Clear Indexes Ideas

Pain is Where You Feel It

For months now, the entire media and the financial blogsphere has been talking about how dismal the US financial markets have been. There is a tendency to believe that we are at the center of the world and that our problems are amplified compared to everyone else’s. In reality, although it may be true that we are situated at the hub of the world economy; but relatively speaking, our problems are not so bad.

The decline of the US market (DJIA) by 7.9% YTD is hardly a dent compared to the losses other countries have been experiencing this year.

Since this global financial crisis originated in the kitchens of Main Street and the laboratories of Wall Street from within the United States, it may seem odd that the US markets are performing so much better than other nations. Although it may be counterintuitive, the declining value of the US dollar is actually working to buoy the US stock market. The decreasing US dollar value causes US stocks to be relatively cheaper and therefore attractive to foreign investors. Additionally, multinationals and US export companies can benefit from creating products at $US cost and selling at relatively higher prices in foreign markets (>45% of revenue from S&P 500 companies comes from outside of the US). As expected, non US countries have experienced the opposite effect of the declining USD. Foreign companies have seen eroded profit margins as they have been forced to decrease prices (relative to their currency) to remain competitive in our retail market.

In addition to benefiting from increased opportunities sparked by declining dollar values, the US stock market has been kept afloat by Bernanke and the Central Bank’s aggressive tactics. Since the beginning of 2008, The Fed Funds rate has declined by 2% and the discount rate has declined by 2.25%. Anybody who follows the stock market has noted how drastically the stock market moves in anticipation of and in response to rate changes. As global as the world has become, international markets are impacted by US interest rate changes. The response and benefit of rate cuts on the US market is relatively much greater. We too are affected by rate changes and currency fluctuations with our trading partners as well. Stay tuned.

World Interest Rates Table

Major Central Banks Overview
Central Bank	Next Meeting	Last Change	Current Interest Rate
Bank of Canada	Apr 22 2008	Mar 04 2008	3.5%
Bank of England	Apr 10 2008	Feb 07 2008	5.25%
Bank of Japan	Apr 09 2008	Feb 21 2007	0.5%
European Central Bank	Apr 10 2008	Jun 06 2007	4%
Federal Reserve	Apr 30 2008	Mar 18 2008	2.25%
Swiss National Bank	Jun 19 2008	Sep 13 2007	2.75%
The Reserve Bank of Australia	Apr 01 2008	Mar 04 2008	7.25%

China Hiccups

Back on March 10, I read with great interest an AP piece concerning China's trade surplus. Apparently it dropped in February as U.S. and European demand for Chinese goods weakened and the country's imports rose sharply. This report came from the government in Beijing.

• The 63% drop in the trade gap from the year-earlier period reflected the impact of a U.S. slowdown while China's own expansion has stayed robust, driving demand for imported energy, consumer goods and industrial equipment.
  
  
• China is under pressure from the U.S. and the European Union to ease import barriers and currency controls that they say are adding to its multibillion-dollar surplus. Some American lawmakers are calling for trade sanctions.
  
  
• China's trade surplus in February totaled $8.6 billion, down from $23.7 billion in February 2007, the customs agency reported.

The reasons for this change in trade surplus range from weather to tax law changes. It sounds to me like China is learning some communications skills from US companies as well.

• China's imports in February surged 35% to $78.8 billion from the year-earlier period, according to the customs agency.
  
  
• Exports grew by 6.5% to US$87.4 billion -- a much slower growth rate than January's 26%. That could spur worries that slowing U.S. demand will hurt Chinese exporters and could wipe out thousands of jobs.

February's monthly trade gap with the 27-nation EU, China's biggest trading partner closed by 15% to $10 billion compared to last year. The U.S., China's No. 2 trading partner, shrank 23% to $9.4 billion compared with the same month in 2007, China's customs agency said.

Inflation seems to be another import with the price of food, energy and other commodities on the rise. Sounds familiar doesn’t it?

This is not all about the falling dollar as the trade gap with the EU closed as well. Certainly the weak dollar has intentionally increased exports for US firms. The country is learning to manufacture again.

So it seems if the US sneezes and wipes its nose, China may have not yet caught a cold. But it certainly is showing early symptoms closer to its EU and US brethren. Did I hear a hiccup?

The Root of All Evil?

Or the American dream? You decide.

I am talking about home ownership and the financial burden and tax deduction that come along with it; mortgages. Mortgages have brought riches to corporate  America,  banks, home builders, mortgage brokers and pure play mortgage companies. It also brought joy, capital appreciation and riches to many individuals.

That was until mid last year.

Owning a home is as American as Apple pie. It was so patriotic to do so, that many ordinary citizens purchased second and third homes for vacations, rental income, investments, or to flip and other get rich quick schemes. It all seemed to work… for a pretty good run.

Some not so ordinary citizens purchased homes too. These are the people who are just as deserving to own a real place, but did not fully understand the financial responsibilities or how they will change over time.

We all know how this ended, or do we?

The fall of Bear Stearns (BSC), the run on Lehman Brothers (LEH) and the rumors of Washington Mutual Inc. (WM) add to the fray of firms that the general community thought were at least one step removed from the eye of the storm.

There have been write downs for banks, i-banks, mortgage companies and it is not over. Default rates are hitting records not seen in 20 years.

In response the Fed has flooded the system with liquidity and lowered interest rates. The global financial community expects another big rate reduction today.

Does it matter?

At first we all thought that the most effected were riskier mortgage, subprime, tier three. The media also focuses on the adjustable rate mortgages, many of which will adjust, meaning change interest rates (and up the rates go) this year. I have one of those initially really low adjustable rate mortgages. It resets in September so I still have some time to refinance. The issue is after talking to my bank is that rates are not all that low for anyone despite the interest rate redutions.

Martin Crutsinger, an Economics Writer for AP posted a piece last Thursday.

Freddie Mac, the mortgage company, reported Thursday that 30-year fixed-rate mortgages averaged 6.13 percent this week, up from 6.03 percent last week.

Rates on 30-year mortgages dropped below the 6 percent threshold in the second week of January and stayed there for six straight weeks as the economic slowdown stirred concerns about a possible recession.

However, in the past month, bond markets have grown worried about rising inflation pressures that are coming as the economy slows. Bond investors are always on the watch for any hints that inflation pressures could be increasing since higher inflation erodes the value of their fixed-rate bonds.

Four consecutive weeks of mortgage rates increasing. That is the sad reality facing those with shorter time frames and fewer options than me. Uncle Ben will probably deliver another rate reduction today. The equity markets will cheer. The vast number of us with mortgages readjusting, first time home buyers with a dream, relocations and those still looking to refinance are seeking the benefits of these rate reductions. Over a 15 or 30 year mortgage, we are talking a lot of cake.

Someone tell the bond market it worries too much about tier one paper. I am not the 100th person to write about this topic. We are watching it become a negative self fulfilling prophecy.

If no one can get a decent mortgage than the problem for this section of the bond market will take care of itself. I think it will be called market efficiency. Unfortunately it will effect the rest of us and the entire economy. This is fixable. It will take cool heads and liquidity in the markets. That seems to be coming along.

For all of us, the clock is ticking.

Disclosure: No positions in the companies mentioned.

Bloomberg Radio Tomorrow

I am pleased to be able to provide some notice of a radio appearance. It is tomorrow 3/18/08 at 11:30am eastern to discuss earnings for Goldman Sachs Group Inc. (GS) and Lehman Brothers Holdings Inc. (LEH). Both firms are caught up in the Bear/subprime/credit/liquidity mess. Earnings are of course historical. Investors, clients and most of the business world are more interested in liquidity and each firm’s ability to conduct business moving forward.

As an investor, I share these concerns, but I am curious well beyond survival. I will be scrutinizing how each firm, from an operating profit and earnings perspective, have weathered and adapted to a vastly changed environment.

Both firms are constituents in the Clear Global Exchanges, Brokers and Asset Managers Index which is licensed for the ETF (EXB).

Disclosure: Mr. Corn does not directly own the stocks mentioned and does own shares of (EXB).

The Geek in Me Cannot Resist Today - Again

Today is Pi day 3/14. Pi is one of those numbers that makes us giddy.

So my favorite geek trick, the one that got me all the girls in high school involves a standard calculator. If you can handle all the attention and want to be the life of the party today / tonight follow this simple set of instructions. Enter 22 and divide it by 7. Most basic calculators will return 3.1428571. Now multiply it by 7, most calculators will return 21.999999 (due to rounding) instead of the expected 22.

Well the fatal flaw in most calculators is (this is the knowledge that one must memorize to truly get all the girls or guys) the way the round. Enter 3.1428572 (yes I have this number memorized since seventh grade)and multiply that by 7, and one usually receives 22. Now that is putting math skills to good use.

Enjoy 3.14 and be careful with who you use this demonstration. Too much swooning on a market / school day can have unintended consequences.

ETFs: History Repeats Itself - Again

I read with interest this weekend various takes on the reduction in overall assets of ETFs. Index Universe did a fine job of showing the net reduction in AUM by issuer. The breakdown of overall market loss, which investment thesis is working in this environment and which is not are all to be explored. I am confident that asset allocators and investment analysts are busy doing just that.

Out flows tend to occur as the market goes down. Investors love to chase the hot dot on the chart - - the fund or investment thesis in vogue. This has investors and undisciplined advisers miss most of the upside and lock in losses as they chase themes that are already working and redeem falling investments. I suspect that much of this pattern is being followed in the ETF world.

I view this as a normal psychological response versus a new scratch in the Teflon of the ETF world.

To gain some insight, we quickly looked at a predecessor industry; Mutual Funds. It appears to be Ground Hog Day AGAIN as Bill Murray would say in the movie. ETFs seem to be following the pattern of the retail investment industry. Does that translate into broad acceptance and is a positive?

The US, the largest mutual fund market, saw its investors responded to sharp market declines in the first weeks of the year by pulling $32.9 billion dollars from equity funds. This is the largest outflow since July 2002. The combined assets of the nation's mutual funds decreased by $302.99 billion, or 2.5% to $11.717 trillion in January, according to the Investment Company Institute's official survey of the mutual fund industry.

Outside the US,  Italy, France and Canada had significant declines in January too showing the herd is reallocating on a global basis.

According to AMG Data Services, a California provider of Mutual Fund Money Flow & Holdings data, the first two weeks of February brought positive inflows of $1.5 billion into equity funds in the U.S, which included sectors such as finance/banking, real estate and aggressive growth/value funds. This may signal a small but possible recovery. Or this could be IRA and 401k money going to work.

So as investors go, so do ETFs. The fact that ETFs are following long standing trends in mutual fund land and other investment vehicles should not be a surprise. One good/bad characteristic of ETFs is that it is easier for a retail investor to trade an ETF than a mutual fund which includes both buying and selling. Redemptions and money flows need to be tracked and trends acknowledged. But before there is panic or industry disparaging, looking to comparable situations is prudent even if not reassuring.

Disclosure: Mr. Corn is CEO of Clear indexes LLC which designs and publishes custom indexes that are tracked by packaged products such as ETFs. He is also CEO of Clear Asset Management Inc that uses ETFs in its investment process.

It Starts with the Baby Sitter

I spoke to several couples in the last few weeks who cancelled plans to go out in order to save a few bucks before spring break. They have no rational reason to fear for their income, but in these uncertain times, their mindset is important. Who else is influenced by feelings of uncertainty?

By staying home, these couples hurt restaurants, nightlife, and obviously taxi drivers. Let us look at the bigger and more typical consumer chain of events. Had a couple gone out rather than stay in, they would have hired a baby sitter. This young woman, usually a college student (in our world), would have ordered out for dinner with the kids providing a restaurant with business. Without her Saturday night job, she will have less disposable income and perhaps a feeling that less work is coming. Her reaction: one less download from iTunes, one less trip to H&M or the mall, one less candy bar or fewer searches on Google for that perfect pair of shoes. Each action has a cumulative effect. Her biggest action based on this event? It is talking about the cancelation By talking about her lost income, the babysitter will create more uneasy people.

This chain reaction is normal, yet with media hype, even these innocent college kids are talking the "R" word fueling the fire further.

Not spending is not limited to consumers or college kids right now. According to data compiled by S&P, corporate America is sitting on $611 billion in cash, a near record. That cash should be invested in new products, infrastructure upgrades, marketing or strategic acquisitions. But companies right now are acting like consumers.

"There's no denying that shoppers are determined to keep a tight lid on spending, and we expect retail sales to generally remain weaker and deteriorate through the rest of the year," says Frank Badillo, senior economist for TNS Retail Forward, a Columbus, Ohio-based retail consultant.

In its most recent ShopperScape survey, the data from TNS demonstrates that the cutting back trend is strongest among lower income households. 31% of down-market shoppers in its survey say they plan to spend less than last year, compared with 28% of middle market households, and 25% of affluent households; all these cut backs begin with high gasoline and food prices. These numbers of planned cut backs are astounding and can push us towards a recession by themselves.

Yesterday retailers posted dismal same store sales across numerous categories sending stocks in the sector down. In February, only a few discounters benefited. Wal-Mart (WMT) reported same-store sales results that outperformed the market gaining in the US 2.5% over the prior year. Sales were also up at Target (TGT), which reported same-store sales up 0.5% slightly beating its forecast.

Floyd Norris over at the NY Times (NYT) published: Aversion to Risk Deepens Credit Woes. This connects the tight wallet mindset to the credit markets.

The credit markets came under renewed stress Thursday as investors sought absolute safety and even moved away from debt issued by Fannie Mae and Freddie Mac, the government-sponsored mortgage lending enterprises.

The intensifying credit crisis came as one regulator, Timothy F. Geithner, the president of the Federal Reserve Bank of New York, said that some banks had moved from being too willing to take on risks to being reluctant to take any chance of losing money, a move that was making the crisis worse.

"The rational actions taken by even the strongest financial institutions to reduce exposure to future losses have caused significant collateral damage to market functioning," Mr. Geithner said in a speech to the Council on Foreign Relations. "This, in turn, has intensified the liquidity problems for a wide range of bank and nonbank financial institutions."

Fannie Mae (FNM) and Freddie Mac (FRE), whose debt has been viewed as almost as safe as that of the government itself, have played an essential role in keeping the mortgage markets functioning. That is because many mortgage companies have gone out of business and investors have been unwilling to buy mortgage-backed securities unless the government, or one of the enterprises, guaranteed the mortgages.

The lack of credit is being felt in Statehouses, municipalities, hospitals and others who regularly roll over notes and other debt instruments. The buyers, regardless of the credit worthiness of the issuers have almost dried up. There is some fire behind all of this smoke in the mortgage market.

The Mortgage Bankers Association reported that the proportion of borrowers more than 30 days delinquent rose to 5.82 percent, the highest since 1985. The situation was worst among subprime borrowers who had taken out adjustable rate mortgages, but the proportion of prime mortgages that were delinquent also rose, to 3.24 percent.

The government has not sat by idly. President Bush is trying to put some cash in every pock in the form of a tax rebate. The bigger move has been by the Fed reducing interest rates. That has not impressed the media or the stock market. As observed by Paul Lim also of the NY Times, history is not exactly repeating itself since the beginning of rate cuts last fall.

Since 1954, the Standard & Poor's 500-stock index has surged 13 percent, on average, in the six months after the first in a series of Fed rate cuts.

Well, nearly half a year has passed since the Fed began to lower short-term rates, last Sept. 18. But this time, the S.& P. 500 has lost more than 12 percent of its value.

What's more, virtually every market sector has fallen since mid-September, in many cases significantly so. Financial stocks have plummeted 26 percent, on average; telecommunications stocks are down 21 percent; and technology shares are down 14 percent. If this market lived up to historical patterns, all 10 sectors of the market should have rallied sharply.

Investors have sent the market down materially in the last six trading days. It seems there is no place to hide. Of course that is not factual. There have been positive trading days. It only feels like the market is consistently down.

I am not suggesting that consumers go out and spend or that corporations immediately tap into their stockpiles of cash just to help the market. The vast majority of consumers with decent jobs should go about their lives without media induced stress. Companies should strategically invest in their future; R&D, infrastructure, new products and markets and logical acquisitions. Together these actions will soften the current downturn and help lead the nation back to growth.

Perhaps we all need to do what my baby sitter does when she is stressed, take a yoga class and go shopping.

Smile, and most of all, have a stress-free weekend.