Economy Articles

Market Trends – September 09

General Market

A) Millions on the Verge of Exhausting Unemployment Benefits

There is a whole new crisis coming: by the end of the year, as many as 1.5 million jobless Americans will have exhausted their unemployment benefits. The National Employment Law Project, a privately funded advocate for the unemployed, released a study over the first weekend of August, which caused quite a stir. According to the group’s research, over 140,000 people have collected the maximum unemployment benefits the government allows. By December, there will be 1.4 million more jobless Americans.

So a swell of long-term-jobless folks suddenly stripped of government support, right as the unemployment rate blows past 10% and toward 11%. It’s already over 15% in Michigan and this could get a little ugly. Thus, Congress is under pressure to extend benefits again. Emergency legislation has already bumped unemployment programs to 79 weeks in half the states, about triple the norm and the longest since its 1930 inception (the rest of the states have programs ranging from 46-72 weeks). Word on the street is that Congress will tack on another 13 weeks for states with unemployment rates over 9% at a cost of $70 billion. Adding more numbers to unemployment rate, the private sector shed another 371,000 jobs in July, ADP reports on August 5^th. That is higher than the 350,000 the Street had expected. ADP said the economy lost 473,000 jobs in June, roughly 80,000 more than expected. Then the government reported 467,000 lost jobs, which is also more than expected.

However, the Labor Department announced that America has lost 247,000 jobs in July, on August 7^th. That blows all popular expectations out of the water: ADP’s guess on Wednesday of 371,000 lost jobs didn’t come close, and even the Street’s expectations of 325,000 was beaten handily. At an official 247,000 jobs, it’s the best monthly report since August 2008. According to the government, the unemployment rate actually fell, from 9.5% to 9.4%. The Labor Department revised June and May job losses for the better, taking out roughly 43,000 job losses previously reported. The average hourly workweek inched up from a record low 33 hours in June to 33.1 hours. The number of workers seeking full-time employment but regretfully working part-time fell 2%. In addition, the government is adding new jobs at a slower pace.

B) The Fed has Promised to Stop Manipulating the Bond Market by October

The Fed has promised to stop manipulating the bond market by October. They will “gradually slow” the pace of its official Treasury purchases, but the $300 billion program will now run through October instead of ending in September, as the Fed had previously scheduled. Outside of the Treasury bond announcement, the FOMC statement was about what you’d expect: Interest rates were left at 0% and will remain “exceptionally low” for an “extended period.” While “economic activity is leveling out,” it will “likely remain weak for some time.” And, of course, “inflation will remain subdued for some time.” The Fed’s announcement hit just about every market: bonds, stocks, currencies and commodities.

No surprise that the Fed’s announcement hurt bond prices. Not only did they forecast the end of their official purchases, but that “leveling out” talk also hints of higher interest rates, and thus lower bond prices. The yield on a 10-year jumped as much as 10 basis points; to 3.7%, on the news. But this morning it’s already given it back on the heels of the latest retail and jobless numbers. Stocks rallied in advance of the FOMC meeting in expectation of some kind of good news. Up 1.3% before the announcement, the S&P 500 seemed content with the Fed’s lilywhite forecast and finished up 1.2% on August 13^th.

C) Is Recession Over?

Capacity utilization inched up a few tenths of a percent in July, the Fed proclaimed on August 14^th. American companies utilized 68.5% of their productive potential, up from June’s record low of 68.1%. Over the last 40 years, an uptick in capacity utilization has marked the end of recession as you can see in the graph.

So is this it? Of course, the National Bureau of Economic Research (NBER) will be of no help. Having no interest in real-time forecasting, they won’t officially call an end to this recession until it’s long past. It took until December 2008 to tell us that this whole mess started in December 2007.The reason behind capacity utilization’s meager rise provides the best answer: July’s improvement was driven entirely by auto manufacturers coming back to life. They had to bump up production 20.1% to keep up with the initial response to “cash for clunkers.” But just for kicks, is it safe to claim that recession is over?

57% of economists already believe the recession has ended, according to a Wall Street Journal survey published on second week of August. Another 23% think it’ll be over in the next couple months. Nevertheless, rests of the world are claiming that recession is over. Hong Kong announced on August 14^th that its economy has stopped contracting. Just like France and Germany on August 13^th, Hong Kong unveiled surprise GDP growth in the second quarter. The Hong Kong economy popped up 3.3% from the first quarter to the second, double Bloomberg’s estimate and its first GDP growth in a year. “The worst is over for the global economy,” Li Ka-shing (Hong Kong’s Warren Buffett) declared, with this important caveat: “It’s too optimistic to say the global economy has reached a turning point. The degree of decline has shrunk, but that doesn’t mean it has stopped shrinking.” On August 17^th, Japan has joined the ranks of recession-emerging nations. The Japanese government claimed the country’s GDP grew 3.7% in the second quarter. That puts an end to a five-quarter losing streak and the longest period of Japanese GDP contraction since World War II. As with Germany, France and Hong Kong during second week of August, there’s little expectation for Japan to maintain this growth in the coming quarters.

D) China, FDIC, U.S. consumers trigger global sell-off

Global stock sell-off that was noted in the market on August 17^th really started on Friday, when the U.S. suffered its worst bank failure of 2009. Alabama-based Colonial Bank gasped its last breath late Friday (August 14^th). With roughly $25 billion in assets, it was the biggest bank failure since Washington Mutual back in September. Like WaMu, the FDIC brokered most of Colonial’s burden onto another bank’s balance sheet. BB&T picked up the lion’s share. And just like the WaMu/JP Morgan deal, the FDIC greased the gears by including some kind of backstop provision. In this case, BB&T and the FDIC will enter a loss sharing agreement on $15 billion in shaky Colonial assets. Colonial’s failure took a $2.8 billion chunk out of the FDIC’s deposit insurance fund. With just $13 billion left, at best, the fund is at its lowest level since 1993. Along with four other banks that failed over the weekend as well, the FDIC has closed 77 banks this year. One more and we’ve tripled last year’s count.

It seems that FDIC has been tardy in resolving banks, which will result in higher costs to the FDIC in the long run. In addition, with these ‘loss sharing’ deals (Colonial/BB&T), the FDIC is putting off the recognition of losses over a period of years, and its estimates of ultimate losses will likely be low, whether they’re ultimately absorbed by the deposit insurance fund or acquiring banks like BB&T.

Already anxious over Friday’s (August 14^th) lousy U.S. consumer confidence number and Colonial’s failure, Chinese traders slammed the bid today on rumors that the Chinese government is going to tighten lending standards. No official word yet from Beijing, but rumor alone was enough to knock the Shanghai Composite down almost 6%. The Chinese benchmark is down 12% so far this month. Thus, the foundation of the U.S. bear market rally is quickly eroding: The consumer is pulling back again, the banking crisis is alive and well, and China, the world’s great hope for growth, is slowing down. Add all that up and the S&P 500 opened down almost 2% on August 17^th morning.

E) Stocks Stand Still in August

After a remarkable 51% rise, the S&P 500 has spent all of August wondering what to do next. There have been some sell-offs and rebounds, but essentially, stocks have taken the month off as you can see in the graph.

Where is the market heading? Financial Analyst and advisor Dan Amoss answers, “Consider the sentiment toward the overall market, aside from the investor sentiment polls, you can tell how bullish investors are by the multiples they are willing to pay for stocks. And right now, after the sharpest five-month rally since the 1930s, the market is trading at valuations that require a strong economic recovery and a return to credit bubble conditions. The rally was powered entirely by P/E multiple expansion, not earnings growth. That sort of rally would be justifiable if corporate revenues and earnings were about to soar, but they’re not. Most earnings surprises were due to cost cutting, rather than top-line growth, which is like burning your furniture to stay warm. The market is not even that cheap when you consider how artificially inflated earnings were at the 2007 peak. Financial earnings made up 18% of the S&P 500’s earnings in 2007 and much more if you add the ‘earnings’ from the finance divisions of industrial conglomerates like GE and GM. Any claims that the S&P 500 is cheap because 2007 somehow represents ‘normalized earnings power’ are bogus. The corporate profit margins and earnings won’t return to that level for many years. The talking heads are getting more creative in their rationale for owning stocks right now. Most money managers seem to be thinking: ‘I don’t believe in this rally, but I’ll ride it until it looks like it’s over, and then I’ll sell.’ This is the type of dangerous crowd psychology that consumes most people during bubbles. When enough investors share this Ponzi sentiment, and nobody’s investing on the basis of sober, rational fundamental analysis, the result is sometimes a crash.”

Somewhat supporting study was conducted by Morgan Stanley who recently evaluated the performance of 19 bear markets in different countries around the world. It’s a comprehensive list that includes the bear market in Switzerland during the 1960s, Japan in the 1990s and Australia in the 1980s, among others. What they found is that the median fall from a market’s peak is 56% and lasts 29 months. The S&P fell 58% over 18 months from its peak in October 2007. U.S. markets have rebounded roughly 51% in five months from March lows, but the median bear market rebound is 70% over 17 months. This suggests the market rally still has some legs.

F) Prime mortgage record high foreclosures vs. NAR says the worst is over

The Fed seems fully committed to keeping this rebound alive. The Fed announced on August 21^st that its balance sheet expanded by $46 billion. But just last week, in a quiet press release, the central bank showed its holdings of mortgage-backed securities rose to $609 billion, from $542 billion a week before. U.S. bond buying picked up too, up $8 billion, to $736 billion. US debt is still on the rise.

Focusing more on US real estate market, a record 4 million American mortgages were delinquent in the second quarter, a 44% rise from the same time last year. That means over 9% of all mortgages in the U.S. are, at best, 30 days late on a payment, says the Mortgage Bankers Association’s National Delinquency Survey, released on August 20^th. That rate doesn’t include loans already in foreclosure. Roughly 4% of all American mortgages (also a US record) are in that mess. Thus, 13.16% of all mortgages are either past due or in foreclosure.

In addition, as we mention before in this report, “There was a major drop in foreclosures on subprime ARM loans,” said the MBA statement. “The drop, however, was offset by increases in the foreclosure rates on the other types of loans, with prime fixed-rate loans having the biggest increase.” One in every three foreclosure starts in the second quarter was on a prime fixed-rate mortgage.

However, “The housing market has decisively turned for the better,” National Association of Realtors chief economist Lawrence Yun declared on August 21^st. This morning’s NAR report showed a 7.2% rise in July existing home sales. That’s the highest month-over-month move in 10 years, and at an annual clip of 5.24 million, the largest home sales rate in two years.

However, if studied little more in detailed, the fine print does not look that positive:

Sales were driven by a crash in prices. The median fell 15% from last year, to $178,400

Distressed sales accounted for 31% of July’s number

The inventory of empty homes actually rose 7.3% in July, to 4.09 million. That’s a 9.4-month supply

We believe that real estate market in general, even though, there are emerging markets throughout the US, may have some more bumps ahead.

G) Banks Fail, One Big Enough for History Books & FDIC

Guaranty Financial of Texas went belly up late Friday (August 14^th) and secured a spot in the history books. With $13 billion in assets, the bank is the third largest to fail this year and tied for the 11th biggest bank failure in U.S. history. Even more interestingly, the FDIC brokered Guaranty’s assets to Banco Bilbao Vizcaya Argentaria, a bank from northern Spain. This event is surprised on two interesting points: 1) A bank from Spain, strapped with double-digit unemployment and a wretched housing bust, wants to bring their euros to the US and 2) BBVA already has a huge presence in Texas. With this acquisition, they will be the fourth largest banking chain in the Texas State. That could be an interesting trend to watch.

Three other banks failed alongside Guaranty: CaptialSouth, First Coweta and ebank. That brings the yearly total to 81 by August 24^th. This should put the FDIC’s deposit insurance fund on its last legs. At the beginning of 2008, the FDIC’s bank failure war chest had over $52 billion. At the end of the March 2009, the last time the FDIC has given us a look into the DIF, they had $13 billion left. 60 banks have failed since, including Guaranty and Colonial, which by themselves took out half of that remaining $13 billion. Only the FDIC can say with accuracy if there is any money left, but this chart gives you a pretty good idea of how the trend is shaping up. This chart compares the FDIC’s Deposit Insurance Funds and the ratio of DIF cash to FDIC insured deposits. The DIF does have a source of income; it taxes member banks a significant insurance fee. But we have to think that the DIF is still in bad shape, perhaps even empty and that the FDIC will soon be hitting up someone to refill their fund.

With failures in California, Minnesota and Maryland by August 31^st, the FDIC has bumped the yearly total of failed banks to 84. The three shuttered banks had about $1.9 billion in assets, which ended up putting a $446 million additional dent in the FDIC’s deposit insurance fund. More than one in four banks announced an unprofitable quarter, referring to the FDIC’s latest quarterly report, Nonperforming loans now make up 2.77% of the entire banking industry’s assets. This is up from 1.4% in June 2008 and 0.47% in June 2006. As these loans get ‘worked out’ in today’s credit environment, the market will start to realize how severe net charge-offs will be.

The FDIC published updated figures for the combined noncurrent loans and loan loss allowance at all FDIC-insured institutions. Here is an updated version of the chart (the moves from December 2008 to June 2009 are highlighted in the dotted lines at the far right of this chart):

You can see how problem loans are increasing at a much faster rate than the rate at which the banking industry is adding to its loss allowance. This means that published capital ratios are misleadingly high. The FDIC has put the taxpayer on the hook for another $80 billion in potential future losses, the Wall Street Journal reports on August 31^st. That sum is the totality of the FDIC’s “loss share” agreements, in which the FDIC promises to take a huge amount of possible future losses if another bank agrees to take on a failed financial’s assets. The FDIC currently predicts the $80 billion in backstops will end up costing the insurer “just” $14 billion. $4 billion over the present balance of its deposit insurance fund.

The Fed has made $14 billion in paper profits from emergency loan programs, the bank quietly announced on August 31^st. Since the start of their unusual programs about two years ago, small interest rates and fees on loans worth hundreds of billions of dollars have actually netted the private/public bank an embarrassment of riches.

Stocks and Commodities Market

“I’m prepared to declare that the recession is really, most probably over,” said Newsweek’s business guru, Daniel Gross. Yet a few paragraphs later, he concluded, “Without the tail wind of cheap money and a housing boom, it’s difficult to see — as it always is at the beginning of expansions — what is going to produce large-scale jobs growth.”

Emerging stock markets are back to pre-credit crisis highs. On August 3^rd early morning, the MSCI Emerging Markets Index had hit 855, the highest level since Sept. 12 2008, the Friday before Lehman bit the dust. That’s still well off its all-time high of 1,338, but the index’s 44% return so far this year puts the American bear market rally to shame. The S&P 500 opened up about 0.5% on the very same morning. Stocks are on the rise thanks to momentum from July’s nearly 9% rise. The ISM, expectations for August 3^rd’s auto sales numbers and some big earnings beats in Europe. In particular, HSBC and Barclays both reported surprise second-quarter profits on August 3^rd morning. Those unexpected revenues came from the investment-banking units in both companies, but that’s the kind of detail they can worry about next quarter. After roaring ahead on August 3^rd to a 1.5% gain, the S&P slow downed on the next day. The index closed over 1,000 on August 3^rd for the first time since November, but the S&P opened down 0.5% on August 4^th morning: a good old-fashioned profit taking.

The stock market continued to climb: August 7^th better-than-expected jobs report bumped the major indexes up about 1.3%, to their highest levels since October. The Dow and S&P 500 finished up over 2% for the week. The stock market had an interesting rally during August, which in the end, ended about break-even. However, on August 31^st morning, Chinese traders dumped shares, after a popular magazine rumored that the booming Chinese loan market is cooling off and affected the world significantly. Caijing magazine guessed that the Chinese loaned about $29 billion in August, a 43% crash from July. While that number isn’t official, traders around the red nation raced for the exits. The Shanghai Composite closed down 6.7%, its worst day in over a year. 16% of the stocks on the Shanghai Composite fell 10%, the daily limit down. Thus, as charted above, Chinese stocks are in a textbook bear market. In fact, down 23% since its 2009 peak earlier this month, the Shanghai Composite will be the worst performing major national index in the world for the month of August. Even though market is still up around 50% for the year, with the Shanghai Composite still priced 29 times earnings, it’s hard to be too enthusiastic. According to Bloomberg, the MSCI Emerging Markets Index is going for 19 times earnings. China frazzled the U.S. market too. The S&P 500 opened down 1% on August 31^st.

Commodities were flying off the virtual shelves from August 3^rd. Another positive manufacturing report from China and the American stock rally offer strength to the “global rebound” argument. Thus, oil had been up almost $2, to $71 a barrel. Copper’s up 10 cents (3.8%), to $2.70 a pound. Gold had a nice bump too, up $25 from Friday’s low (July 31^st), to roughly $960 an ounce. The Reuters/Jefferies CRB Index of the 19 most popular commodities shot up 3.9% on August 3^rd, its best day since March. With a score of 266, it’s at the highest point since November. What’s more, the CRB just got a technical tail wind as you can see in the graph.

In addition, if the greenback has any bearing on the price of commodities, which it certainly does, the dollar index makes the CRB look a bit cheap as well. The last time the dollar index was at today’s (August 3^rd) value was back in late September: when the CRB was just under 350. Chris Mayer, a financial analyst and advisor, comments, “People will blame the higher oil price on speculators, but something interesting is happening in the markets for minor metals like molybdenum. Prices are rising, too. The silvery metal, used to strengthen steel, is now $15 a pound. It nearly double the $8 and change it fetched in April. This is significant, because there is no futures exchange for moly. It trades on a physical spot market. Speculators play a very small role here. The buyers of the metal use the metal. So there is a demand story shaping up here, too, mostly focusing on a fragile recovery of some sort and mostly centered on China and the emerging markets. The market is looking ahead. Every rally, like every bottle of beer, has a finite life span. There will be lots of bumps along the way, but the prices of many commodities, such as oil, iron ore and moly, will tack higher, in my view.”

U.S. farmland has fallen in value for the first time in 22 years, the USDA said on August 5^th. Farmland averaged $2,100 an acre at the end of 2008, they claim, down 3.2% from 2007. That’s the first drop since 1987. But given the 19% drop in urban home prices over the same period, farms still seem like a fine store of wealth. Chris Mayer interprets, “U.S. farmland values got ahead of themselves, but if I owned farmland, I wouldn’t worry. In addition, American farmland is very expensive, deservedly so, in most cases. There are cheaper options overseas. North of the border, you can buy Saskatchewan farmland, which is still among the best bargains in the world. I think farmland will be one of the best performing asset classes over the next 10 years. Maybe not be the U.S. variety, but there are pockets of cheap farmland. Put that together with a rising demand for food and a falling supply of arable land and you’ve got a winner.”

Back to common commodities, Dollar weakness has given commodities a bump on the second week of August. On August 12^th, oil is up a buck and change, to $70 a barrel. At $948 an ounce, the recent gold sell-off seems to have come to an end as well. Commodities were under lots of pressure on August 17^th, thanks mostly to Chinese investor anxiety. Oil’s down about $5 from Friday’s (August 14^th) high, to $65 a barrel. Gold had fallen over $20 since Friday and goes for $932 an ounce on August 17^th. On August 24^th, oil was on the rise, along with stocks. Light sweet crude was just below $75 a barrel, a 10-month high. Gold is holding steady after Friday’s (August 14^th) rise. It jumped $15 at the end of the week, to $955 an ounce, and it’s stayed there since.

China’s sell-off that mentioned above has hit just about every asset class on August 31st, especially commodities. Commodity traders of the world have pinned hopes on China’s rise, and every time they falter, oil and copper hit the bid. Light, sweet crude is down over 3%, to $69 a barrel. Copper shed about 3% as well. Gold took a little hit on the very morning. Traders raced out of stocks and into the dollar. Thus, the spot price shed about $10 at the New York open, and rest just below $950 an ounce.

US Housing Market

According to the National Association of Realtors, pending home sales rose 3.6% in June. That’s the fifth straight month of improvement and the best streak since 2003. Pending home sales are up 6.7% since June of last year. This latest pending home sales number has affected the stock market greatly.

Nonetheless, the mortgage industry seems to struggle. The FDIC warned banks on August 4^th that they should batten down for more losses on home equity loans. Banks “should consider their historical loss experience on the group, adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans,” reads the FDIC letter. In addition, according to zillow.com, 93 million homes, condos and co-ops have mortgages that exceed their appraisal value. Home equity loans on those places are likely worth not much (and banks cannot call those assets).

Jumbo mortgages, home loans exceeding $417,000, now have the fastest rising default rates of any mortgage class. According to recent data from First American CoreLogic, 7.4% of these larger-than-life mortgages are currently in some form of default, nearly three times the rate at the start of 2008. As you can see, when stocks tanked in late 2008, the market for super-sized mortgage loans followed suit as you can see in the graph.

The Obama administration has done plenty to help out their beloved middle-class homeowner with various techniques such as the $8,000 first-time homebuyer credit, artificially low FHA mortgage rates, and several mortgage modification programs. But those programs don’t apply to jumbo loans. Even Fannie and Freddie, masters of mortgage speculation, will no longer stand behind jumbo mortgages. To make the matter worse, the market is blowing jumbo loans a stiff head wind. Mortgage rates are roughly 100 points higher for jumbos and inventory level is pretty remarkable. With an accelerating rate of default, government’s cold shoulder, higher than normal lending rates, and a huge, growing glut of supply, economy could lead to an ugly situation.

Another bad news in the mortgage industry was announced by one of the world’s biggest banks: 48% of U.S. mortgages will be underwater by 2011. But that’s the word from Deutsche Bank this week, which claims the number of U.S. mortgages worth more than the actual value of homes is going to double in the next couple of years. The bank is especially worried for prime and jumbo borrowers. 41% of prime borrowers will be underwater by 2011, says the DB forecast, up from 16% at the start of this year. Jumbos will be even worse, with a 46% underwater rate. “The impact of this is significant given that these markets have the largest share of the total mortgage market outstanding,” said the bank. They’re expecting home prices to fall another 14% by 2011, for a total crash of 41%.

One more bad news was released on August 13^th, which was noted to public, not only by NVI, but also from various sources: U.S. foreclosures rose to another record high in June, said RealtyTrac. One in 355 households, or about 360,000 homes, were in some form of foreclosure during the month. As we mentioned in this report, roughly one quarter of all mortgages are worth more than the present value of the homes they cover. That’s not good for the average home price, down 15% last quarter to $174,100 (existing single-family home).

In addition to these bad news, there are some issues that US RE market to pay attention to: the “cure rate” on ailing mortgages is plummeting. According to a Fitch study released on August 25^th, in between 2000-2006, an average 45% of prime mortgage holders who fell behind on a monthly payment were able to catch back up the very next month. In July 2009, that “cure rate” was 6%. We reiterate, that was for the best, prime-level borrowers. These rates went from an average 30% to 4%. Sub-primes shrank from 19% to 5%. “Cure rates have really collapsed,” commented Roelof Slump, Fitch’s managing director. Not only does this give us pause in celebrating a housing comeback, but it reinforces a trend we’ve been pounding the table about over the last month or so: This isn’t about subprime anymore. The NAR boasted a 7.2% leap in existing home sales for July last week, the biggest month-to-month gain since they started keeping track. But with the overwhelming majority coming from foreclosures, distressed sales and the lowest of the low end… what does it really say about the true state of U.S. housing? (The chart shows the US sales year over year by home price.

Here is some good news: The rate of U.S. home price decline definitely stopped accelerating in the second quarter. That’s the word from the June edition of the S&P/Case-Shiller home price index, which was released this morning. National home prices registered a 14.9% decline from the second quarter of 2008 to the same time in 2009. While that’s hardly worth celebrating, it’s way better than the record 19.1% year-over-year fall in the first quarter. As the chart shows, it ain’t as bad as it used to be. But at the same time, home prices are still at early 2003 levels. You could call this a housing rebound, but it’s more like a deceleration yet. It’s an impressive turnaround. This is a sudden upward swing. We think it might mark a change in trend, but we are not sure whether the market has reached its bottom. Yet, it is safe to believe that it is just a suggestive of a turning point. We’ve seen other corrections like this reverse.

The Dollar Index

The dollar index found a new 2009 low on August 3^rd. The American stock rally and better-than-expected manufacturing data from China, Europe and the U.S. pushed the dollar index as low as 77.4. You’ll have to go back to late September 2008 to find the index that beaten down.

The dollar index arrested its slide on August 4^th morning, but still remained around 77.5. After falling to a 2009 low on August 3^rd, the dollar index has been trading flat as a pancake: around at 77.7, just 2/10ths of a point above its yearly low.

The dollar is falling again on August 12^th, thanks to a rally in stocks. The dollar index is down to 78.9 as we write, from its early morning high of 79.3. That’s puts the euro at $1.42, the pound at $1.65 and one dollar will exchange for 96 yen. After selling off over the last 48 hours (August 12 ~ 13), the dollar was holding steady on August 14^th. The dollar index fell nearly a full point from Wednesday’s high, to 78.4. By August 26^th, due to weakening stock market, the dollar index was up roughly half a point, to 78.8.

The World

A) Manufacturing Sector & Other

The Chinese manufacturing sector grew for the fifth month in a row in July, the Chinese government announced today. Their purchasing managers index rose to 53.3 last month, from 53.2 in June. Like the ISM, a score above 50 indicates expansion. The American manufacturing sector is still contracting, but just barely. The ISM manufacturing index rose from 44.8 to 48.9 in July, says the ISM on August 3^rd. That’s the best score since September and just 1.1 points away from crossing the contraction/expansion threshold. Still, that’s after almost an entire year of manufacturing contraction.

Additionally, the U.S. service sector shrank for the 10th consecutive month in July, says the ISM with August 5^th’s other major data point. Their non-manufacturing index fell to 46.4 in July, from 47 in June, suggesting that not only did the service economy contract (scoring below 50), but it shrank at a faster pace. The Street was hoping for a bump up to 48.

B) China Goes from Boom to Bubble & Other Regions

Chinese property sales are up over 60% so far this year, the nation’s National Bureau of Statistics proclaimed on August 10^th. That puts the housing bubble here to shame:

New loan issuance has tripled in the first half of 2009, to $1.1 trillion. That’s more than half of the entire Chinese GDP over the same period.

95% of those loans went to state-owned enterprises or provincial entities.

The Shanghai Composite is up 79% year to date, the best major market performance in the world.

Stocks on the Shanghai Composite trade for 35.4 times earnings, double that of the MSCI Emerging Markets index.

M2 money supply rose over 28.5% in the first half of the year.

The seven largest bond sales in the world this year were domestic transactions in China.

Nearly everything is up dramatically in China in 2009, except exports. Strangely, we don’t hear a lot of concern that the backbone of their economy has contracted 23% since this time last year.

The Chinese government realizes that its stimulus spending and pressure on banks to expand lending is inflating a massive bubble in the Chinese stock and property markets. The problem with unsustainable economy activity must eventually end. But for now, the Chinese have much more room to borrow and inflate than the United States. Eventually, the market will cut them off. The end will not be pretty, and at some point in the future, shorting Chinese stocks may be one of the best short-selling opportunities in history. In the meantime, it makes no sense to bet against China. The Communist government has proven very efficient at stealing the resources of its people (via inflation and taxation) and channeling them into whatever infrastructure project they seem necessary.

While China bubbles up, its BRIC-brother Russia is melting down. Russian GDP contracted a record 10.9% annualized pace in the second quarter, the Russian government announced this on August 10^th morning. The world just doesn’t want oil and natural gas like it used to, and that’s really the only game in Mother Russia. “We can’t develop like this any longer,” President Dmitry Medvedev said on that very morning, “It’s a dead end. And the crisis has placed us in a situation where we will have to make decisions on changing the structure of the economy.”

If the BRIC nations are giving you pause, check out MENA: the Middle East and North Africa, or MENA. MENA is one of the fastest-growing regions in the world. Over the last 50 years, MENA’s population is up more than fourfold. In addition, the population is still young, with the majority of the population under 25 years old. Over the next 30 years, MENA’s population will grow more than 60%, to nearly 700 million people. Trade there is expanding just as quickly. The most interesting thing about this growth is that it is happening in a part of the world where it is most difficult to grow food. Water is scarce. MENA consumes far more water than it gets via rainfall. In some places, the disparity is dramatic. In Kuwait, for instance, annual water consumption is 22 times annual rainfall. No wonder the whole area is a net importer of food. The Middle East is actually the world’s largest regional importer of food. Egypt, for instance, actually imports more wheat than China. The GCC countries, the gulf coast countries, will import 60% of their food by 2010 and it’s likely to get worse. Saudi Arabia aims to phase out wheat production by 2016 to conserve water.

C) Despite its Recent Rally, in General, Gold is the Place to Invest

Over the third weekend, the Financial Times had a piece that highlights things the Chinese like to buy. This is important because the Chinese are becoming increasingly affluent in large numbers. Total consumer spending was $1.7 trillion in 2007, compared to $12 trillion in the U.S. But that number is growing rapidly. The FT focused on the new rich. China now boasts more millionaires than the U.K. The rapid growth of this group has companies all over the world spending more money and time figuring out ways to get in their pockets. Outside of ordinary things like flashy cars and booze and quirky things like ivory and dried seahorses, one thing was mentioned in the FT piece that caught our eye: The Chinese love gold. “‘China loves gold in all its forms,’ the FT reports, ‘as a reserve currency, jewelry, an investment.’ The Chinese central bank doubled its holdings of gold this year, but it’s more widespread than that. The rising middle class in China also buys a lot of gold. Since 2007, Chinese consumers have been the second largest purchasers of gold jewelry in the world, behind only India. The FT points out those gold sales were up 28% year over year in May. Total gold demand for the year was up 21%, to 400 million tonnes. There are not too many sales of any kind going up that much in this financial crisis, but there it is. The financial crisis and weak stock market have helped gold as people look for a place to park some money. In general, the market thinks gold will remain a good place to be for some time yet. Many are reporting falling cash costs, yet the price of gold is staying up here in the $900s and is likely headed much higher. That means gold stocks are reporting good increases in cash flow, among the few sectors to do so.

The Issues We Need to Think About:

A) Alan Knuckman says invest in Natural Gas

Resource trader Alan Knuckman says, “A neglected sector that has gotten my attention is natural gas. The last few months have shown resurgence in crude with the global economy stabilizing and demand picking up. Crude has more than doubled from the lows, with natural gas lagging far behind. The risk on natural gas is on the upside. In other words, I don’t want to risk missing a big upturn. Prices have already fallen from $12 down to under $4, which is a $40,000 move per futures contract. The upside potential far outweighs the chance of the downtrend continuing much lower. Gas cannot go to zero. It will always have some value, and many fundamentals can change the present landscape of low, low prices. Thankfully, very few ‘sheeple’ are grazing on the green, green grass from natural gas demand. Significant supplies are used to produce the fertilizer necessary to feed the world. Natural gas also provides much of the electricity to cool our cities in the dog days of summer. Plus, the hurricane season is always a wild card that can add risk premium. Any weather disruption can spark an explosion in prices. Katrina and Rita sent prices to all-time highs just a few short years ago. You don’t go shopping for an umbrella after the rain starts. Think of your reaction to possible oil plays back in February when no bottom was in sight. That’s how natural gas feels now. Being ahead of the energy curve is the place you want to be. When things don’t develop as planned, the losses at lower levels are manageable. Probability is on our side that eventually natural gas prices will move up.”

B) Telecommunication Service Sector is for Income Investment

Income analyst Jim Nelson opinions, “It’s been a rough year for dividends, but if you know where to look, your income will be just fine. As you can see, the biggest loser on the list is financials, which shouldn’t be a surprise. The segment’s dividend yield fell 300 basis points (right-hand column) from last year to now. The sector that pays the most is doing so under the radar: telecommunication services. This is a favorite of ours. That 14 basis point increase is primarily due to AT&T and Verizon. Both are paying out around 6%. These dividends aren’t nearly as safe as we’d like, though. Instead of gunning for the U.S. telecom industry, we like to play that game in emerging markets. We already have a Pacific Rim telecom in the Lifetime Income Report portfolio, and we’ll be adding another this week. Even after that, we’ll continue to keep our eyes peeled and noses to the ground in case something else pops up in that industry. Going back to that table, you can see the next two best-paying sectors are utilities and consumer staples.”

C) Judge Orders Immediate Improved Transparency on FEDs

A U.S. district judge has ordered the Fed to identify the beneficiaries of 11 different shadow loan programs. Ben Bernanke and his brood lost their lawsuit with Bloomberg on August 24^th, which claimed that the central bank was violating the Freedom of Information Act by not disclosing the targets of their multibillion-dollar lending programs. Until now, the Fed has refused to name names or disclose the origins and varieties of collateral offered under its several multibillion-dollar lending programs. Doing so, they claim, might unsettle shareholders and depositors. No more, says Judge Loretta Preska of the Manhattan District Court: She ruled that the Fed “essentially speculates on how a borrower might enter a downward spiral of financial instability if its participation in the Federal Reserve lending programs were to be disclosed. Conjecture, without evidence of imminent harm, simply fails to meet the board’s burden” of proof. Of course, there’s no telling what will really come of this ruling, but we have to think it’s a step in the right direction. We’ll let you know how it unfolds.