Sunday, January 31, 2010

Growth Hits 6-Year High

By JUSTIN LAHART The U.S. economy grew at its fastest pace in six years in the last three months of 2009, expanding at a 5.7% yearly rate over the previous quarter, as businesses drew less from their stockrooms and stepped up purchases of equipment and software. Exports surged and consumers spent more. But the pace of the recovery is unlikely to continue as strongly once the temporary jolt from the inventory drawdown passes and government stimulus fades, keeping unemployment high through the end of the year. "You get a one-off boost, but that's not going to be repeated in the first quarter," said Michael Carey, chief economist at Calyon Securities in New York. Of the 5.7% rise in gross domestic product, 3.4 percentage points came from businesses shrinking inventories more slowly than in the previous quarter. That's a plus for economic growth: When businesses pull fewer goods from warehouses, they have to produce more. Total inventories fell at an annual rate of $33.5 billion in the fourth quarter, compared to a $139.2 billion reduction in the previous quarter. Stocks jumped higher following the report, but finished the day down despite the news of the growth spurt. The Dow Jones industrial average fell 53.13 points, or 0.52%, to 10067.33. In Washington, reaction was subdued as policymakers focused on the high unemployment rate. "We need to be vigilant that this increase in GDP translates into an immediate increase in jobs," said Rep. Caroline Maloney, the New York Democrat who chairs the Joint Economic Committee. Manufacturers and distributors are benefitting from the inventory-related bounce. But they are treating it cautiously and don't seem to be in a rush to hire. "I'm not seeing much of a recovery right now," said Clint Binley, president of Pallets Inc., a maker of wooden pallets in Fort Edward, N.Y. Orders have picked up, said Mr. Binley, but rather than hiring more workers, he has increased hours. He says he doesn't foresee hiring anyone this year. Collings Guitars Inc., a maker of acoustic guitars and other instruments in Austin, Tex., has seen an inventory-related uptick in orders. Hit during the downturn, many guitar shops cut the number of instruments they had on hand, and Collings saw orders drop. Now stores are restocking, and orders are bouncing back. "I can't just ramp things up to meet that," says general manager Steve McCreary. After logging fewer hours last year, Collings 66-employee workforce is spending more time on the clock. Mr. McCreary is also looking to add a few people. The U.S. economy began contracting in the first quarter of 2008. It eked out a bit of growth in the second quarter of that year and then contracted sharply over the ensuing four quarters until growth returned at a 2.2.% annual rate in the third quarter of 2009. Even after the fourth-quarter gain, GDP remains 1.9% below its peak 2008 level. After inventories, an increase in consumer spending was the largest contributor to GDP growth in the fourth quarter. Consumer spending grew at a 2% annual rate, the Commerce Department said. That was down from the third-quarter, when spending grew at a 2.8% rate, boosted by auto sales related to the government's cash-for-clunkers program. Sales of goods besides autos grew at a faster clip than in the third quarter. That suggests households are spending more freely, said Barclays Capital economist Dean Maki. "That is likely because wage and salary income is improving," he said. "Consumers are spending the additional money." The Labor Department said Friday that wages and salaries of civilian workers rose a seasonally adjusted 0.5% in the fourth quarter. That was the largest increase in over a year, but was muted by historic standards. Separately, the Reuters/University of Michigan consumer sentiment index rose to 74.4 for January from 72.5 in December. That's up from a low of 56.3 last February, reflecting improved confidence among households. But it's still well below its levels prior to the recession's start in December 2007. "I tend to watch what I'm buying a bit more," says Wade Walter, 34, of Jacksonville, Fla., who works the deli counter at a Costco, the big-box discounter. "I'm not just buying DVDs or games or going out as much as I used to. I don't want to say I'm buckling down, but I put my money into things that are more worth it, or put it in the bank." Lost wealth and tight credit are keeping household spending in check. This suggests Americans are likely to increase their spending only once companies step up hiring and wages. That leaves the recovery more dependent on firms' confidence than in past upturns, when increases in consumer spending helped lead recoveries. One sign from the GDP report of improved confidence at companies was a annualized 13.3% increase in spending on equipment and software—the biggest gain in nearly four years. In the past, rises in capital spending have tended to signal an increased willingness to hire. When it reported results for its most recent quarter on Wednesday, Rockwell Automation Inc., a leading producer of factory-automation equipment and software, said it expects revenue of $4.4 billion to $4.6 billion for its fiscal year ending September, better than the $4.1 billion to $4.4 billion it previously forecast. "We believe we are at the start of a recovery," said Rockwell CEO Keith Nosbusch. "Our goal is to be very successful as it returns." But the company is cautious, and has increased hiring only slightly despite its expectation for better sales.

Garrottes and sticks

The first of four articles on the implications of the Volcker rule examines reactions on Wall Street Jan 28th 2010 NEW YORK From The Economist print edition Illustration by S. KambayashiA RECENT episode of “Mad Money” on CNBC, a financial-news network, featured the “Lloyd Blankfein piñata”. Hung from the studio ceiling to symbolise the beating that bankers—not least Goldman Sachs’s boss—have been taking lately at the hands of politicians, the effigy rained down fake gold coins when split apart. Wall Street’s predicament is the inverse of the one it faced in late 2008, says Frederick Cannon of Keefe, Bruyette & Woods, a broking firm. Then, officials wheeled out weekly plans to save banks. Now they are rushing out measure after measure to punish the survivors, accompanied by increasingly fiery rhetoric. Barack Obama kept up the assault in his State of the Union address this week. Admitting that the bank bail-out was “as popular as a root canal”, he vowed to take on lobbyists who were “already trying to kill” financial reform. The bombardment began on January 14th, with a new ten-year tax on big banks’ liabilities. But it intensified greatly on January 21st with a plan to cap their size, ban their “proprietary” trading (bets made for their own account) and limit their involvement in hedge funds and private equity. Mr Obama wants these measures to be wrapped into a broader set of reforms that is grinding its way through Congress. A bill passed by the House of Representatives, but not yet taken up by the Senate, already allows regulators to limit the scope and scale of firms that pose a threat to financial stability. The new proposals require them to do so. Though widely characterised as a return to the Glass-Steagall act, the plan falls far short of the Depression-era law that separated commercial banking and investment banking (and was repealed in 1999). Banks can continue to offer investment-banking services to clients, such as underwriting securities and making markets. The plan’s aim, say officials, is narrow: to stop Wall Street from gambling in capital markets with subsidised deposits. The timing of the proposal—two days after Mr Obama’s party suffered a thumping Senate-election loss in Massachusetts—looks nakedly political. But it was not dreamed up overnight. Last year the president’s economic lieutenants had seemed content to shackle the banks with tougher regulation and higher capital ratios, rather than limiting their activities. In recent months, though, they warmed to the ideas of Paul Volcker, a former chairman of the Federal Reserve, who was advocating more drastic action—and after whom the new rule is named (see article). Banks have been scrambling to estimate the potential damage. Despite the lack of detail, for most the impact looks manageable. Officials admit that new limits on non-deposit funding are designed to prevent further growth rather than to force firms to shrink. Banks were already scaling back their proprietary-trading activity sharply as a result of the crisis: some say its contribution to revenue has fallen by more than half in the past three years. Prop trading now typically accounts for a mere percentage point or two of firms’ revenues (see table)—if it is defined narrowly to exclude risk-taking related to client business. Drawing a line between the two will be horribly difficult, but that will be the regulators’ problem. Moreover, banks will be allowed to keep hedge funds that hold clients’ money. JPMorgan Chase will not have to offload its prized Highbridge subsidiary, for instance. American banks have only $10 billion of their own capital invested in hedge funds, according to Preqin, a research firm. Private equity is more problematic. Several firms have large dollops of their own capital in buy-out funds, which also generate fees for their advisory and lending arms. Even if the Volcker rule’s financial impact is modest, banks could face “a thousand cuts” to profits when the full range of regulatory initiatives is totted up, says Richard Ramsden of Goldman Sachs. The latest proposals, on top of recent credit-card and overdraft restrictions, could together cost JPMorgan Chase $4.5 billion in after-tax profit, he says. Meredith Whitney, an independent analyst, sees banks losing “several points” of return on equity. Much attention is focused on the new rule’s impact on Mr Ramsden’s own firm. Goldman says that 10% of its revenues come from proprietary trading, well above rivals’ shares. Some analysts put the figure much higher. With its blend of advisory work, trading and co-investing with clients, the firm’s “entire culture is, in a sense, proprietary,” says Ms Whitney. Fortunately for Goldman, it has an escape hatch. If it gives up its small deposit-taking arm, it can go back to being a broker-cum-hedge fund, free to trade as it likes. Officials defend this get-out, saying Goldman would have no access to central-bank funding and would still be subject to enhanced capital requirements and supervision. But it would continue to enjoy implicit state support, unless markets can be convinced that it would be allowed to fail if it got into trouble. That seems unlikely. Congressional leaders may balk at giving what could be portrayed as a free pass to such an unpopular firm. The Volcker rule could easily get mangled in the legislative process. Republicans loathe such government heavy-handedness, even if they are wary of being seen to support bankers. Some senior Democrats, such as Chris Dodd, head of the Senate banking committee, have given the plan a lukewarm reaction. Mr Dodd already faced a struggle to craft a financial-reform bill that would win some Republican support. If the White House’s new initiative makes his task harder, it could prove to be a spectacular own goal. Nor has the plan won overwhelming support across the Atlantic. Britain’s opposition Conservatives, who are likely to reassume power this year, reacted positively, as did Jean-Claude Trichet, head of the European Central Bank. The Financial Stability Board, a Basel-based body which is marshalling the international reform drive, gave a qualified thumbs-up, stressing that a broader mix of approaches was needed to tame financial monsters. France and Germany were less enthusiastic. Both are wary of following an initiative that could be stillborn. “A lot of people here are saying that we shouldn’t fool ourselves into doing something that America will not do because of lobbying by American banks,” says Nicolas Véron of Brueghel, a Brussels think-tank. Many in Europe favour higher capital charges for all trading activity, arguing that risky bets are the real enemy, whether they are placed for clients or made on banks’ own accounts. If Europe fails to follow America’s lead, it would be a blow for efforts to create a joined-up approach to global regulation. With the American plan coming on the heels of Britain’s tax on bonuses, there are fears of growing unilateralism. One danger is that this fragmentation results in what Sir Howard Davies, a former head of Britain’s Financial Services Authority, has called “reckless prudence”: a cumbersome patchwork of inconsistent, overlapping rules. That would create a second risk, regulatory arbitrage. If American banks were at a real disadvantage to foreign rivals, they would try to game the rules. For America’s big banks a more immediate worry is that Mr Obama, stung by accusations that he has been too soft on bankers, unveils more punitive measures in the run-up to mid-term elections in November. The back-in-vogue Mr Volcker, it should be noted, supports inflicting bank-like regulation on money-market funds, many of which sit within Wall Street firms. The Securities and Exchange Commission voted on January 27th to impose new disclosure and liquidity rules on these funds. The administration is “trying to legislate by shouting,” Steve Bartlett of the Financial Services Roundtable, an industry group, told NPR radio, pointing out that when Mr Obama unveiled the Volcker rule he devoted more words to trashing banks than to outlining the plan. But bashing banks is good politics: a majority of Americans say Wall Street should not have been bailed out. Moves to assuage the outrage over bonuses, such as Goldman’s capping of London partners’ total pay at £1m ($1.6m), are doomed to disappoint. If public anger grows, a reintroduction of Glass-Steagall may just start to look possible. The uncertainty bred by this regulatory risk has a financial impact. Bankers are growing worried that institutional shareholders, spooked by regulatory unpredictability, will start to lose faith. It could also raise the cost of issuing debt. Moneymen fret about possible unintended consequences, too (see Buttonwood). Trading limits and caps on bank liabilities could make the huge, low-margin business of repurchase (“repo”) lending much less economical, reducing liquidity in mortgage-backed securities and Treasuries, which are used as collateral in such loans. This is no time for bankers to carp publicly. Dick Bove, a veteran bank analyst with Rochdale Securities, may overdo it in describing Mr Obama’s assault on the banks as “Venezuelan-style democracy”, but open dissent is unwise. An investment banker likens the atmosphere to the aftermath of the September 11th attacks, when no one dared call for restraint in torturing suspected terrorists. That choice of analogy may reveal as much about the depth of Wall Street’s persecution complex, and its inability to face up to its role in the crisis, as it does about those beating it with sticks.

Saturday, January 30, 2010

My big fat sell-off

A successful bond issue provides only temporary respite Jan 28th 2010 From The Economist print edition THE Greek finance minister, George Papaconstantinou, must feel like a man who finds a one-euro coin on the pavement only to discover he had earlier dropped a five-euro note. Worries about Greece’s public finances seemed to recede on January 25th when it raised €8 billion ($11 billion) in an issue of five-year bonds. That appeared to kill the idea that Greece may not be able to tap bond markets for much-needed cash. Yet two days later the yields on Greek government bonds jumped to their highest since 1999. The sell-off renewed fears that markets may lose faith in Greece altogether. Talk of a bail-out by its euro-zone partners is growing. The country’s initial fundraising success came at a hefty price. The new five-year bonds will pay a coupon of 6.2%, a 3.5 percentage-point spread over the “mid-swaps” rate, a yardstick for creditworthy borrowers of euros. Yet the deal suggested there is appetite for risky sovereign bonds at the right price. The bank syndicate placing the bonds was able to drum up €25 billion-worth of orders in a few hours. If the Greek government had decided to meet all that demand, it would now be halfway to meeting its gross borrowing requirement for this year. According to Fitch, a credit-rating agency, Greece needs to raise €51 billion this year to cover its budget deficit, to roll over its short-term borrowings and to redeem its maturing longer-term debt, much of which comes due in April and May. The reasons for leaving money on the table seemed sound at the time. Issuers typically like to have oversubscribed offerings: it makes it more likely that bonds will rally once the deal closes. Greece may have hoped that by showing markets that it could raise cash so readily, it would be rewarded with lower borrowing costs for future issues. A grab for money might also have been taken as a sign of weak commitment to budgetary discipline. Any reward for restraint did not last long. On January 27th the bond markets smacked Greece down again. The interest-rate spread on its five-year government bonds widened to a record 4.1 percentage points over German bunds. That change was mirrored in higher prices for credit-default swaps, a form of insurance against default (see chart). There seemed to be no single proximate cause of the sell-off in Greek bonds. Financial markets were in a general funk, caused in part by America’s bank-reform plans and in part by worries about policy-tightening in China. Investors fleeing from risk drove the dollar up and pushed the yield on one-month Treasury bills into negative territory for the first time in ten months. Closer to home, Portugal’s government announced that its budget deficit was 9.3% of GDP in 2009, higher than previous forecasts. It also said that the deficit would narrow only slightly to 8.3% of GDP this year, adding to the sense that troubled euro-area countries are not doing enough to right their rickety public finances. Perhaps most unnerving of all were reports, later denied by Greece, that it had tried and failed to place bonds worth €25 billion with China. The rumour struck at the notion, cherished by some holders of Greek bonds, that there is untapped demand in Asia for the riskier sorts of euro paper. For less sanguine investors, the idea of going cap in hand to China smacked of desperation. Some may have recalled the trek that Bear Stearns made to China in the months before the bank imploded. The bond market’s skittishness puts more pressure on the Greek government to come up with a credible plan for fiscal retrenchment. A pledge to follow Ireland’s example in making substantial cuts to public-sector wages may now be necessary to ensure Greece can fund itself at reasonable cost. Having raised €8 billion this week the Greeks probably have enough money to see them through until May, when a chunk of their long-term borrowing falls due. The danger now is that market sentiment spirals out of control. If that happens, only the most radical measures, or a euro-zone bail-out, will turn things around

The book of Jobs - Jesus Tablet

It has revolutionised one industry after another. Now Apple hopes to transform three at once Jan 28th 2010 From The Economist print edition Apple is regularly voted the most innovative company in the world, but its inventiveness takes a particular form. Rather than developing entirely new product categories, it excels at taking existing, half-baked ideas and showing the rest of the world how to do them properly. Under its mercurial and visionary boss, Steve Jobs, it has already done this three times. In 1984 Apple launched the Macintosh. It was not the first graphical, mouse-driven computer, but it employed these concepts in a useful product. Then, in 2001, came the iPod. It was not the first digital-music player, but it was simple and elegant, and carried digital music into the mainstream. In 2007 Apple went on to launch the iPhone. It was not the first smart-phone, but Apple succeeded where other handset-makers had failed, making mobile internet access and software downloads a mass-market phenomenon. As rivals rushed to copy Apple’s approach, the computer, music and telecoms industries were transformed. Now Mr Jobs hopes to pull off the same trick for a fourth time. On January 27th he unveiled his company’s latest product, the iPad—a thin, tablet-shaped device with a ten-inch touch-screen which will go on sale in late March for $499-829 (see article). Years in the making, it has been the subject of hysterical online speculation in recent months, verging at times on religious hysteria: sceptics in the blogosphere jokingly call it the Jesus Tablet. The enthusiasm of the Apple faithful may be overdone, but Mr Jobs’s record suggests that when he blesses a market, it takes off. And tablet computing promises to transform not just one industry, but three—computing, telecoms and media. Companies in the first two businesses view the iPad’s arrival with trepidation, for Apple’s history makes it a fearsome competitor. The media industry, by contrast, welcomes it wholeheartedly. Piracy, free content and the dispersal of advertising around the web have made the internet a difficult environment for media companies. They are not much keener on the Kindle, an e-reader made by Amazon, which has driven down book prices and cannot carry advertising. They hope this new device will give them a new lease of life, by encouraging people to read digital versions of books, newspapers and magazines while on the move. True, there are worries that Apple could end up wielding a lot of power in these new markets, as it already does in digital music. But a new market opened up and dominated by Apple is better than a shrinking market, or no market at all. Keep taking the tablets Tablet computers aimed at business people have not worked. Microsoft has been pushing them for years, with little success. Apple itself launched a pen-based tablet computer, the Newton, in 1993, but it was a flop. The Kindle has done reasonably well, and has spawned a host of similar devices with equally silly names, including the Nook, the Skiff and the Que. Meanwhile, Apple’s pocket-sized touch-screen devices, the iPhone and iPod Touch, have taken off as music and video players and hand-held games consoles. The iPad is, in essence, a giant iPhone on steroids. Its large screen will make it an attractive e-reader and video player, but it will also inherit a vast array of games and other software from the iPhone. Apple hopes that many people will also use it instead of a laptop. If the company is right, it could open up a new market for devices that are larger than phones, smaller than laptops, and also double as e-readers, music and video players and games consoles. Different industries are already converging on this market: mobile-phone makers are launching small laptops, known as netbooks, and computer-makers are moving into smart-phones. Newcomers such as Google, which is moving into mobile phones and laptops, and Amazon, with the Kindle, are also entering the fray: Amazon has just announced plans for an iPhone-style “app store” for the Kindle, which will enable it to be more than just an e-reader. If the past is any guide, Apple’s entry into the field will not just unleash fierce competition among device-makers, but also prompt consumers and publishers who had previously been wary of e-books to take the plunge, accelerating the adoption of this nascent technology. Sales of e-readers are expected to reach 12m this year, up from 5m in 2009 and 1m in 2008, according to iSuppli, a market-research firm. Hold the front pixels Will the spread of tablets save struggling media companies? Sadly not. Some outfits—metropolitan newspapers, for instance—are probably doomed by their reliance on classified advertising, which is migrating to dedicated websites. Others are too far gone already. Tablets are expensive, and it will be some years before they are widespread enough to fulfil their promise. In theory a newspaper could ask its readers to sign up for a two-year electronic subscription, say, and subsidise the cost of a tablet. But such a subsidy would be hugely pricey, and expensive printing presses will have to be kept running for readers who want to stick with paper. Still, even though tablets will not save weak media companies, they are likely to give strong ones a boost. Charging for content, which has proved difficult on the web, may get easier. Already, people are prepared to pay to receive newspapers and magazines (including The Economist) on the Kindle. The iPad, with its colour screen and integration with Apple’s online stores, could make downloading books, newspapers and magazines as easy and popular as downloading music. Most important, it will allow for advertising, on which American magazines, in particular, depend. Tablets could eventually lead to a wholesale switch to digital delivery, which would allow newspapers and book publishers to cut costs by closing down printing presses. If Mr Jobs manages to pull off another amazing trick with another brilliant device, then the benefits of the digital revolution to media companies with genuinely popular products may soon start to outweigh the costs. But some media companies are dying, and a new gadget will not resurrect them. Even the Jesus Tablet cannot perform miracles.

Wednesday, January 27, 2010

Greek Government Five-Year Bonds Tumble in First Day of Trading

By Abigail Moses and Caroline Hyde Jan. 27 (Bloomberg) -- Greece’s new 8 billion euros ($11 billion) of five-year bonds tumbled in the first day of trading, pushing the cost of insuring the government’s debt from default to a record. The spread on the notes, due August 2015, widened as much as 35 basis points to 385 over the benchmark mid-swap rate, according to Markit Group Ltd. iBoxx prices on Bloomberg. Credit-default swaps protecting against losses on Greece for five years soared 48 basis points to 373, according to CMA DataVision. “Technically, the term is that it’s getting smacked,” said Gary Jenkins, head of credit strategy at Evolution Securities Ltd. in London. “Clearly what’s happening is very negative and could lead to a vicious circle.” Spyros Papanicolaou, head of the Greek debt agency, said yesterday he expected the spread on the bonds to tighten because the country has been “misjudged.” The European Commission said today that Greece hasn’t done enough to rein in its deficit that reached 12.7 percent of gross domestic product in 2009. One-year credit-default swaps on Greek debt jumped 43 basis points to 481, CMA prices show. They rose above the cost of five-year swaps for the first time Jan. 13, inverting the so- called yield curve and signaling investors perceive an increased risk of default. “Unless this bond stabilizes and general debt stabilizes, you have to ask the question: Who’s going to lend money to them next time and at what price?” Jenkins said. Order Book Greece received 25 billion euros in orders for the bonds, after offering 0.3 percentage-point more yield than on the nation’s existing debt with similar maturities. The government sold almost 75 percent of the bonds to international investors, Papanicolaou said. U.K. investors bought more than 29 percent of the notes sold via banks, according to Papanicolaou. French investors purchased almost 8 percent and domestic buyers acquired more than 26 percent. “This may be the biggest order book ever achieved for a single tranche deal,” said Daniel Shane, head of sovereign, supranational and agency syndication in London at Morgan Stanley, one of the managers on the deal. “The importance of Greece’s transaction cannot be overstated, not only for the issuer, but also for other European sovereigns and the credit markets in general.” Ratings Downgrade Greece, which had its credit rankings cut by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings last month, needs to raise 53 billion euros this year. The government gave plans to the European Commission on Jan. 15. designed to reduce the shortfall to within the EU’s 3 percent limit. Concern that Greece will struggle fund its deficit spread to other countries, with default swaps on Spain rising 17 basis points to 127, Portugal climbing 18.5 to 149 and Italy up 10 basis points at 114, CMA prices show. The Markit iTraxx SovX Western Europe Index of credit- default swaps on 15 governments from Germany to Greece rose 9.25 basis points to a record 87.25, according to London-based CMA. That means it costs $87,250 a year to insure against losses on $10 million of debt for five years. The yield on the Greek 10-year bond rose 44 basis points to 6.68 percent as of 4:35 p.m. in Athens, with the difference in yield, or spread, against German bunds increasing by 46 basis points to 350 basis points, the widest since December 1998. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company or country fail to adhere to its debt agreements. An increase signals deterioration in perceptions of credit quality. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year. To contact the reporter on this story: Abigail Moses in London at

Tuesday, January 26, 2010

U.S. Stocks Advance as Emerging Markets, Commodities Retreat Share Business Exchange

By Michael P. Regan Jan. 26 (Bloomberg) -- U.S. stocks gained on higher-than- estimated consumer confidence and earnings, while commodities fell and Asian equities extended their longest slump in two years on concern lending restrictions in China will curb growth. The Standard & Poor’s 500 Index rose 0.4 percent to 1,100.63 at 12:08 p.m. in New York. Oil, copper, silver and lead retreated as the dollar strengthened, while the MSCI Asia- Pacific Index sank 1.7 percent for a seventh straight day of losses. Europe’s Dow Jones Stoxx 600 Index recovered from earlier declines and added 0.5 percent. Treasuries pared gains, leaving the benchmark 10-year note’s yield down less than 0.01 percentage point at 3.63 percent. The Conference Board’s confidence index increased to 55.9 this month, higher than the median estimate in a Bloomberg survey, as the job market improved and Americans became more upbeat about the immediate future. Apple Inc. and Travelers Cos. gained at least 2.9 percent and DuPont Co. climbed 0.8 percent as quarterly profits topped estimates, bolstering optimism that improving earnings will justify a 10-month rally in equities. “The consumer confidence rebound is great news for the stock market,” said Michael Holland, who oversees more than $4 billion as chairman of Holland & Co. in New York. “The consumer is key for the economy. On top of that, the latest earnings numbers are very supportive. However, concern about a Chinese cool-down is still out there. China is one of the engines of the global economy.” The S&P 500 tumbled 5.1 percent in the final three days of last week, its biggest slide since sinking to a 12-year low in March, after President Barack Obama proposed reining in risk- taking at banks and concern grew over China’s measures to cool growth. Earnings Season A record nine-quarter earnings slump for S&P 500 companies is projected to have ended in the fourth quarter with a 73 percent increase in profits. More than 130 companies in the index are scheduled to release results this week. Asian shares slid as Bank of China Ltd. and China Construction Bank Corp. were told to restrict new loans, according to people familiar with the matter, potentially slowing expansion in the world’s fastest-growing major economy. Record government borrowing is troubling investors even as economies rebound. Credit-default swaps on Chinese government debt hit a two- month high, according to CMA DataVision. Standard & Poor’s cut its outlook on Japan’s AA sovereign credit rating to “negative,” citing diminishing flexibility to cope with debt. ‘Looming Risk’ “There’s a looming risk of governments making decisions that adversely affect the economy, and that’s materializing in China,” said Tim Brunne, a credit strategist at UniCredit SpA in Munich. “We’ve had a huge amount of fresh credit from banks supporting the Chinese economy and the question has always been if the money flooding into the economy was really helpful or driving asset bubbles.” While German business confidence rose more than economists forecast to an 18-month high, Fitch Ratings said European governments will need to borrow 2.2 trillion euros ($3.1 trillion) from capital markets in 2010. That amounts to 19 percent of GDP. The U.K. economy resumed growth at a slower pace than economists forecast in the fourth quarter. Service industries and manufacturing expanded just enough to pull Britain out of its longest recession on record. Growth Forecasts Raised The International Monetary Fund raised its forecast for global economic growth this year, to 3.9 percent from a 3.1 percent projection in October. The Washington-based lender predicted a 2.7 percent expansion in the U.S. and 10 percent in China. Still, high unemployment and rising public debt will restrain growth and contain inflation, the IMF said. The MSCI World Index trimmed losses as U.S. shares extended gains, leaving it little changed after four straight declines. The Dubai Financial Market General Index sank 3.6 percent, the biggest loss among benchmark indexes. The MSCI Emerging Markets Index fell 2 percent as JPMorgan Chase & Co. downgraded Brazil’s stocks to “neutral,” sending the benchmark Bovespa index down 1.4 percent. Taiwan’s Taiex lost 3.5 percent and Russia’s Micex Index dropped 2.2 percent as oil prices slumped. All but one of 26 developing-nation currency tracked by Bloomberg weakened against the dollar, led by a 1.1 percent decline in South Korea’s won after that nation’s economic growth slowed more than estimated in the fourth quarter. The Dollar Index, which tracks the U.S. currency against of those of six major trading partners, snapped three days of declines to advance 0.3 percent. Crude oil for March delivery retreated to $74.86 a barrel in New York. Copper for delivery in three months fell 1.1 percent to $3.3535 a pound in New York, helping to lead a decline in industrial metals. China is the world’s second- biggest oil consumer and the biggest user of copper. Palladium for immediate delivery declined 2.8 percent to $430.25 an ounce and platinum dropped 1.1 percent. To contact the reporter on this story: Michael P. Regan at

Monday, January 25, 2010

Tishman Venture Gives Up Stuyvesant Project

High-Profile Purchase of Manhattan Complex Collapses Under Debt Mountain By LINGLING WEI And MIKE SPECTOR A group led by Tishman Speyer Properties has decided to give up the sprawling Peter Cooper Village and Stuyvesant Town apartment complex in Manhattan to its creditors in the collapse of one of the most high-profile deals of the real-estate boom. The decision comes after the venture between Tishman and BlackRock Inc. defaulted on the $4.4 billion debt used to help finance the deal. The venture acquired the 56-building, 11,000-unit property for $5.4 billion in 2006—the most ever paid for a single residential property in the U.S. The venture had been struggling for months to restructure the debt but capitulated facing a massive debt load and a weak New York City economy that has undercut rents and demand for high-priced apartments. Tishman Speyer's deal for Stuyvesant Town and Peter Cooper Village, which was the biggest real estate deal at the time, may end up in bankruptcy, the News Hub panel reports. Related Video Will Stuy Town Tenants be Reimbursed? The property's owners signaled they would be unable to reach a deal with lenders and instead decided to allow creditors to proceed with what amounts to an orderly deed-in-lieu of foreclosure, which means a borrower voluntarily gives the property back to lenders to avoid a foreclosure proceeding. "It has become clear to us through this process that the only viable alternative to bankruptcy would be to transfer control and operation of the property, in an orderly manner, to the lenders and their representatives," the venture said in a statement to The Wall Street Journal. "We make this decision as we feel a battle over the property or a contested bankruptcy proceeding is not in the long-term interest of the property, its residents, our partnership or the city." The troubles at Stuyvesant Town reflect the dismal condition of the apartment market throughout the country as high unemployment hammers rents and occupancy levels. Hardest-hit are highly leveraged deals done by private companies that, unlike large public real-estate companies, have been closed out of the capital markets. Stuyvesant Town creditors weren't immediately available for comment. But pressure on the Tishman group has mounted in recent weeks as some of the property's creditors have threatened to foreclose. In a letter sent to Tishman last week, a group including Concord Capital, an affiliate of Winthrop Realty Trust, said it intends to pursue "its rights and remedies," including possibly moving to foreclose on the property within 90 to 180 days. By some accounts, Stuyvesant Town is only valued at $1.8 billion now, less than half the purchase price. By that measure, all the equity investors—including the California Public Employees' Retirement System, a Florida pension fund and the Church of England—and many of the debtholders, including Government of Singapore Investment Corp., or GIC, and Hartford Financial Services Group, are in danger of seeing most, if not all, of their investments wiped out. The Tishman venture's decision to hand back the keys represents a defeat for a company that for years represented the gold standard of commercial real-estate deals, reaping high returns for investors. Journal Communitydiscuss“ It does not take a financial genius to know from the get-go that it was a huge bad investment for Tishman and others. Then again, back then, money was growing on trees. ” —Phillip Hwee Tishman Speyer has invested in such trophy assets as Rockefeller Center and the Chrysler Building, and its founder, Jerry Speyer, has been a major player in both real-estate and political circles for years. His son Rob Speyer is being groomed to take over the family real-estate empire. The Stuyvesant Town deal is one of several Tishman Speyer did at the top of the market that the company is trying to save. But the company itself isn't threatened. It took advantage of easy credit and investors' eagerness to buy into real estate during the good times. As a result, it didn't put much of its own cash into deals. Of the $5.4 billion price tag on the Stuyvesant property, Tishman invested only $112 million of its own money, with about $56 million from Jerry Speyer and Rob Speyer, co-chief executives of the New York-based company. Tishman has earned more than $10 million in property-management fees since the Stuyvesant Town acquisition, according to analysts at Deutsche Bank AG. Tishman decided to waive certain fees last year and managed the property for a loss, according to a person familiar with the matter. Tishman Speyer "would not consider a long-term management contract to continue operating the property that does not involve ownership," the partnership said in the statement. "Without a restructuring that would keep our ownership group as part of the equity, we felt it best that the new owners install a new management team." The Tishman venture's acquisition of Stuyvesant Town was controversial in New York. The Stuyvesant Town complex was developed by MetLife for returning World War II veterans and remained a middle-class haven even as rents in other parts of the city soared. Tishman's plans were to raise the rents for hundreds of the units to market rates. From the Archives Court Rules Against Tishman in Stuyvesant Town, (10/23/2009)An Apartment Complex Teeters, (10/15/2009)But the strategy backfired because of a slowing New York economy, a heavy debt load and a court ruling hindering the owners' ability to convert rent-controlled units to market rentals. In January, the property depleted what was left in reserve funds and defaulted on its first mortgage. View Full Image Bloomberg News Stuyvesant Town was developed by MetLife for returning World War II veterans. Tishman planned to raise rents for many units to market rates. Nationwide, scores of other apartment deals also are tanking as landlords are being forced to cut rents and offer incentives like flat-screen TVs to attract and retain tenants. San Francisco's Lembi family, the biggest apartment owner in that city, has been forced to give up numerous apartment properties to its lenders because it couldn't repay debt. Investors who purchased commercial-mortgage-backed securities, or CMBS, also are facing losses. In December, more multifamily CMBS loans moved into delinquency than for any other property type, with 113 new loans, totaling $1.1 billion, becoming delinquent, according to Moody's Investors Service. The Stuyvesant Town collapse comes amid mounting woes in the market for retail stores, hotels, apartments and other commercial property. Mall-giant General Growth Properties and hotel-chain Extended Stay Inc. filed for bankruptcy-court protection last year, and more commercial-property projects could fail amid an inability to repay debt because of dwindling rent rolls and still-scarce financing for all but large real-estate investment trusts. The troubles experienced by landlords nationwide are stoking fears among regulators and bankers that turmoil in commercial real-estate may derail the hoped-for economic recovery. Research firm Foresight Analytics estimates delinquencies on commercial real-estate loans held by banks will rise to 9.47% in the fourth quarter, up from 5.49% a year earlier. Meanwhile, the delinquency rate on CMBS stood at 4.9% in December, according to Moody's, up five-fold in just a year. Write to Lingling Wei at and Mike Spector at

Thursday, January 21, 2010

New Bank Rules Sink Stocks

Obama Proposal Would Restrict Risk-Taking by Biggest Firms as Battle Looms

WASHINGTON—President Barack Obama proposed new limits on the size and activities of the nation's largest banks, pushing a more muscular approach toward regulation that yanked down bank stocks and raised the stakes in his campaign to show he's tough on Wall Street.

[0121obama1] Associated Press

Economic Recovery Advisory Board Chair Paul Volcker (left) looks on as President Barack Obama outlines his proposals to regulate large U.S. banks.

President Obama proposes new rules designed to restrict the size and activities of the nation's biggest banks. WSJ's Jerry Seib joins the News Hub to discuss the latest in a series of administration moves to curb Wall Street. Plus, House Speaker Nancy Pelosi (D., Calif.) tells reporters the House is unlikely to pass Senate health-care legislation without changes. The News Hub brings you the latest.

News Hub: White House Outlines Bank Restrictions


Under the White House's proposed bank regulations, banks will be forced to choose between taking deposits and trading. The News Hub weighs in on what this means for the future of banking.

With former Federal Reserve Chairman Paul Volcker at his side, Mr. Obama said he wanted to toughen existing limits on the size of financial firms and force them to choose between the protection of the government's safety net and the often-lucrative business of trading for their own accounts or owning hedge funds or private-equity. Mr. Volcker has been an outspoken advocate of such rules; until recently Mr. Obama's top economic advisers, including Treasury Secretary Timothy Geithner and Lawrence Summers, were less than enthusiastic.

"Never again will the American taxpayer be held hostage by a bank that is too big to fail," Mr. Obama said Thursday, two days after voters crimped his ability to pursue his agenda by sending a Republican to the Senate to fill a vacancy created by the death of Edward M. Kennedy. The election deprived Democrats of the 60 votes often needed to get major measures through the Senate.

Administration officials said they weren't trying to resurrect the Depression-era law—known as Glass-Steagall—that strictly divided commercial banks from the business of underwriting securities. Nor would their proposals force existing financial firms to downsize, officials said.

If accepted by Congress, the Obama proposals could force significant changes in how the nation's biggest banks do business.The specter of new profit-crimping regulation battered bank stocks Thursday, dragging down the Dow Jones Industrial Average by 213.27 points, or 2%, to 10398.88. Some financial stocks sank by more than 5%, though they recovered slightly after Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee, said the new rules would take effect over three to five years, not immediately. J.P. Morgan Chase & Co.'s stock was the hardest hit, sinking 6.6%.

The fate of the Obama proposal is uncertain. The House already has passed a provision that would give regulators new authority to limit the scope and scale of banks. Congressional passage now depends primarily on Senate Republicans. Several Republican senators expressed skepticism about the Obama proposal Thursday. "Let's solve problems," said Arizona Republican Sen. Jon Kyl. "Let's not be finding a bogeyman so that we can turn public attention away from what they're doing wrong in the administration."

But in a political environment decidedly hostile to big banks, Democrats might need only a few Republican votes to enact a variant of what Mr. Obama called "the Volcker rule." Sen. John McCain, the Arizona Republican, said the White House appears to be moving closer to a proposal he is co-sponsoring that would reinstate restrictions on banks that were repealed in the late 1990s. "It seems to me that a number of the proposals [Mr. Obama] has move in that direction," Sen. McCain said, "but I haven't had a chance to examine the details."

Big banks and their trade groups attacked the Obama proposals as unnecessary and unwise. "If people are focused on things that caused or were real contributors to the financial crisis, it wasn't trading," said David Viniar, chief financial officer at Goldman Sachs.

Over the past several years, banks have bulked up their profits in areas far beyond taking deposits, making loans and trading stocks and bonds on behalf of customers.

Some have bought or sponsored hedge funds. Others have moved to invest their own money in the markets.

After the collapse of Lehman Brothers and the rescue of American International Group in the fall of 2008, investment banks Goldman Sachs and Morgan Stanley formally became banks—giving them access to Fed loans and federal guarantees of their borrowing in financial markets.

When the crisis ebbed, Goldman and some other banks were able to borrow at low rates and turn profits trading for their own accounts. This gave Mr. Volcker and his allies, who include Vice President Joseph Biden, new fuel for their argument that government-backed banks should be prevented from taking big trading risks.

"The key issue is that institutions that are getting a backstop from the taxpayer shouldn't be able to make a profit off their own investing," said Austan Goolsbee, a White House economist who staffs the presidential advisory board Mr. Volcker chairs.

Looking Back: Glass-Steagall

Read the Journal's coverage of the early days of the 1933 Glass-Steagall Act, which first walled off commercial banks from investment banks.

Bank executives scrambled Thursday to interpret the proposals, particularly their effect on areas where bank capital is intermingled with client funds. The new rules would, for instance, likely force J.P. Morgan to shed its One Equity Partners private-equity business, which invests the firm's money. Disentangling Goldman's private-equity business, however, could be trickier because it invests its own money in the same funds that clients invest in.

Under the Obama proposal, banks that take federally insured deposits or have the right to borrow from the Fed would be prohibited from owning, investing in or sponsoring hedge funds or private equity firms. "You can choose to engage in proprietary trading, or you can own a bank, but you can't do both," an administration official said.

The president also called for expanding the reach of a 1994 law that forbids banks from acquiring another bank if the deal would give it more than 10% of the nation's insured deposits. He would expand that limit to cover other types of funding—such as bank's short-term borrowing from financial markets—and perhaps put a cap on the share of assets any one firm could hold.

The Thursday announcement is the latest move by the White House to target Wall Street and banks. Earlier this month, the president proposed a new fee on large banks and insurance companies that would raise $90 billion over ten years, ostensibly to offset the costs of the bailout of financial firms and auto giants.

—Michael R. Crittenden and Susanne Craig contributed to this article.

Write to Damian Paletta at and Robin Sidel at




  【《财经》记者 杨中旭】20091218日,中国投资有限责任公司(以下简称中投)总经理高西庆参加“2010预测与战略财经年会并发表演讲。在演讲中高西庆说:媒体对于我们的评论很多了,哪个东西上市我们买了一点,第二天(媒体)就会说中投又亏了。







  2009429日,中投发布消息称,根据资产类别、市场领域、投资方式、合规经营等因素和要求的不同,中投公司设立相对收益投资部、策略投资部、私募投资部、专项投资部四个部门,取代原来的股权投资部、固定收益投资部和另类资产投资部’” 中投董事会做出决定,转变现金为王策略,大举进军新能源和老能源领域。



  200973日,中投宣布同意通过其全资子公司福布罗投资有限责任公司(下称中投福布罗),以私募方式在每股17.21加元价位(入股价)购买泰克资源公司(Teck Resources Limited101304474股次级投票权B类股票中投公司此次的投资金额总额为15亿美元(约17.4亿加元)。此前,中投公司并没有持有任何泰克资源公司的股票。

  2010113日,《财经》记者登录泰克资源公司网站,其B类股票股价为41.31 加元(约合35.61美元),半年溢价24.1加元(约合20.78美元)。中投仅此一项投资,账面收益已高达21.05亿美元。

  2009115日,中投宣布,已于近期投资约8.58亿美元,以每股2.1137新加坡元的价格购买来宝集团(Noble Group Limited5.73亿股股票,合计约占来宝集团未摊薄总发行股本的14.91%。中投购买时的股价是 2.1137新加坡元。


  20091026日,中投福布罗以30年期高级有抵押可转债方式向加拿大南戈壁能源有限公司(SouthGobi Energy Resources Limited,下称南戈壁)投资5亿美元(5.8亿加元)45312500股。南戈壁是一家在加拿大创业板上市的煤炭开采及勘探公司,其主要资产位于蒙古。该项投资可转换成南戈壁普通股。入股之时,南戈壁股价为12.80加元。


  2009116日,中投公司向美国爱依斯电力公司(AES Corporation)投资15.8亿美元,以每股12.6美元的配售价格购买该公司1.255亿股股票。投资完成后,中投持有爱依斯电力公司15%的股份。根据双方达成的协议,中投公司将任命一名董事进入爱依斯电力公司董事会。












  2009115日,中投宣布,近期以高级抵押债权形式对印度尼西亚布密公司(PT. Bumi Resources Tbk)投资19亿 美元。与此同时,中投公司与布密公司同意建立战略合作关系,中投公司将参与布密公司或其附属机构未来的融资行动,包括为其将来扩建基础设施提供项目融资。 双方还将寻求在采矿业方面的其他合作机会。布密公司拥有一流资产,经营管理稳健,商业前景广阔,是中投公司在印度尼西亚的第一笔重要投资。


  此外,中投福布罗还曾于2009930日购买哈萨克斯坦石油天然气勘探开发股份有限公司(JSC KazMunaiGas Exploration Production)约11%的全球存托凭证(GDRs),交易金额约9.39亿美元。而中投投资的俄罗斯诺贝鲁项目,目前尚未有详细消息传出。


Tuesday, January 19, 2010

Mortgage-Bond Leverage Reaches 10-to-1, Markets Heal

(Update1) Share Business ExchangeTwitterFacebook| Email | Print | A A A By Jody Shenn Jan. 19 (Bloomberg) -- Wall Street firms are loosening terms of their lending to mortgage-bond investors as markets heal, an RBS Securities Inc. executive said. Repurchase agreement, or repo, lending against the debt has expanded so much since freezing in late 2008 that some banks now offer as much as 10-to-1 leverage and terms as long as one year on certain securities backed by prime jumbo-home loans, said Scott Eichel, the Royal Bank of Scotland unit’s global co-head of asset- and mortgage-backed securities. “It’s getting very competitive,” Eichel said in a Jan. 14 interview at Bloomberg headquarters in New York. “We’re at the point where I don’t think we would feel comfortable if things go too much further.” Increasing availability of leverage for mortgage-bond buyers was among the reasons that JPMorgan Chase & Co. and Barclays Plc each said in analyst reports this month that a record rally in U.S. home-loan securities without government- backed guarantees may continue even amid record foreclosures and further declines in home prices. Stamford, Connecticut-based RBS Securities was the second- largest underwriter of structured-finance securities worldwide last year, according to newsletter Asset-Backed Alert. In a repo, one party provides securities to another in exchange for cash, with an agreement to reverse the exchange at the end of a pre-set time period. The difference between the market value of the collateral and size of the loan is known as a haircut, and it determines the amount of leverage. Repo Data Federal Reserve data show the 18 primary dealers required to bid at Treasury auctions held $32.7 billion of securities aside from Treasuries, agency debt and agency mortgage bonds as collateral for financings lasting more than one day as of Jan. 6, up from $15.8 billion on May 6. That’s down from $113.9 billion in 2007 and reflects so-called reverse repo, securities- lending agreements and other arrangements. Using borrowed money allows debt buyers such as hedge funds to potentially earn greater returns even as they buy at higher prices, though also increasing risk. As asset values dropped during 2007 and 2008, leverage boosted losses, wiping out hedge funds run by London-based Peloton Partners LLP and New York-based Bears Stearns Cos., and damaged markets by leading to forced sales by firms, including Santa Fe, New Mexico-based Thornburg Mortgage Inc., which filed for bankruptcy. ‘A Little Frightening’ “I’ve got to be honest, leverage coming back this quickly is a little frightening,” said Jim Shallcross, who oversees about $12 billion of bonds as director of portfolio management at Declaration Management & Research LLC in McLean, Virginia. “You can’t assume everybody is going to do stuff rationally.” While excessive leverage employed by borrowers ranging from consumers and commercial-property buyers to banks and funds led to markets collapsing, the economy needs some amount, Brian Lancaster, RBS Securities’ head of asset- and mortgage-backed securities strategy, said in a joint interview with Eichel. “It’s like the children’s story, there’s ‘too much,’ ‘too little’ and ‘just right,’” Lancaster said, referring to the tale of Goldilocks and the Three Bears. “Only, it’s really not easy to tell the difference.” RBS Securities, which traded $200 billion of mortgage bonds last year, has ramped up repo lending, though it “hasn’t gotten” to offering 10 percent haircuts on debt with long durations, exceeding four years, Eichel said. Competitors may be going further in a bid to win market share in businesses such as trading and underwriting, he said. Bear Stearns To lead the division’s repo business, RBS last year hired Matthew Chasin, who joined a group of other former Bear Stearns employees, including Eichel, who arrived after JPMorgan Chase & Co.’s purchase of the investment bank in 2008. Ten percent haircuts aren’t risky with certain securities, such as senior ones projected to be retired soon by foreclosure proceeds, refinancings and home sales, Declaration’s Shallcross said. Before markets for AAA rated home-loan bonds collapsed in 2007, repo haircuts on the debt were as low as 3 percent, UBS AG said in reports at the time. Banks are seeking to provide more financing for mortgage bonds in part because they are finding it difficult to add assets by making safe loans to consumers and companies with the economy still weak, Shallcross said. The best mortgage investments today may involve using leverage with safe securities, such as ones from 2003 and 2004 whose underlying homeowners owe less than their property’s current value, said Scott Buchta, head of investment strategy at Guggenheim Securities LLC in Chicago. His firm is “definitely hearing that haircuts for high quality assets have been offered as low as 10 to 15 percent,” he said. Return Profile “You’re going to have a better return profile buying a high- quality bond with leverage than a low quality one without it or less leverage,” Buchta said. “That’s something a lot of customers are thinking here.” Typical prices for the most-senior fixed-rate prime-jumbo securities soared to 86 cents on the dollar last week, up from a record low of 63 cents in March, Barclays data show. Projected yields have “firmly” fallen below 10 percent across all types of so-called non-agency home-loan securities, the London-based bank’s analysts wrote in a Jan. 8 report. They added to their recommended portfolio a trade using repos to buy prime-jumbo securities, a tactic that would offer yields in the “mid to high 20 percent” range. The terms they cited were a haircut of 15 percent, with funding costs of 1.5 percentage points more than the London interbank offered rate. Jumbo mortgages are ones larger than government-supported Fannie Mae or Freddie Mac are allowed to finance, currently $417,000 in most places to as much as $729,500 in high-cost areas. Non-agency mortgage securities lack guarantees from the mortgage-finance companies or federal agency Ginnie Mae. To contact the reporter on this story: Jody Shenn in New York at

2010 Investment Strategies from Gary Shilling

2010 Investment Strategies: Six Areas To Buy, 11 Areas To Sell

(excerpted from the January 2010 edition of A. Gary Shilling's INSIGHT)

Our investment strategies for 2010 follow from our forecast of continued economic weakness and deflation, as discussed earlier in this report and in previous Insights, especially our Dec. 2009 edition. We see the 2010 investment climate dominated by weak economic growth here and abroad, led by U.S. consumer retrenchment. More government fiscal stimulus and continuing Fed policy ease are likely in this setting. So is low inflation or deflation.


1. Buy Treasury Bonds. Long-term Insight readers know we started recommending long Treasury bonds back in 1981 when we forecast secular and huge declines in inflation and interest rates. So we declared back then that "we're entering the bond rally of a lifetime." The yield on 30-year Treasurys was 14.7% and our eventual target was 3%. Last year, yields blew through 3% to reach 2.6% at year's end, so in our Jan. 2009 Insight we declared "mission accomplished" and removed Treasury bonds from our recommended list.

But then Treasurys sold off, pushing the yield on the 30-year bond to 4.7% at the end of 2009. So we've reactivated the strategy with our forecast of a return in yields to 3.0% or lower. Treasurys will continue to be a safe haven in a troubled world and benefit from deflation as well as their three sterling features. They are the best credits in the world. They are highly liquid. And they generally can't be called by the Treasury, and calls limit price appreciation when interest rates fall.

A decline in yields from 4.7% at present to 3.0% may not sound like much, but the bond price would appreciate over 34%. If it occurs over two years, then two years' worth of interest is collected, and the total return on the 30-year Treasury would be 44%. On a 30-year zero-coupon Treasury, which pays no interest but is issued at a discount, the total return would be about 64% -- most attractive! Recall that in 2008 when 30-year Treasurys rallied from 4.5% to 2.7%, their total return for the year was 42%..

Treasury bonds way outperformed equities in the 1980s and 1990s in what was the longest and strongest stock bull market on record. The superiority of Treasurys has been even more so since then. Chart 1, our all-time favorite graph, shows the results from investing $100 in a 25-year zero-coupon Treasury bond at its yield high (and price low) in October 1981, and rolling it into another 25-year Treasury annually to maintain that 25year maturity. In November 2009, that $100 was worth $16,972 with a compound annual return of 20.1%. In contrast, $100 invested in the S&P 500 at its low in July 1982 was worth $2,099 in November for an 11.8% annual return including dividend reinvestment. So Treasurys outperformed stocks by 8.1 times!



Many believe Treasury yields are headed up, not down. They think that all the bank reserves created by the Fed that have not generated bank loans will do so, flooding the economy with money and then create excess demand and inflation. They also think the continual heavy issuance of Treasurys to fund the nonstop federal deficits will push up yields. In contrast, we don't foresee the rapid economic growth needed to induce chastened banks to lend and cautious creditworthy borrowers to borrow. And if we're wrong, it will take at least several years to eat up global excess capacity during which the ever-inflation-wary Fed will no doubt remove the excess bank reserves, as Fed officials have already indicated.

We do expect large federal deficits for many years, in part because of pressure on government to create jobs and restrain unemployment in a slow growth economy. But those deficits will increasingly be funded by U.S. consumers as their saving spree continues. Although stock market bulls salivate over the prospect that increased saving will mean more equity purchases, we believe most of the money will continue to reduce the immense debt consumers have accumulated in recent decades.

Repaying debt will be attractive to many Americans in 2010 and beyond as they shun many investments after their huge losses in stocks throughout this decade and their shocking setbacks in real estate. A number will want to be less leveraged as slower economic growth makes employment less stable and unemployment more likely. Chastened lenders, pressed by regulators, will be pushing individuals to lower their leverage by repaying debt.

Another concern for Treasury bonds is that continued huge federal deficits and the required Treasury financing will erode confidence in these issues by Americans and foreigners, as noted earlier. This seems unlikely, especially before the end of this year. Also, as U.S. consumers save more and curb spending on domestic products and imports, the trade and current account deficits will continue to shrink. Earlier federal deficits were financed by foreigners as they recycled back to the U.S. the dollars gained from their trade and current account surpluses. The growing U.S. current account deficit measured the increasing gap between domestic saving and investment, or, in effect, and the need for foreigners to not only finance government deficits but also make up for declining U.S. consumer saving.

But now, the current account and trade deficits are shrinking, and further declines will accrue in future years if, as we forecast, exports grow faster than imports. So foreigners will have smaller American current account deficits to finance. At the same time, much more of federal deficits will be financed by rising U.S. consumer saving.

With 3-month treasury bills yielding 0.046%, we've moved out on the yield curve for what is essentially cash positions in some cases. Sure, 5-year obligations are much more volatile than 3-month bills and do have risk of loss if interest rates rise. But we think the direction is down in that part of the interest rate curve, and 2.6% returns vs. 0.046% seem enough to offset the risks.

2. Buy Income-Producing Securities. This includes high-quality corporate and municipal bonds as well as stocks of utilities, consumer product companies, health care firms and others that pay meaningful dividends that are likely to rise. Master Limited Partnerships are also possibilities, but only if their underlying businesses are secure enough to continue significant income flows to limited partners and stockholders. Banks used to pay significant dividends but slashed them when their earnings collapsed. Nevertheless, their deleveraging and reversion to safer but less growth-oriented businesses will probably pressure them to again pay attractive dividends.

Utilities lagged behind the stock market last year, but at the end of November, the dividend yield on utilities averaged 4.5% compared to 2% for the S&P 500 index. That low return compares with 3%, which used to be the floor (Chart 2). Payout ratios recently have been essentially meaningless with the collapse in corporate earnings, but low, 31% in the third quarter of 2009. Under pressure from stockholders, dividend yields are likely to return to 3% or more. The current high level of corporate cash will also encourage dividend paying.. Also, the S&P utility sector has returned 53%, including dividends, since 2000 while the total return on the S&P 500 index has been a minus 11%.


With stocks likely to be weak this year, dividend yields may constitute 100% or more of total returns. Note, however, that although the prices of utility and other defensive stocks sometimes rise in bear markets associated with recessions, that's not always the case. That was clearly true in 2008 when virtually every stock sector went down. Utility and other dividend-paying stocks and ETFs based on them, however, can be hedged against general stock market declines.

3. Buy Consumer Staples and Foods. Items like laundry detergent, bread and toothpaste are basic essentials of life that are purchased in good times and bad. In fact, as we've seen lately, consumers are buying more of their calories in supermarkets and they economize by eating at home rather than in restaurants. Note, however, that they are downgrading from national brands to cheaper house brands, and likely will continue to do so as a weak economy and high unemployment persist. Among retailers, the winners may continue to be discounters. Producers of national brands will need to continue to adapt to consumer downgrading by emphasizing cheaper "value" products.

4. Buy Small Luxuries. This is an investment concept we developed years ago. Consumers, especially when they're hard pressed, tend to buy the very best of what they can afford, even if it's within a low-priced category. We first noticed this tendency years ago, before apartheid ended in South Africa. We read that urban blacks there often carried the elegant, slim and expensive umbrellas typical of investment bankers in London. They couldn't afford cars or maybe even taxi fares, but did achieve status and satisfaction with fine umbrellas. We also learned of a currently unemployed man who enjoyed the status of morning coffee at 7-Eleven six days a week. By reusing his cup and the one he takes home to his wife, he gets a 32-cent discount per $1.37 serving and saves $655 a year on this small luxury.

Companies are adapting to small luxury modes in various ways. Some are offering the same products with lower cost and selling prices. Coach is cutting ladies handbag prices and working with suppliers to reduce costs. Neiman Marcus is pressing suppliers for lower-cost versions of designer styles.

Others are putting their prestigious names on different products. C.F. Martin reintroduced its stripped down 1930s guitar for under $1,000. Average prices were in the $2,000 to $3,000 range and its top of the line guitar sells for $100,000. California winemakers are emphasizing cheaper wines as sales of those over $25 per bottle slump. Consumers are retrenching and dining out less at upscale restaurants where fine wines are sold. Tiffany sales of products over $50,000 are weak, but high-quality small items continue to sell well--always in its trademark blue box. Procter & Gamble has not cut prices on its top of the line products that sell at premiums but carry high-quality images. Consumers still splurge on such small luxuries as Gillette's five-blade Fusion razor and Olay's Pro-X moisturizer. But P&G has introduced cheaper "value" versions of Tide and other products to compete with the growing consumer interest in lower-cost national and house brands.

5. Buy The Dollar. Dumping on the dollar was the favorite sport of investors and the financial media until very recently. The financial meltdown in 2008 drove investors to the dollar as the global safe haven, but in early 2009 that status faded as fears of financial collapse melted. Buck-busters cited the record low short-term interest rates, with the fed funds target rate at 0-0.25%, even lower than in Japan. This made the greenback the preferred funding currency for the carry trade in which it is borrowed and then sold for other higher yielding currencies with rising interest rates. The falling dollar against those currencies enhances the profitability of those trades. Buck dumpers also emphasized the tremendous amount of dollars being pumped out by the Fed and the Treasury 70 in their attempt to revitalize the economy 68 and the Fed's clearly-stated commitment to keep short-term interest rates low for an extended period.

Despite all its drawbacks, however, the dollar remains the world's reserve currency and safe haven, regardless of suggestions by the Chinese and others that the dollar should eventually be replaced by a global currency. This status for the buck appears to be reemerging and will grow if we're right and hopes for a rapid economic recovery are dashed. Furthermore, almost everyone was on the dump-the-dollar side of the boat, a situation similar to early in 2008 that preceded the dollar's jump starting in mid-year (Chart 3). History suggests that when that happens, the winds often shift and all those folks will get tossed into the water as the boat sails in the reverse direction.


We favor selling British sterling since the U.K. economy remains in deep trouble, with even higher external debt than in the U.S.-- a ratio to GDP of 404% in 2008 compared to 95% in this country, which has caused bond rating agencies to threaten a downgrade of U.K. government debt. Also, the troubled British financial sector accounts for 21% of total jobs compared with 14% in the U.S. The U.K. was almost alone among advanced countries in suffering a falling economy in the third quarter of last year.

The euro is vulnerable, in our view, because the eurozone has a one-size-fits-all monetary policy but its economies vary in strength from Germany and the Low Countries at the top to Portugal, Italy, Spain, Greece and Ireland at the bottom. Those lands can't use independent monetary policies to stimulate their economies since that's the providence of the European Central Bank. So they need to resort to fiscal stimuli and increasing government borrowing to finance the resulting deficits. A number have suffered sovereign debt rating downgrades, which increase their borrowing costs, and more are likely. This could spark renewed threats that one or more countries will withdraw from the eurozone and go back to using drachmas, draculas or whatever as their currencies. That probably won't happen as the ECB will do all it can to prevent dissolution, but serious discussion of the likelihood could depress the euro considerably against the dollar.

These concerns are not new for us. Just as the euro was being launched 10 years ago, we wrote in our Dec. 1998 Insight that with a common currency, individual countries would be forced to rely on fiscal policy to deal with local business conditions and "the limit on fiscal stimulus will be default risks. Government bond investors and rating agencies will become the policemen and will blow the whistle.... It's even possible that economic differentials among countries may be so great that the common currency doesn't hold together, especially in the next European recession when unemployment leaps...."

Commodity-driven currencies like the Canadian, Australian and New Zealand dollars are also likely to weaken against the greenback as commodity prices fall. The Japanese economy remains weak and back in deflation, but the yen's involvement I the carry trade makes it a tricky currency for investment.

6. Buy Eurodollar Futures. In most markets, traders want to be where the action is, where liquidity is the greatest even though that's where competition is the strongest. Years ago, a jeweler in New York City complained to us about how fierce the competition was in his location. His shop was on 47th Street between Fifth and Sixth Avenues, the heart of the jewelry district. We asked why he didn't move to a less competitive area. He shrugged and said, "This is where the action is." In the case of short-term credit instruments used in futures trading, eurodollars are where the action is.

Our interest is in eurodollar futures contracts. Eurodollar futures are a way for companies and banks to lock in an interest rate today, for money it intends to borrow or lend in the future, and for investors to bet on the future direction of short-term interest rates. Each Eurodollar futures contract has a notional or "face value" of $1 million, though the leverage used in futures allows one contract to be traded with a margin of about $1,000. Trading in Eurodollar futures is extensive, and the market for them tends to be very liquid. The prices of Eurodollars are quite responsive to Fed policy, inflation, and economic indicators. It's ironic that eurodollar futures markets dominate trading, not those for Treasury bills or federal funds on which eurodollars are essentially based.

Eurodollar futures prices are determined by the market's forecast of the 3-month US$ LIBOR interest rate expected to prevail on the settlement date. Eurodollar futures contracts extend out for 40 quarters or 10 years, so they can be used to bet on interest rate movements many quarters ahead.

Long positions in eurodollar futures have been one of our most successful investments in recent years. Earlier, the futures market did not price in the full extent of the Fed-engineered decline in short-term interest rates. With our forecast of the financial crisis and the worst recession since the 1930s, however, we believed that the Fed would ease dramatically. So we reasoned that eurodollar futures prices would rise as they reflected the Fed's action. So far, they have.

Now the futures market assumes that the Fed will raise its target rate in the course of this year, so the LIBOR rate on which eurodollar futures settle will increase by 1.22 percentage points between January and December. We, however, believe that a weak economy will keep the Fed on hold throughout this year, so the interest rate implied by the December 2010 contract will fall by 1.22 percentage points. That would result in a $3,050 profit on a $1 million futures contract. That's a mere 0.3% gain. This is hardly worth the investment without leverage. But with only a $1,000 margin requirement on the futures contract, well, you do the math.


We hope these six investment strategies for 2010 that involve buying or being long securities are useful. But given our forecast that, at best, the U.S. and global economies will be sluggish this year, it won't be a surprise that we have a longer list of strategies that involve selling or avoiding various sectors. In fact, there are 11, or nearly twice as many.

7. Sell U.S. Stocks in General. The S&P 500 index in late December was selling at 19 times top-down Wall Street strategists' operating earnings estimate of $60.59 per share for this year, as noted earlier. That's an historically high P/E to start with that makes stocks vulnerable going into the year. Even more so because it assumes a steep economic recovery in 2010. And even more so if our forecast of continuing recession or sluggish recovery at best proves out. Our $50 estimate of operating earnings, down 11% from estimates for 2009, puts the S&P 500 index P/E at a nosebleed 22.5 level, as noted earlier.

Selling stock indices short, either through futures contracts or ETFs, strikes us as a prudent idea. Index shorts can also hedge long positions in utilities or other long strategies we discussed earlier.

Be well aware that our forecast of a declining U.S. stock market is critical to many other strategies we'll discuss later that involve selling or avoiding equity sectors here and abroad. We believe they all will perform worse than the stock market overall, but if we're wrong and the stock market leaps this year, we'll probably also be wrong on many of these other strategies.

8. Sell Homebuilder and Selected Related Stocks. Homebuilder stocks rebounded sharply from their March 2009 lows, along with stocks in general, but peaked in September with a slight downward trend since then. This may be beginning to reflect our forecast of another 10% decline in house prices (Chart 4). Excess inventories of houses for sale, the mortal enemy of prices, remain huge. And inventories may rise, even with housing starts at very low levels, as people foreclosed out of their houses double up with family and friends.


Also, a quarter of homeowners with mortgages are under water, 40% of those who took out mortgages in 2006. Increasing numbers of these people are convinced that they'll never regain positive home equity and are abandoning their abodes in favor of renting other houses at lower monthly costs. Still, the subsequent foreclosures on their mortgages will keep them from qualifying for a government-guaranteed mortgage for three to five years and will stay on their credit records for seven years.

Despite leaping mortgage delinquencies, federally-mandated but mostly unsuccessful mortgage modification programs are keeping many houses, especially middle- and higher-priced homes, from being foreclosed and sold--temporarily. Furthermore, the investment tax credit for new and some existing home buyers, which was extended beyond November 2009, is scheduled to expire in April. The overhang of aging new single-family homes available for sale is huge (Chart 5 ). Also note that new residential mortgages are almost entirely dependent on guarantees from government entities such as Fannie Mae, Freddie Mac and the FHA, and they are tightening their credit standards.


Low mortgage rates are a plus, but are only meaningful to those who qualify for loans as lending standards tighten. Most now need to meet the old conservative standards of 20% down, good credit, full documentation of income and assets, etc. And lower borrowing rates don't help underwater homeowners either refinance or buy other houses. Furthermore, rates on large "jumbo" mortgages remain high. Finally, lower house prices don't induce buyers who expect the downward trend to continue and hold out for even-lower prices.

9. Sell Selected Big-Ticket Consumer Discretionary Equities--for two powerful reasons. First, as consumers persist in their saving spree they'll continue to curtail spending on expensive postponeable items. Second, as widespread price declines persist, they will be anticipated. Prospective buyers will wait for lower prices. As a result, excess inventories and unused capacity will mount, forcing prices lower. That will confirm prospective buyers' suspicions so they'll wait for still-lower prices in a self-feeding downward spiral.

Deflationary expectations are clearly at work in the vehicle market. The cash-for-clunkers program generated one-time sales as buyers viewed it as just one more rebate inducement in a never-ending stream. But who would dare announce to a friend that he paid the full sticker price for any car? Of course, deflationary expectations don't work for small, inexpensive items. Suppose you know for sure that toothpaste will be cheaper next month. If you run out, you won't brush your teeth with Ajax while waiting for lower prices before buying a tube.

Even the rich, normally immune to recessions, are cutting back and downgrading. Note the weak sales at Tiffanys, Nordstrom and Saks Fifth Avenue and the poor auction results for Sotheby's and Christie's. A Merrill Lynch study found that the number of people in the world with $1 million or more in investable assets fell from 10.1 million in 2007 to 8.6 million in 2008. Those assets dropped from $40.7 trillion to $32.8 trillion. Their equity holdings fell in step with the S&P 500, about 40%, and their real estate also dropped in value.

Ever since the data series began in 1967, the share of income of the top 20% has trended up while all other shares fell. Note that these are shares, not income levels--which have grown on balance for all quintiles. Studies have found considerable rotation in and out of the various quintiles, with many of those in the top bracket in a given year absent from it in earlier and later years. Still, the drop in purchasing power for many middle-income people in the last year in addition to the collapse in their homes' values has created considerable anger at those at the top.

The equities of most producers of big-ticket consumer discretionary goods and services collapsed in the 2007-2009 bear market, reflecting consumers' buying strike, but have recovered somewhat since March. With our conviction that American consumers have reached a watershed and switched from a quarter century borrowing-and-spending binge to a decade or longer saving spree, we are very suspicious of the sustainability of any rebound in stocks of producers of major consumer discretionary products such as cruise lines and airlines.

10. Sell Banks and Other Financial Institutions. During the financial free-for-all days, large banks moved well beyond traditional spread lending--taking deposits and then lending them with interest rate spreads to cover their costs, loan risks and reasonable profits. They hyped their leverage--and their risk--as they set up off-balance sheet vehicles, engaged in proprietary trading and in the origination of and investment in derivatives. Regulators stood by under the theory that free markets would discipline excessive risk-taking. Both the big banks and the regulators, however, knew or should have known that those institutions were too big to fail and could take the financial system down with them. So those financial institutions were really playing a game of, heads we win, tails we get bailed out.

And fail they did, and bailed out they have been. Many investors seem to believe that's the end of the unpleasantness and now it's back to business as usual. The recent big trading profits by some financial institutions certainly point in that direction as did the stock rebounds until recently. We doubt it, though. The financial sector expanded its leverage over about three decades and its deleveraging will probably consume most or all of the next decade. Big risk-taking CEOs like Ken Lewis at Bank of America are being forced out, sending a clear message to the senior officers who remain.

Stringent, probably excessive regulation is replacing the laissez faire model. Higher capital requirements and other limits on risk-taking will curb bank profitability. So will the limits on executive pay aimed at reducing the incentive to take big risks.

Weak Loan Demand

Furthermore, with slow economic growth, consumer zeal to save and repay debts, and weak capital spending this year, loan demand will likely be weak. In addition, the present steep yield curve makes borrowing cheap deposits and lending long-term at higher interest rates very profitable. But it will probably flatten as the year progresses and long rates fall. Banks, of course, can increase fees on checking and other accounts, but are limited by competition from money market funds and other alternatives.

Also, banks' costs of borrowing in the bond market is well off its highs relative to Treasurys, but still elevated compared to pre-crisis years. The spread now runs over three percentage points compared to about one in pre-crisis days. Much of the cheap debt banks acquired from private markets in earlier years and the government more recently will mature in the next several years and need to be replaced at much higher costs. The maturities for U.S. banks have dropped from 7.8 to 3.2 years in the past five years.

Regional and community banks are also likely to be unattractive investments this year. Ironically, in the go-go days, many of them were unwilling to virtually abandon their underwriting standards to compete with nonblank residential mortgage lenders. So they lent to the commercial real estate market instead. That's proving to be a jump from the frying pan into the fire, as discussed earlier, and is shown by weak demand, falling prices and rising delinquencies. Regional banks have more than their share of the $1.7 trillion in outstanding commercial real estate owned by all banks. These loans constitute 35% of regional banks; total loans, up from 25% in 2000.

Due to bad commercial as well as residential real estate loans, smaller banks are dropping like flies, 140 so far this year (Chart 6 ). Individually, they aren't too big to fail, but collectively they are since they are the primary financers of smaller businesses. Those businesses don't have access to commercial paper and other credit market vehicles and must rely on their local banks for loans--or on the personal credit cards of their owners.


11. Sell Consumer Lenders' Stocks. Consumer lenders' stocks have also rebounded sharply from their March 2009 lows. We were wrong on our strategy of selling them last year, but believe it will work in 2010.

Consumer lenders had their hey day during the long consumer borrowing-and-spending spree. Consumers were trained--and we use that word deliberately--to believe they deserved instant material gratification. Buy now, put it on the plastic card and pay later-- much later--became the norm. And creditworthiness was no problem for credit card issuers and other consumer lenders. They sliced and diced consumers' financial statuses, used sophisticated models to determine payment risks and charged fees and interest rates to fit any risk category.

But their models and analyses inherently assumed that the borrowing-and-spending binge, as well as the ability to repay, would last indefinitely. But then consumers suddenly switched to a saving spree and started to pay down credit card and other debts. Also, heavy layoffs, leaping unemployment and collapsing house prices and inadequate consumer incomes spiked credit card delinquencies. Congress last year restricted credit card fees and interest charges. Also, consumers went on a buyers strike a year ago and cut back on their use of credit, debit and charge cards.

Recent developments are virtually all negative for the credit card business now and for years to come. The cottage industry to help these people deal with their huge credit card debts is exploding in size. As noted earlier, charge cards and debit cards are replacing credit cards as consumers realize they can't trust themselves to restrain debt and need to pay off monthly or accumulate the money in a bank account before spending it. Layaway plans are replacing the buy now-pay later approach. With the switch from a quarter century consumer borrowing-and-spending binge to a long run saving spree, the credit card business has moved from a growth industry to a laggard.

12. Sell Many Low and Old Tech Capital Equipment Producers. Low and old tech producers will remain depressed in a world of chronic excess capacity. When operating rates are low, producers don't need more capacity and worry that revenues, prices and profits won't be adequate to justify even existing capacity. And note that the volatility of the producers of equipment is much greater than that of the users. Auto sales declined by over 47% from their peak in July 2005, but orders for machine tools, automatic transfer lines and other equipment fell much more as auto assemblers and parts makers almost froze orders. Recall as well how the recession-sired excess capacity in airlines has caused massive cancellations and postponements of orders for Boeing's Dreamliner.

Earlier, we discussed our statistical models that explained capital spending. They show that in accounting for the year-over-year change in the equipment and software or in equipment and software plus nonresidential structures components of GDP, thelevel of operating rates is far and away the most important explanatory variable, even more so for the year-over-year change in operating rates. This indicates that even if capacity utilization is growing rapidly, if it remains at low levels as at present, the growth in capital spending will be subdued.

Other variables, such as the year-over-year changes in cash flow, profits and interest costs, were statistically significant in our models, but much less effective in explaining the change in capital spending. These findings are important because many believe that the negative gap between capital expenditures and internal funds is sure to generate a capital spending surge. But our models, based on history, say that with huge excess capacity, that cash flow won't burn holes in corporate pockets. And our models don't quantify and add in the extra corporate caution spawned by today's recessionary climate and financial crises.

Besides the depressing effects of excess capacity, low and old tech companies suffer from ongoing problems. Foreign competition continues to grow as their technology is transferred to China and other cheap production locales. Some suffer rising cost pressures due to lack of productivity gains. High-cost unionized labor forces are sometimes a problem. And many sell into saturated, slow growth markets.

13. If You Plan to Sell Your House, Second Home or Investment Houses Any Time Soon, Do So Yesterday. This strategy has worked for the last two years and will continue to do so if we're correct and house prices nationwide fall another 10%. Sure, prices have been weakest in states like Florida, Arizona, Nevada and California where the biggest bubbles preceded the collapses. But almost every area of the country has experienced price declines (Chart 7 ).


Many owners have tried to wait out the bear market in housing, a technique that worked in earlier years when any price declines were small and short-lived. But huge excess inventories, a flood of distressed sales after mortgage modification attempts are over, depressed incomes and rising unemployment will probably keep sellers plentiful, buyers reluctant and prices falling throughout 2010 and perhaps beyond. In past regional house price collapses, it's taken homeowners a year-and-a-half to give up and throw their houses on the market for whatever they will bring. After the final bottom is reached, house prices will likely mirror inflation, or in future years, deflation as they have historically.

14. Sell Junk Bonds. During the dark days of the financial crisis, the yields on junk bonds leaped to 19.3 percentage points over Treasurys as investors worried about complete financial collapse and widespread defaults among low-grade issues. Triple-C rated bonds, the lowest junk tier, sold at 42.6 cents on the dollar at the beginning of last year.

But the bailout of the big banks and easing of the financial crisis allayed investor fears and junk spreads narrowed. Institutional investors piled in, followed by individual investors, many of whom sought alternatives to low returns on bank deposits and money market funds. So the spread has dropped to 4.6 percentage points, much closer to where it was before the crisis began. Last year, junk bonds returned over 50%, much more than the 25% gain on the S&P 500 index.

Nevertheless, we believe this rally is way overdone. Default rates on junk bonds normally peak late in recessions or in the year after it ends. Also, the default rate may reach or exceed the previous peak in 2002 if the economy remains weak, suggesting major declines in junk bond prices. Furthermore, the value of bonds after default is likely to go lower if the recession drags on, as we forecast. Slow revenue and cash flow growth will make it difficult if not impossible for a number of financially weak and weakening firms to service their bonds and other debts.

15. Sell Commercial Real Estate. As discussed earlier, excess capacity and big refinancing requirements in coming years will continue to plague hotels, malls, warehouses and office buildings. Moody's/REAL Commercial Property Price Index was down 44% last October from its October 2007 peak. Retailers closed 8,300 stores last year, more than the previous peak of 6,900 in 2001. Businesses will continue to cut costs this year, not only by holding down employment and therefore the need for office space, but also by moving in the partitions to fit the remaining people in less space, as mentioned earlier.

Increasing use of telecommuting will also reduce need for office buildings. And more teleconferencing will cut hotel-utilizing business trips, especially after intensified airport security in reaction to the recent terrorist incident in Detroit on Christmas Day. At the same time, frugal consumers will restrain discretionary travel and the hotel and motel use involved. Weak consumer spending will keep mall and warehouse space under pressure.

Some believe that commercial real estate woes may exceed the residential collapse, and they may be right. Commercial tends to be less leveraged but if refinancing isn't available, it may note make much difference how leveraged it is. Also, distressed commercial real estate owners definitely don't have the political sympathy and bailout prospects enjoyed by troubled homeowners. The Fed has set high standards for bailout loans on commercial real estate. Commercial real estate REITs rebounded last year along with the overall stock market (Chart 8 ), but strike us as vulnerable. These leaps combined with plummeting real estate prices have pushed REIT prices to a 25% premium over their net asset values.


16. Sell Most Commodities. Commodity prices rebounded last year and benefited from cheap and available money. Some live in their own worlds. Petroleum is not only influenced by fundamental supply-demand conditions, but also by OPEC decisions. Natural gas prices in the U.S. weakened last year with the recession, but also because of new production technology that unlocked abundant shale gas. The prices of agriculture commodities, including honey, are highly dependent on weather.

In any event, we believe that economic supply and demand will rule most industrial commodity prices this year and result in weakness due to sluggish global business conditions. Also, investors put a record $50 billion into commodities in 2008 but then retreated last year after prices nosedived. They learned the hard way that commodities aren't an asset class but speculations, and may be cautious this year. And the strengthening dollar should depress the prices of the many commodities traded worldwide in dollar terms. We look for falling commodity prices this year. Also, we believe that many commodity-producing companies and their suppliers of equipment and supplies will be unattractive investments as weak demand, excess capacity and soft prices persist. The same is true for economies such as Persian Gulf sheikdoms that depend heavily on petroleum, as witnessed by the financial collapse of Dubai.

17. Sell Developing Country Stocks and Bonds. As late as the end of 2007, most forecasters believed in decoupling. Even if the U.S. economy suffers a setback, they said, the rest of the world, especially developing countries like China and India, would continue to flourish. Indeed, the strength of those economies could even aid the U.S. as they bought more American exports.

We disagreed. We did a study two years ago that found that China was not yet developed sufficiently to have enough people with discretionary spending to support the economy domestically. She remained export-led, with most of those exports going directly or indirectly to U.S. consumers. So, with our forecast of a major retrenchment by U.S. consumers, we predicted big trouble for China. Our analysis revealed that in China, it takes about $5,000 per capita to have meaningful discretionary spending power. About 110 million Chinese had that much or more, but they constituted only 8% of the population. In India, that class was a mere 5% of the population. In contrast, it takes $26,000 per capita in the U.S. to have discretionary spending power and 80% of Americans have at least that much.

Well, as they say, the rest is history. The Chinese and most other developing Asian countries nosedived as U.S. consumers retrenched. But in the wake of China's huge $585 billion stimulus program last year, massive imports of industrial materials like iron ore and copper, jumps in construction of cement, steel and power plants and other industrial capacity, and a pick up in economic growth, many forecasters again believe in decoupling.

We continue to disagree. Sure, some countries such as Brazil were not hurt too severely by the global recession, at least so far. Still, most developing economies depend on exports for growth, and the U.S. consumer has been the biggest buyer of those exports and far and away the globe's biggest spenders. As the American consumer saving spree continues to shrink the U.S. trade and current account deficits (Chart 9), those developing economies will be subdued.


China's economy looks like a house of cards. Her most recent fiscal stimulus not only went into industrial capacity-building but also bank lending-spawned stock market and real estate speculation. But what will utilize that capacity and justify those speculations? The usual outlet, exports, is curtailed by retrenching U.S. consumers. And, as noted, China is not far enough down the road to industrialization for local consumers to fill the gap.

We doubt that the rebounds in emerging market stocks and bonds correctly forecast robust, decoupled economic growth that is sustainable. While the S&P 500 now trades at 20 times earnings over the last 12 months, normally cheaper emerging markets are more expensive. Recently, the Shanghai Composite Index sported a 32 P/E while South Korea's was at 35 and Indonesia's was at 29. And note that the 65% jump in emerging market stocks in 2009 only offset two-thirds of the 54% drop in 2008.

Furthermore, as was made clear by the universal weakness in security markets in 2008, bond and stock markets around the world are highly correlated. With globalization, the days are gone when a globe-trotting sleuth can discover gems in the remote reaches of Asia or Latin America. The similarity of bond and stock performance is even greater when adjusted for risk. Emerging market stocks and bonds may climb more in bull markets, but have greater falls when the bear arrives, as we believe he is about to. There's no such thing as free lunch.