Putting the spice back into investing.

Contrarian Tales

Friday, January 30, 2004
Geoffrey Chaucer wrote the Canterbury Tales between 1387 and 1400. This collection of stories within a story is one of most studied works of literature because it paints a very concise picture of English society during the 14th century. One of the pilgrims making their way to Canterbury is a wealthy merchant who is introduced with the following words:
There was a MERCHANT with forked beard
In motley gown, and high on horse he sat,
Upon his head a Flemish beaver hat;
His boots were fastened neatly and elegantly.
He spoke out his opinions very solemnly,
Stressing the times when he had won, not lost.
He wanted the sea were guarded at any cost
Between Middleburgh and the town of Orwel.
He knew how to deal foreign currencies, buy and sell.
This worthy man kept all his wits well set;
There was no person that knew he was in debt,
So well he managed all his trade affairs
With bargains and with borrowings and with shares.
Indeed, he was a worthy man withall,
But, to tell the truth, his name I can't recall
I wonder how this worthy man made his fortune? He regaled the party with tales "Stressing the times when he had won, not lost." which sounds very much like the way a typical investor would talk. He was risk averse as he was all for guarding the sea (hedging?) and he seems to have done some speculating in the fx markets as he knew "how to deal foreign currencies, buy and sell."

Could this wise man have been a contrarian investor? Another famous Englishman, John Maynard Keynes offers this little hint to investors:

The central principle of investment is to go contrary to the general opinion, on the grounds that if everyone agreed about its merits, the investment is inevitably too dear and therefore unattractive.
The thing that strikes me about the current market situation is that everyone seems to be singing from the same songbook. Would our 14th century "worthy man" who "kept all his wits well set" agree with the consensus that markets are going to go up until the summer and then start to go soft? Typical commentary reads like this:
While practically no one expects the market to drop dramatically in the next few months, they predict that a mostly steady climb over the past 10 months or so could turn into a less confident, up-and-down pattern by summer, if not earlier.
"A lot of unresolved things out there could go bump in the middle of the night at any time," says A.C. Moore, chief investment strategist with Dunvegan Associates in Santa Barbara, Calif. "I really think markets could soften between now and the end of the summer."
I love this kind of commentary because it implies that investors will be able to identify the turning point and then be able to head for the door in an orderly fashion.

What would our merchant do? As someone who is conditioned to buying cheap and selling high he would probably sell stocks, sell corporate bonds and sell commodities. He would then use his proceeds to stock up on the dollar and long government bonds. I don't want to use this post to argue about what the "fair value" of the dollar is - I just want to point out that almost everyone is expecting the dollar to keep declining. A look at traders net short positions show that everyone is short the dollar - is everyone right?

The same thing is true for commodities - "everyone" just knows that commodities are the place to be. China is sucking in every bit of raw material it can get whilst the synchronized global recovery is doing it's bit to lift prices. But how long will this go on? What will happen if China goes the way of Japan in the late 80's? The trigger could be the sorry state of China's banking system which could go into meltdown at any time.

Corporate bonds are being bid up regardless of the underlying data. Investors are starting to chase returns in an almost drastic fashion with spreads at a point where a long hard look leads to my nose starting to bleed. Everyone seems to be short duration-wise as well. Of course they are, they're expecting a rate hike. What if it doesn't materialize?

At times like this I like to take the other end of the deal. I do believe that the probability of a rising dollar, imploding China and rocketing spreads is low, but I also believe that it is larger than zero. The reason that I'm getting more and more contrarian is that I believe that the possible magnitude of a correction is much larger than the magnitude of possible (and probable) gains going forward.

Is a contrarian stance the correct way to "manage[d] all his trade affairs with bargains and with borrowings and with shares" in this market? We'll just have to see - the only thing we know is that we'll remain anonymous because only daredevils get their fifteen minutes of fame. Constant plodding and buying low and selling high will lead to people saying this about you:

Indeed, he was a worthy man withall,
But, to tell the truth, his name I can't recall

Fed Watch

One of the major pieces of news to hit the wires over the past week was the changed wording of the FOMC Statement. My suggestion was to buy the dollar if the statement omitted the words "considerable period". Well guess what!

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 1 percent.

The Committee continues to believe that an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity. The evidence accumulated over the intermeeting period confirms that output is expanding briskly. Although new hiring remains subdued, other indicators suggest an improvement in the labor market. Increases in core consumer prices are muted and expected to remain low.

The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.
I've highlighted the changes vs. the previous statement. What I found interesting ist the fact that the minutes of the December meeting showed that there was some discussion as to whether the "considerable period" should have been dropped in December.

I would wager that this new wording does not imply that we should start looking for a rate cut right away. The December minutes show that inflation fears amongst the committee are still subdued although they are worried about what could happen if the stimulus which has been thrown at the economy really turns out to have kick-started a recovery.

Members also expressed concern about the potential for an increase in inflation expectations given highly stimulative macroeconomic policies and economic growth that seemed to be gathering momentum.
I stand by my view that the Fed will not hike rates unless we continue to see very robust numbers going forward - and as regular readers of Curryblog you'll know that I'm still not convinced that this is a sustainable recovery. I think the FOMC has changed the wording because of the fact that this new turn of phrase gives them more room to maneuver in the following months. This verbal hedging was expressed very nicely by the December minutes:
Views differed with regard to the reference in recent statements to maintaining an accommodative monetary policy "for a considerable period." A number of members argued that its deletion would serve to enhance the Committee's flexibility to adjust monetary policy at a later date when that was deemed appropriate on the basis of evolving economic circumstances.
I am therefore still not looking for a rate hike in 2004.

Overnight / This Morning

Tuesday, January 27, 2004
Home sales rose by 6.9% in December reversing the declines seen in the previous months. The housing market keeps looking very robust (...or even more bubbly according to some people).

In other news: the German IFO business climate index was up more than expected. The index rose to a value of 97.4 (from 96.9 in December). Commentators were expecting the reading to come in flat at around 97 with a very vocal minority predicting a fall in confidence because of the strong EUR. The assessment of the current business situation rose; the expectations for the future were unchanged vs. the previous month. The economists at IFO hastened to add that this does not mean that the euro can rise to hights yet unseen without damaging sentiment - they quote 1.30 in EUR/USD as the Rubicon with regard to the pain threshold. European markets are up by around 1% at the time of writing.
10:36 AM :: Karsten :: permalink ::

Averages again...

Monday, January 26, 2004
Prof. Smolira was nice enough to comment on my post re the senselessness of averages. Professor Smolira writes:
In this week's Carnival of the Capitalists, Karsten Jung posts why investors should be wary of average returns. Using the old adage "If your feet are in the freezer and your head is in the oven, you should feel comfy," he argues that investors should be concerned with the modal, or most common, return. Unfortunately, his analysis is incorrect.

He then goes on to explain the difference between arithmetic and geometric returns. I kept reading with my breath bated but I couldn't actually find any argument which supported not using the "modal, or most common, return" as a proxy for future returns. I find this argument fascinating - I never actually referred to one of the calculation methods of return, but the the rebuttal is all about a difference I don't give a fig about. In a one shot situation (i.e. investing for retirement) the average can be extremely misleading.

The intention of my post was to make a point about the relative merits of using means of any sort in skewed distributions. If you have a positively skewed distribution you will normally see mode < median < mean. My point was that the investor should not care about the "mean return" regardless of the way the mean was calculated. Investing with your sights set on achieving the mean implies hanging around long enough for the central limit theorem to kick in. I would rather bet on the most common outcome instead of the outcome that (might) materialize if I hang around long enough.

The interesting thing about Professor Smolira's arguments for the geometric mean is that the case for it is not as cut and dried as it may seem. Blume (Marshall E. Blume, "Unbiased estimators of long run expected rates of return", Journal of the American Statistical Association, Volume 69, Number 347 (September 1974)) found that:

The extent of bias in the arithmetic and geometric means was considered by Blume under the assumption that returns were independently and normally distributed. Using simulation analysis, he found that the arithmetic mean overestimated and the geometric mean underestimated the true expected compound rate of return over N future periods, where N was greater than one but less than the T periods of data under consideration.

The subject is again referenced in Freeman et. al. (Freeman, M.C., Indro, D.C. and W.Y. Lee (2003) "Biases in arithmetic, geometric and horizon-weighted averages as estimates of long-run expected returns" University of Arkansas working paper). For a quick read, head over to Brian McCulloch's place on the Web and read "Geometric Return and Portfolio Analysis" which comes to this conclusion:
Expected geometric return is routinely reported as a summary measure of the prospective performance of asset classes and investment portfolios. It has intuitive appeal because its historical counterpart, the geometric average, provides a useful descriptive measure of the annualised proportional change in wealth that actually occurred over a past time series, as if there had been no volatility in return. However, for applications that involve future projections or other prospective analyses, expected geometric return has limited value and often the expected annual arithmetic return is a more relevant statistic for modelling and analysis. Despite this, the distinction between expected annual arithmetic return and expected geometric return is not well understood, both in respect of individual asset classes and in respect of portfolios. This confusion persists even though it is explained routinely in finance textbooks and other reference sources.

To sum it up: I am not convinced by Prof. Smolira's arguments. He does not explain why the geometric return is superior to the modal value as a predictor of returns in a one-shot investment situation. I'll concede the fact that the modal value will probably err to the low side - but I hold that it is always better to underpromise and then to overdeliver.

Monday morning roundup

You'll probably have noticed that posting has been light in the last couple of days - real life just took over and placed some higher than usual demands on my time. Having said that...

... nothing much changed in the past week. Verbal intervention in the fx markets is getting a boost from the upcoming G7 meeting. I wouldn't bet on the G7 meeting doing much for the EUR/USD exchange rate (and I really don't expect that we'll see concerted intervention during or following the meeting). My view - which I have expressed before - is that the ECB will only start intervening if we see a meltdown in the EUR/USD cross. The first line of action would be a rate cut (which the market is not really expecting either). The IMF's Anne Krueger agrees - she's on record thusly:
International Monetary Fund first deputy managing director Anne Krueger also told Reuters that policymakers should only consider action to temper currency moves "in the most extreme circumstances". "I know of no evidence as yet that this is the most extreme of circumstances -- or even close. I emphasise 'as yet'," Krueger said. She said foreign exchange rates should be left to markets and that the euro was not far from its 30-year average against the dollar on a real effective exchange rate basis. At its current level -- the euro was trading at 1.2590 against the U.S. dollar late Friday -- "there is a strong presumption against" currency intervention, Krueger said. When asked whether a euro/dollar exchange rate of $1.30 would change her view, Krueger said, "No."

Davos was pretty lackluster - there was a little barb from French FinMin Francis Mer when he implied that Asian intervention is hurting the Eurozone. He said:
The markets are very powerful. We shall meet in Boca Raton and we shall try to discover what is best for our individual area. But we cannot succeed basically (without) the others. There are a lot of players. You cannot forget Asia in this subject.

There is a FOMC meeting tomorrow which could support the greenback - watch this space for an analysis of the statement's wording (hint: if the words "considerable period" don't appear, buy the dollar). My opinion is that the chances are that nothing much will happen.
11:05 AM :: Karsten :: permalink ::

Light news week...

Thursday, January 22, 2004
...hence not much posting. Data output is pretty light this week. A quick look at my screen tells me that continuing verbal intervention by pundits interested in talking down the euro is producing less in the way of success as time goes by. The market is daring policy makers to put "their money where their mouth is". I'm not holding my breath.

Housing markets are looking robust - the UK RICS survey showed that property owners saw the value of their house rise over the last quarter of 2003. Housing starts in the US rose 1.7% in November on the back of low interest rates and the perception that house prices will never fall. Strange thing that Treasuries are rising...
10:12 AM :: Karsten :: permalink ::

Do yourself a favor...

Saturday, January 17, 2004
...and read this (the best conversation between man and rabbit that I've ever read!).

Will someone please tell the folks at BusinessWeek...

...that the Britain does not use the euro? I was reading the online edition of the magazine on my palm via Plucker and came across an article with the title: "A Battered Buck Brings Back Tourists". I started to scan the piece and came across this:

The cheap dollar gave Benjamin Atkins a nice present on a December trip to the U.S. The British visitor exchanged 800 euros for $900, garnering 30% more than he would have had when the greenback peaked a few years ago. That allowed Atkins and his wife, Shannon, to go on a buying spree, snatching up Christmas gifts for others and clothes for themselves. "It's always nice when you get more for your money than the last time you came," he says.
Well fancy that! Mr.Atkins must have had a few euros left over from his last trip to the continent. The more logical explanation is that the writer used a fictional couple to illustrate his point. Just to bad that he doesn't know what the heck he's writing about. The best thing about the article is this:

By Christopher Palmeri in Los Angeles, with Brian Grow in Chicago, David Fairlamb in Frankfurt, Stanley Reed in London, and Michael Eidam in Atlanta
Five people in three countries don't know that Britain is not in the Eurozone. Sad.

In the long run we're all dead. On the senselessness of averages.

Just imagine yourself at your school reunion: you get a chance to meet all your former classmates and you're enjoying a glass of you favorite beverage. Your old friend John is right in middle of telling you a very complicated story involving a horse, a circus midget and your math teacher when someone goes up to the podium and suggests the following: "You'll all have noticed that our school's gym is in a rather horrible state. I suggest that we all donate 1% of our savings to help build a new gym."

A short discussion ensues and everyone agrees. Someone passes a hat and everyone tosses in a check. Half an hour passes and finally the grand total is announced: $10 million! You count the people in the room, do some dividing and feel like a total loser. You counted 100 guests - on average, everyone should have made 10 Mio. - which you definitely didn't manage to do! Dreading the answer you ask John "John, how much did you make?" he answers: "Around 2 Million". This is much closer to the 2.5 million you managed to save! You turn around and ask Frank the same question. He answers "Well, around 3 million." After asking most of the other people standing around you, you come to the conclusion that around half of the people made around 3 million or less. As the average is still so high you conclude that someone must have really struck it rich. You finally come across Randy - he invested in a popular search engine and became immensely wealthy after in went public.

This example is a somewhat expanded version of the old saw: "If your feet are in the oven and your head is in the freezer, chances are that on average you'll feel pretty comfy". The simple message is that averages should always be subjected to stringent analysis - especially in the field of investments. The investment industry bombards clients with messages such as "This asset class (fund, stock, commodity, investment strategy) has returned 10,2% on average since the beginning of time" - well great. The client invests his money (say 100 USD) and goes to sleep for the next ten years. After that time he looks at his account and finds that it has grown to only 155 USD - not the 262 USD he was counting on by way of extrapolating the average return. Bad luck - but hey, if he keeps on investing forever he might even achieve the return he was expecting.

The answer is to not rely on averages. The investor might have been better off if he had looked at the median value. The investor has a 50% chance of getting a better (or worse) result. Even better would be to look at the modal value. In investment terms: the modal value is the most frequently occurring return. The difference between the three numbers can be very large and is a function of their underlying distribution. But keep in mind that even small differences can add up very quickly over time.

Finance theory (and financial advisors) assume that we are going to continue living and investing forever - that is why the tell us to maximize expected returns. The only problem is that we only get one draw from the urn (or one chance at investing if you prefer). It just isn't possible to to stand there at retirement age and look at your portfolio and say "Oh, well, I'll just keep repeating this experiment strategy until my returns converge towards the average". The next time your advisor tells you about averages just nod sagely and ask him about his assumptions regarding the underlying distribution and the modal value of the returns. Chances are that the advisor's eyes will glaze over and that he'll file you under "I" for insolent. But the point is still valid - if you want to maximize something, maximize the modal value of returns!

Economic Roundup

Friday, January 16, 2004
Lots of US data out yesterday. In a nutshell: the Empire State and Philly Fed indices showed strong gains - this should bode well for the ISM numbers.

CPI remains very low while retail sales were softer than expected. Initial claims for unemployment insurance were down.

These numbers confirm the familiar picture of a recovering economy. The fly in the ointment is the fact that the labor market is still very anemic. The markets chose to put a positive spin on the data (and the continued verbal intervention by European talking heads helped) and started buying the greenback. We proceeded to breach support at the 1.26 level and are now sitting at around 1.25 at the time of writing.

Sentiment is good with equity mutual funds recieving net cash inflows of $5.7 billion in the week ended Jan 14.

The new picture is much like the old one. Robust growth and good sentiment - just not much of the good news feeding through to the unemployed.
12:44 PM :: Karsten :: permalink ::

Iraq reconstruction ringfenced?

Thursday, January 15, 2004
Whenever people in my vicinity started talking about the pros and cons of not letting "old Europe" bid on reconstruction in Iraq I always started to twiddle my fingers and waited for the subject to pass. Most of "old Europe's" governments did the same. Why? Because it is an non-issue. Reality is seeping in - just read this little article to see what's going to be in store:
Germany's Siemens Awarded Iraq Contract
Siemens Becomes First German Company to Secure Iraq Contract; Will Develop Cell Phone Network
Washington last month excluded firms from countries that opposed the war from bidding on reconstruction projects, but they are not barred from subcontractor work.
Siemens signed a contract before Christmas to set up the cell phone network in northern Iraq for Kuwait's Wataniya Telecom, Gottal said. The Kuwaiti company is the local partner of AsiaCell, which operated cell networks in Kurdish areas of northern Iraq during Saddam Hussein's rule.

Siemens' U.S. affiliate, Siemens-Westinghouse, is working to win a contract to supply two power stations with parts in conjunction with the U.S. engineering giant Bechtel, Gottal said.

The entire thing was political posturing - although I have to admit that I'm pretty shocked that stalwart US allies with large experience in rebuilding infrastructure such as Uganda, Rwanda, Ethiopia and Eritrea are not managing to win their share of bids!

Quick note

I'm just to tired to post something coherent today - I'll give you my take on the lastest batch of numbers tomorrow. Be sure to come back!

No bonus for someone at Citigroup

Tuesday, January 13, 2004
Citigroup won a very competitive bidding to place 20% of the German chipmaker Infineon. The stock was placed via an accelerated bookbuilding yesterday. The reason that Citi won the bidding was that they agreed to backstop the deal at around 12 EUR per share - not a very good idea seeing that the stock closed at around 11.75 EUR. Rumor has it that Citi was also very active in the market to support the stock during the bookbuilding phase - this could mean that they are still sitting on stock (11.53 right now).

Won the deal, lost money in execution - around 30 - 40 million (Forbes). Someone is going to get his bonus axed ...

The blogger oracle!

Monday, January 12, 2004
Blogger's spell checker suggests "tricked" as the correct spelling for "Trichet". Hmmm,... should this tell us something?

Running Toshihiko Fukui (BoJ) through Blogger's spell checker returns tosses and toxic (first name) and fugue, fussy, fuzzy, Fuji, fuse, puke (last name). Interesting combinations possible - my favorites: "Toxic Fugue" or "Tosses Puke". Ahh, the senselessness of it all...

Weekend roundup

Unless you've been in a cave for the past week, you'll have seen the awful payroll numbers last week. A series of economist's comments on the data were compiled by Barry L. Ritholtz - you can find them here. If you read this blog on a regular basis you'll know that my view is that we're probably looking at a mini-cycle and not at a sustainable recovery. I'd love to be wrong and would gladly change my mind if and when I see evidence of positive movement in the labor market. Time for a uptick in employment is running out - if we don't get a large improvement in employment before summer (end of fiscal stimulus) we could see the rug being pulled out under this recovery very quickly.

The treasury market was on fire with the curve getting pretty steep. Expectations of a quick interest hike started to evaporate. There is actually no reason to look for a hike - inflation is low (and falling). Some inflation measures - such as the price index for personal consumption are flirting with the 1% inflation threshold. I don't expect the weaker dollar to significantly raise prices either - if you look at the dollar exchange rate in trade weighted terms you'll see that the decline has been much less dramatic than the headlines suggest.

In related news: the weak economic data led to the dollar looking ever more anemic vis a vis the Euro and the Yen. Look for more intervention (of the verbal kind) as we get ever closer to 1.3 in the EUR/USD cross. ECB chief Trichet expressed concern about high volatility in the currency markets at a press conference today. The result according to Reuters:
The euro, which reached fresh record highs against the dollar on Monday, slipped after Trichet used tough language that Europe opposes volatility. It was trading at $1.2837, down from $1.2852 before the news conference.

No other real news from the G10 central bankers meeting - China says that floating the renminbi is the "ultimate goal" which means that they'll float whenever they feel like it. The massive capital injection into the Chinese banking system was commented thusly:
Trichet said the G10 welcomed China's "bold moves" to bail out two out of four of its big, state-owned banks, and that the action could help the banks list their shares on the stock exchange. Bailouts of the other two state-run banks may come later, he said. "It was a full-fledged move to a very, very important modernisation of the banking sector in China," he said.

Nice turn of phrase. I think that Jakub from The Ventilator sums it up in a succinct manner when he says:
The issue for China's banking industry is not capital inadequacy (even though the banks probably have negative capital if all the loans were properly classified) but the culture of corruption and mismanagement. Until that changes, injections of funds will merely treat the symptoms, not the disease.


Friday, January 09, 2004
Ooops. Reuters says:

WRAPUP 1-US Dec payrolls barely rise, worse than expected
(Adds details, background, market reaction)
By Anna Willard
WASHINGTON, Jan 9 (Reuters) - American employers barely took on any new workers in December, a disappointing government report on Friday showed, indicating the economic recovery has yet to translate into sustained jobs growth. The unemployment rate fell to 5.7 percent, the lowest level in over a year and down from 5.9 percent in November. But this was largely due to people leaving the workforce, according to the Labor Department's report.

The number of workers on U.S. payrolls outside the farm sector in December increased by just 1,000, after a downwardly revised rise of 43,000 in November. It was the fifth consecutive monthly rise but was far worse than economist expectations of a rise of 130,000.

The poor report will likely be a headache for President George W. Bush as he seeks re-election in November with the economy -- specifically job creation -- expected to be a key issue in the run-up to the vote.


Beating the bogey vs. achieving goals. Benchmarks and private investors.

If you look at the far right side of my desk you'll see a framed Dilbert cartoon. I've never actually found a cartoon to be so compelling with regard to it's message that I felt an urge to clip it - this particular one being the exception.

The cartoon shows a hapless investor (Dilbert) consulting with his broker. The broker offers Dilbert a choice regarding their future business relationship. The broker can either
a) pretend that he knows which stocks are better than others and then gain the investors trust by comparing the results to a misleading benchmark or use the more "direct approach"
b) just sell Dilbert whatever earns him the highest commission.

I'd like to focus on the first alternative, which neatly sums up what most of the investment business is about. Most advisors will use their first contact with the client to asses his or her risk tolerance and investment horizon. This then usually leads to an investment policy in which certain minimum, maximum and neutral asset weights are defined. The neutral asset weights are then translated into a benchmark which future performance can be compared against.

This then leads to the song and dance phase in which the broker tries to convince you that he knows more than everyone else - also known as tactical asset allocation. So far so good. The only problem is that this entire process does not - in my opinion - help the individual investor one iota.

Policy benchmarks are abstract entities which usually do not relate well to an individual investor's goals. Anecdotal evidence shows that clients love benchmarks in strong market phases and disregard them in weak markets. Most people will not be happy to find out that they outperformed the benchmark but still managed to lose large amounts of money in the process. Most investment advisors love benchmarks in bear markets because all they have to do is hold some cash and otherwise track the benchmark in order to outperform - not exactly what clients are hoping for from an active money manager.

The broker in the Dilbert cartoon uses the phrase "misleading benchmarks" - I contend that benchmarks are mostly irrelevant to private investors and therefore always misleading. Most retail clients are absolute return investors at heart - not benchmark oriented institutions. I am hoping that the investment management business starts to focus on fulfilling investors goals and not on using benchmarks to shift blame to "the market".

The same problem exists in the institutional sphere as well - a research note from First Quadrant notices that: "the average US pension fund has a 3% tracking error relative to its policy benchmark, and an 18% tracking error relative to its liabilities."

The note goes on to say

Benchmarking is not without merit. What can be measured will be measured, and indeed should be measured. Benchmarking allows us to measure the value that a manager adds, and the risk he or she is taking to produce additional return.


However, a benchmark should bear some resemblance to the obligations that a portfolio is intended to serve and should be used to gauge risk, not to suppress it


The industry's craze to "beat the bogey," rather than to "meet the fund's obligations" encourages asset managers to follow the markets "animal spirits" rather than to gauge when such risks are likely to bear rewards.
Quite. The quotes above are doubly true for private investors for which failing "to meet the fund's obligations" can literally mean living out your retirement eating dog food even after having managed to outperform the benchmark. Weak consolation indeed!

Quo vadis ECB?

Thursday, January 08, 2004
Today's press conference has confirmed my view that the ECB is probably not going to intervene in the currency markets unless something really drastic starts to happen. A rapid further fall of the dollar right through 1.35 in the next couple of weeks could force the bank's hand but I'm not all that sure that the ECB would intervene even then. We'll probably have to see 1.4 before they even think of doing something. Intervention is probably not on the menu anyway - the bank is pretty keen on working in concert with other central banks and I don't really see the Fed starting to buy the greenback right now. My bet is that a further rise in the EUR wil lead to the bank cutting rates - this is not as obvious as it sounds. EURIBOR futures are still pricing in a rate hike!

I scooped CNN/Money!

Wednesday, January 07, 2004
I wrote about credit card debt yesterday and made a connection with housing prices and home equity extraction by referring to an older posting. What do my tired eyes see as the headline on CNN/Money? Well, this: Credit crunch coming?. Must be a real slow news day (or a very obvious story).

CNN also picked up on the next batch of fiscal stimulus headed our (well actually "your") way (I don't live in the States).

If you have kids you may recall getting a $400 check from Uncle Sam last summer. That was your "advance refund" on the expanded child tax credit, which for the 2003 tax year is worth $1,000. That's up from $600.

If you got your money, then there's another $600 credit waiting for you. Just fill out the amount of additional credit you're owed on Form 8812.

You can then use the money to pay off your credit card debt, save it for your kids college tuition bill or shop till you drop.

In other news we had Michael Rogowski, head of the Federation of German Industry announcing that EUR/USD could rise up to 1.4 before industry starts to worry. This continues a trend of assorted talking heads raising the bar re "crisis levels" in the EUR/USD cross. I'm interested in what Trichet will say in tomorrow's Q&A session. For what its worth: US Treasury's Snow backs strong US dollar.

Shopping can be hazardous to your wealth

Tuesday, January 06, 2004
I posted about the state of the housing market a couiple of weeks ago and commented on the fact that home equity extraction and refinancing was behind at least some of the robust consumer spending numbers we've continued to see throughout the past "economic rough patch". This really confounds me to a certain extent - usually consumers and corporates use economic downturns to repair their respective balance sheets. Spending money like a drunken sailor in a a foreign port isn't something which would come naturally during a phase in which you are expecting to lose your job. Now we all know that if something can't go on forever, it won't. Some of the proverbial chickens are coming home to roost.

What excessive shopping can lead to is described here. The meat of it:

WASHINGTON (Reuters) - The weak U.S. job market helped nudge credit card delinquencies to a record high in the third quarter of 2003, a banking trade association said in a report released Tuesday.

Credit card delinquencies rose to a seasonally adjusted 4.09 percent of all accounts in the period from 4.04 percent in the second quarter, the American Bankers Association said.


Delinquency rates for direct auto loans and home equity loans also rose, the ABA said.

Stories like this have me hoping that payrolls start rising pretty quickly. I just don't want to imagine what could happen if large numbers of households decide that now is a great time to pay down debt (i.e. do something they haven't been doing much of: namely save).



A fugitive from the bullpen

Monday, January 05, 2004
Why do I get this shiver up and down my spine when I read things like this? Need some sunshine in your day? Read on:

NEW YORK (CNN/Money) - Stocks up big again, Osama nabbed, the Fed on hold and gold spiking to $500.

That's what the world will look like this year, according to Morgan Stanley's veteran market strategist Byron Wien.

Wien, who has put out his annual forecast for the 19th straight year, also thinks the mutual fund scandal will die out in 2004, the dollar will rebound, the Nikkei will rally, and Vice President Dick Cheney won't run for re-election with President Bush.

Wien made some surprisingly accurate predictions for 2003, including the big rally in stocks, a return to solid economic growth, oil prices hitting $30, and Microsoft, among other companies, starting to pay dividends.

And if Osama is dead already, we'll ring the opening bell with his thighbone! Oh wait, Wien is hedging his bets with an alternative scenario:

But in his more bearish take on the new year, Wien focuses on increasing inflationary pressures and their impact on stocks, bonds and currency.

Among his alternate predictions: The S&P 500 runs out of fuel after an early rally and falls back to 1,000, the 10-year Treasury yield jumps to 6 percent, the dollar falls further and the Fed jacks short-term rates up to 4 percent.

No, I'd like the first one. Waiter! Scenario one please!

Bernanke, Mizoguchi - some talk, some action

Or better: more of the same. Fed Governor Bernanke showed no sign of talking up the dollar - it looks as if the Fed is quite satisfied with the way the dollar is behaving. After all only a "modest" porportion of goods and services consumed in the US are affected by the worsening exchange rate. True enough - most of the stuff sold at Walmart comes from China - not from Euroland or Japan. The ECB is treading water - no sign of distress. The market keeps pushing back the critical (i.e. the level at which intervention could be likely) exchange rate. I've heard numbers of around 1.35 being mentioned this morning.

The Gevernors statements have also led come commentators coming around to my position that a rate hike is not imminent in the US. Fed Funds Futures have been showing consistently falling implied forward yields over the past couple of months. The big number will be out this Friday (non-farm payrolls). I'm pretty sure that anything except for a blowout will have no effect on the forex market.

The BoJ has no qualms regarding intervention. They have been intervening all through last year and are continuing this year. They're not shy about it either - they've drawn their line in the sand. The following quote is taken from Forbes:

Japan's top financial diplomat, Zembei Mizoguchi, said on Monday that the Japanese authorities remained ready to step into the foreign exchange market if there was a danger of volatility.

"We will take appropriate measures when necessary. There is no change in our position" Mizoguchi, vice finance minister for international affairs, told reporters as he arrived for work.

On a related note: the Japanese PMI is showing continued expansion (December number at 56) albeit at a moderate pace. This led to rising yields amid expections that the economy could get into gear before possible negative exchange rate movements choke off the nascent recovery.


Sunday, January 04, 2004
Blog got a facelift today. Template courtesy of eris :: design. I was so sick of the standard blogger-look that I bit the bullet and changed things 'round. Still some quirks to iron out but on the whole I'm satisfied.

2003 all wrapped up

Saturday, January 03, 2004
After having spent the festive season doing what one does (i.e. generally eat too much) I toyed with the idea of writing a summary of 2003. I stopped right after reading last week's Buttonwood column at the Economist. I can only say that he echoes my sentiments exactly (but writes much better).

I just want to give you some excerpts below - but please read the whole thing.
Whether recovery is sustainable is another matter. The simple fact is that Americans spend a lot and save almost nothing. That is why their country runs a huge current-account deficit. That is also why Joe Public, after he has forgotten the pain of the last experience, periodically rushes into risky assets again. He needs apparently turbo-charged returns to fund his spending habits. The fall in long- and short-term interest rates has boosted house prices and made Americans feel richer. But in the long term they will have to save more.

Helped by surging profits and rock-bottom interest rates, corporate balance-sheet repair has been happening, but there has probably been more talk than action. That is why the big rating agencies are still downgrading far more companies than they are upgrading. Corporate America (corporate everywhere, indeed) is, in other words, still awash with debt, and rating agencies are less convinced than they were that it will be paid back. Not that this has bothered investors much. Credit spreads - the difference in yield between corporate bonds and Treasuries - have more than halved for investment-grade bonds. The high-yield market no longer yields enough to be given that moniker, such has been the thirst for high-risk, high-return assets.
I look at the current market and the underlying trends in the (world) economy and see some risks going forward. Some people say that I'm contrarian because of that - not true. I just force myself to look at the other side of the current market picture as a way to escape from confirmatory bias (i.e. looking for information that supports your views). What do I really think? I think that the real economy has to do some catching up to get to where the market is now. That catching up might or might not happen - I just believe that the risks are on the downside. That does not mean that I expect the market to fall - it means that I expect a fall to be substantially higher than the (rather more probable) further gains. This leads to my seeing "risk" in terms of expected value terms.