rising Euro Hamper EU Exports?

The Eurozone economy is performing well right now, with growth in 2007 expected to be near 3%, but economists here are worried about two things: spillover effects from slowing growth in the U.S., and slowing export growth due to the appreciating Euro.

The common Eurozone currency is trading at all time highs against the U.S. dollar and also on a trade-weighted basis. In the U.K., the pound has likewise been strong. One of the reasons is that both the EU and Bank of England have been raising interest rates in recent years. In fact, EU rates have doubled in the past two years alone, resulting in higher borrowing costs for both businesses and consumers.

Now comes the credit-crunch, and the worry that a perfect storm may be brewing, whereby market rates such as LIBOR remain elevated or move even higher. Since many business loans, mortgage loans, and other consumer debts are indexed to LIBOR; higher rates would almost certainly result in reduced business and consumer spending, even as central banks in Europe attempt to prop up the economy by injecting “liquidity.”

A Home Grown Credit Crunch Could Clip Housing

The news of Northern Rock Plc’s difficulty is particularly jarring to European investors.

The Eurozone has enjoyed big export growth thanks to fast growing markets in Eastern Europe and Asia; but the EU’s largest export market is still the U.K. If troubles at Northern Rock broaden to include other institutions there, it could trigger a crisis of confidence, sending interest rates spiraling even higher.

Then there’s housing. In Spain, the economy is expanding at a robust clip of 4% this year, while bank credit is growing more than 23% year over year; sounds good! But with so much speculation in real estate in recent years (sound familiar?), Spaniards are understandably worried about their home values.

According to a recent article in the Financial Times, a Madrid based economist estimates that half a million families in Spain will have difficulty paying their mortgages if euro interest rates rise much further.

This sounds eerily similar to the sub-prime/housing decline script being followed in America. Could Europeans soon be facing a home-grown housing crisis of their own?

Despite Rate Cut, Credit Markets Not Out of the Woods Just Yet

Greeting investors this morning, a headline in Bloomberg noted that the yen appreciated overnight against the other currencies, more evidence of the carry-trade unwind, due to the fact that “credit market losses are spreading.”

News out of the UK indicates that the run on the bank at Northern Rock Plc, another victim of the sub-prime mess, has left the British deposit protection plan (the rough equivalent of U.S. FDIC insurance) short of cash to cope with the bailout of the bank.

According to Bloomberg, “Northern Rock customers withdrew an estimated 2 billion pounds” in deposits from the troubled mortgage lender in recent weeks.

Trouble is, “the U.K. Financial Services Compensation Scheme holds 4.4 million pounds ($8.9 million), while a similar U.S. fund has $49 billion. The plan may have to increase insurance fees from participating banks.”

More Sub-Prime Induced Market Shocks

Meanwhile in Canada, investors are running from the Canadian commercial paper markets, freezing-up about $40 Billion worth of CP rollovers. Seventeen funds run by Canadian finance companies "couldn't raise money to pay back lenders, according to ratings company DBRS Ltd" due to fears of more fallout from the sub-prime contagion.

Beginning in July, “growing defaults in U.S. home loans caused the cost of borrowing to increase for all but the most creditworthy companies. Rates on asset-backed commercial paper soared, rising to six-year highs in the U.S.” according to Bloomberg.

Even the International Monetary Fund, which has repeatedly raised its estimates for global growth (most recently to 5.2% this year), has warned that “instability stemming from credit-market turmoil in the U.S. is ‘likely to be protracted,’ according to the Bloomberg article.

More Soft Economic Data out of U.S.

Today, the National Association of Realtors should report another slump in existing home sales, expected to drop another 5% in the most recent month, while consumer confidence is expected to slump in September.

The ongoing housing recession is likely to get much worse in coming months, as an estimated $600 billion in adjustable-rate mortgages ratchet up to higher monthly payments.

This will pressure home prices further, as more homeowners throw in the towel and sell at fire-sale prices – dragging down Americans' wealth even more.

And for those homeowners who manage to hang in there with higher mortgage payments, discretionary spending on other “stuff” will most certainly slow.

Bottom line: Fed rate cut or no – we’re not out of the woods just yet.

Why the Fed's Dollar-Bashing Move Doesn't Make Sense

I’m on the road again in Europe at the moment, attending a conference just outside Paris, France. I arrived in Paris last Friday morning after what seemed like a very long overnight flight (on a very crowded 747) to attend this conference graciously hosted by Bill Bonner, the founder and president of Agora Publishing, our parent company.

Bill was kind enough to open his beautiful 18th century Chateau to the 30 or so guests who are in attendance here in Courtomer, France, just over an hour and a half by train from Paris. The Château du Courtomer, Bill explained, was the last regal residence constructed for the nobility before the French Revolution. The Chateau is a very spacious and comfortable setting for the conference – the perfect setting to reflect upon recent events in financial markets.

The recent turbulence on Wall Street seems so far away in this idyllic setting in the French countryside, but I found myself using my lunchtime and the dinner hour to catch up on the early action from Wall Street… money never sleeps.

The Fed’s easy-money move last week – cutting benchmark rates by a half-percent – was a leading topic for conversation over the weekend. Bill believes that the Fed is “desperate to avoid a recession”, but rather than helping prop up the U.S. economy with this action – as the mainstream press seems to think – the Fed has “kicked the buck into freefall, and with it, Americans’ real wealth”, according to Bill. He’s got a very valid point that many investors still don’t fully appreciate.

Of course gold, oil, and other commodities have made spectacular moves in recent years; and international markets have far out-performed the U.S.; most investors are quite well aware of this. Fundamental imbalances in supply and demand on a global basis are a key factor in higher commodities; and robust growth in many emerging markets account for why international stocks are soaring.

However, it’s important to understand that these moves have also been propelled in a very meaningful way by the falling value of the U.S. dollar against just about every other global currency in recent years.

In fact the dollar just made a new all-time low against the euro; or as Bill correctly points out, when “measured against crude oil it hit another new record low – worth only 1/83rd of a barrel. As for commodities generally, the dollar also registered a new record low – at 441 on the CRB index.”

Since global economies are being drawn closer together, the eroding value of the dollar simply can’t be ignored, even if you never leave the U.S. Nearly every major commodity is priced in dollars, so as the dollar falls in value, oil, gold and other resources must be pushed higher just to remain at par. The price of everything we import goes up, reducing our purchasing power in direct proportion.

And when it comes to traveling the world, forget it. From the time the euro was first printed up to the present, an American in Paris has lost nearly 60% of his purchasing power, according to Bill’s reckoning. “In the gold market, he has lost even more; his dollars from ’99 will buy only one-third as much of the metal.”

The Fed cut rates to help safeguard the domestic economy from recession… so the thinking goes, but this same easy money policy has only made Americans poorer relative to the rest of the world, as the dollar declines.

The Fed’s policy just doesn’t make much sense.

The Credit Crunch Eases for Now... But is There More to Come?

Global credit markets are enjoying a bounce this week, along with stock indexes world wide in the wake of the Fed’s decision Tuesday to cut its benchmark rate by a full-fifty basis points. Bankers and brokers at trading desks around the globe are breathing a bit easier – at least for now -- after the Fed came to the rescue. But there’s good reason to believe that this respite may not last long.

To recap the sorry state of credit markets following the recent sub-prime crunch, let’s take a quick look back. Short term lending markets in both the U.S. and in Europe virtually ground to a halt in July and August as uncertainty spread about the extent of lending losses on debt securities backed by risky U.S. subprime mortgage loans.

Although the dominoes began to fall with adjustable rate subprime loans made by aggressive lenders in the U.S., the repercussions were felt far from Main Street USA, owing to the fact that Wall Street banks and brokers did such a wonderful job slicing and dicing these loans into any number of asset backed securities and derivatives. These were then packaged and sold globally to any investor in search of slightly higher than normal market yields, but without any additional risk – such was the “free lunch” promised by Wall Street.

Trouble is, globalization means that financial markets are intricately connected in many ways, shapes and forms. Take for instance the gridlock in commercial paper (CP) markets. Why, you may ask would U.S. sub-prime loan problems spill over into the corporate CP market? Good question, here’s the simple explanation.

Commercial paper is a key source of day to day funding for companies and financial firms both large and small. According to the Financial Times, “more than half of the commercial paper outstanding is issued to fund portfolios of securities backed by mortgages and other loans.”

So when U.S. subprime mortgage loans began to default this spring and summer in much higher than expected numbers, the market for commercial paper also locked-up, as lenders (or investors) in the CP market backed away from the new-found uncertainty. The crisis that ensued “made banks reluctant to lend to each other and pushed interbank lending rates above central bank target rates.”

For example, LIBOR rates for 3-month US dollar loans soared to a peak of 5.725% in early September, more than half-a-percent higher than fed funds at the time. UK LIBOR rates went even higher, to nearly 7%, before backing off recently, after the Fed cut its discount rate, followed by the Fed funds rate this week.

But according to the Financial Times article, there’s still something of a “standoff” between potential lenders and borrowers, as markets are still jittery in this environment. So a credit market conundrum has developed: “If you are not a top tier bank, you are not getting the money. If you are a top tier bank, you are not going to want to pay the current rates.”

Reminds me of the old saying that a banker is someone who offers to loan you his umbrella when the sun is shining, but demands it back the instant it clouds up! The semi-dysfunctional state that credit markets are still in doesn’t bode well for big banks and brokers going forward – and could well lead to fresh market shocks.

For one thing, investment banks are now sitting on about $300 billion of high-yield bond and loan deals tied to announced leverage buyouts, that they still have been unable to sell to investors. Another potential wild-card – and it’s a very big one indeed – is the sad state of affairs that continues in sub-prime USA.

There are about $900 billion worth of adjustable rate mortgages that will reset to much higher rates in the next 18 months. Naturally, this could trigger a tidal-wave of increased defaults – threatening commercial paper, and credit markets globally all over again.

Will Emerging Markets Outbid Pentagon on Defense Spending?

One home grown U.S. industry that’ doing just fine these days, has in fact been thriving in recent years, is the defense sector. No credit crunch here!

In fact, the Pentagon’s budget for 2008 is expected to surpass that of the entire Dutch economy in terms of size, thanks to ongoing spending for the “War on Terror” including sizeable costs for missions in Iraq and Afghanistan, according to a recent Financial Times article.

But one day, perhaps in the not-so-distant future, fast growing emerging economies in India, China and Middle Eastern countries, may crowd out U.S. Defense Department spending – to become the prime customers for U.S. based contractors.

Of course this is good news for the big-five U.S. based military defense contractors which include: Lockheed Martin (LMT), Boeing (BA), Northrop Grumman (NOC), General Dynamics (GD) and Raytheon (RTN).

In another prime example of going global, by investing local, shareholders in these firms are increasingly betting on globalization in the defense industry.

According to the article, Lockheed Martin, Boeing – along with European firms Dassault and Saab – “are among those eyeing the opportunity of supplying India with a new fleet of fighter jets to replace its ageing fleet of Russian-built MiG-21s.” The oil-rich Middle Eastern states provide another lineup of eager customers; as do the central Asian republics surrounding Afghanistan.

These same aircraft manufacturers and others are also battling for another big contract in supply Japan with new fighter jets to replace its aging fleet of US mad F-4 and F-15 aircraft. Increasingly China’s growth will certainly lead to more defense spending in the future. There are barriers to U.S. companies exporting certain military technology to China, but the share of the pie will certainly grow for both U.S., and especially European firms.

And there’s bound to be an extra tail-wind from consolidation in this industry as well. Recently, Britain’s BAE Systems purchased U.S. defense contractor Armor Holdings, which provides high-tech armoring technology for Humvee’s and trucks, as well as personal body-armor. No doubt the falling value of the buck made Armor Holdings looks particularly attractive in the UK.

The defense industry is going global, and that’s one area of the economy where the U.S. still has a competitive edge – and U.S. firms look cheap.

Bernanke Blinks!

Staring down the gun-barrel of the worst credit crunch at least since the implosion of Long Term Capital in 1998 – and perhaps since the U.S. Savings & Loan crisis of the late 1980’s – the Federal Reserve once again called on the old reliable reflation play yesterday.

Fed Chairman Ben Bernanke essentially said: "I love the smell of freshly minted money in the morning"; so fire up those printing presses, and crank up the credit-choppers – helicopter-Ben is on the job.

In case you missed the fun yesterday afternoon, here’s a recap: Following up on the first appearance of the Plunge Protection Team about one-month ago with a surprise half-point cut in the discount rate, the FOMC yesterday matched that easing with a 50 basis point cut of its own in the more closely watched Fed funds rate.

Saying that “the tightening of credit conditions has the potential to intensify the housing correction, and to restrain economic growth”, the FOMC voted unanimously to rush to Wall Street’s… er, that is... the economy’s aid, by taking a full 50-basis points off its benchmark lending rate now. In other words: over-react now, and lose all credibility as an inflation-fighting institution in the process.

No surprise that along with across-the board stock market gains, investors also witnessed gold soaring above $730 an ounce, oil crack $82 per barrel (both on the way much higher) and the U.S. dollar sink to yet another record low!

Delaying the Financial Day of Reckoning

Indeed, all the Fed has succeeded in doing is to postpone the inevitable day of financial reckoning on Wall Street. It has bought some time, by issuing a new round of Bernanke Puts – but at what cost?

At its present rate of decline the U.S. dollar, not so long ago the world’s preferred, will more closely resemble the currency of a 1970’s-era banana republic – except those countries south of the border at least had natural resource riches to prop them back up.

Another tangible cost will almost certainly be paid in the form of much higher structural inflation down the road. For investors with portfolios top-heavy in U.S.-based assets this represents a double-threat to purchasing power and asset values from BOTH a sinking currency and the corrosive impact of inflation. It’s a threat not to be taken lightly.

Housing Remains in Recession, Which the Overall Economy May Now Avoid

The Fed’s move also has direct implications for your immediate portfolio strategy, and for the shape of the rally that’s likely to follow. The shift back to reflating the bubble – any bubble – means the game is afoot once again. The yen carry trade will no doubt swing back into action.

The U.S. economy is now likely to avoid recession, although housing will remain in its own private bear market, perhaps for several more years to come – just as tech shares (the previous burst-bubble class) have been laggards during the current bull market rise. The real action however is likely to be back in commodities and emerging markets, which should remain the asset class de jour!

In recent weeks, noticing potential breakout moves developing in several natural resource sectors, and in select emerging market leaders, I recommended a number of commodity-based plays as well as re-recommending a way to play the world’s fastest growing major economy.

Now that the Fed has given the green light to even more risk taking; it’s time for us all to sharpen our pencils and add to our buy lists! Of course it will all end badly… eventually. It always does. But it should be one heck of a blow-off rally in the meantime. You may as well play it for all it’s worth…

Hey, if you can’t beat them, you may as well join them… or at least profit off them!

Wanted: A Full Accounting of Wall Street’s Dirty Laundry

Aside from the high-drama being provided later today by the FOMC meeting; another interesting side-show in this week’s circus-like environment is the fact that Wall Street’s top-dogs are scheduled to release their latest earnings reports.

This will give investors the first look at the financial industry fallout from this summer's credit crunch. This is only fitting, since the turmoil has at least in part, been a market shock of Wall Street’s own making.

Big banks and brokerage firms earned a mint in recent years by packaging up and selling the mortgage-backed derivatives that are now at the heart of the credit crunch. So in effect Wall Street sowed the seeds for the sub-prime debacle; and now gets to reap the whirlwind of the credit crunch first-hand.

Wall Street Set to Report Plunging Profits

Lehman Brothers (LEH) leads off the hit-parade of profit (or loss) reports today, followed by heavyweights Morgan Stanley (MS) on Wednesday, and both Bear Stearns (BSC) and Goldman Sachs (GS) report Thursday. A regular rogue’s gallery of Wall Street’s walking wounded!

What investors are looking for out of these brokerage firms’ is not necessarily the bottom line facts and figures – these are most likely dismal to be sure.

In fact, investors are bracing for what Bloomberg says could be “the worst year-on-year decline in earnings per share since the second quarter of 2005” for Wall Street.

If you subtract a one-time gain on asset sales booked by Goldman Sachs last quarter, this could prove to be the biggest decline in Wall Street profitability since 2001!

Bear Stearns for example, which suffered two hedge fund liquidations in June, is likely to report that second-quarter profits fell nearly 50% year over year.

What Investors Really Want from Wall Street

So the negative earnings reports to come are in some respects already reflected in slumping broker share prices; but the question will be: has all of Wall Street’s dirty laundry been aired out yet?

The key, in these reports will be the “forward looking statements” and “guidance” (if any) from the titans of Wall Street... and the key word to search for is: “transparency”. Investors are desperate to know whether Wall Street has yet been able to asses the full extent of sub-prime related losses.

The real bottom line is that financial market participants are suffering from a crisis of confidence in the system itself. Investors are unsure if the checks and balances are in place to limit losses in opaque derivatives tied to sub-prime mortgage loans, and other asset-backed “paper”. When it comes to accounting for the true market value of Wall Street’s credit derivatives, the following excerpt from Bloomberg says it all (emphasis is mine):

“Prices for some instruments are either unavailable or unreliable, turning such mark-to-market accounting into guesswork. Many securities have all but stopped trading since the sudden increase in defaults on subprime home loans early this year left investors leery of products with limited transparency, such as mortgage-backed bonds and collateralized debt obligations.”

A Little Less “Guesswork” and a Little More Transparency Please

What financial markets need to settle down to business as usual again; in fact what they’re demanding, is a full accounting for the supposed value that backs up all those “pieces of paper” floating around the global financial system.

In other words the question is; can Wall Street back up its derivative “promises”?

The shadowy world of complex financial derivatives is a $415 trillion market – equivalent to eight-times the value of the world’s total economic output – and yet it’s a largely unregulated market where transactions are made between, and values fixed by, big banks and brokerage firms with little oversight, and even less transparency.

It is high time Wall Street opened the shades and let a little sunlight shine in on the full extent of sub-prime derivative losses, investors need such transparency to fully regain confidence in financial markets.

In the absence of such candor from Wall Street this week, we are bound to see more market shocks impacting the financial world.

It’s Fed Week!

Last week witnessed a well-coordinated rally in global financial markets that propelled U.S. stocks more than 2% higher as investors around the world waited for the Fed’s response to the global credit crunch.

Of course the high-profile event of this week will undoubtedly be tomorrow’s FOMC meeting when the Fed is widely expected to cut interest rates in the face of mounting evidence of a U.S. economic slowdown.

According to Bloomberg news “Interest-rate futures show traders see a 58 percent chance of a half-percentage-point cut in the Fed's target for the overnight lending rate”; that probability has increased sharply from virtually ZERO chance of a hefty half-point cut just one month ago.

Will this Be Just the First of Many Cuts?

Still, the Fed’s most likely course of action would be a “measured” quarter-point cut in fed funds to 5%, followed by a more intense “monitoring of incoming data” on the economy before it moves to ease rates by another quarter-point in the near future.

Whatever the actual policy action, it’s worth remembering that the Fed has historically moved interest rates up and down in broad cycles – meaning that even just a quarter-point rate cut tomorrow is likely to be only the first of several similar moves.

The last time the Fed made a rate move – any move – was June 2006 when it hiked fed funds a quarter-point to 5.25%, in the last of seventeen-straight rate increases over a two-year period that began with a benchmark rate of just 1% back in June 2004.

However, the Fed finds itself between a rock and a hard place when it comes to interest rate easing, whether “measured” or not. In point of fact the Fed is caught between a plunging dollar on the one hand and the possibility of recession on the other.

Falling interest rates may help prop up the economy, but should put the dollar under even more intense selling pressure.

Defending the Dollar... Rate Cuts Sure Won’t Help

Last week, the greenback fell within a penny of its record low against the euro, and notched a fresh 30 year low against the Canadian dollar. And the ongoing yen carry-trade unwind led to the biggest dollar decline against Japan’s currency in more than a week.

If we are in store for a “slow and steady easing cycle in the U.S.”, according to one analyst quoted by Bloomberg, and “interest-rate differentials return to drive currencies and the Fed is likely to ease relatively to other countries, there's a lot of capacity for dollar selling from institutional investors.”

It should be an interesting week... oh and Wall Street’s major brokerage firms including the much beleaguered Bear Stearns are set to report their latest quarterly financial results this week too... warts and all! Look for more on the profit outlook for brokers in tomorrow’s blog.

Agri-Commodities May Surge Most as the Buck Slumps

In yesterday’s blog I explained why I believe energy prices are heading higher, but it’s not just crude oil and natural gas that are set to outperform – commodities are set to enjoy an across the board surge to the upside again.

And the policy response in fighting the credit crunch correction has a lot to do with soaring natural resources in my view.

Gold recently topped $700 per ounce, a fresh 16-month high, and it’s now taking aim at multi-decade highs set last year – perhaps on its way to $1,000 during this next secular move.

Silver, copper and other metals prices are also swinging higher, as persistent industrial demand from emerging economies squeezes global supplies.

Even agricultural commodities are getting in gear to the upside this summer – and this sector in particular might hold the best profit potential going forward.

Agri-Commodities is Where “Prices Have Moved the Least”

Wheat has more than doubled in the past year, hitting new record highs, as dry weather threatens crops from Australia to Argentina. Corn is of course a key ingredient (although not all that fuel-efficient) in the production of ethanol in the U.S. – and as gasoline prices rise – so has corn surged 51% higher in price.

As a result, U.S. food makers such as Sara Lee and General Mills are hiking prices to keep up – that box of Cheerios will get even more expensive. In China, the soaring cost of food is Beijing’s primary concern, fearful that surging inflation may spark social unrest.

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Even after these big recent gains, agricultural commodities in particular should still have a long way to go. Global investment guru Jim Rogers, who is a big bull on commodities said not long ago: “If I were looking at new opportunities now, I'd be looking at agriculture. That's where prices have moved least, that's where the opportunities are, that's where fundamentals are also changing. All these agricultural commodities are still very cheap on any historical basis.”

Demand for Commodities Heats Up, but the Slumping U.S. Dollar Plays a Big Role

One of the biggest reasons for soaring agricultural commodities is the same old story that’s driving energy, and metals higher: surging global demand.

Emerging economies especially have a growing “appetite” for all sorts of foods.

In fact, global stockpiles of wheat are projected to fall to a 26-year low according to the USDA – that’s in spite of record harvests in the U.S.

But there’s another key reason for surging commodities prices: the slumping value of the U.S. dollar! Yesterday, the dollar fell to a fresh all-time low against the euro, and the U.S. dollar index is threatening to plunge to lows not seen since 1992!

Since so many global commodities are priced in U.S. dollars, the sinking value of the greenback requires commodity producers to hike prices just to stay even!

Now, add in the unbalanced supply-demand equation that we’re seeing in so many resource markets, and the result is likely to be another round of steadily higher commodity prices ahead.

Better head to the grocery store and stock up now!

Hundred-Dollar Oil Could be Just Around the Corner!

The Energy Department (DoE) reported today that U.S. crude oil inventories once again fell sharply, and much more than expected.

That’s not really a big surprise to me, since I watch global energy markets very closely, and have been expecting the usual seasonal strength across the energy complex to begin kicking in.

In fact, if not for the credit crunch correction throwing a healthy dose of fear into investors over the past 60 days – crude oil would probably be a lot higher than $80 a barrel right now.

Back to the numbers: the DoE said that crude oil supplies fell by more than 7 million barrels in the week ended Sept. 7th – that’s more than twice the 2.7 million-barrel decline that analysts forecast.

This comes on the heels of a similarly large shortfall in the last week of August, and couldn’t happen at a worse time.

Seasonality and Continued Strong Demand Point to Still Higher Energy Prices

From a seasonal perspective, right now is the time that refineries and wholesalers should be building crude oil and natural gas stockpiles ahead of the upcoming winter heating oil season. Instead, energy stocks are dwindling as global demand heats up.

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Add to this the ever-present “geo-political” scare – since so much of the world’s oil comes from the most unstable places – and the fact that tropical storm season is just heating up near the Gulf of Mexico; and you’ve got a recipe for tight demand and higher prices.

And it’s not just crude oil either; gasoline prices are rising, also thanks to declining inventories. Heating oil is moving up too, and natural gas surged 8% today alone, after gaining 7% on Tuesday.

Sounds to me like another leg up in the energy commodities bull market is underway. Tune in to my blog tomorrow, when I’ll tell you about some other commodities that are on the move higher, and why.

Why a Fed Rate Cut May Be No Quick-Fix for Credit Markets

In yesterday's blog post, I discussed how Friday's dismal jobs report sent stocks into a tail-spin to end the week on a sour note. Over the weekend and continuing Yesterday, all I heard was a deluge of financial pundits harping about how the Fed MUST cut benchmark interest rates when they meet one week from today.

But would a quarter-point (or even a half-point) cut in the Fed funds rate really be the cure-all for gridlocked credit markets that everyone seems to believe? Call me skeptical!

There's no doubt a very strong argument to be made for why the Fed can afford to cut interest rates on September 18, officially ending its restrictive policy stance held over since the Greenspan era.

Inflation Seems "Well Contained" Greenlighting a Fed Cut

Recent data indicates that inflation expectations have receded. The yield spread on U.S. Treasury issued inflation protected (TIPS) bonds, has fallen to just over 2% -- which indicates that the current 5.25% fed funds rate is too high.

We've also seen a dramatic decline in yields on all Treasuries across the entire yield-curve, from shorter-term Bills and Notes, to long bonds; benchmark 10-year Treasury yields have tumbled to 4.3%.

So the fed funds rate at 5.25% sticks out like a soar thumb! Even the Fed is having trouble maintaining this high target rate.

A Fed rate cut is probably a forgone conclusion after the weak August payroll numbers last Friday, leaving pundits to debate only the degree of easing that should be forthcoming. But at the same time that government-mandated rates are falling, market-based rates for financial-sector transactions are moving higher.

Market Based Interest Rates Likely to Remain Elevated Despite Fed Move

The London interbank offered rate, or LIBOR, rose to nearly nine-year highs at 6.9% today -- up more than a full percent in just the past week! Such an elevated level in this important lending rate signals a general unwillingness among big banks to extend credit.

The reason for this is simple, LIBOR doesn't reflect a mandated target rate of interest set by a government entity (such as the Fed); instead LIBOR is a market rate of interest set by big banks around the world who submit open market offers to lend money to one another on a short term basis in the normal course of doing business. Recently, this normal business of lending has slowed sharply, as reflected by sky-rocketing LIBOR rates.

Banks, Brokers are Stepping Back from Credit Markets, Reluctant to Lend

Since the credit crunch first made headlines in July, all borrowers are considered "suspect" by lenders, commercial paper markets have seized up, even money market funds are looked at with a much greater degree of suspicion.  Banks can no longer be sure of the underlying credit quality of assets pledged as collateral for loans.

In other words, it's no longer the return ON their money that banks are concerned about, it's the return OF their money.

Naturally, in such an environment, global bankers are demanding higher rates for short-term loans, even as politicians and pundits call for a cut in benchmark rates.

To a certain degree then, the Fed may be pushing on a string next Tuesday even as it slashes its target fed funds rate. To be sure, such a move should improve market psychology, by giving the investment "crowd" what it wants. But even a half-point cut in fed funds may not be enough to re-energize the flow of credit in global capital markets. You see, there's still this troubling matter of the slow-motion housing crash to sort out.

Sub-prime Market Shock Still Far from Over

According to research from the Bank Credit Analyst, "about 60% of sub-prime mortgages carry an adjustable rate, and $650 billion of these toxic loans will reset at a higher interest rate in the next 16 months."

There are more than 6.2 million outstanding sub-prime mortgages, nearly half of which are adjustable rate. Delinquencies on these mortgages rose to almost 15% per cent of all loans last quarter, but estimates call for delinquencies to rise much, much higher in the months ahead.

In fact, the peak in sub-prime resets won't occur until spring 2008, so the credit crunch is liable to get even worse, before it gets better. That's because most adjustable-rate mortgages are indexed to rising LIBOR, rather than a (likely) falling fed funds rate.

And higher rates could lead to even higher than forecast defaults going forward, putting more pressure on home prices, and resulting in more hits to the balance sheets of big banks and brokers, leading to even less credit creation. A vicious cycle that's far from complete.

Jobs Slump Sends Fresh Jitters Through Wall Street

The global stock market bounce got thrown a nasty breaking curve-ball on Friday, as a much worse than expected jobs report tipped the delicate balance of psychology back into the fear camp, leading to another triple-digit loss for the Dow.

The monthly employment report released last Friday showed a surprising reversal of fortune in the U.S. jobs market. Rather than the 100,000 or so jobs that the economy was expected to add last month, according to forecasts, the data indicate a loss of 4,000 jobs.

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That was the first time the economy has lost jobs in more than four years, and brought fresh fears to Wall Street that the credit crunch may be finally spilling over onto Main Street.

Main Street Feeling the Pinch of Lost Jobs

Since the sub-prime induced credit crunch began to roil financial markets in July, this has been the key debate: how much (if at all) would credit market woes spill over into the "real economy".

The housing market in the U.S. which had been such a key driver of overall growth for many years, is suffering its worst contraction since the Depression. But up until now, we haven’t seen a very negative impact on consumer spending, or on employment. All that appears to have changed now.

Not only were 4,000 jobs lost in August, but the data revealed huge revisions to employment over the last two months as well.  The number of jobs created in June and July was previously reported as a robust 218,000; but Friday’s report revised those gains sharply lower to just 69,000 new jobs in June and 68,000 in July.

Odds Increase for a Fed Rate Cut, But Will it Help

Combined with Augusts' loss of 4,000 jobs, this is a three-month moving average of less than 50,000 new payrolls per month. Economists generally agree that a healthy economy should add about 150,000 jobs per month in order to keep unemployment from rising.

These are troubling signs for the health of Main Street consumers.

This Friday we’ll get to see a report from the Commerce Department on August retail sales; economists are forecasting a rise of 0.4%... place your bets.

Speaking of wagers, the futures market is now indicating roughly 75% chance of a cut in the Fed funds rate at the FOMC’s meeting September 18. Up sharply from less than 50% before Friday’s dismal jobs repot.

In tomorrow’s blog post, I’ll explain why a cut in fed funds may NOT be the panacea for financial markets that many investors seem to believe.

Global Firms on U. S. Shopping Spree

n yesterday’s blog I explained how offshore acquirers are picking up the slack for domestic private equity firms, and keeping the global M&A binge rolling along.

While the value of private equity deals fell to just $19 billion in August, down sharply from $131 billion of transactions in June; foreign buyers are stepping up to the plate, accounting for more than one-quarter of all U.S. buyout deals so far in 2007 – the most in four years.

In fact, foreign firms have spent nearly $300 billion already this year on buyouts of U.S. based companies.

Putting a whole new twist on “globalization”, firms from as far a field as India, Dubai, and Singapore have announced blockbuster deals for U.S. assets.

Rather than exporting more “stuff” to U.S. consumers – these emerging market companies are now exporting their cash to buy U.S. companies on the cheap.

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Recently, India’s Tata Motors made a bid for Ford’s Jaguar and Land Rover automotive divisions. Dubai World made a $5 billion investment in Las Vegas’ MGM Mirage; and contract electronics firm Flextronics of Singapore bought its U.S. based rival Solectron in a deal valued at $3.6 billion.

These are just a few examples of the growing appetite among foreign buyers looking to acquire U.S. assets on the cheap.

A large number of these deals are being done by emerging Asian companies who are flush with cash and searching for attractive investment opportunities beyond their own borders. According to the Financial Times, a “key driver for Asia’s giants is the need to expand beyond domestic markets.”

Asian Banks & Buyout Firms Still Open for Business

One investment banker put it this way, “Asian corporations also have strong balance sheets and ample access to finance.” And the evidence seems to bear this out. While Wall Street and Europe are still suffering from the sub-prime induced credit crunch contagion that continues to roil credit markets on both sides of the Atlantic – companies across the Pacific so far seem immune.

According to a recent report by credit rating agency Moody’s, “Asian firms are largely protected from these credit market disruptions since they can “source funding from banks and local bond markets.”

According to Bloomberg, the report said “Moody’s is seeing no evidence so far of a reduction in the ability or willingness of the banking sector in Asian to lend to corporates.”

Maybe some of the Wall Street hedge funds that have suffered steep losses as a result of a liquidity drain in the Western banking sector should instead look east to establish new lines of credit. Asian banks are apparently still open for business.

Offshore Buyers Finding Bargains in U.S.

Profit prospects for Wall Street’s investment banks may not be so dim after all, thanks to record Merger and Acquisition (M&A) activity from offshore investors. Or as a recent story in Bloomberg put it; the number of “takeover offers for U.S. companies is beginning to recover from a near- death experience in August.”

While US based private equity firms may still be ducking for cover from the after-shocks of the Wall Street credit crunch – overseas buyers in both Europe and Asia – are still eager to do deals. It seems these strategic M&A buyers are attracted by cheap U.S. dollar-denominated assets.

“Mergers and acquisitions may set a worldwide record of more than $3.57 trillion before this year ends,” according to the article, spurred by “cross-border activity.” International buyers are picking up the slack from U.S. based buyout firms, with $282 billion of announced M&A deals so far this year – more than in six of the past seven years.

Reversal of Fortune for Private Equity

In fact, “takeovers by overseas buyers account for 26 percent of all U.S. acquisitions, the most in four years, helping insulate Wall Street bankers from the drop in leveraged buyouts”, according to Bloomberg. For domestic private equity firms, it’s a reversal of fortune. After announcing a flurry of transactions totaling more than $200 billion in June and July alone, private-equity deals announced last month fell to just $19 billion.

What’s more, overseas acquirers may just be getting warmed up. “The pace of foreign purchases ultimately might match the volume of domestic deals, as chief executive officers outside the U.S. diversify their holdings,” according to the article.

The reason is simple: a weaker U.S. dollar, and corporate profit margins that have (so far at least) held up near record highs, combine to make U.S. based firms appear more attractive than ever to offshore buyers.

The euro and yen have both appreciated against the dollar this year, and with the probability of Fed interest rate cuts on the rise, to help ease the credit crunch, the greenback may slide even further in the months ahead.

It’s worth noting that the last buyout boom by foreign companies peaked at $350 billion – right at the top of the internet-bubble market in 2000 – and many of those deals turned out to be… rather poor investments.