Sunday, October 26, 2008

A Week in Review, Currencies and More

If you are reading this, thank you, and please take a minute to add your email address in the red box to the right. You will NOT get new blog entries to your email, but you will get an upcoming newsletter. Warning... this is a long entry, and it does not scratch the surface of what is going on! For the meaning of the Canadian flag you have to make it to the bottom of this entry.......

Last week was a horrible one for global equities, and in particular for many emerging markets. Andrew Barry’s piece in this week’s Barrons – That Was Way Too Close For Comfort – provides a great overview. On the second page of the article you will fund a summary of the weekly and YTD performance numbers for most major markets. Needless to say it is not pretty. US equities lost almost 7% on the week and are down 40% on the year. Though that is clearly worth losing your breakfast over, China is down 65% followed by India at 57%. You may be quick to remind me that those markets also moved up the most over the past few years, and you would be right. They, unlike us however, continue to grow at a healthy rate and have issues very different from those in the US. Though China in particular is sure to suffer with the decrease in US demand, there are more than a handful of reasons why they are likely to recover much faster and not the least of which is that their government has $1.8 trillion in reserves that they can spend, and they are not suffering under massive budget deficits. If you turn to the back page of the ECONOMIST ( my favorite magazine and an absolute must read for anyone who wants the easiest way to stay current on almost everything you need to know about the world of economics and finance), you will find that China had a $371 BB current account balance in 2007. Though that will most surely decline, positive numbers in general are a very good thing.
One comment that drew my attention related to US stocks. It makes me nuts when people say that stocks are cheap just because they are down a lot. That might well be a reason to think they might be cheap, but generally it means that something has fundamentally changed. When it comes down to stock valuation I look first to price/earnings ratios.
Andrew Barry says….

“VALUATIONS OF STOCKS LOOK pretty reasonable, even assuming marked earnings declines. The S&P 500, at 876, is trading for just 10 times 2007 operating earnings of $85. This year's profits will be a disaster due to write-offs and losses, and the 2009 earnings outlook remains uncertain. Citigroup analysts see $79 in S&P earnings, but even assuming $70, the index is valued at less than 13 times earnings. The dividend yield on the S&P 500 stands at 3% and the price/book ratio is 1.8 times, versus 3.3 a year ago.”
Even modern history tells us that Bear Markets can take stocks much cheaper than that. I made note in my journal of a great piece written earlier in the month by Jason Zweig from the Wall Street Journal that provides a great history lesson. He states

“But when the stock market moves away from historical norms, it tends to overshoot. The modern low on the Graham PE ( which divides the price of major US Stocks by their net earnings averaged over the past 10 years) was 6.6 in July and August of 1992. "

Others I have spoken to say that PEs at the bottom are in the 8 to 9 times forward (often deeply pessimistic) earnings. Though I am hopeful that stocks find a bottom, it is a stretch to say overall they are a buy.
Despite me writing about equities the story this week was really one of currencies. There were so many educational pieces I just have to highlight a few below. A quick look at the table published daily in the WSJ tells its own story. If your currency was not pegged to the dollar, and you were not the Yen, your currency got hammered! I cannot begin to tell you the problems this is causing around the world. Again, a subject of a longer piece…. But in short, Bretton Woods Two Baby, Bretton Woods Two.

First it was a list of mortgage bankers that were going under, then banks, then investment banks now it is companies, hedge funds, and countries. Countries. It seems EVERYONE has their hand out and I worry deeply that there is just not enough money ( particularly US dollars) to go around at the moment.
Last note – The folks in Washington, and for that matter all government officials and central bankers, need to either refresh themselves or learn some basic economics in order to plan how we are all going to get out of this mess. Sadly what they are likely going to learn if they take a macro economist to dinner is that it is not going to end nicely. You cannot just go on spending your way out of the problem. The irony is that historically when the US has offered help to countries who faced currency and debt crisis due to overspending the only way we would help is if they introduced hard core fiscal discipline. Now the US is the country that has been fiscally irresponsible ( as have others) , but because we are the reserve currency, ours is the one that strengthens ( short term )??? The arguement goes that we are so much better off then the countries that are in currency crisis, but really? This US dollar strength cannot go on forever. There will be no soft landing of the US economy. Do some preparing for the worst and be pleasantly surprised if the worst does not happen.

Last last note - As a Canadian what is going on in the C dollar makes no sense longer term. No sense. Stronger banks, positive trade balance, positive current account - very nice people and the Olympics in 2010. It makes no sense... buy Canada.

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