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Market Trends – July.09
July 1, 2009 by admin · Leave a Comment
General Market
A) Federal Reserve and Other Agencies sees the bright side of the Economy
On 06/24/2009 Mr. Bernanke and his Federal Open Market Committee declared that the pace of economic is slowing, economic activity is likely to remain weak for a time, and inflation will remain subdued for some time, which is same old story from the Federal Reserve. On the very same day Warren Buffett said more interesting things, “I get figures on 70-odd businesses, a lot of them daily. Everything that I see about the economy is that we’ve had no bounce. The financial system was really where the crisis was last September and October, and that’s been surmounted and that’s enormously important. But in terms of the economy coming back, it takes awhile. There were a lot of excesses to be wrung out and that process is still under way and it looks to me like it will be under way for quite a while. In the [Berkshire Hathaway] annual report, I said the economy would be in a shambles this year and probably well beyond. I’m afraid that’s true. I had a cataract operation on my left eye about a month ago and I thought maybe now I’ll be able to see green shoots. We’re not seeing them. Whether it’s retailing, manufacturing, wherever. We have a big utility operation. Industrial demand is down like we’ve never seen it for a simple thing like electricity. So it hasn’t happened yet. It will happen. I want to emphasize that. But it hasn’t happened yet.” Thus, let’s not get too crazy about the stocks, yet, despite of recent flattering news from the Federal Reserve that recession has bottomed.
Despite all the data out this month, new and existing home sales, GDP, jobless claims, only one has impacted the market: durable goods. Orders for items to last a few years increased from April to May exceeded the Wall Street’s expected growth of 0.4%.[1]
Adding more optimistic mood, the Commerce Department announced on 6/25/2009 that the US economy did not contract as much as reported in the first quarter. Their initial report claimed 6.1% contraction and now claims economy contract just 5.5% in the first quarter of 2009.
In addition, Jorgen Elmeskov, the OECD chief economist, and OECD has drastically revised the growth expectations for the US. Jorgen Elmeskov claims, “Signs have multiplied that U.S. activity could bottom out in the course of the second half of this year.” OECD now forecasts a 2.8% U.S. economic contraction in 2009 and 0.9% growth in 2010, which is a huge revision from their most recent call of a 4% decline this year and zero growth in 2010.
B) The House passes Climate Change Bill
On June 26, 2009, the House passed their climate change bill and the entire energy industry is targeted for reform. Greenhouse gasses must be cut 17% by 2020 and 80% by 2050. Emissions from factories, power plants, refineries and energy distributors will make up most of the cut. A cap-and-trade system will cut these emissions. The government will issue a limited number of 1-ton permits each year, which companies will have to obtain if they wish to emit greenhouse gasses. Each year, the government will issue fewer permits. Thus, companies will have to clean up operations, use more green alternatives or invest money in offset projects, like a paper mill planting more trees. 12% of power from electric utility companies must be from renewable resources by 2020 and new office buildings must be 30% more efficient by 2012. Cap and trade will be the largest tax increase in U.S. history.
The question is with higher energy costs throughout the economy, plus an immense new level of state control over economic activity, can the U.S. make the transition to that mythical carbon-neutral energy economy? Cap and trade will breed more problems, which will lead to more taxes and even more regulations and while we live through the consequences of what’s going to happen, there will be a lot of misallocation of resources throughout the economy.
Stocks and Commodities Market
As far as the stock market goes, since June 22, 2009 swift sell-off, major indexes have gone nowhere. Despite all the data and the latest FOMC meeting, the Dow decreased 0.2% on June 23, and 0.3% on June 24, 2009. Merrill Lynch commodities trader Alan Knuckman writes, “This sideways trade for the last few weeks is typical of summer markets, even in an anything but a typical year for investors. Everyone is so conditioned for strong moves in either direction it has left many unable to handle an undefined trend. The stall has disappointed many market watchers, with some calling for a new downturn. Over my years I have found it better to follow the trend without trying to catch the turn. Don’t be too proud to miss some of it. Most of the money is made in the middle of a trend. Volume seems light and something is needed to spark movement after the large bull run. The S&P 500 channel, with lows last week (3rd week of June) at the 899 level (as a support level) and highs at 925+, is an area to watch closely for future clues. At the same time, Treasury bond futures weekly highs at 117 and lows at 114 have held traders in check. The breakout for either asset class will light the way down the future path for the markets. For now, let’s wait and see what trend develops.”
Commodities have yielded to selling pressure. Since peaking at $987 in late May, gold has been in a state of steady decline. It found a temporary bottom early fourth week of June at $919 an ounce and has since inched back up to $935. Oil fell from a recent high of $72 a barrel to as low as $66 during the fourth week of June. The front-month contract has recovered to about $68 on June 25, 2009 morning. Oil had a strong climb and pushed up over $70 per barrel just a few weeks ago. Then oil met with market resistance, therefore, the price of oil retreated into the current $60 range. At least for a short term, Oil price could go even lower. Oil could drop back into the $50s, despite its traditional strength during the summer driving season. A pullback like that in oil prices will take the steam out of recent stock market gains for oil producers and oil services. Thus, take your recent energy gains now. Book some profit, and hold onto the cash for later buying opportunities. However, this does not mean that energy sector will not perform well in a long term. Oil is, definitely, headed upward in price. Half of the world’s daily oil use is now going to developing countries. In summary, we might have a pullback in an otherwise long-term, generally rising trend for energy.
For additional perspective, let’s examine the current structure of the American energy supply. Right now, most of the U.S. energy mix comes from burning coal, natural gas and oil. In fact, according to the U.S. Department of Energy, the U.S. gets 87% of its total energy mix from burning fossil fuels. Another 7% of U.S. energy supply comes from nuclear power. The total is 94%. That leaves about 6% of the U.S. energy mix to come from so-called “renewable” and alternative sources. Approximately an half of that 6% is renewable hydropower from unique sources like the Hoover, Grand Coulee and other dams; however, the US is not building any more big dams. Thus, only about 3% of U.S. total energy comes from things that grow, blow or shine. Of that 3%, about half (1.5%) is from “biofuels,” and that’s if you count a company like Weyerhaeuser (WY: NYSE) burning sawdust to run the sawmills. Finally, there’s a very minor part of the total U.S. energy mix, which is about 1.5%, that comes from windmills, solar and geothermal. For as much visibility as these things get in the media and pop culture, their energy output is tiny, slightly above statistical noise in the overall national mix.
Thus, just follow the numbers. The “alternative” energy sources are a miniscule component of the current energy mix. That’s after a few good years of significant investment, with lots of political support and plenty of tax breaks.
US Housing Market
The U.S. housing market is back to underperforming expectations. Latest existing home sales and new home sales numbers failed to meet the Wall Street’s forecast. The National Association of Realtors reported 2.4% growth in existing home sales on June 23, 2009 to an annual rate of 4.7 million transactions. Even though sales managed to increase in back-to-back months for the first time since 2005, existing home prices are still plummeting, distressed sales are still booming and the market is still saturated with a 9.6-month supply of homes. The stock market no longer satisfied with meager housing growth, the market expected a rate of 4.9 million and thus caused a small sell-off.
According to the Commerce Department report on June 24, 2009, Sales of new houses fell another 0.6%, to a 342,000 annual rate. Comparing to 2008, this is a 32.8% decrease. Wall Street analysts were calling for a 2% rise in new home sales, and like existing home sales, the price of new homes is still falling (down another 3%, to $221,600), and inventory is still at a lofty 10-month supply.
The Dollar Index
The dollar’s still stuck in a range. The dollar index took a quick trip below the infamous 80 score on June 24, 2009 after the FOMC’s announcement, but has since climbed back up to 80.6, which is not far from where it’s been for the last two weeks. On June 25, 2009, IMF chief economist Olivier Blanchard stated, “For the U.S., it is absolutely no question that a sustained recovery has to come from a large increase in exports, which may not be very easy to do. This may require fairly substantial adjustments in the dollar.”
The latest report titled The Long Term Budget Outlook from the Congressional Budget Office (CBO) predicts that, under the most likely scenario, our national debt will exceed 100% of the US GDP by 2023 and 200% by the late 2030s. In formulating their projections, the CBO used two scenarios. The first, the “extended baseline scenario,” assumes things will remain about the same over the next decade: all scheduled changes under current law will occur and all budget projections will be met. The second, their “alternative fiscal scenario,” accounts for budget changes widely expected to occur, like preserving Bush tax cuts for the middle class, reigning in the alternative minimum tax and failure to drastically cut Medicare costs.
Both scenarios paint a dark picture for our fiscal future. No CBO report has ever predicted this much debt, accumulated at such a rate. The CBO is assuming, like the rest of the government, that the worst of the recession is largely behind us, unless the US do something about it. According to the CBO, even under the less severe scenario, “an immediate and permanent reduction in spending or an immediate and permanent increase in revenues equal to 3.2% of GDP would be needed to create a sustainable fiscal path for the next three-quarters of a century.” This means that the US government will need to cut spending or raise taxes by about $440 billion and maintain those adjustments every year for a long, long time. Under the CBO’s worse, more likely scenario, it’s closer to $740 billion.
At least the general Americans are doing the right thing: Americans are saving at the highest rate in 15 years. According to this morning’s personal income and spending report from the Commerce Department, the consumer savings rate is up to 6.9%, its best since 1993. Americans have stashed away an estimated $768 billion, an all-time high.
The World
A) Follow the Needs of Chinese
As an investor, buy what the Chinese MUST buy because they cannot produce enough of for itself. The very best places seems to be in potash, soybeans, iron ore and oil. In these commodities, China’s share of world production is low. For potash, China represents less than 5% of global production, as shown by the vertical axis. It is also not self-sufficient. As the horizontal axis shows, China’s production of potash is little more than 20% of its domestic demand. The Chinese use 12-15 million tonnes of potash every year, but produce only 3 million tonnes.
Therefore, China relies on imports of potash to obtain most of its supply. But Chinese farmers could use a lot more of this unique fertilizer. In fact, China’s potash “application rates” are half what they are in the West. Quite simply, the Chinese need to use more potash to boost their crop yields to where the U.S. and Europe are. Potash is an important nutrient because it controls the plants’ water intake, reduces water loss, increases root growth and improves drought resistance. Clearly, crop yields are higher and crop quality is better with the application of potash. Yet last year, China’s consumption of potash fell. It will probably decline slightly again this year. That’s incompatible with the Chinese Government’s goals and the need of increasing crop yields and quality. Potash prices soared in 2008 and Chinese farmers pushed back by buying less. The price of potash is cheaper now, but not by all that much. In any event, the Chinese farmers can afford it, as the economic return from using potash is compelling. This two-year decline in potash consumption is unprecedented. And its effects on crop yields and production will not be good. Most of the potash suppliers that deal in the Chinese markets believe that Chinese demand will pick up later this year as the Chinese burn through their existing inventories of potash and look forward to the 2010 planting season. The Chinese will be hard- pressed to match the record production of 2008 without potash. The quirky thing about potash is that it tends to stay in the soil and you can skip a year, maybe even two, but no more than that.
As for soybeans, China was once the world’s largest exporter. In 1995, it flipped to a net importer and has been the largest importer of soybeans in the world since 2000. Much of its supply is in the hands of companies such as Archer Daniels Midland, Bunge and Cargill.
In general, this phenomenon illustrates China’s growing demand for food, and its growing dependence on foreign suppliers. This is why we see China in recent months making deals for food. It made a $500 million deal for poultry and pigs from the U.S. China attempted, but failed, to buy farmland in Mozambique and the Philippines. You may have also seen reports on Chinese deals in Africa. In Zambia, Chinese farmers already produce about a quarter of the eggs sold in Lusaka, the capital, for export to China. As China maneuvers to secure its future food supply, one can easily see that the economic axis of the world is shifting from West to East. Understanding the dynamics of this shift will create some wonderful investment opportunities in the years ahead.
In addition, China is also developing a taste for the good life. Protein consumption always increases as a population’s wealth increases. That’s because wealthy populations tend to eat more meat than poor ones, while also eating more fresh fruits and veggies. The diet becomes more diverse, less centered on consuming base grains. The demand for grains doesn’t diminish, though, because the need to produce meat increases the demand for grains exponentially. Generally, five to ten pounds of grain goes into every pound of beef that lands on a dinner plate.
China’s population is also increasing, which is further boosting demand for grains. However, it holds only 10% of the world’s arable land, but 20% of the population. And its arable land resource is in decline. There were about 121 million hectares in service at the end of 2008. That’s down from 133 million hectares as recently as 1988. Increasingly, because of water shortages, desertification, development, urban migration, pollution and a host of other reasons, China is growing less of its own food and relying more on foreign suppliers.
As a side note: Potash cannot be used directly to grow fruits and veggies. These crops such as, tomatoes, avocados, melons, and etc., are sensitive to chloride and salt and thus, potash should be modified and remove the chlorine. These potash-based fertilizers, potassium sulphate (SOP) and potassium nitrate (NOP), are ideal for fruits and veggies. As it turns out, you also need SOP and NOP to grow tobacco. Tobacco is fussy about what fertilizer it will take without messing up its taste or combustibility. It also needs a lot of potash. Yet again, chlorine is a detriment. Chlorine makes the leaves taste sour and can destroy the commercial value of a crop. As with fruits and veggies, you need SOP and NOP.
Selling SOP and NOP to China’s tobacco farmers is also a good business. For one thing, China has the largest population of smokers on the planet, some 350 million. Since potash represents less than 1% of the cost of making cigarettes, the tobacco growers are less price sensitive. What they really want is a quality product consistently delivered.
B) The 2009 World Wealth Report, by Merrill Lynch and Capgemini.
The number of global millionaires fell at a record rate in 2008, led by North Americans. The credit crisis wiped out 15% of the world’s millionaire population, now at just 8.6 million “high net worth individuals (HNWI),” as Merrill Lynch puts it. The total worth of the world’s wealthy fell about $7 trillion last year, to $32.8 trillion. North America was the greatest victim of 2008, shedding 600,000 millionaires and roughly $2.8 trillion in HNWI wealth. North Americans are still at the top, but the reports illustrates that will change. They use some rosy projections for global economic and market recovery for the next few years. Expecting the coffers of HNWI to grow at an annualized rate of 8.1% over the next four years and simple ratios alone make an Asian takeover seem inevitable: One out of every 195 North Americans are millionaires. Only one in about 1,700 Asians can say the same.
C) Iran, the Rising Market and Asia
The population of Iran is 66 million. That makes it the 19th most populous country on the planet, even more populous than France, the U.K., Italy and South Korea. Iran is in the top 10 in terms of contributing to population growth. Economically, Iran is an important link in the New Silk Road, that growing trade relationship between Asia and the Middle East. Iran is a big market for Asian exports. Iran has plenty of oil and gas, which it exports to pay for Asian imports of cars, clothes and other goods. Increasingly, Iran is turning to Asia for these goods, rather than Europe.
Iran is the third largest supplier of crude oil to China. It makes up 12% of China’s total annual oil consumption. No surprise that China will help Iran finance its $3.2 billion expansion of its mammoth South Pars natural gas field.
[1] Data from St. Louis Fed.
