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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: mishedlo who wrote (13803)	10/21/2004 9:17:48 AM
From: zonder	Respond to of 116555

Monthly Report - Saxo Bank Macro Fund "Leaders must invoke an alchemy of great vision". Henry Kissinger US dollar will weaken to 1.5000 against the EURO US economy heading towards recession courtesy of Fed trying to go "neutral" on Fed funds John Kerry and his ketchup will take the White House EUR/USD in 1.5000 before end of 2005 Although I don’t believe strongly in my powers of prediction, I will say that the odds are stacked nicely for major move in the EUR/USD and soon:. The US dollar constitutes 70% of foreign reserves in central banks around the world. This is against a 30% share of world GDP for the US. Of course, one needs to add about 10% to the equation since the US dollar is the reserve currency of choice – but the share of USD is still MAXED OUT as a component of these banks’ portfolios. Conclusion: It's hard to see central banks increasing their reserves of US dollars beyond 70%. Now lets look at recent trends among central banks: In the last ten months "official buying" (Central banks) has taken 35% of the net inflow of US dollars from abroad- this equals in rough terms two times the long-term average and 5 times the period of 2000-2002. The present ever increasing current account deficit is in other words becoming less and less financed by the private sector and more and more financed by quasi- and wholly governmental agencies! This is ok as long as these agencies make money, but.......here comes the catch: the US dollar in its broadest sense is down 10% and leaving nasty loses on the central banks books, let me illustrate this by looking at the Bundesbank’s numbers: Their 2003 accounts had net profit of €248 million (which is transferred to the budget) against 2002 profit of: €5.4 billion. EURO. The Bundesbank also stated that it had to make significant write-offs on its foreign reserves. The Bundesbank took a hit of €2.3 billion on the mark-to-market value on their US dollars assets! More to the point though the REAL-REAL loss was €3.8 billion (only some fancy footwork on legacy valuation reduced the loss to the €2.3 billion number) This is nasty surprise for a Government in dire need of considerable funding (Germany once again is bumping up against budget constraints and admits they will violate the spirit of the Maastricht treaty) and this could become a thorny issue in the Bundestag as their US dollar reserves of $40 billion look massive considering their bilateral needs is €13 bln. placed in the ECB pool of reserves. (All Central banks in the EU gives part of their reserves to ECB to manage) My point: the Bundesbank’ huge reserves are too big for their needs as the ECB is the source of intervention. Being long US treasuries at 2-3% and losing on the currency does not make much sense for any portfolio manager and less so for quasi-governmental agency! The Bundesbank’s situation parallels that of the Bank of China, Bank of Japan, and Bank of Taiwan. The recent acquisition of Bank of China of a major Canadian mining company could be indication of more active ownership for their reserves. I am NOT saying that overnight the central banks will sell out of their US dollars, but I am saying that the NET accumulation of US dollars will not happen at the same speed going forward as it does not make financial or political sense. This seems indeed to be the pattern also in the custody holdings from the Fed. The two most recent months have seen the inflow slow. This happens against a background of ever increasing current account deficits from the US, indicating some other form of funding (bank loans, equity buying) is taking the place of foreign central banks, as the net sum of ANY current account has to be zero. Note also that the indirect bidder, in fixed income lingo, for central banks has been less and less visible at recent US Treasury auctions. All in all evidence is there to create a move, it will need a catalyst but I expect this process to be well under way before the new year. Recession courtesy of Fed (Greenspan) Greenspan is losing the battle against the market. His plan was to gradually nudge rates towards a 'neutral rate'. That's the rate that keeps the economy humming for the longest period. The real fund rate has averaged 2% for the past forty years, so with the present inflation expectations of 1.5-2.0% it would indicate a 'neutral rate' of 3.5-4.0% (presently: 1,75%) leaving Fed to hike 175 basis points, but...and that’s the key here, Greenspan realise that this is not normal circumstances as the US economy' ability to keep growth coming has been on the back of: Tax cuts, which have added more than 100 basis point of growth since summer of 2001. Low interest rates that created asset inflation, especially in the housing sector, which saw an unprecedented new home building and refinancing boom (Giving house owners cash for bricks!). Basically Greenspan was thinking he could "sneak" rates to 2.5-3.0% before having to cut again! The reloading of the interest rate cut gun has failed! The market got wind of Greenspan’s plan and that’s the exact reason why yield has been doing nothing but going down the last two quarters leaving many of my peers in the red, as they have made massive bets that US yield was going much, much higher. The reality is that the recovery in the US economy is markedly weak compared to previous recoveries, which can be seen most clearly by the anemic job growth. It's ironic that the useless investment bank strategist' of the world are finally realising this when we in my opinion are less than 2-3 month away from major cyclical swing in rates generated by the above mentioned potential for funding crisis/US dollar crisis. A country like the US with no savings and growing current account- and budget deficits needs to makes it assets attractive. That means lower stock prices (which I doubt) higher yields (which will need to go higher) or a cheap currency. The latter will happen and I think some of the adjustment will have to come through higher US yield. I am not talking rates back to neutral but of 75-125 basis points over the next 14 months. Kerry looks more and more like a winner to me (and we will all lose) I may be on my own here in prediction that Kerry will win, but I remain confident that the stock market is an accurate barometer of election outcome. The excellent study by Kenneth Tower from Schwab on incumbent Presidents and the market that I mentioned last month made me think about the potential for measuring the optionality of Bush winning based on how the market performs year-to-date: The premise is: There have been 10 losses for incumbent Presidents in 26 elections (104 years) Six of these happened when the Dow FAILED by gaining less than 20% on aggregate for the four years in office. (Bush is already losing using this measure alone!). Of the remaining 4 losses to incumbent, none of them won when the stock market was down year-to-date. The Dow is down 4.30% as I write this column. This makes the probability of Bush winning 19% (actually less as he lost on the four years aggregate rule). This is a very crude/simple way of measuring the outcome and only measures the probability of the market making it back to ZERO. (Me arguing that at least Bush needs Dow in positive territory for 2004 to have 50/50 chance). For full disclaiming purposes it should be said our internal analysis of the recent polls points to Bush victory by margin of 52/48 based on different quantitative analysis of recent polls but as said my money is with the market! Let me hasten to add I am NOT endorsing Kerry, I merely believe that financial markets are better indicators of event risk like elections than the exotic discipline of polling. The above is semantic though. Whoever takes the White House will have to rein in the spending and look seriously at the savings rates in the US. Real consumption has risen 4.2% in the US while real disposable income has increased a mere +0.8% leaving a "funding gap" which means dis-saving or falling saving rate. The US consumer saves 90 cents for every 100 USD of income! You can run your credit card to its limit but eventually you will have to pay it back, and more so if the cost of carrying the debt increases (i.e. higher rates). As for the post-election markets, the US (and Europe) will have some of the most boring markets since Bush Senior was President. I still expect sideways trading in stocks to last 3-5 years keeping its S&P range of 800-1.200. Yields will gradually rise and the only game in town may be a weaker US dollar and rising Asia dominance. I have the utmost respect for the US and its economic model, but the bottom line here is that there are better places to invest for growth, currency gains, and to some extent companies than in the US right now. China and its Asian peers have exceeded US growth for some time now and will continue to do so. Young MBA's today wants to go to Asia, that’s the true new capitalism. I for one am with the young people, especially now that I have turned 40! Finally, as always my predictions and views are totally random, throw your own dart and you will most likely do better! Saxo Macro Funds present positions: Long EUR.USD cash and options. Short USD.JPY Short NOK.SEK Long NASDAQ Long EAC.co Short 5y notes The Saxo Bank Macro Fund performance for September reads: As per September 30th 2004: Last months' return 2.61% Cumulative Return Since Launch: 63.47% Average Monthly Return: 2.37% Annualized Return: 32.42% Largest Monthly Gain: 20.35% Largest Monthly Loss: -20.93% % Months Profitable: 76.19% Highest 12 Month Return: 48.84% Lowest 12 Month Return: 18.19% Year To Date Return Fund (2004) 24.42% Maximum Drawdown: 20.93% Average Monthly Standard Deviation: 10.02% Annual Sharpe Ratio: 0.89 Calmar Ratio: 1.55 Returns chart Steen Jakobsen, Saxo Fund Management Saxo Bank A/S