Global Stock Market BLOG - Mike Burnick

All Eyes on Fed... But I’m Watching Libor Rates

As investors across the globe await the Fed’s decision later today, one indicator is signaling a strange (and perhaps frightening) disconnect with the widely-held belief that more Fed rate cuts will rescue credit markets.

The London Interbank Offered Rate (Libor), a key interest rate that big banks charge each other for overnight loans, remains at a stubbornly high level.

In fact, according to the Financial Times, the spread between three-month Libor rates, and the expected Fed funds rate three months down the road, remains unusually elevated at 60 basis points.

This is down from a “peak of 95 basis points prior to last month's rate cut by the Fed. But under normal conditions, the swap should trade around 8bp.”

Elevated Libor rates indicate a healthy amount of fear among banks and other financial institutions around the world. They clearly remain hesitant to lend to each other in the current environment.

Three month Libor is currently around 5.1%, while the Fed funds rate is 4.75%. But the Fed is widely expected to cut rates today by at least 25 basis points, with increasing odds of another quarter-point cut in December. Something just doesn’t add up.

In a normally functioning credit market, Libor should be no higher than about 4.6% (factoring in today’s likely move), and could be as low as 4.3% (in the event of a 50 basis point easing by the Fed), but Libor is stuck at much higher levels than this.

Libor is signaling one of two things: either the world’s banks don’t believe the Fed intends to cut rates much further – or they doubt such easing will do any good for what really ails credit markets.

Either way makes for a potential nightmare on Wall Street this Halloween!

Will Another Fed Rate Cut Rescue U.S. Stocks?

All eyes will be on the Federal Reserve’s policy setting open market committee this week (FOMC) which begins a two-day meeting tomorrow in Washington. By about 2:15 pm  Wednesday, expect the FOMC to announce another cut in the benchmark Fed funds rate – most likely by 25 basis points this time around – as a follow-up move to the Fed’s surprise half-point cut in September.

Since the Fed’s last move financial market conditions have grown somewhat less stressful, with commercial paper rates easing from wide spreads over the Fed funds rate in August. However the news on housing continues to be dismal, with existing home sales plunging another 8% in September to new lows, as reported last week.

Typically, Fed interest rate cuts are good medicine for stock investors. In fact, since 1990 when the Fed has cut rates the S&P 500 has rallied 5.5% on average within the first four months after the Fed’s first easing. Stocks usually go on to post double-digit gains within one-year.

But not all Fed rate cuts are created equal. The last major campaign of easing rates from 2001 to 2003 was in the midst of growing stock market stress as a result of the tech-bubble bursting on Wall Street.

As the chart above shows, the Fed cut rates repeatedly during this period – from over 6% in 2000 all the way down to 1% in 2003 – but this failed to help the stock market enjoy a sustained rally.

In fact, the S&P 500 fell about 40% even while the Fed was continuously cutting rates, before stocks finally began moving higher in 2003 – more than two years after the Fed’s first rate cut in 2001!

This time around, Wall Street is suffering from stress brought on by the bursting of the housing bubble. So the big question is, will another Fed rate cut this week (with more likely to follow) help stocks recover or not?

Above is another interesting chart that shows the S&P 500 enjoyed a nice rally after the Fed’s first rate cut in September, only to roll over again in recent weeks.

In fact, the S&P 500 is now trading below the level it was before the Fed’s surprise half-point move. Stay tuned!

More Questions, and My Answers, About Those “Leaky” SIVs

In response to a recent article (The Next Market Shock Meltdown on Wall Street: a Tale of M-LECs and SIVs), I received a number of reader responses. One email in particular covered a range of topics, and included some really good follow up questions for me. So I though that I would post it here, along with my responses, for the benefit of all readers. Enjoy…

Mike: Read your article from October 21, about SIVs. A couple of questions for you.

1)  I am assuming that money market funds and corporations that have excess cash to invest buy the commercial paper issued by SIV's.

Yes, some of this toxic commercial paper (CP) does in fact lurk in the portfolios of money market funds, in fact a few in the U.S. came under severe stress due to this issue in July, although no big funds had problems in terms of "breaking the buck" (when a money market fund falls below a dollar bid). Most of the SIV paper however resides with banks, brokers, hedge funds, and other institutional investors.

2)  Does the entity that sets up the SIV put up some cash to start the SIV?

Yes, in the case of Citigroup (the King of SIVs), they have started several with a total capital base of $300 billion . Some of this "seed capital" is put up by Citi itself, the rest is from outside investors.

3)  If you look at alot of these investment banks they have gone from 8 or 10% shareholder equity compared to total assets to 4% recently. So they have leveraged up. Looks like they are leveraging up even more using SIV's.

Exactly right! The spreads earned by the SIVs (the interest rate difference between their cost of borrowing, and the yield received on the debt they purchase) are pretty small to begin with, so it's a game of leverage, which is why the sub-prime credit crunch is far from over.

That's because there are several layers of leverage involved, making it more difficult for investors holding this paper to know just how big their ultimate exposure is. Whenever you add lots of leverage, even small changes in underlying asset value can result in huge losses (see Long Term Capital Management - or this year's example - Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund).

4)  You say that the "SIV's typically issue short term commercial paper to raise capital.  Then they turn around and leverage up the cash, typically 10-15 times." So who are the SIV's borrowing money from? If they default who is responsible for the losses on this borrowing.  Is the entity who loaned them the money stuck for the losses, or is the parent company/investment bank on the hook to pay in full the money borrowed by the SIV?

SIVs primarily raise money by issuing this asset-backed commercial paper, using their high credit rating (thanks to their cozy relationship with Citi, and other big banks) to borrow at relatively cheap rates, then invest this money in bundles of collateralized debt. In the event of default, technically the losses reside with the SIV, which means investors who bought CP from the SIV face substantial if not total losses, and the "seed capital" put up by banks and other investors would likely be a total loss.

This is essentially what did happen to those two Bear Stearns hedge funds back in June, which put the sub-prime credit crunch in the headlines.

Some SIVs are structured so a bank is explicitly on the hook in the event of default, and for other SIVs this backstop is implicit. However, the "speculation" is that a big bank with a reputation to protect (like Citi) would never allow one of its SIVs to fail outright.

If that were to happen, then Citi would have a hard time selling another similar structured product to investors down the road. So the more likely scenario is for the bank to "wind down" the SIV by taking the assets back onto its own balance sheet; and sell them in a more orderly fashion, rather than at fire-sale prices in a panic liquidation.

That's why a group of Wall Street firms, led (not coincidentally) by Citigroup, is in such hurry to set up this M-LEC with the Treasury Department's blessing. Such a vehicle would serve as a sort of "weigh-station" for moving assets out of troubled SIVs, but without bringing them onto the banks' own balance sheets. It's essentially replacing one shell-company, with another shell-company, but the shell game is allowed to continue.

5)  It would seem that if the SIV market implodes, there will be a rush to buy short term treasuries (short rates will go down) and a forced sale of long term debt causing long rates to go up.

Two year Treasuries have in fact been soaring in price (sending short-rates lower) since August when CP markets began to seize up. There may or may not be a “forced sale” of long-term bonds, it depends on the type of debt. Treasury bonds for instant may actually attract buying as a “flight to quality trade”. But I would be leery of “risky” debt securities, such as high-yield corporate bonds, which suffered some distress during July and August.

If the SIV market does "implode" in a big way, with several forced liquidations then, to paraphrase the great Warren Buffett: we would have an extreme-low tide of liquidity and we'd find out exactly how many Wall Street firms were swimming naked... which would be a very ugly sight to see!

Are Price Controls the Answer to Soaring Food Costs?

Russian President Vladimir Putin is taking a page out of the old Soviet Union playbook to fight soaring food inflation. According to yesterday’s Financial Times, “Russia is introducing Soviet-style price controls on some basic foods.” But it’s not just Russian consumers who are feeling the pinch from spiraling food costs.

China also instituted food price controls recently after inflation rose 6.5% in August from a year ago, the biggest increase in a decade. The culprit here was an 18% surge in food prices. Meat and poultry prices are up nearly 50% in China from the same time last year. Eggs rose 23.6%, and vegetables are up 22.5%.

Pork prices are going through the roof, and for a country like China that eats pork like American’s do hamburgers, that’s putting a serious dent in consumer budgets.

Less developed countries tend to spend a much larger percentage of their disposable incomes on food, than in mature countries like the U.S.

For instance in China, food accounts for 37% of the average total spending for the typical family. In Russia, it’s more than 40%. And in poorer countries in Africa, food costs can be 60% or more of disposable income.

Meanwhile, in the U.S. and most European countries, food costs only account for 10% or less of the average family’s spending.

So the fact that food prices are soaring on a global basis, is a really big deal to most of the world, even if it’s not as big of an issue in the U.S.

Russia Imposes Food Price Freeze

In Russia, food prices rose steeply in September, with vegetable oil gaining 13.5%, butter up 9.4%, and milk climbing more than 7%. This is pushing overall inflation in Russia beyond its target of 8%, and may top 10% by year’s end, according to the article. Since it’s an election year in Russia, with parliamentary elections scheduled for December, the Kremlin is eager to make any move necessary to keep voters happy.

So the government reached an agreement with Russia’s largest food retailers and producers to freeze prices at October 15 levels on selected items including bread, cheese, milk, eggs and vegetable oil, until the end of the year – conveniently after election day on December 2.

History Suggests, Price Controls Won't Work

But just how much good can price controls do to combat inflation? Unfortunately, the historical precedents aren’t very favorable. More than thirty years ago the Nixon administration tried a “wage and price freeze” to combat soaring inflation in the U.S. The result was an even deeper recession in the mid-1970s, and price controls were soon abandoned.

Price controls in Russia, China and other nations might succeed in holding down headline inflation numbers for a short time, but in the long run it won’t reduce the overall inflation rate. Instead, it will just cause dislocations as retailers are forced to raise other prices and producers reduce output.

The law of unintended consequences usually foil any government-sponsored price controls. For example, Russia said recently it’s considering an increase in export tariffs on wheat from 10% to 30% beginning in November, to keep the domestic economy better supplied with grain this winter.

The result: wheat prices at the CME in Chicago surged 6% in just one week – stoking even more food price inflation.

Wall Street Takes a $20 Billion Hit... Here's Why this is Just a Drop in the Bucket Compared to Potential Losses Still Lurking!

In my last blog post (The Next Market Shock Meltdown on Wall Street: a Tale of M-LECs and SIVs), I explained how a joint Wall Street/Treasury Department “super-fund” is in the works that aims to help resurrect gridlocked credit markets.

In my opinion, this initiative amounts to little more than a desperate, self-serving move to bail-out Wall Street – and try to put off the inevitable – another downside market shock in the financial sector.

Well according to an article in today’s New York Times, this financial day of reckoning may be even closer at hand.

“Collateralized debt obligations — made up of bonds backed by thousands of subprime home loans — are starting to shut off cash payments to investors in lower-rated bonds as credit-rating agencies downgrade the securities they own.”

Collateralized debt obligations (or CDOs) are just one of the many derivative securities created in recent years out of Wall Street’s slicing and dicing of credit risks. CDOs are made up of thousands of individual loans (and other debt), repackaged into shiny triple-A-rated boxes, and sold off to investors around the world.

Some CDOs May Become “Largely Worthless Overnight”

Pension funds, hedge funds, insurance companies and the big banks and investment firms are the biggest buyers of CDOs, typically using off-balance sheet entities such as SIVs (see blog article above), to do the buying using lots of leverage.

Up until now, investors holding these CDOs have mostly been getting paid on time – but not anymore. “On Friday, Standard & Poor’s lowered the ratings on $22 billion in bonds backed by mortgages made to people with weak credit in 2006,” according to the article.

What triggered this downgrade? You guessed it; “continued deterioration in the housing market.” Another ratings agency Moody’s, took the same action in downgrading “a similarly large group of bonds earlier in the month.”

When such a downgrade takes place, investors in these CDO securities are forced to mark-down, the value of their holdings, sometimes significantly. The result: surprise, your CDO’s are now virtually worthless.

Investors that hold the CDOs impacted by downgrades “may be forced to write down mortgage investments beyond the billions they have already written off. Some bonds, for example, may go from being valued at, say, 70 cents on the dollar to becoming largely worthless overnight,” according to the Times article.

Simple Equation: Higher Rates = More Foreclosures = More Losses for Wall Street

As I have been saying right along, the next act of the credit crunch market shock drama is just getting underway – and this mess may take longer to play out than the typical three-acts.

Home foreclosures recently hit a 35-year high, but even though the number of foreclosure filings doubled in each of the last few months, many more adjustable rate mortgages will reset to higher interest rates over the next 18 months. In other words, the worst of the housing recession still lies ahead.

Inevitably, this will trigger more foreclosures, leading to even higher mortgage loan losses and more Wall Street write-offs. It's a vicious cycle with no clear end in sight!

We're Still in the "Early Stages" of this Credit Crunch with more Market Shocks Ahead

How much worse can it get for Wall Street?  Big banks and investment firms wrote-off about $20 billion worth of CDOs and other bad debt over the last two-weeks alone, but that’s just the tip of the iceberg.

“Investment banks issued some $486 billion in debt obligations linked to mortgages in 2006 and the first half of 2007,” according to the Times. So far, only a small fraction of these securities have actually been downgraded by S&P and Moody’s.

An official at one of the credit ratings agencies was quoted as saying: “It’s still the early stages of a very significant stress.” Translation: brace yourself for more housing/credit related market shocks ahead!

The Next Market Shock Meltdown on Wall Street: a Tale of M-LECs and SIVs

Two related news items rocked Wall Street last week. The first was mounting losses in the financial sector tied to the sub-prime credit crunch. The second was a hail-Mary play drawn up by the U.S. Treasury and Wall Street banks, to create a “super-fund” to help jump-start gridlocked credit markets.

It’s clear to me that Wall Street is desperate and it’s time to hit the panic-button.

Third quarter profit reports took a turn for the worst last week. Of the S&P 500 financial firms that have reported so far, earnings are plunging 17% from a year ago. That’s the largest decline in Wall Street profitability since Bloomberg began tracking the numbers in 1997!

Wall Street is writing-off tens of billons in sub-prime and other loan losses as a result of the credit crunch. So they’ve asked the Treasury Department for what amounts to a bail out. The solution is to set up a new and suitably cryptic Wall Street acronym know as an M-LEC (Master Liquidity Enhancement Conduit) to help bail out another obscure Wall Street acronym known as an SIV (Structured Investment Vehicle).

Just what are SIVs, you may ask, and why do they need to be rescued by an M-LEC?

That’s a good question; but have no fear -- Wall Street and Washington are diligently working on the answer, which is akin to a high-finance version of the old shell-game... let me explain.

The SIV Shell-Game

SIVs were created by Wall Street’s big banks and brokers for the sole purpose of hiding assets... legally of course. Although some economists, including NYUs Nouriel Roubini have said that SIVs should be “forbidden”, these special purpose vehicles are allowed by accounting regulations, and have become big business in recent years.

Typically set up by banks and investment firms, SIVs issue short-term commercial paper (backed by the parent firm) and use the money to purchase long term asset-backed debt securities.  In recent years, this has included lots of sub-prime mortgage loans, many of which are now defaulting at alarming rates, and that’s the problem now impacting credit markets.

Here’s how the operation usually works. A big bank, say Citigroup, sets up an SIV for the sole purpose of buying, let’s say, mortgage-backed securities. The SIV is considered a separate operating company apart from Citigroup, therefore the assets, and more important the liabilities, are NOT consolidated on Citigroup’s own balance sheet.

And that's the key to SIVs. Banks and brokers are subject to strict reserve and net capital requirements that limits their ability to leverage up their balance sheet. Too much debt appearing on the balance sheet after all might lead to a credit-rating downgrade. And financial firms are very sensitive to their sterling credit ratings.

Banks like Citigroup are still ultimately on the hook for the SIV’s debts, but these are considered “contingent liabilities” that aren’t typically counted in the credit-rating equation.

Commercial Paper Market Plunges, Cutting Off SIV Funding

So the SIVs come in handy as a short of shell-company, keeping mountains of risky debt off the parent firm's balance sheet. The SIVs typically issue short-term commercial paper to raise capital. Then they turn around and leverage up the cash – typically 10-15 times – but sometimes as high as 20 times! With this highly leveraged capital base, the SIV can buy even more mortgages and other debt.

Citigroup is in fact is the King of SIVs, with no less than $100 billion in assets outstanding as of July. At the peak, the total market size for SIVs was about $425 billion as of mid-July, but according to data from Moody’s, the industry has shrunk rapidly by more than 10% since the credit crunch shock began to roil markets.

The reason is that SIV funding depends upon constant issuance (or rolling over) of short-term commercial paper at favorable interest rates.

But when the credit crunch struck this summer, investors soon discovered that too much defaulting sub-prime debt was lurking in these portfolios, and they quickly backed away from buying commercial paper issued by SIVs. Interest rates on commercial paper soared as a result, reaching a peak of nearly one-full percentage point above the fed funds rate in August.

Since then, rates have come back down, but are still quite a bit higher than normal. So now the $300 billion SIV market – leveraged up as much as 10- to 20-times that amount in asset-backed securities – is teetering on the brink of collapse, no longer able to access cheap financing.

Could a Sub-Prime Fire Sale be Just Around the Corner?

Without funding, the SIVs have little choice but to start selling leveraged assets at fire-sale prices to raise cash. Some of these assets include exotic and illiquid collateralized mortgage obligations that can’t even be accurately priced in the current environment, much less in a panic sale.

Mass liquidation would create a downward spiral in asset values that would end in the outright collapse of many SIV. Such a scenario is Wall Street’s worst nightmare, because the big banks and brokers would then be forced to take these troubled securities back onto their own books – resulting in potential losses in the hundreds of billions.

It’s no wonder that Wall Street’s biggest firms are busy lobbying the Treasury Department to create this super (bailout) fund: they are desperate to avoid a fire-sale of $320 billion is troubled assets, that would end up coming home to roost on their balance sheets.

It’s no coincidence that investors in the Treasury bailout fund so far include Citigroup, Bank of America, and JP Morgan, who collectively have agreed to kick-in as much as $80 billion to rescue the SIVs. These three firms reported multi-billion dollar losses and charge-offs in recent weeks (see table above), and now they’re staring down the gun-barrel of a much bigger hit if they don’t do something fast to bail out these SIVs.

Desperate times call for desperate measures, and the Treasury sponsored super-fund is just such a measure

Cleaning up the Commercial Paper Market Crash

There are already plenty of skeptics to the super-fund idea. According to a story in Bloomberg, former Fed Chairman Alan Greenspan indicated last week that the fund could do more harm than good saying: “It's not clear to me that the benefits exceed the risks.”

The asset-backed commercial paper market – the life-blood of cheap SIV financing – declined again last week for the 10th straight week, extending the worst slump in seven years that has caused the total value of the outstanding commercial paper market to contract 25% since July.

Imagine investors’ reaction to a stock market crash of 25% – such as occurred on Wall Street 20-years ago – and you get an idea of what SIVs are now facing. But in the aftermath of this crash, it may not be so easy to clean up the mess.

The credit crunch correction is far from over... and the next market shock to hit Wall Street looks even nastier!

Is the Housing Bubble Over, Over There?

While I was in Europe last month for a conference near Paris, I had a chance to chat with folks from the U.K., Ireland, Spain, and other nations about the ongoing sub-prime housing crisis gripping U.S. markets.

The biggest concern on their minds was whether Europe would soon be facing a housing recession of its own. An intriguing question to be sure, so I did some digging.

As I detailed in a blog post at the time (Is a Home-Grown Housing Crisis Brewing... in Europe?), sharply rising home prices in recent years have put housing affordability out of reach for many home buyers -- on both sides of the Atlantic!

If you thought the rise in U.S. home prices was over inflated, you should take a look at these numbers:

A common measure of housing affordability is the price to rent ratio, which compares home prices to owner-equivalent rents. In the U.S. the price-rent ratio increased about 40% between 1990 and 2006, but in parts of Europe this ratio has really skyrocketed.

In France, Spain and the U.K. the price-rent ratio expanded about 50% over the same period. In Holland it jumped 125% and in Ireland soared over 225%!

U.K. May Soon Face a Housing Slump of its Own

A recent article in the Financial Times details just how worried Britons are about their overpriced housing market. In the U.K. home prices jumped 144% since 1996, while U.S. home values increased 127% from 1996 to 2006.

The higher the rise, the greater the potential fall, so if anything U.K. home values appear even more overdone than in the U.S.

Recently, British home owners are beginning to experience a reversal of fortune.

Overall prices have fallen by about 1.5% in Birmingham England since July, while overall home prices in the U.K. fell 0.6% in September, according to mortgage lender Halifax.

“Even in prime central London, the upward momentum is showing signs of flagging”, according to the Times article. While the City’s home prices are still appreciating, September brought the “smallest price growth for more than a year.”

Will Britain Follow the U.S. into a Housing Recession?

The worry now is that Britain is likely to follow the U.S. in a sustained downward spiral in home values, just a year or so behind our lead. Already shares of U.K. home builders have fallen 28% since January, the worst performing sector on the London Stock Exchange.

It’s worth noting here that the U.S. Housing Sector Index served as an early-warning signal, foreshadowing the recession in home values here. The index actually peaked in mid-2005, as U.S. home price appreciation leveled off. And the Housing Sector Index had already plunged about 28% from its high, by the time U.S. home values began declining on a national basis about one-year later.

The similarities are stunning between housing “bubbles” in the U.S. and the U.K., but there are differences as well.

Britain has endured a shortage of hew housing for years, and new construction there never hit such a frenzied pace as in the U.S.

Also, U.K. lenders did not indulge in quite as much “creative lending” as U.S. mortgage brokers. However, the U.K. market did experience a “relaxation of credit standards” similar to the U.S.

U.S. Sub-Prime Contagion Spills Over on the Other Side of the Atlantic

But the crisis in U.S. sub-prime mortgages hit property markets in the U.K. pretty hard; the recent bailout of Northern Rock, the fifth-largest mortgage lender in the U.K. is testament to that fact. As a result, "fewer loans are being made and interest rates for most mortgages have shot up, meaning that repossessions (foreclosures) could rise", according to the article.

And as the U.S. housing and financial sectors brace for hundreds of billions in sub-prime mortgage resets over the next 18 months, the outlook is similar in the U.K.

Independent analysts say that U.K. homeowners face “one of the largest payment shocks witnessed since the 1990’s” as 1 million customers with floating rate loans face higher payments. This means monthly mortgage repayments for U.K. borrowers could jump by about 30% over the next year.

For those who believe a recovery in housing and financial markets is just around the corner, this story should serve as a cautionary tale... on both sides of the Atlantic.

“Foreigners Dump Record U.S. Securities” Reports NDR

It’s long been speculated just how much pain foreign investors in U.S. dollar denominated securities are willing to absorb before crying uncle, throwing in the towel and selling.

This headline from the well-respected Ned Davis Research says it all: “Foreigners Dump Record U.S. Securities.”

Perhaps that tipping point arrived with the sub-prime credit crunch correction in August. According to Davis’ economic analysis of U.S. Treasury data, foreign investors sold a record $34.9 billion worth of long-term U.S. securities in August.

Perhaps this is due to the market correction early in the month, but the relentless slide of the buck may have played a role in these asset re-allocation decisions too.

Overseas investors still showed a small appetite for U.S. fixed income securities, as net purchases of bonds “inched up to $5.8 billion.” But foreigners were wholesale sellers of equities, as they unloaded $40.6 billion worth of U.S. stocks – the most ever!

There were other dubious milestones in the TIC data:

August saw the largest ever selling of U.S. Treasuries by official institutions – aka other central banks. However, the U.K. and Caribbean Banking havens were still buying.

Japan and China, the two biggest foreign owners of Treasury bonds pared back their holdings by a combined $33.6 billion in August. Perhaps both nations are growing tired of Washington’s constant bashing about undervalued currencies... so they are retaliating in kind!

Foreigners also sold a record $1.2 billion in corporate bonds, mostly coming out of private investor portfolios. Add to this the $34.5 billion that domestic investors moved offshore into long-term foreign securities in August, and a record $69 billion of investment cash departed this country.

That’s more than three times the net capital outflow of $19.5 billion recorded just the month before.

Perhaps I’m not well qualified to weigh in on what this record outflow of foreign investment cash means to the already distressed U.S. dollar... I’ll leave such complicated currency analysis to luminaries such as Jack Crooks, and our new Currency Chief Sean Hyman, to divine.

For decades U.S. securities were seen by foreigners as the ultimate safe-haven, can’t miss investment. But with the once mighty dollar now in headlong retreat against most major (and many minor) foreign currencies – perhaps foreign investors have become more concerned with the return OF their money, than the return ON their money!

In This Emerging Market, You Get What You Pay For, And Much More!

As I explained in a recent post (Watch Out: It’s Time for Another Earnings Season!), the third-quarter profit reporting season has so far gotten off to a disappointing start for the S&P 500. Just yesterday, Citigroup announced a 57% slide in profits, joining a growing list of financial shares reporting tens of billions in losses this quarter, thanks to the sub-prime credit crunch that began in July.

In fact, by some estimates profits for the S&P 500 may decline in aggregate for the first time since 2002, with Standard & Poor’s now forecasting a 1% fall in profits from last year’s third quarter.

However the news isn’t all bad this profit reporting season in all corners of the globe. There’s one red-hot market half a world away that’s set to report a 40% surge in profits this year: it’s in Hong Kong!

H-Shares Set to Shoot the Lights Out... Again!

Lately, I have seen a fair share of media commentary about how China is in a “bubble.” It’s gone up far too much already, or so the story goes, and China is way overvalued. Well, yes and no.

You see, there are really two Chinas from an investment perspective. First, there’s the over-hyped, over-priced, and rigged game known as China’s mainland A-share markets. Then there’s the Hong Kong listed H-share market of Chinese mainland stocks.

The A-share market as represented by the Shanghai Composite Index certainly appears to be in “bubble-land” after more than tripling in the past year alone. That’s a run up in price reminiscent of the dot-com era in U.S. tech stocks circa 1999.

But the Hong Kong listed H-share market, while not the bargain it was six months to a year ago, still appears attractive, and is drawing investment money from mainland Chinese investors, as well as global investors, seeking a cheaper way to buy into the booming mainland markets.

Despite Big Gains, Hong Kong is Still a Bargain Compared to China

Increasingly Hong Kong has become a destination exchange for Chinese mainland firms listing their shares to more easily raise capital from global investors. In fact, the market value of Chinese mainland stocks now accounts for 53% of Hong Kong’s total market value, up from just 16% when Great Britain turned over its former colony to China in 1999.

Even after a 40%-plus rally since mid-August, Hong Kong’s main benchmark, the Hang Seng Index, trades at just 19 times earnings, compared to a P/E ratio of about 51 times for the Shanghai Composite – that’s quite a discount in favor of Hong Kong shares.

In fact, according to Bloomberg, “Of the 45 Chinese companies with equities traded both at home and in Hong Kong, the so-called H shares are about 34 percent cheaper than their yuan-denominated A shares.”

Take China Life for example. The leading insurer in mainland China is valued at 74 times earnings in Shanghai, but in Hong Kong, China Life’s H-shares have a P/E of 40.5. In other words, the H-shares would have to rally 82% to close this valuation gap.

Hong Kong Enjoys Growing Cash Flows from Mainland Investors

Earlier this year Beijing began to loosen restrictions on where Chinese citizens could invest their estimated $2.3 trillion in household savings. Recently, the government announced a pilot program that allows retail investors to trade directly in Hong Kong listed shares for the first time.

As a result, JP Morgan estimates $60 billion may flow into Hong Kong in the next year seeking to exploit the cheaper valuations found there. Don’t look now, but it looks like this great wall of Chinese retail money is already finding its way south.

In spite of the major move already this year, Hong Kong can still be considered “undervalued” by some measures. While its P/E ratio of 19 has moved up over the past few years, it’s still far cheaper than Shanghai’s valuation, and in line with the S&P 500’s P/E of 18.

Hong Kong Shares Offer Much Stronger Growth Potential to Boot

Take a look at cash flow and Hong Kong looks like an even bigger bargain, trading at just 5.2 times cash flow, compared with 12 times for the S&P 500 and 11.5 times for the MSCI Asia-Pacific Index, according to Bloomberg.

Profits for H-share companies are forecast to surge 40% higher this year, compared to 22% earnings growth for emerging markets overall. Investing in the S&P 500 by contrast, you’ll be lucky to see profits expand just 7% or so this year. You get what you pay for!

Beijing will have it’s time in the global spotlight during next year’s Olympic games, and Shanghai is still China’s principle trading hub – but Hong Kong is increasingly being viewed as the financial gateway to mainland China – as well as mainland China’s gateway to a wider world of investments.

Anyone Remember Stagflation?

Recent data is delivering mixed signals on the state of the U.S. economy. A slowdown in growth appears to be underway to be sure, and yet headline inflation appears to be picking up at the same time... sounds like stagflation to me.

Anyone who lived (and invested) through stagflation in the U.S. during the 1970s can recall the term in all too vivid terms. During this period oil prices rose dramatically, (sound familiar?) first as a result of the Arab oil embargo early in the decade, and a few years later when Iran cut of supplies.

The result was a sharp rise for inflation in the U.S accompanied by slower growth and rising unemployment. Oh, and the U.S. stock market, although it appeared to move higher in nominal terms in the late 1970's, actually lost value in real terms, when adjusted for inflation.

Is Economic History Repeating?

Let's see if we are witnessing some of the same signs of stagflation today:

So far this decade we have seen crude oil prices soar from around $20 a barrel in 2000, to $80 today... check. We’ve also seen uneven rates of economic growth in recent quarters. In fact, the U.S. economy is forecast to grow less than 2% for all of 2007 – well below trend... check.

The only missing ingredient so far is that job growth appears to be holding up. Even here we are seeing some pretty volatile numbers that may indicate fraying at the edges.

Unemployment Rate Edges Higher... Along with Producer Prices

The initial August jobs report issued in early September indicated the first net monthly loss of jobs in four years, but revisions in the September data, reported one month later, miraculously disclosed that payrolls grew instead.

A healthy portion of this “revision” came from government jobs, adding even more suspicion to the validity of any data coming out of Washington. Despite the revised job “gains” the unemployment rate still rose to 4.7%, the highest in a year.

Data on the economy released last week shows discretionary consumer spending was flat for a second straight month in September, amid slowing real retail sales. Meanwhile, the producer price index registered its biggest increase since February, thanks to an 8.4% surge in gasoline prices. The overall rate of producer price inflation doubled to 4.4% in September, up from 2.2% a year ago, the fastest pace since June 2006... stagflation anyone!

Reaping the Gains of U.S. Farm Subsidies

With the NFL football season in full-swing, a different kind of political football is being tossed around on Capitol Hill right now: The 2007 version of the U.S. farm bill – a federal government boondoggle if ever there was one.

The Bush administration and Congress just love to bash China for “manipulating” its currency to boost global exports of cheap Chinese manufactured goods. But when it comes to farm policy, the U.S. is itself one of the biggest manipulators on the global stage.

Congress has enacted a vast array of agricultural subsidies and price supports to artificially prop up American crops costing taxpayers billions; and the U.S. places punitive tariffs on agricultural imports that might otherwise lead to lower prices for American consumers.

Down on the Corporate Farm

Fewer than 2% of Americans even work down on the farm, but the current farm bill in place since 2002 has averaged just over $80 billion a year in support payments. And most of the handouts go to big businesses, and wealthy absentee landlords, not to the quintessential small-town American farmer.

In fact, from 2002 to 2007, $72.9 billion was spent on “commodity support” programs – essentially direct handouts – and 75% of that money went to just 10% of American farms.

Payments are heavily concentrated on crops that reflect the structure of U.S. agriculture back in the Depression era of the 1930’s: including price supports for corn, cotton, rice soybean and wheat, which only encourages irrational overproduction.

For example, U.S. cotton growers sell their crops on global export markets for about half what it costs them to grow the stuff, and the American taxpayer picks up the difference. This of course means that cotton farmers in the developing world, where nearly half the population is dependent on agricultural exports for survival, can’t compete.

Import Tariffs Inflating U.S. Food Prices

At the same America slaps high tariffs on imported crops. The average U.S. tariff on agricultural imports is 18% -- much higher than the 5% average tariff on other imports. So not only are U.S. consumers subsidizing big agribusinesses who don’t need the help, but at the same time we’re paying much higher prices for the food on our tables this Thanksgiving than we need to.

The U.S. Senate is currently debating the 2007 farm bill, which comes up for renewal every five years. Hope springs eternal for reform, but judging from the version of the bill passed by the U.S. House of Representatives, we may have to live with this boondoggle for another 5 years.

In July, the House version of the farm bill actually increased the overall size of potential support payments, eliminating some recent tax cuts to pay for the increased agricultural largess. Your tax dollars at work!

It's Time for U.S. Investors to Grab a Bigger Piece of The Global Growth Pie!

Over the last few days, I’ve discussed how fast-growing emerging markets are in the spotlight again, leading U.S. stocks by a wide margin, in the wake of the Fed’s recent rate cut, and prospects for more to come.

Yesterday, I mentioned that earnings expectations for the S&P 500 call for just 1% or so growth in the third quarter from the same period a year ago. That’s the worst earnings performance for the index since 2002; but the numbers would look even worse – in fact we would likely be witnessing an earnings recession in the U.S. already – if not for the fast-paced earnings growth provided by the overseas subsidiaries of S&P 500 firms!

Increased globalization means a growing share of U.S. corporate profits are coming from international markets, rather than domestic consumers and businesses. In fact, about 44% of the S&P 500’s 2006 sales came from overseas markets, compared with just 32% in 2001, according to data from Standard & Poor’s (S&P) – that’s a huge increase.

U.S. is a Shrinking Part of the Global Economic Pie

Globalization is having a big impact on all-American S&P 500 earnings – and in a very positive way. You may not know this from reading Wall Street’s slanted research, but profit growth for the blue-chip index actually peaked in 2004, and has been drifting lower ever since, according to BCA Research.

If you examine national income data, you’ll find that profits of domestic based companies rose by a paltry 4.2% in the four-quarters ended June 2007, while the profits of U.S. firms’ overseas subsidiaries surged nearly 15%!

This is just another sign that the U.S. economy is an ever shrinking piece of the global economic pie, as more dynamic emerging economies in Asia, Eastern Europe, and Latin America grow ever larger.

In fact, according to IMF data, the U.S. represented only 12% of global GDP growth last year – while emerging markets accounted for nearly 70% of the expansion in total worldwide output.

Economies in the developing world “grew at a blistering pace of 7.3% last year, according to the World Bank, compared with growth of just 3.1% in developed countries,” reports the Wall Street Journal.

Faster EM Economic Growth = Superior Market Returns

This gap of more than 2-to-1 in output growth enjoyed by emerging markets typically translates into more robust stock market returns as well. S&P forecasts economic growth in the U.S., Europe, and Japan will advance just 2% to 2.2% next year; meanwhile Asia ex-Japan is expected to grow nearly 8%, emerging Europe 6.2%, and Latin America almost 5% in 2008.

S&P 500 profit growth, after slumping to barely 1% in the third-quarter, should come in at 8% overall this year, and estimates call for a pickup to 12% in 2008. Let’s just say I’m “highly suspicious” of that forecast in the aftermath of a U.S. housing market recession that has yet to find a bottom.

I wouldn’t be surprised to see low-to-mid single digit profit growth in 2008, if at all.

Meanwhile, emerging market earnings per share should expand nearly 14% in 2008, according to S&P – that’s almost twice the 7.8% profit growth forecast for developed markets. Yet, in spite of this robust growth, developing markets still maintain an edge in terms of valuation.

The emerging market index, even after surging 35% higher so far this year, still trades at just 13 times 2008 estimated profits, while the U.S. trades at about 15 times earnings, and other developed international markets are valued at 13.2 times next year’s profits. The performance gap between fast growing, yet attractively valued emerging markets, and stagnating developed markets, is only bound to increase going forward.

The Fed’s easy-money policy resulting in a renewed slide in the U.S. dollar, plus dimming domestic growth prospects will see to that.

Back on CNBC

I was on CNBC's Closing Bell yesterday afternoon, talking about Alcoa's earnings.

To watch the video on CNBC's website, click here.

Watch Out: It’s Time for Another Earnings Season!

In my humble opinion, the Fed’s latest bail out for Wall Street does have its advantages; namely, this easy-money move should stimulate even more investment cash flows into red-hot emerging markets. As if global investors needed another excuse to invest there.

Emerging markets already take top honors as this year’s best performers. In fact, the MSCI Emerging Market Index has trounced the S&P 500 in terms of performance by a margin of better than 3 to 1 so far this year.

While the S&P 500 has rebounded from its credit-crunch induced summer slump, it’s only posting returns of about 10% so far this year (see graph); meanwhile the Emerging Market Index has already gained over 35% -- and counting.

In fact, a big part of the performance advantage for EMs have come since the August low, when expectations of a Fed rate cut began to gain currency, but it’s not only about interest rates.

There are a number of good reasons to favor emerging markets over the S&P 500 in this environment. Fundamentals, like sales and earnings growth is a very big reason.

After a record setting run of 14 consecutive quarters of double-digit profit growth for the S&P 500 from 2003-2006; investors are now bracing for disappointing earnings reports in the third quarter.

In fact, the S&P 500 is expected to post year over year earnings growth of less than 1% for the 3 months ended September – down sharply from a forecast of 6% profit growth as recently as July 1st, according to data from Thomson Financial. Ongoing uncertainty about the sick housing sector and its impact on the U.S. economy is to blame here.

If this forecast proves correct, it would be the weakest quarterly profit result for the blue-chip index in more than five years. Certain sectors should still produce good results however, particularly the defensive sectors of the S&P 500, and those that earn much of their profits from booming international sales. Healthcare and technology for instance, should continue to post double-digit earnings gains. But watch out for financial and consumer stocks, where profits are expected to decline 6% and 7% respectively.

P.S. I'll be making a guest appearance on CNBCs “Closing Bell” today at 3:45 PM EDT to discuss the impact of 3rd quarter earnings season . Be sure to tune in to hear more about my favorite stocks and sectors to own right now!

To watch the video on CNBC's website, click here.

Let the Good Times Roll… in Emerging Markets

Happy days are here again, at least for emerging markets and for selected U.S. stocks that earn most of their profits from overseas. These shares are partying like it’s 1999 all over again.

In fact, since the Fed cut benchmark interest rates by a surprisingly large 50 basis points (one-half percent), the asset classes with the strongest upside performance have been found in assorted commodities markets, and especially in emerging markets.

Over the past thirty days (September 4 – October 5, 2007) the best performing stock markets by far have been emerging markets. The Hang Seng Index of Hong Kong shares gets top honors with a gain over 16%, India is third-best up 15%, followed by Turkey (+13.7%), which is tied with Brazil (13.7%); according to data from the Wall Street Journal.

It’s not really surprising to me why this should be so. Since the world’s major central banks appear to be coordinated in their efforts to move toward an easy money policy, it’s clear that the “reflation trade” that has been so profitable in recent years is destined to have another run.

As a recent Financial Times article describes it: “Most emerging economies on the back of buoyant global demand and high commodity prices have expanded rapidly and are less vulnerable to external shocks. Robust earnings growth and reduced country risk have propelled stock markets higher and bond yields lower.”

In such an environment the “riskier” asset classes typically outperform. In one sense, the Fed’s response to this summer’s credit crunch contagion looks remarkably similar to what happened in 1998, when the Fed last resorted to an “emergency” rate cut to save troubled financial markets after the failure of hedge fund Long Term Capital Management.

“In the first 30 trading days after that cut, the Nasdaq Composite gained 23.2 percent,” according to the article, on its way to triple-digit gains in 1999 as the tech bubble inflated to massive proportions. This time around, “in the 30 trading days since the credit squeeze forced the Fed to cut the rate at which it lends to banks, the MSCI emerging markets index has done even better, gaining 25.8%,” according to the Financial Times.

Sounds like it’s time to party like it’s 1999 all over again… but perhaps not in technology. This time around emerging markets and commodities are the investments de jour!

Is Wall Street’s Buyout Boom Going Bust?

The Titans of Wall Street were in full-spin mode this week as big banks and brokerage houses fessed-up to bleak third-quarter financial results. Here’s just a sample of the dismal details...

>UBS, the big Swiss banking revealed it will write off as much as 4 billion Swiss francs (US$3.4 billion) in assets, including securities tied to… you guessed it, U.S. sub-prime mortgages.

>Citigroup said third-quarter profits will plunge 60% from a year ago due to “dislocations in the mortgage-backed securities and credit markets.” Citi suffered a $3.3 billion loss on leveraged buyout loans it committed to, but cannot sell to investors in this environment.

>Deutsche Bank disclosed a $3.1 billion write off “related to the U.S. mortgage morass.” About two-thirds of the loss, or $2 billion, is the result of mortgage backed securities gone bust, and another $1 billion went down the drain on its leveraged loan portfolio. Like Citigroup this billion dollar charge-off is due to the freeze up in M&A activity.

> Just today, Merrill Lynch topped them all with a $5 billion write-off of sub-prime mortgage securities and similar collateralized debt obligations, which have plunged in value due to the credit crunch. As a result of these charges, Merrill expects to report a bottom-line loss of 50-cents per share, rather than the $1.24 in profits that analysts had forecast... oops!

As I have said before, it’s clear that the global credit crunch is having a bigger impact on these firms than many investors thought possible. And these low-lights are just from the past few days – third-quarter earnings season is just getting underway!

Financials Catch a Dead-Cat-Bounce... Enjoy it While it Lasts!

The funny thing is that the stocks of these financial titans all rallied amid the bad news; due to a misguided belief that the worst of the credit crunch is over. But I’m not buying into the Pollyanna view... not for one second.

As I explained in greater detail in posts yesterday (Housing Market in “Freefall”, But How Low Can it Go?) and Wednesday (The Hits Just Keep on Coming…), the housing bubble has burst in a big way, and this mess is going to get a lot worse before it gets better. There are record numbers of adjustable rate loans lurking out there with resets coming soon.

So I see very strong evidence of more market shocks to come. This is only the first of a growing wave of Wall Street write-offs that will most likely intensify in 2008. 

Wall Street Waits for Another Shoe to Drop...

Setting aside the ongoing fallout from the debacle in housing, Wall Street’s got another big reason to be worried: global M&A activity – the real bread-n-butter for these firms – has also slowed dramatically.

A recent article in the Economist magazine notes that “In a matter of weeks the private-equity boom has been strangled, its oxygen—cheap debt—cut off by the credit crisis.”

Private equity firms, and the M&A buyout deals they pursue, make them Wall Street’s most lucrative clientele. But since the commercial paper and leveraged loan markets froze up in mid-July, deals are no longer getting done.

M&A Deals Slow to a Trickle

Buyout firms are walking away, unable to secure debt financing on reasonable terms. Needless to say, this cuts deeply into another lucrative revenue stream for Wall Street: the fat fees generated by advising on M&A deals, and underwriting the debt that goes to finance them.

It looks as if the $8 billion buyout of Harman International, an American audio-equipment maker, may not happen since the buyers, “Kohlberg Kravis Roberts (KKR) and Goldman Sachs, insist they no longer have to honour the $8 billion deal”, according to the article.

The Economist goes on to say: “Other takeovers may be heading the same way. The group buying SLM, owner of Sallie Mae, a student lender, has said it plans to withdraw its offer. The buy-out of Tribune, a newspaper group, looks wobbly too.”

Investment Bankers on the Chopping Block

According to figures from Dealogic, the volume of global buyouts, which exceeded $300 billion in May and June alone, slowed to a trickle of less than $25 billion in August, and was lower still through the third week of September.

What will Wall Street do without all that rich bonus money to throw around come year-end?

Wall Street investment bankers have much more to worry about than reduced bonuses this year. According to a recent report “job losses are mounting by the day, thanks to the mortgage meltdown. This week, Bear Stearns, Credit Suisse and Morgan Stanley announced cuts. Wall Street's now up to 130,000 layoffs for the year -- that's four times as many as last year.”

Never mind the bonuses, how about just hanging on to your job, as the credit crunch rolls on.

Housing Market in “Freefall”, But How Low Can it Go?

In yesterday’s blog post, I warned you that, contrary to popular Wall Street opinion, the housing induced, sub-prime market shock is far from over.

The reason is simple: the U.S. housing market appears to still be in “freefall” – indicating that home prices have much further to decline. This continued deterioration in household wealth, occurring at the same time that hundreds of billions in adjustable rate loans reset to higher monthly payments, has the potential to send home prices spiraling even lower, but just how low is the key question.

Wall Street’s cheerleaders would have you believe that the worst is over, and it’s back to business as usual. The big banks and brokers are booking billions in loan losses as they report dismal third-quarter results, but don’t worry they say, markets are getting back to “normal” – whatever that is.

The Fed’s half-point cut in interest rates is widely viewed by the consensus as a panacea that will cure all ills in credit markets, and the housing sector alike. Shares of struggling home builders are jumping higher again; and bankrupt mortgage lenders are actually getting buyout bids from private equity firms – so all’s well that ends well, right? Wrong!

Housing Bubble Deflation Still Has a Long Way to Go

The ugly fact is that we’re nowhere near the end of the line in this housing debacle. In fact, both Wall Street and Main Street are going to be dealing with the after-shocks for years to come. Let’s look at some of the numbers I’m seeing.

The U.S. housing market has been deflating for more than 18 months now, but according to comments from BCA Research, “prices are still very high relative to rents and wages.” In other words, in spite of sliding home values in 75% of major U.S.-metro housing markets, housing affordability remains very close to 20-year lows.

This graph (from BCA Research) shows the fall in existing home prices from a peak growth rate of 15% year over year in 2005, to a low single-digit decline currently.

Now take a closer look at the bottom panel of this graph and you’ll see that the National Association of Realtors Housing Affordability Index has barely budged from the record lows reached last year.

In fact, home prices in the U.S. are still very close to the most unaffordable levels since the mid-1980s. And it’s bound to get worse before it gets better.

Expect Fresh Shocks to the Economy from Falling Home Prices

A few weeks ago, Congress convened special hearings in Washington D.C. to do a post-mortem on the housing crisis, as politicians love to do after the fact and when the damage is already done.

Robert Shiller, a Yale economist who correctly warned about “irrational exuberance” before the tech-bubble burst in 2000, has recently been sounding the alarm about a similar steep correction in housing. In fact Shiller, in conjunction with Standard & Poor’s created his own home price indexes (see graph) – to better track the unfolding carnage in the housing sector.

So far, the Case-Shiller house price index shows roughly a 4% year over year decline in average home prices across the U.S. -- that's it. Shiller warned Congress that “the decline in house prices stands to create future dislocations like the credit crisis we have just seen.”

Former Fed Chief Alan Greenspan has said that it would not be surprising to see double-digit declines in home prices from their peak – which means that at the moment we aren’t even half-way through with this housing bear market.

Where’s the Bottom is the $3 Trillion Question

Congress heard from other experts on housing who predicted a 15% fall in home prices would wipe out $3 trillion of household wealth. If true, that means we are less than one-third of the way through the current housing recession. The trigger for such a steeper slide in home prices is sitting right on the horizon.

According to various research estimates I’ve seen, there are about $650 billion worth of sub-prime adjustable rate loans that are scheduled to reset to much higher rates (meaning sharply higher monthly payments) over the next 15 months. In fact, we won’t even reach the peak in resets until sometime in the spring of 2008 and the amount of mortgages resetting to higher rates may not subside significantly until 2009!

Bottom line: the housing market may have much further to go on the downside, taking a very large chunk of America’s net-worth down with it.

The Hits Just Keep on Coming…

More “good” news out on the housing front yesterday; the National Association of Realtors reports that its index of pending home sales fell to the lowest level on record last month – down a whopping 22% from this time last year.

Home purchase agreements dropped in all four regions of the country. Apparently more than 10% of pending sales contracts “fell through at the last minute in August, as a result of canceled loan commitments from lenders” according to a Bloomberg article.

This is just another sign that the lingering impact of the credit crunch correction is far from over.

So while Wall Street rejoices in the recent Fed rate cut, Main Street USA is still feeling the pain of frozen credit markets and a much tighter lending environment. According to Bloomberg, the main trouble is that less lending is taking place “because of mortgage availability issues.”

“So far, the Fed's half-point rate cut on Sept. 18 has failed to lower mortgage rates and boost demand. Average 30- year, fixed-rate mortgage rates ended last week at 6.42 percent, compared with an average 6.3 percent the prior week,” according to the article.

Housing in Freefall

Sales of existing homes fell in August to the lowest level in five-years, while new-home sales dropped to a seven-year low. At the same time, home prices continue to fall, feeding a self-reinforcing vicious circle of dwindling household net worth – it’s a reverse “wealth effect,” and is bound to get worse before it gets any better.

The graph above shows just how dependent new home buyers became on sub-prime mortgages and other “creative financing” options during the boom years of the housing bubble. But now in the wake of the housing bust, American homeowners face a deepening bear-market in residential real estate.

And as more adjustable rate loans reset higher in coming months, it will put even more downward pressure on home prices. As one economist quoted in the Bloomberg article put it: “The existing homes market is now in freefall.”

No bottom in sight just yet; stay tuned…

Boom Time for Commodity-Backed ETFs

The U.S. dollar index plunged last week to a record low – the lowest level in fact since the New York Board of Trade began calculating the index way back in 1973. It was a history making event, as my colleague Jack Crooks said; but it’s the wrong kind of history if you’ve got too much of your investments denominated in the sinking buck.

Ironically, and perhaps NOT coincidentally, the U.S. dollar index is now lower than at any time since right after Richard Nixon took America off the gold standard in 1971. Gold sold for about $40 per ounce back then, today it fetches nearly twenty-times that price, at nearly $740 an ounce.

Notwithstanding yesterday’s sell-off, which was predicated on a bounce in the buck, gold has been rallying strongly for six-straight weeks – while the greenback was grinding lower. With gold recently trading at its highest level in 27 years, it’s no surprise that investors are rushing into gold-backed investments; including gold exchange-traded funds.

Demand Surging for ETCs

In fact, the Financial Times reports that “demand for ETCs linked to gold and other precious metals is high as investors are drawn to their safe-haven qualities.” It’s ironic too, that “safe-haven” used to be a phrase describing U.S. dollar buying; but it’s not much in vogue anymore.

ETCs, or Exchange Traded Commodities are structured very similar to ETFs, but instead of holding stocks or bonds, these funds hold physical commodities or are designed to track commodity future indexes.

Lately, much of the buying interest in ETCs seems to be lining up for the funds backed by physical delivery of precious metals. According to ETF Securities Ltd (ETFS), the firm that introduced the first commodity-backed ETCs on the London Stock Exchange in 2003, its gold ETC has attracted a lot buying interest in recent weeks.

In fact, the ETFS Physical Gold ETC (PHAU: LN) has seen a stunning 240% increase in assets in just the past seven weeks. Total assets under management in all of the firm’s precious metal ETCs has surged to more than $500 million, out of a grand total of $1.5 billion in assets spread over 42 different ETCs, which track a wide range of commodities in addition to precious metals.

Diversifying with Non-Correlated Commodity Funds

Much of the buying interest seems to be coming from “investors seeking to diversify their portfolios away from equities and bonds,” according to ETFS, and for good reason. Research studies show that commodities have historically had a low to negative correlation with stocks and bonds. So they provide important risk-reduction benefits, especially in times of stock market stress – like the present environment.

Combine that with the ease of trading ETFs, right from a standard stock brokerage account, and their cost-effectiveness, and it’s no wonder investors are flocking to them.

ETFS sees growing investor demand for more exchange-traded commodity funds, and is set to launch some new and innovative products to meet that demand. Recently, the firm launched a series of ETCs that invest in forward futures contracts on crude oil; going out one, two, or even three years. And this week ETFS is launching more forward futures ETCs that will follow 29 different individual commodities and baskets of commodities – tracking everything from Aluminum to Zinc.

Double Your Pleasure with Leveraged Commodity ETFs

Not to be outdone, a U.S. based fund provider has come up with an innovative commodity-backed ETF strategy of its own… just add leverage!

PowerShares is planning to launch three commodity futures ETFs that are targeting double the return of the underlying index. The world’s first leveraged commodity ETFs will track existing gold and silver funds already offered by the firm, plus a precious metals basket leveraged ETF that includes a mix of both gold and silver. So the next time gold makes a 5% daily move – you can leverage up for potential gains of 10% in these new ETFs. What will they think of next!

I’m holding out hope for the world’s first ETF that tracks sub-prime mortgage loans… so I can sell it short!

Where Does Your Emerging Market Rank?

Flying home to Florida from Paris last Thursday was an interesting experience, to say the least. I took a short side trip for just a few days to Munich – home of the annual Oktoberfest celebration – which began this year on September 22. I figured that as long as I was in the neighborhood, I might as well drop in… all work and no play…

So after being up at 5:30 am to catch a 7:00 am connecting flight from Munich to Paris and then (after being delayed over an hour) a very long flight from Charles De Gaulle airport to Miami, I finally made it home about eighteen hours later. At least I had the chance to catch up on my reading. In fact, one article from the Wall Street Journal was particularly interesting and helpful to the global market research I routinely perform.

The World's Most Improved Economies for Doing Business

The World Bank recently produced its annual survey ranking 178 global economies in terms of the ease of doing business in each local market. The survey includes such factors as the amount of red-tape involved in starting and operating a business, the ease of obtaining licenses, registering property and getting access to credit, among other factors.

Apparently, each year the World Bank rankings are eagerly awaited by developing nations, who compete with each other to move up on the list. A higher ranking of course means the potential of more foreign direct investment flows into the country, and ultimately faster economic growth.

This year’s list showed that two Middle Eastern countries: Egypt, and Saudi Arabia are among the top 10 “reformers” according to the World Bank; meaning their business climates were the most improved over the past year. Several eastern European countries made the list also: including Croatia, Macedonia, Georgia and Bulgaria. And rounding out the top10 are Ghana, Kenya, China and Colombia. China has been a repeat performer.

Consistent Improvement is the Key to Capital Inflows

According to the survey, there’s not necessarily a direct link between a country’s ranking and its rate of economic growth, China for instance is still ranked only 83rd. Rather, it’s the consistent progress a nation makes in moving up the World Bank’s list that seems to indicate strong performance for its economy.

China for example was ranked 108th just two years ago – so it has moved up and impressive 25 slots. India too has moved up from 138th two years back to 120th now – still some work to do there.

You’re probably wondering which is the “worst” performing country in terms of reform: Venezuela of course, home to Hugo Chavez “21st Century Socialism”, which has featured rampant confiscation of private-sector assets, dropped to number 172 out of 178 – way to go Hugo!