December 2009 Market Update – International Markets

International markets have been soaring recently, so why are we not investing in international investments? Here is the reason:

“Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling huge bubbles that may spark another financial crisis” said Nouriel Roubini via satellite to a conference in Cape Town, South Africa. Roubini is a New York University Professor who accurately predicted the banking crisis.

Fed Chairman Ben Bernanke has been keeping interest rates low so individuals and businesses can borrow cheaply just to keep going. Institutions with huge size and active involvement in the currency markets are using the opportunity to borrow money cheaply to buy up inexpensive stocks, bonds, real estate and commodities in emerging markets. This is called carry trading; carrying money from one country where rates are low to another to invest in higher yielding assets.

The result has been an enormous run up in the prices of these assets.The price for real estate in Singapore for instance, went up 16% in the third quarter alone.Once the Fed starts to increase rates as it withdraws stimulus money there will be a “rush for the exits”. “We have the mother of all carry trades. Everybody is playing the same game and the game is becoming dangerous” says Roubini. The bust may not occur for a year of two but the current prices are not sustainable. Sound familiar?

The President of the World Bank Group, Robert Zoelick says, “for a hint of the future look to Asia where a new risk is emerging; asset bubbles. Asset bubbles could be the next fragility as the world recovers, threatening again to destroy livelihoods and trap millions more in poverty.”

Needless to say, the international markets are not the place for the small investor at this time.Because of the inherent instability of the prices of these assets, an investor would be at enormous risk.


The domestic stock market is up more than 50% from its low in March of 2009. What does it know that you and I do not? Nothing!T his year’s amazing market rally has boiled down to a few sources.

1. Hedge funds (the investment vehicle of the super rich and those that want to be, by taking enormous risks with borrowed money) have been able to reestablish their borrowing lines (margin) that they in turn leveraged this year to make up for last year’s disaster.

2. Massive short covering. A short sale is when an investor expects a stock to decline in price so he sells the stock (that is usually borrowed and not owned by the investor) at the current higher price and later will buy the stock back (cover the short) at the cheaper price and pockets the difference. This type of stock buying is a great deal different than buying a stock because you like the company’s prospects for growth. There are still 13.2 billion short positions on the New York Stock Exchange to be covered.

In addition, trading volume has been very light.

These are not sustainable sources of buying power based on fundamentals such as; banks freely loaning money to businesses, new hiring, and pent-up demand on the part of consumers. Ultimately, the individual investor has to participate which is what provided the impetus for the 1980s bull market.

So what is the individual investor doing? In October, the private investor pulled $7.1 billion out of stock investments and invested a net $45 billion into bond investments. Unfortunately, the typical investor is ill-advised in that open ended bond investments do not guarantee any return of principal because the bonds do not mature in the investment, but the illusion of safety is definitely the attraction.


Derivatives are traded on the OTC (over-the-counter) market and consist of privately negotiated contracts that enable investors to bet against swings in the value of bonds, interest rate, currencies, commodities, stock and even carbon credits. Unlike exchanges, the OTC market is unregulated and prices are not public.

Based on company reports collected by the Federal Reserve, the five biggest derivative dealers in the U. S. – JP Morgan, Goldman Sachs, Bank of America, Morgan Stanley and Citigroup Inc. — made $35 billion trading both derivates and cash instruments in the first six months of 2009. About half of their trading revenue from 2006 to 2008 came from derivatives, according to Alexander Yavorsky, a senior analyst at Moody’s. In other words, nothing has changed since derivatives caused the melt down of 2008.


As you know, my requirement for returning to the equity markets is the elimination or substantial regulation of derivative trading. As you have read above, what is going on in both the international and domestic regulated markets is mainly high stakes gambling for the benefit of a few. What goes on in the unregulated markets is even more speculative and dangerous to all of us because of the volatility it provokes in all of the markets.

However the fight for regulation has finally begun. The House Financial Services Committee, chaired by Barney Frank, passed a weak draft bill last month exempting the largest players from having to comply.

Maryland law professor and ex-federal regulator Michael Greenberger says, “I don’t think he ever fully understood the legislation” in its early stages. Many of the key lobbyists now are the same gang that helped to get us into this mess before, and they’re spending huge sums once again. In the first three quarters of 2009, financial-industry interest have spent $344 million on lobbying efforts, putting them on pace to break all records, according to the Center for Responsive Politics.

A Congressional staffer involved in drafting the legislation spoke to Newsweek (12/4/2009) and said, “This is an orchestrated, well-funded effort by the banks to manipulate our legislation and leave no fingerprints.”

Frank concedes that “Financial reform is the hardest thing I’ve ever done in my 35 years in the house. It’s taken over my life,” he says.

This is going to be a long fight.I will keep you posted as to any progress being made and you will be the first to know when it is safe to go back into the water.

An encouraging sign is that according to the November 30th, 2009 edition of the Wall Street Journal, China has created “a New Body to clear derivative trades”. Remember 75% of derivatives are traded overseas.


The economic reality of the country is very different than one would expect by watching the baseless activity of the stock market.

Consider these points:

  1. FDIC in the Red – According to the FDIC, the total U. S. bank lending in the third quarter contracted by a record 3% and now we are up to 552 troubled banks.In the third quarter alone, 50 banks failed bringing the 2009 total to 130; the most in 17 years. The FDIC fund balance is now in the negative by 8.2 billion.
  2. Nearly half of all U. S. mortgages seen underwater by 2011 – Deutsche Bank released a report in August 2009 saying that an estimated 25 million homeowners or 48% of those with mortgages will owe more on the loan than the house is worth by the first quarter of 2011.
  3. Commercial Real Estate Crisis – Randall Zisler, CEO of Zisler Real Estate, estimates that building owners will default on $500 billion to $750 billion, or 54% of the commercial real estate debt that will come due in the next four years.

What does this mean for all of us? It means that our banking system is broken. Banks have loaned out so much money that will not be repaid that they have to post enormous amounts of reserves to cover those losses or close down. They certainly will not be willing to make new loans which are what the economy needs to recover. The other option is the government posting the reserves for them with tax payer money such as the TARP plan. As we have seen, that may keep the banks solvent but they still do not necessarily make new loans.

Is the recession over? The pundits are forecasting a recovery based on patterns of prior recessions; here is the BIG difference: past recessions did not follow a period of inordinate overspending by the consumer to the tune of 120% of income. Pent-up demand pulled the economy out of past recessions. There is no pent-up demand this time around because the consumer is still paying off the last spending binge and now has also lost his job. Also, how can you declare a recovery when the economy is still mainly running on stimulus money?

Was the Stimulus Package a good idea? Unfortunately because the financial crisis wiped out trillions of dollars of wealth, the Fed and all central banks worldwide have had to print new money in the form of stimulus packages to keep the financial systems running. The problem with printing money is that too much money can be put in circulation versus the amount of product being bought. This is the definition of inflation; too much money chasing too few goods.The result is the purchasing power of each dollar then decreases. The value of $1.00 shrank to $.25 during the 1970s.

So the central banks are anxious to end their stimulus programs to avoid future inflation. The U. S. inflation rate in 2008 was 3.8%. The danger however is that they may remove the stimulus before the economies can stand on their own. Because of unemployment and banks not lending, there may not be enough money in circulation without the stimulus to support prices. This is deflation. The 1930s depression was a deflationary cycle.

THE WORLD IS POISED AT A TIPPING POINT; one way is inflation, the other deflation. Neither is a desirable option. Wish the Fed and all the other central banks luck in leading us down a very narrow path between the two.


I realize none of the above is exactly cheerful. We are still in early days after suffering the financial equivalent of a stroke, heart attack and cancer in one year. We will survive this. The only question is what the financial playing field will look like once the game is back in play. For now we are on the sideline in Treasuries and high quality corporate bonds with a maturity date and earning a reasonable rate of return. With every month that goes by the jigsaw puzzle that is the future, gains another piece. For the time being we do not want to be swimming with the sharks.

Remember what Darwin illustrated in the Origin of Species was that survival belongs not to the smartest or the strongest but to the most adaptable.

Have a wonderful holiday and call if you have any questions at all or just to say hello.