A Sustained Period of Low Yields Is Necessary for the Next Sustainable Economic Expansion

A Daily Snapshot of Market Moving Developments
by David A.Rosenberg

On the data front

This is a truly global recession. We learned overnight that Japanese exports collapsed 26.7% year-over-year in November; that's the biggest drop on record. Shipments to the US plunged at an unprecedented 34% year-over-year rate. Meanwhile, imports into Japan sank 14.4% year-over-year in a sign of weakening domestic demand. A similar story out of Thailand, where exports dropped 18.6% in what was the biggest drop in at least 16 years. In China, interest rates were cut for the fifth time in three months. The key one-year lending rate was cut 27 bps to 5.31%. The reserve requirement was cut 50 bps to 15.5% for big banks and 13.5% for smaller ones. Chinese policymakers are trying to head off social unrest. Take a look at page A8 of today's WSJ, "China Faces Unrest as Economy Falters." For a read of how another BRIC nation has hit a wall in the face of a deepening global recession, turn to page A10 of today's WSJ, "India's Textile Industry Unravels."

Across the pond, signs of deflation abound. Germany's import price index dropped 3.4% MoM in November on top of a 3.6% drop in October. This was well below the consensus estimate, which was looking for a 2.5% decline. In France, producer prices plunged 1.9% in November on top of a 0.9% decline in October, well below the consensus, which was looking for a 0.9% drop for the month. Meanwhile, European industrial orders dropped 4.7% MoM in October on top of a downwardly revised 5.4% decline in September. This took the year-over-year rate to -15.1%, which is the the worst on record. We also see that German consumer confidence remained essentially unchanged at 2.1 in January from 2.2 in December.

The next bailout: commercial real estate

Now that the auto-makers have secured a $17 billion bailout, the next group heading to Washington for government assistance is property developers. Take a look at the front page of today's Wall Street Journal, "Developers Ask US For Bailout as Massive Debt Looms." Developers are warning policymakers that office complexes, malls, hotels and other commercial real estate are headed into default and bankruptcy. According to Foresight Analytics, some $350 billion of commercial mortgages will be due for refinancing over the next three years. And, with credit virtually unavailable, borrowers will have give up the property to lenders.

We don't understand why so many are bearish on rates

What we truly don't understand is why it is that so many folks are bearish on interest rates when in fact we need a sustained period of very low yields to help blaze the trail for the next sustainable economic expansion: After all, isn't it good news that, because of Mr. Bond's strength and resolve, we now have the benchmark 30-year fixed-rate mortgage at the lowest level in at least 37 years (5.27%)? Mortgage rates are now down 7 weeks in a row (it does the beg the question, however, as to why it is that mortgage applications for new purchases slid at a 20% annual rate in November and are off in 9 of the past 10 months). And despite the best affordability ratios in 35 years, what did we hear from Lennar last week - that its order book collapsed 46% in the past year and backlogs are down 67%. Maybe the classic affordability ratios that use conventional mortgages don't tell the complete story - because nonconventional mortgage rates have lagged with jumbo loans still costing 6.9%.

Source: John Mauldin's Outside The Box E-Letter

Fed Cuts Rates To Near Zero To Battle Slump

The Federal Reserve cut its target interest rate Tuesday to historic lows between zero and a quarter percentage point and said it could expand a program of unorthodox lending and securities purchases.

Wells Fargo, Wachovia and U.S. Bancorp immediately lowered their prime lending rates from 4 percent to 3.25 percent, and other banks will probably follow suit. Economists cautioned, though, that people frightened by the economy and worried about their own jobs may not feel like taking on more debt.

After two days of discussion among Fed officials, the central bank said it would use every weapon from its arsenal to lift the U.S. from recession. It began by reducing its target interest rate -- an overnight bank-lending rate called the federal-funds rate -- from 1%. Another Fed lending rate, the discount rate, will go to half a percentage point, a level last seen in the 1940s.

The cut was more than many economists expected, and the statement that came with it marked the latest signal by the Fed and its chairman, Ben Bernanke, that the central bank was prepared to take aggressive steps to revive the economy.

"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," the Fed said in a statement. It added that it expected interest rates to remain "exceptionally" low for some time, a subtle commitment to the current policy that could help bring down longer-term interest rates.

In normal times, lower rates reduce the cost of borrowing for households, businesses and financial institutions, which spurs borrowing and economic activity. Those effects are being muted now, however, because many businesses and households are weighed down by heavy debts.

Still, stocks rallied on the news of the Fed's action. The Dow Jones Industrial Average finished at 8924.14, up 359.61 points, or 4.2%, on the day. Treasury bonds rallied, sending their yields lower. Yields on 10-year Treasury notes hit 2.269%. The dollar sank against the euro and the yen.

A number of official borrowing rates -- such as rates on three-month Treasury bills -- have tumbled to near zero, a level they haven't been near since the Great Depression.
President-elect Barack Obama used the Fed move as a rallying call for more fiscal stimulus, the idea of increased government spending or tax cuts, which Fed officials support.

"We are running out of the traditional ammunition that's used in a recession, which is to lower interest rates," Mr. Obama said in a news conference. "They're getting to be about as low as they can go. And although the Fed is still going to have more tools available to it, it is critical that the other branches of government step up."

The trouble for Fed officials is that while official borrowing rates are very low, interest rates for borrowers with even a modicum of risk remain far above levels of a few months ago, which is squeezing the economy.

Beyond lowering interest rates, the central bank said it could expand lending programs, including a plan to buy mortgage-backed securities. The Fed also said it was studying such rescue measures as purchasing U.S. Treasury securities, which could help reduce long-term borrowing rates.

Sixteen months into a campaign to lift the U.S. economy from a gathering financial storm, the Fed's efforts have so far failed, despite cutting interest rates more than five percentage points. In the latest example of the deepening recession, the Commerce Department said new home building dropped 19% in November, to a seasonally adjusted annual rate of 625,000 units, a record monthly low.

"The Fed gets an 'A' or 'A-minus' for effort and not very good marks for results," said Alan Blinder, a Princeton economist and former Fed vice chairman.

Meantime, consumer prices posted their second straight record monthly drop, with the consumer price index falling by 1.7% in November. Gasoline prices tumbled, while car dealers, retailers and others stepped up their discounting to move goods and sell services.

In a sign that inflation is decelerating sharply, core consumer prices, which exclude volatile food and energy prices, were unchanged in November. In the past three months, they have risen at an annual rate of just 0.4%.

Price declines have helped many consumers in the short run, but a longer-run bout of falling consumer prices could be dangerous, giving households even more incentive to slow spending and hoard cash.

Persistently falling prices also raise the real cost of borrowing for businesses and households, and thus Fed officials are determined to try to avoid it. A senior Fed official said after the meeting that the central bank isn't now worried about deflation, but expects the inflation rate to decelerate further.

Officials spent much of two days of meetings deliberating over what other rescue steps the central bank could take as interest rates approach zero. Mr. Bernanke spent much of his academic career studying that and other questions related to financial crises, and the Fed is now employing almost every prescription he laid out in the past.

The approach carries several risks. It could eventually lead to the opposite of the current problem: higher inflation. It also exposes the independent central bank to political meddling and to losses on loans. Then there's the risk that it won't work.

The Fed has already started a campaign to lend directly to damaged financial markets and companies -- nearly anyone with collateral. Its statement Tuesday said those efforts could "sustain the size of the Federal Reserve's balance sheet at a high level."

By such lending, officials have effectively concluded that if banks and financial markets won't extend credit, it will do part of the job for them.

Two large Fed programs are still being ramped up. In one, the central bank has said it will buy as much as $600 billion of debt issued or guaranteed by Fannie Mae, Freddie Mac and other government-backed mortgage businesses.

So far, the Fed has only committed $8 billion to those purchases. Officials were relieved that mortgage rates have fallen since announcing the program last month. Rates on a conforming 30-year mortgages have dropped to 5.28% from 6.64% since the Fed's last meeting, according to HSH Associates, a financial publishing firm.

Read more: http://online.wsj.com/article/SB122945283457211111.html

Bear Markets Started in October 2007

How long will the latest bear markets last? 18 months or 24 months or...?

For future reference.

Quote of the Day

"Give a man some monies, he who is frugal can save some, but he who is a big spender will consume every penny." - value-life

The History of Bear Markets

Words of Wisdom from Kenneth Fisher

Stocks to Survive On
Ken Fisher (10.02.08)

Though I walk through the valley of the shadow of death I fear no evil. Seems that almost everyone else does, though. Most investors need their investments to last them a long, long time, yet they're acting like the next few months are everything. The shadow of death is an illusion. In the long term equities always do well. They will now, too, even if they fall further first.

My firm has 25,000 high-net-worth clients. A typical account would be that of a couple aged 65 and 60 who need their money to last the rest of their lives, 25 to 35 years. They have a long time to go, and they accomplish nothing by getting in and out of the market from fear now. Yet such folks are so overloaded by the doom and gloom they hear around them that many must be re-reminded of their primary purpose and long-term needs.

If you have a time horizon that long, even a 9% minicrash, such as we had on Sept. 29, is something you can take in stride. Over long periods equities have always done well compared with other liquid alternatives. Even if you have a shorter time horizon, such as a decade, you know that stocks are more likely than not to recover from a market decline.

I hear 60-year-olds say nonsense like, "I won't be able to retire because of the market's downturn." That's ridiculous. History has seen many similar bear markets. Yet folks have kept retiring. The next bull market more than makes up for what we lost in the last decline. The average bull market, of which there have been ten since World War II, takes stock up 150% before the cycle turns. The average 12-month rebound from the bottom is 36%. No, I don't know where the bottom is. I just know that stocks don't go down and stay down.

We can argue about where stocks are headed, and there are always two sides to the argument. But put that aside. Think longer. Unless you are in your late 80s and were an adult as World War II ended, stocks are cheaper, adjusted for tax rates and interest rates, than they've been at any time in your adult life. That's a simply stunning statement looking forward. You're walking forward. Stop myopically looking at your feet and focus on the horizon. Just buy great franchises at cheap prices now and be patient. Here are some long-horizon stocks I like now.

Looking past all the immediate hysteria, focusing several years ahead, it's hard for me to see cheaper oil. Hence simple, strong holdings like Norway's StatoilHydro (24, STO) seem logical. As a vertically integrated oil and gas firm with $220 a share of proven reserves, this $89 billion (in revenue) business will keep growing steadily. It sells for ten times likely earnings in 2009 and one times revenue. It offers a 3.75% dividend yield.

The world believes McCain or Obama, and Congress, will beat up on the drug stocks. Hence they sell like nongrowth stocks. I suspect that, as happened when the Clintons were terrorizing the health care industry, the antipharma movement will generate more rhetoric than action. How can Congress curb drug companies without hurting the baby boomers who need their products?

You don't need Viagra to get excited about Pfizer. It's the world's largest drug producer, with such blockbusters as Lipitor for cholesterol, Celebrex for arthritis and Lyrica for epilepsy. As these come off patent, Pfizer will be drawing new revenue from Sutent for cancer and Chantix to help smokers stop. Pfizer sells at less than ten times likely 2009 earnings, with a 7% dividend yield.

Another buy is Bank of America. Built on acquisition and consolidation, Bank of America is the world's largest consumer bank. It has used the credit meltdown to make smart and cheap acquisitions of Countrywide, to make it the largest mortgage lender, and now of Merrill Lynch, to give it the largest securities distribution force. Having made fewer mistakes than its peers, it's marvelously positioned looking a few years out, yet it sells at ten times next year's earnings, with a 7.6% dividend yield.

Celanese, though much smaller, is a globally diversified second-tier chemical company. Its chemicals are used to make industrial colorants, paints, adhesives and complex polymers for most basic industries. It's not exciting, but it's fundamental and cheap. Its markets won't go away. If you buy now at 70% of revenue and six times 2008 earnings, you've got to win a few years out.

Carpetmaker Mohawk Industries has seen its stock sink for four years because of the collapse in housing. But the much larger nonresidential construction market should pick up the slack. It sells at 60% of revenue and 15 times depressed current earnings.