Sunday, January 30, 2011

Market turbulence - Egypt, Earnings, Energy and more

High unemployment, corrupt leaders and repressive political systems have driven unrest in the Middle East and Northern Africa in recent weeks. The initial protests in Tunisia have inspired protests in Lebanon, Yemen and Egypt as well. Unfortunately, as the protesting in Egypt intensified this past week, Hosni Mubarak, the country’s President since October 1981, decided to abolish his government, limit Internet and telecommunications services in parts of the country and close its stock exchange. Markets reacted poorly to the news with 1) the Egyptian stock index trading down almost 16% for the last week, 2) a sharp sell-off in many global equity markets on Friday and 2) concerns that Middle East oil production could be disrupted driving oil prices higher.

MY TAKE: While the problems in the Middle East are troubling (and unlikely to be resolved in the near term), the pull back in many global equity markets are likely also reacting to 1) equity markets that have experienced persistent positive gains since late August 2010; 2) disappointing earnings this week from several firms including Inc (AMZN), Ford Motor Co. (US: F), Johnson & Johnson (US: JNJ), Colgate Palmolive (US: CL), Procter & Gamble (US: PG), and SanDisk (US: SNDK) and 3) a US GDP report that was good, showing a 3.2% growth rate, but slightly below expectations of 3.5%.

The investor challenge: "buy on the dips" or manage volatility and risk

On Friday, several of the factors mentioned above drove the VIX volatility index up 24% for the day. The VIX, which is a measure of expected volatility of S&P 500 stocks in the next 30 days, is considered a measure of investor fear/uncertainty. As the VIX increases, it is assumed that investors are less sure of market direction.

MY TAKE: Some traders and investors seek “fast paced” opportunities when volatility rises above 20 (at the close on Friday, the VIX was 20.4). They thrive on volatility. However, a market where the VIX is trending up and breaking through 20 can be challenging for longer term investors. While a “buy on the dips” approach may work for some investors, I continue to encourage a more cautious short-term approach to the markets. This seems like a good time to research new investment ideas and wait for a bit more market stability.

Is the Bernanke rally over?

One of the expected outcomes of the U.S. Federal Reserve’s second round of quantitative easing (QE2) was an increased appetite for riskier assets such as equities and commodities. In late August, when Chairman Ben Bernanke mentioned that the Fed would pump additional money into the economy as part of QE2, he also noted, “there are clearly many challenges in communicating and conducting monetary policy in a low-inflation environment, including the uncertainties associated with the use of nonconventional policy tools”. Since that time, the S&P 500 is up 22.3%, the MSCI World index is up 20.5%, the Russell 2000 index is up 28.5% and the Dow Jones- UBS Commodity index is up 20.5%.

MY TAKE: As expected, QE2 has driven strong performance in many global equity and commodity markets. Going forward, the critical issue is whether this economic stimulus will continue to drive corporate profits and result in positive job creation. Additionally, while concerns about Eurozone sovereign debt and U.S. local and state government budget issues seems muted for now, these issues remain unresolved. The free-ride is likely over and investors should increasingly focus on the risks associated with their positions.

Sunday, January 16, 2011

Rising food prices and energy prices drive inflation concerns in India and other regions

When 50% of personal income is spent on food and food prices increase over 16% from the prior year, a country will likely face economic, political and investment challenges – this is India’s situation today. Overall, India’s wholesale price inflation is up 8.4% from a year ago. Factors contributing to the price increase are 1) high energy prices (crude oil is India’s largest import), 2) growing world demand for food, 3) poor harvests, 4) the impact of La Nina weather patterns and 5) speculation by commodity traders. Global food prices have risen 32 % since June 2010, according to the United Nations Food and Agriculture Organization’s world food price index (which tracks the prices of meat; dairy; cereal; oils and sugar).

MY TAKE: Inflation concerns are increasing in other developing regions as well, such as Indonesia and Russia, and government leaders in China and the European Union are discussing the need to manage inflation. In India, the Reserve Bank of India (RBI) will likely continue to increase interest rates to manage inflation. However, this strategy could slow the country’s economic growth. Note for equity investors: while there are few absolute rules in the investment process, equities generally perform poorly when an economy’s inflation rate is above 6%. An inflation rate between 1-3% tends to be the economic “sweet spot”. With high inflation, India’s Sensex stock index has dropped 8.9% in the past two weeks.

Sunday, January 9, 2011

U.S. foreclosure processing update

Since this past October, I have shared updates on the home foreclosure processing problems related to the issues of “robo-signing” and no-documentation mortgages. On Friday, the Massachusetts Supreme Judicial Court upheld a lower court ruling that Wells Fargo & Co. (US: WFC) and US Bancorp (US: USB) could not foreclose on homes because they lacked the supporting mortgage documentation.

MY TAKE: With foreclosure practices under investigation in all 50 states, this case will likely set the tone on how homeowners, mortgage holders and regulators will proceed in resolving the mess. There will continue to be strong tension between the desire for economic expediency and “rule of law” processes in clearing out the foreclosure backlog. The most significant factors that drive US economic growth relate to industrial manufacturing and housing. While manufacturing seems to be improving, a recovery in housing continues to remain less certain.

Somber words for the U.S. Federal Reserve

During testimony this past week to the U.S. Senate’s Committee on the Budget, Federal Reserve Chairman Ben Bernanke said, “in circumstances like those we face now, very low inflation or deflation does not necessarily imply any increase in household purchasing power. Rather, because of the associated deterioration in economic performance, very low inflation or deflation arising from economic slack is generally linked with reductions rather than gains in living standards.”

MY TAKE: Given that the Federal Reserve will move forward with an additional $600 billion of stimulus, the economy remains in a state of adjustment. Factors that investors must incorporate into their assessment process include the impact from rapid increases in commodity prices, along with the lackluster employment market recovery.

Sunday, January 2, 2011

U.S. data fuels the Bulls vs. Bears debate

During the past week, there were promising signs that the economy is improving as 1) the Chicago Purchasing Manager’s Index (PMI) increased from 62.5 to 68.6 – the best performance since the 1980s and 2) the number of Americans filing for unemployment benefits dropped below 400,000 for the first time in over two years. At the same time, the number of home foreclosures rose by 31 per cent compared with the second quarter of 2010 and increased by 3.7 per cent when compared with 2009 - these foreclosed homes add to the 1.2 million of properties in the process of foreclosure.

MY TAKE: The U.S. Federal Reserves’ announcement of quantitative easing in late August has had a positive impact on equity market performance and may be driving improved economic performance as well. However, it is likely that additional work remains in restructuring consumer and commercial real estate loans and while unemployment is becoming “less bad”, signs of improvement are needed. In the near term, global economic data will likely support both bullish and bearish scenarios with the potential for “unintended consequences” from varied government stimulus and intervention efforts remaining a wild card. How investors interpret these dynamics will determine how markets perform during 2011.

Action Plan for 2011

During the New Year's resolution season, there are increased expectations that we will improve ourselves and our relationship with others through efforts such as eating better, exercising more often, and increasing volunteer/charitable efforts.

MY TAKE: "Just do it!" - applying these famous three words to our personal, business and investment objectives can result in powerful outcomes. Embracing them means moving from the "planning/talking/analyzing" phase to the "doing" phase. YES - the act of doing is riskier than planning, but let's get going. Execute your plan, improve upon your process and stay focused. Make some mistakes and learn from them. Happy New Year and welcome to 2011!