Author Bio

The upturn in global economic activity that began more than two years ago faces a stern test of its resilience – in view of the ongoing trauma in the euro-zone – and, could well be short-circuited should the elevated stress in credit markets refuse to subside in the near future.  The financial markets have already priced in a mild European recession over the next two quarters, which the global economy should be able to withstand without too much dislocation but, such optimism could well be misplaced.

Indeed, it is not difficult to construct a scenario in which a probable downturn in euro-zone activity is more severe and, of longer duration than most commentators currently believe.  Should such an outcome unfold, strong global interdependence amongst economies virtually ensures that the negative impact on economic activity across the globe would be far more pronounced than the consensus currently anticipates.

The current cheery consensus among market practitioners is difficult to fathom given recent developments in the euro-zone and, more than likely, reflects the all-too-human tendency to overweigh the positive potential outcomes and, to place too little emphasis on uncomfortable negative scenarios.  The fact of the matter however, is that the probability of a severe recession can no longer be considered non-trivial for a number of reasons and, as a result, asset allocations should be adjusted appropriately to reflect expected outcomes rather than wishful thinking.

Euro-zone business surveys have already slipped to levels that are consistent with a contraction in economic activity but, the optimists are confident that Europe’s leadership will do whatever is necessary to contain the decline.  Such optimism appears to be based on hope rather than reality however, as both Brussels and Frankfurt appear to believe that the only road to lower market interest rates and a return to healthy economic growth is fiscal austerity – a policy prescription that is almost certain to lead to heightened rather than reduced market stress.

Fiscal austerity across the euro-zone is unlikely to appease the financial markets for one simply reason – domestic private demand is not sufficiently strong to absorb the deflationary impact.  Indeed, the elevated stress in the credit markets has already taken a heavy toll on business confidence while, surveys of lending conditions show that the banking system has become less willing to supply credit and, standards are virtually certain to tighten further, once the recapitalisation of ailing balance sheets – as prescribed by policymakers – gets underway.

A deep recession is virtually certain given current policy prescriptions and, as a result, financial market stress is unlikely to ease.  The contraction in economic output will cause tax revenues to fall short of plan and, government expenditures to exceed original estimates due to the rise in unemployment benefits.  The wider-than-expected budget deficits mean that public debt-to-GDP ratios across the euro-zone are likely to edge higher and, ensure that yields on sovereign debt remain uncomfortably high.

The optimists argue that such a scenario is unlikely to unfold, which seems to be predicated on the belief that the ECB will reduce policy rates aggressively and, ultimately purchase sovereign debt in sufficient size to ease the strain on governments.  Once again, such premises are built on hope rather than hard fact.

First, market funding costs have already disconnected from policy rates, while lending standards are beginning to show a similar dynamic.  As such, it is reasonable to argue that the stimulus to economic activity, arising from a reduction in interest rates from their current low levels, is likely to be negligible.

Second, the ECB is extremely reluctant to expand its balance sheet and purchase large quantities of stressed sovereign debt given the credit risk that it would assume.  Any sovereign that issues debt in a currency that it does not control, is simply not free of default risk.  Indeed, the Greek case clearly demonstrates to private investors that holding distressed euro-zone sovereign debt is not that far removed from owning high-yield bonds.

The truth of the matter is that the ECB is unlikely to purchase troubled sovereign debt without an ironclad guarantee that it will be compensated in the event of losses.  Such a guarantee would not appear to be on the table in Berlin and, is unlikely to be, in the absence of further fiscal integration.  This process will take time and as a result, aggressive ECB action could happen later rather than sooner.

The odds of a severe euro-zone recession are growing by the day and, it would be foolish to believe that the rest of the world would emerge unscathed given the increase in financial interconnections and trade linkages.  Indeed, one important lesson to glean from the ‘Great Recession’ is that greater global integration ensures that an economic crisis in one region is quickly transmitted to another.

Global decoupling is nothing but an old wives’ tale and, investors should note that the escalating euro crisis puts the entire world economy at risk.

Originally posted on www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Gyrations in the world’s financial markets have been dominated of late, by negative developments in the euro-zone.  The rolling crisis has assumed a more urgent dimension in recent weeks as, heavy selling of Italian government debt pushed yields beyond the seven per cent threshold that ultimately proved to be the point of no return for the Greek, Irish and Portuguese sovereigns.

The current turmoil has been blamed variously on the political travails of outgoing Prime Minister, Silvio Berlusconi, the large outstanding stock of government debt versus annual economic output and, the economy’s low prospective growth rate.  All of these factors have been known for a considerable length of time however, and, if truth be told, the current malaise was precipitated by the steps taken by Europe’s leadership in Brussels towards the end of last month, which were designed to ease the growing stress.

The measures backfired spectacularly however, as the facts of economic life in a poorly-constructed monetary union became clear for all to see.  The truth of the matter is that debt issued by a government in a currency that it does not control should never be considered free of default risk and, in this regard, euro-zone members are not that far removed from emerging countries that are forced to issue bonds in a foreign currency.

This harsh reality has finally dawned on the bond community and, as the pre-crisis assumption is discarded completely and, credit risk continues to be discounted in government debt prices across the euro-zone, it becomes ever clearer that the only solution to the immediate crisis rests with the European Central Bank (ECB).

In order to prevent the region-wide liquidity crisis from degenerating into a solvency problem, the central bank must make a credible commitment to employ its balance sheet and purchase the debt of troubled sovereigns in whatever size proves necessary.

Until recently, the threat of a solvency issue emerging in Italy was considered small, as the economy does not suffer from the major imbalances that were so evident in the periphery and, possesses important strengths that should have kept the wolves from its door.  These included a small primary fiscal surplus, a relatively long average life on outstanding government debt, relatively conservative non-financial private sector balance sheets and, a relatively low level of external debt.

These strengths counted for nothing however, once Europe’s leadership announced that the rules of the game had changed, which not surprisingly, precipitated a wave of selling across the region’s sovereign debt markets.

First, the large size of the haircut – fifty per cent – pertaining to the private sector holdings of Greek government debt, which is considered by most analysts to be nowhere near sufficient to yield a sustainable public debt position, revealed to investors that credit risk is very real indeed, with eventual losses expected by some to be in the region of ninety per cent.

Second, the decision to exempt official financing from the write-downs sparked the realisation that all credit losses in the event of future write-downs on troubled sovereign debt, would in all likelihood fall in their entirety on the remaining private sector investors – in other words, larger losses for fewer investors.

Finally, the large write-down of Greek debt was designed so as not to trigger credit default swap (CDS) contracts and, as a result, investors cannot expect such insurance to pay-off should further sovereign defaults occur in the future.

The yields on Italian sovereign debt have dropped below seven per cent for now, as a result of ECB purchases but, the lukewarm nature of the buying means that investors cannot be sure how long it will be before the threshold is tested again.  Indeed, media reports suggest that heavy bank selling is in the pipeline and, should yields surge higher in response to the liquidation, the less attractive Italian debt will become, as the probability of default grows.

It is not difficult to envisage a scenario in which insolvency becomes self-fulfilling.  Higher interest rates and the related market stress could plunge the economy into a sharp recession with an attendant increase in the budget deficit and the government’s financing requirement, which could precipitate a further increase in yields and so on.  To prevent such a death spiral from developing, it is absolutely essential that the ECB commits its balance sheet.

However, the monetary authority continues to object to such action on a number of fronts.  First, it is argued that an expansion of the central bank’s balance sheet would lead to inflation.  However, an increase in the monetary base – currency and bank deposits held at the central bank – does not automatically translate to a concomitant increase in the money supply.

Indeed, the traditional money multiplier breaks down at times of crisis due to an increase in liquidity preference.  Furthermore, the level of deposits held by banks at the central bank has little bearing on the credit decision, which is determined by capital adequacy and the availability of profitable lending opportunities.

In this regard, European banks already have a capital shortfall of €106 billion according to official estimates and, a credible commitment to purchase government debt may not only ease the stress on troubled sovereigns but, may also forestall a credit crunch.

Second, the aggressive purchase of Italian government debt would see the ECB assume the risk of default on its own balance sheet and, should a restructuring occur, its capital base could well be wiped out.  However, inaction could have even more dire consequences, as an Italian default would almost certainly unleash the mother of all banking crises and a deep recession that could tear the monetary union apart.

The euro-zone crisis has reached a dangerous phase, as Italy stands on the brink.  The ECB must act forcefully and act now.  The clock is ticking.

Previously posted on www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The foliage is officially adorning the trees here in New England, signaling fall is well underway and the fourth quarter is in full swing. Investors are trying to ride the economic wave before closing their books in a matter of weeks. Here are some headlines we’re reading in preparation for the year-end rally.

Occupy Wall Street continues to remain in the spotlight as movements spread across the globe. For the demonstrations to spur change, organizers say participants’ voices must echo worldwide, and they need to secure support from fellow citizens—even those not taking to the streets. After Occupy marked its first-month anniversary Oct. 17, activists say nearly 55 percent of Americans support the movement. Also seeking support on a grand stage is Europe. The region’s financial leaders are busy preparing for their financial summit this week, and one of the top agenda items is discussing revamped strategies to save Greece from its debt. Before Europe sits at the round table, top U.S. financial experts are acknowledging lessons they’ve learned from this crisis. Speaking in Boston Oct. 18, Federal Reserve Chairman Ben Bernanke said the Fed may revise approaches about monetary policy in the future, including making communication and guidance more transparent. While the global economic crisis has inked a multitude of negative headlines, there are ways to offset market volatility by investing in alternative funds. As many investors know, alternative investments help diversify portfolios, mitigate risk and elevate returns. Stronger-than-expected U.S. retail numbers last week offered a glimmer of optimism that investing can end on a high note for 2011, easing thoughts of the U.S. heading into another recession. Investors are certainly keeping their eye on the prize, hoping to balance their portfolios in the black by year’s end.

• An Occupy Wall Street Founder Talks About The Origins Of The Movement And Where It’s Headed Next, Business Insider, Oct. 23, 2011
• EU Revamping Plans to Contain Debt Crisis, Bloomberg, Oct. 23, 2011
• Is Safe Investing Possible? How to Manage Market Volatility, DailyFinance, Oct. 20, 2011
• How should you position your portfolio for a year-end rally?, Forbes, Oct. 20, 2011
• Alternative investments aren’t for everyone, MarketWatch, Oct. 19, 2011
• Bernanke Sees Evolution, Not Revolution, In Policy After Crisis , Wall Street Journal, Oct. 18, 2011
• The investment clouds are lifting, Forex Crunch, Oct. 17, 2011

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

We were saddened to learn last week of the passing of Steve Jobs, Apple’s co-founder. His revolutionary vision and breakthrough products have tremendously impacted the technology industry. We wish the Jobs family and Apple all the best as we’ve lost a man who’s being hailed as this generation’s Albert Einstein. Here are some other headlines from the past week:

On a bright note, the U.S. economy added 103,000 jobs in September after a sluggish summer. With the unemployment rate remaining at 9.1 percent, the economy isn’t showing immediate worries of a new recession, according to the Oct. 7 Non-Farm Payroll. The Oct. 5 ADP Non-Farm Payroll, which isn’t tandem with the Non-Farm Payroll, showed a gain of 91,000 jobs in the private sector. That gain was higher than the 76,000 jobs experts forecast. Regardless, financial experts are still touting that today’s “recession” has topped The Great Depression of 1929 because of impacts from national debt, home prices and falling Gross Domestic Product. As many Americans worry about finances, some residents in the San Francisco Bay Area have innovated a solution: they’ve created their own community currency, aimed at keeping money squarely in their own municipality. The initiative began this past June as a way to promote awareness of supporting local merchants and small businesses. Across the country, the Occupy Wall Street movement has been expanding as activists continue to voice concerns about the economy. Amid the world economic crisis, it’s no surprise that alternative investment funds have edged out more traditional investment opportunities such as the stock market. Financial experts say alternative funds have demonstrated “their potential effectiveness in helping to build more robust, diversified portfolios.” We think so too.

• World intrigued by “Occupy Wall Street” movement, Reuters, Oct. 11, 2011
• U.S. small business confidence inches up. Financial Times, Oct. 11, 2011
• The legacy of Steve Jobs, Washington Post, Oct. 7, 2011
• Economy Adds 103K Jobs, Rate Stays 9.1 Percent, Associated Press, Oct. 7, 2011
• Community Currencies Aim to Aid Merchants, Wall Street Journal, Oct. 6, 2011
• Easing the Sting of Falling Stock Prices, Wall Street Journal, Oct. 5, 2011
• ADP Non-Farm Payrolls Rise – Appetite for Risk Follows, Forex Crunch, Oct. 5, 2011
• Why Today’s ‘Recession’ Tops The Great Depression, Forbes, Oct. 3, 2011

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The downward pressure on world stock markets, that began some months ago, continues to grow in intensity, as rising recession risks across the Western world can no longer be ignored.  The source of the turmoil has moved back-and-forth across the Atlantic Ocean in recent months, as a lame economic recovery in the US has collided with a debt crisis in the eurozone.  Indeed, the focal point for the latest bout of turbulence centers on Greece and its government’s inability to meet the ambitious targets as prescribed under the EU/IMF adjustment program.

Unfortunately, the focus on Athens has seen most commentators, investors and, even policymakers view the eurozone’s problems through the narrow prism of sovereign debt.  Viewed in this light, profligate government spending precipitated the build-up of sovereign debt to unsustainable levels and, as a consequence, many analysts seem to believe that successful fiscal consolidation in the troubled nations of Greece, Ireland and Portugal, will bring the crisis to an end.

Such a belief however, is extraordinarily naïve as the crisis should be seen, not as a sovereign debt crisis, but more appropriately as a balance of payments and external debt crisis.  The availability of low-priced credit from banks in the eurozone’s core following the launch of the single currency more than a decade ago, allowed the periphery to run large and persistent external deficits that sparked a disturbing increase in the level of foreign debt, both public and private.

The dependence on foreign debt made each of the peripheral nations vulnerable to a sudden reversal in capital flows.  A reassessment of risk premiums, as the ‘Great Recession’ took hold, led to a stunning increase in interest rates and one-by-one, the governments of the peripheral nations had no option, but to seek assistance.

However, while fiscal consolidation as prescribed by the EU/IMF adjustment programs may well be desirable and necessary, the reversal of primary budget deficits alone will not be sufficient to bring the crisis to an end.  The large current account deficits still present in Greece and Portugal in particular, must be eliminated if foreign debt loads are to stabilize but, in the absence of currency devaluation, that task looks nigh on impossible.

Foreign lenders in their search for yield in a low-return world, lent freely to the peripheral countries in the years leading up to the crisis.  Current account deficits were allowed to grow to alarming levels with little, if any, consideration for the true nature of the risks involved.

The Greek external deficit relative to GDP expanded by more than eight percentage points to almost fifteen per cent from 2003 to 2008; the Portuguese deficit widened by more than six percentage points to 12.6 per cent over the same period, while the Irish external position went from near-balance to a deficit of 5.6 per cent over the five-year period.

External imbalances were to be expected following the launch of the single currency, as relatively poorer countries played catch-up with their wealthier brethren.  However, borrowed funds were used primarily to finance current consumption, rather than productive capital investment designed to boost export potential, such that a significant proportion of the foreign lending may never be repaid.

The focus on sovereign debt is understandable in the case of Greece, since it was its unsustainable public debt position that sparked the confidence crisis.  Nevertheless, the country’s non-financial private sector debt ratios still managed to jump from 52 to almost 90 per cent of GDP between 2002 and 2009, as underleveraged Greek households and businesses caught the borrowing bug.

The Portuguese private sector partied that bit harder and the comparable debt ratio surged by more than 50 percentage points to 178 per cent over the same period, while the non-financial private sector in Ireland outdid everyone with the ratio increasing by more than 100 percentage points to almost 200 per cent.

An external financing crisis duly erupted in each country, as the borrowing capacity of both private and public sectors reached exhaustion with net external debt approaching 100 per cent of GDP.  Focus on such disturbing external imbalances was bound to happen sooner or later, irrespective of what happened elsewhere, though the meltdown in America’s mortgage market brought matters to a head sooner than might otherwise have been the case.

The fall-out was severe though hope springs eternal, as the Irish situation has since stabilised. A large trade surplus has allowed the current account to move into positive territory and, not surprisingly, yields on Irish debt have decoupled from their troubled brethren.  Be that as it may, a successful conclusion to the Irish problem hinges on events elsewhere.

Unfortunately, the news from both Greece and Portugal remains grim.  Chronic trade deficits persist in both countries, while foreign debt and interest payments abroad continue to grow.  A large double-digit percentage point reversal in the trade account as a share of GDP is required to stabilise the level of foreign debt in both cases.  Such a development is highly unlikely given the low value-added and uncompetitive nature of the respective export sectors, not to mention the slowdown in external growth.

Absent a herculean reversal in the export sector’s fortunes, the necessary external adjustment could only take place through a depression-like collapse in domestic demand, which would throw fiscal consolidation off course and result in no fall in aggregate debt levels.

Both Greece and Portugal are stuck in a debt-deflation trap and the harsh reality cannot be disguised – both countries are insolvent.  Eventual euro-exit should not be dismissed lightly.

Originally posted on www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

It has been nothing short of a wild ride in the world’s capital markets of late, as fears that a double-dip recession is on the way, have shaken investors’ naturally bullish predisposition.  The optimists discount such concerns and, argue that the slowdown in economic momentum is nothing more than a typical mid-cycle pause.

However, whether the developed world double-dips or not misses the point completely; the fact of the matter is that economic growth is not sufficiently strong to accommodate the necessary deleveraging of overstretched private and public sector balance sheets, whilst simultaneously allowing for a reduction in the large and persistent economic slack.

Indeed, most developed economies have yet to surpass the pre-recession peak in economic activity, while private and public sector debt relative to GDP, are either close to or at an all-time high.  With years of sluggish growth in the offing, it’s hardly surprising that the world’s stock markets exhibit little, if any, upward progress and suffer periodic bouts of painful indigestion.  In such a volatile climate, the buy-and-hold mantra that held sway a decade ago is dead.

It all seemed so different to policymakers in the not too distant past, but their hubris in the lead-up to the global financial crisis three years ago, is unmistakable.  Indeed, back in the year 2000, Gordon Brown, the then U.K. chancellor, confidently declared that there would be no return to boom and bust, as if the Scotsman had somehow singlehandedly eradicated the all-too human characteristics of greed and fear.

Alan Greenspan, the former chairman of the U.S. Federal Reserve, marvelled at the perceived stability later in the decade and, argued that financial innovation has, “contributed to the development of a more flexible and efficient financial system.”  The so-called maestro was oblivious to the fact that the new financial products, which sliced and diced low-quality debt to the nth degree, represented a house of cards that was simply waiting to be blown over.

Even our own Bertie Ahern, the then Taoiseach, got in on the act in 2007 and, poured scorn on those who talked down the economy.  He proclaimed that, “Sitting on the sidelines, cribbing and moaning is a lost opportunity.  I don’t know how people who engage in that don’t commit suicide.”  Mr. Ahern, like so many others, couldn’t see that the rapid build-up of household debt to fund either conspicuous current consumption or investment in unproductive assets such as housing, has never been – and never will be – the road to long-term prosperity.

The accumulation of household debt in the years preceding the crisis was simply staggering.  Household leverage in the U.S., as measured by the ratio of debt to personal disposable income, vaulted by more than 40 percentage points to circa 130 per cent from 1997 to 2007.  In the U.K., the ratio jumped by more than 50 percentage points to about 130 per cent over the same period.  Meanwhile, household leverage in Spain and Portugal doubled to 110 and 115 per cent respectively.  The Irish however, outdid everyone in the reckless borrowing spree, as the ratio jumped by 85 percentage points to more than 190 per cent.

The growing mountain of private debt went unnoticed by many, as bankers, investors and policymakers were seduced by what appeared to be never-ending tranquillity.  Indeed, Gerard Baker of the Times of London wrote at the beginning of 2007, “Welcome to ‘the Great Moderation.’  Historians will marvel at the stability of the era.”  Unfortunately, cracks in the increasingly fragile financial structure were already beginning to appear and, all it took was ripples in a seemingly inconsequential segment of America’s mortgage market, to bring the entire edifice to its knees.

The world economy slipped into the most severe recession since the 1930s and, the cyclical deterioration in public finances – alongside bank recapitalisation costs and stimulus packages of unprecedented magnitude – precipitated the sharpest deterioration in public sector balance sheets across the developed world since the Second World War.  The data reveals that gross public debt ratios across the G7 jumped from 82 per cent in 2007 to 112 per cent in 2010 and continues to edge ever higher.

More than three years on from the previous business cycle peak and, the state of public sector balance sheets across the developed world has caused alarm among the so-called bond market vigilantes and the credit rating agencies alike.  Sovereign risk is no longer considered negligible in nations that were traditionally considered risk-free, while the prospect of defaults among the weaker eurozone countries looms large.

Meanwhile, near-zero interest rates and unconventional monetary policies have failed to ignite an economic recovery that is sufficiently robust to result in a fall in aggregate debt levels.  Combined private and public sector debt ratios continue to rise in most developed countries, while the extent of the deleveraging in others has been minimal so far.

The private sector’s debt addiction in the developed world in the years leading up to the financial crisis – alongside the subsequent leveraging of public balance sheets to absorb the shock once the crisis struck – means that the world’s major economic centres face years of subdued growth, as previous excesses are unwound.

The real question facing investors today is not whether the Western world will double-dip but, whether the ‘Great Recession’ ever really ended.  The secular bear market in stocks rolls on.

Originally posted on www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The Canadian economy has been the envy of the developed world in the recent past, as North America’s largest country weathered the global recession far better than most and, the subsequent recovery has been sufficiently robust to allow both output and employment to return to their pre-recession levels by the middle of 2010.  However, sharply rising house prices alongside a rapid increase in household debt has raised concerns that the so-called ‘Northern Tiger’ is simply an accident waiting to happen.

It is clear that the ‘Northern Tiger’ entered the downturn with critically-important advantages that allowed policymakers to cushion the blow and jump-start a recovery through aggressive monetary easing and extraordinary fiscal stimulus.  These included a strong fiscal position, credible monetary policy, a well-functioning financial system and private sector balance sheets that were not as stretched as much of the Western world.

The Bank of Canada reduced its policy rate to near-zero at the height of the global financial crisis and, because the monetary transmission mechanism was not impaired, consumers were able to exploit generational lows in borrowing costs.  Households took full advantage of the extraordinarily easy monetary policy, which allowed consumption to regain its pre-recession level by the third quarter of 2009, while the boost to housing demand enabled residential investment to recover its previous peak in just 18 months.

The monetary stimulus alongside other policy measures, designed to insulate the housing market, precipitated a marked turnaround in house prices.  The decline in prices from the autumn of 2008 to the spring of the following year, was contained to just ten per cent, while the subsequent rebound in the market has seen prices jump almost 15 per cent above their previous peak.

The Canadian experience stands in sharp contrast to their southern neighbour, the United States, where house prices continue to languish some 30 per cent below their peak, with little sign of a turnaround as far as the eye can see.  However, Canadian house prices had already enjoyed a marked increase from 2003 until the global crisis struck, such that valuations today cannot be described as anything else but elevated.

The average priced home in Canada today is valued at more than five times median family income, as against just three times a decade ago when valuations were close to their historic average.  The situation in Vancouver is even more alarming where the average price exceeds eleven times family income, more than double both the national average and the figure that prevailed at the start of the new millennium.

In spite of the disturbing valuations, Canadians appear to have been seduced by the rise in prices and, a recent survey conducted by the Canadian Association of Accredited Mortgage Professionals, revealed that “almost 60 per cent of respondents thought that now was a good time to buy.”

The rise in house prices alone, is not sufficient to pose a systemic threat but, when combined with high levels of debt, the cocktail could potentially prove explosive.  In this regard, household debt has expanded at twice the rate of personal disposable income since the recovery began during the summer of 2009 and, by the end of last year; the debt-to-income ratio had increased to more than 148 per cent – a level that eclipsed U.S. household indebtedness for the first time in more than a decade.

The additional borrowing, primarily in the form of mortgage loans and home-equity lines-of-credit, means that a Canadian with a two-storey home spends almost half of his household income on mortgage servicing, with the share closer to 70 per cent in Vancouver.

Furthermore, the Bank of Canada estimates that “the proportion of Canadian households that would be highly vulnerable to an adverse economic shock has risen to its highest level in nine years, despite the improving economic conditions and the ongoing low level of interest rates.”  The central bank adds that “this partly reflects the fact that the increase in aggregate household debt over the past decade has been driven by households with the highest debt levels.”

Bulls on the Canadian housing market dismiss such facts and, argue that a U.S. style meltdown is unlikely given the tightly-regulated mortgage insurance market.  The banking sector is not permitted to hold uninsured high loan-to-value mortgages – currently, greater than 80 per cent – and, since the government not only owns the Canadian Mortgage and Housing Corporation (CMHC), which accounts for more than two-thirds of the mortgage insurance in force, but also provides a 90 per cent guarantee on private mortgage insurance obligations, policymakers play a major role in the evolution of underwriting standards and can thus, contain potential excesses.

The government may well exert a strong influence on underwriting standards on paper but, in reality, the government-backed guarantees have introduced moral hazard through the transfer of default risk from bank shareholders to taxpayers.  Bank management are incentivised to play hard-and-fast with the written rules and, should a negative shock arise, the CHMC has little room to absorb the losses.  The government-owned company currently insures $536 billion in mortgages as compared with just $11 billion in equity – or just two per cent equity against its total exposure.  It’s easy to envisage a scenario in which the taxpayer is left holding the bag.

The ‘Northern Tiger’ has attracted plenty of admirers in the recent past but, upon close examination, an accident may well be in the making.  Will it happen?  Time will tell.

Originally posted on: www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

At what point do we stop wondering what the crystal ball will show next?  Lately, every time I turn on the TV, the newscaster is announcing a new prediction for our economic future.  Sometimes two channels are simultaneously reporting completely different forecasts.  At this rate, how can one put faith in any of these hypotheses?  Will we eventually tire of these predictions (which are really nothing more than educated guesses) or will we just give up and roll with the punches?

Our favorite Irish economist Charlie Fell explores our “Prediction Addiction” in his latest blogpost.  Read the full article here.

Human beings are hard-wired to detect patterns and identify causal relationships amidst the constant stream of new information.  This behaviour can be traced to our ancestral past on the African savannah many millennia ago, where the ability to shape expectations from small samples of data, enabled our hunter-gatherer ancestors to successfully forage for edible fruits and seeds, stalk prey, avoid predators, find shelter, and seek mates.  Scott Huettel, a neuroeconomist at Duke University, explains that, “The brain forms expectations about patterns because events in nature often do follow regular patterns:  When lightning flashes, thunder follows.  By rapidly identifying these regularities, the brain … can expect a reward even before it is delivered.” The ability to anticipate outcomes from regular patterns undoubtedly helped our ancestors to flourish but, Huettel warns that, “in our modern world, many events don’t follow the natural physical laws that our brains evolved to interpret.” The human brain is designed to conserve scarce neural resources, and so much so, that it requires only a single confirmation to anticipate a recurring pattern.  Huettel notes that as a result, “The patterns our modern brains identify are often illusory…” Pattern recognition and subsequent tactical buy or sell decisions are part and parcel of active investment management.  Investors however, often place too much emphasis on the recent past when forming expectations about the future – top-down analysts make tactical calls based on recent economic data, while technical analysts divine the future on historical patterns in stock prices. Investors’ ‘prediction addiction,’ as the behaviour has been called by the financial columnist, Jason Zweig, is particularly relevant today.  Economists are busy shaving their economic growth forecasts for both this calendar year and next, following a string of disappointing data that fell well short of expectations.  Meanwhile, technical analysts are arguing for a reduction in equity allocations, given price action in the major stock market averages that confirms a change in the underlying trend. Recession fears are afoot and investors are in need of guidance that will preserve capital and/or yield profits amid the uncertainty.  Indeed, anticipating turning points in the business cycle and, adjusting asset allocation accordingly, is central to successful top-down investing. Unfortunately, economists have a patchy forecasting record at best, having failed to anticipate every one of the last five recessions.  Indeed, the monthly publication, Blue Chip Economic Indicators, noted in July 1990 that, “the year-ago consensus forecast of a soft landing in 1990 remains intact” – the economic expansion peaked that very month! More than a decade later in March 2001, fewer than five per cent of economists anticipated that there would be a recession that year, even though a downturn was set to begin just days later.  More recently during the spring of 2008, the calls for a soft landing were almost deafening, despite the fact that the deepest recession since the 1930s was already underway. Perhaps the study of historical price patterns performs better.  After all, stock price data is not reported with a lag and, unlike economic data, is not subject to revisions that continue several quarters after the fact.  As William Hamilton, the fourth editor of the Wall Street Journal wrote in his 1922 classic, ‘The Stock Market Barometer’ – “The market represents everything everybody knows, hopes, believes, anticipates, with all that knowledge sifted down to … the bloodless verdict of the market place.” The study of historical price patterns suggests that a further decline in the major market averages may lie in wait.  The 18 per cent fall in stock prices from their recent peak late-April, resulted in a bearish ‘Death Cross’ signal on August 12, as the stock market’s 50-day moving average of closing prices dropped below its 200-day moving average. The ‘Death Cross’ is considered by technical analysts to be a portent of future weakness, but is the signal’s presumed ability to anticipate turning points and enhance investment performance supported by the historical record?  To find out, the ‘Death Cross’ and its converse, the ‘Golden Cross’, are employed as tactical sell and buy signals respectively, for a simple long/short strategy and, the investment results – excluding dividends – are compared with those generated from a straightforward buy-and-hold strategy. The historical record shows that before the most recent ‘Death Cross,’ there had been 63 tactical signals since the summer of 1949 – 32 buy and 31 sell signals – which, gives weight to the late Paul Samuelson’s criticism in 1966, that ‘The stock market has predicted nine out of the last five recessions.” The buy and sell signals resulted in 33 winning trades and 30 losing trades, which is not much better than a coin toss.  More importantly, the price return generated by the long/short strategy saw an initial $10,000 investment compound to $537,000 over the period, as against $775,000 for the buy-and-hold strategy. The historical evidence suggests that the ‘Death Cross’ adds no value to the investment process.  However, a more complete examination of its credentials reveals that it subtracts from investment performance during secular bull markets, which are characterised by powerful up-trends with only the briefest of interruptions; it adds to performance during secular bear markets, which are characterised by a protracted sideways pattern that is punctuated by violent downward price swings. The bearish indicator provided ample warning to investors of impending danger, close to a market top in both the autumn of 2000 and the winter of 2007.  Has the ‘Death Cross’ sounded an early warning bell once again?  Time will tell.

 

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

At Currensee, we’re always keeping a close watch on what’s happening in the world currency markets. Here are our picks for the week’s top stories.

Much of the news in the currency world last week concentrated on a growing nervousness in the U.S. stock market. Recent data may hint at a possible double-dip recession on the horizon, and the Dow Jones Industrial Average sank below 12000, reaching its longest-lasting downturn since 2002. Beyond U.S. borders, the euro faces pressure in world currency markets while European leaders continue to spark debate about the proper solution to the economic situation in Greece. Meanwhile, the World Bank is encouraging fast-growing emerging market economies to speed up interest rate increases to promote future growth.

• DJIA Sinks Below 12000, Wall Street Journal, June 10, 2011

• Euro ETFs Feel Weight of Debt Crisis, Seeking Alpha, June 10, 2011

• WORLD FOREX: Currency Markets Nervy; Euro Under Pressure, Wall Street Journal, June 10, 2011

• Economy at tipping point, double-dip risk: Shiller, Reuters, June 9, 2011

• Rift Over Greece Between the ECB and Germany Widens, Forex Crunch, June 8, 2011

• Wall Street set to rebound, downtrend seen intact, International Business Times, June 7, 2011

• Emerging Markets Must Speed Up Rate Increases, World Bank Says, Bloomberg BusinessWeek, June 7, 2011

-------

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The month of March is normally synonymous with madness. For traders that madness equates to volatility. As we move midway into this March there is anything but madness going on in these markets. That doesn’t mean that the remainder of the month won’t be met with moves a minute but duplicating the first half of the month would not excite too many traders.

The bigger picture here and likely the reason why volatility is low is that the global economies continue to grind back towards normalization after the 2007/08 recession. That grinding pace has investors wary of reinvesting back into equities at full-speed. One would think though that the lack of investor conviction and the uncertain economic outlook would be cause for such volatility.

There have been a few exceptions this month. Yen traders will not soon forget the Non-farm Payroll day in the US. Yen pairs started to back-peddle and did not stop until the following Monday afternoon in London. That turned out to be a nice 4 yen move in the market for many Yen pairs. The following Friday also saw some significant volatility in the Canadian Dollar. Although unless you were at the trading desk at 7am est. and took part in the immediate move that followed the Canadian employment release you may have missed 70% of the move.

The good news here is that there is a pattern developing here. Until the markets find their stride again those in search of volatility may have to target the tier one economic data releases. These are easy enough to find as well. On Currensee the Research Dashboard has the global Economic Calendar where it lists daily releases.

Front and center this week looks to be the Euro Zone ZEW survey. Yes it will be released quite early for US and Canadian traders. That said expectations are for another contraction in business sentiment, to 43.6 from 45.1, and a contraction in the Current Conditions from to 52 from 54.8. With such worries on the global economy it is easy enough to see how this release has potential to create a little vol.

The US has a full calendar on Thursday, everything from consumer inflation to jobless claims to money supply figures. By now the US jobless claims will be void of the Mid-Atlantic snowstorm effect and should be able to better represent the labor market. The UK also has a few important releases including their Employment report. That said the majority of the UK employment data is released on a 3 month moving average which is intended to diminish post release fluctuations. The big move this week may be in the Canadian Dollar again and on Friday their retail sales and CPI figures certainly pose as a market stimulus. The retail sales figures in particular will garner attention as expectations are for a 0.6% m/m rise which follows a 0.4% m/m rise the prior month.

Madness will return, volatility will jump to higher levels and traders won’t be able to sleep in anticipation of catching the next move. When will this happen? No one is certain, but checking the Economic Calendar on Currensee will provide some clues as to when it may happen.

This report is for your information only and does not constitute investment or business advice or an offer to buy or sell securities.

======

Be sure to read the full risk disclosure before trading Forex.  Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.