Finance Digest for Week of May 1, 2006

BEHIND CLOSED DOORS

In bull markets, we often look for people to support our bullishness rather than those whose understanding of markets is far deeper than our own. We can either look to those who are experts in their field, or those who are experts at marketing their expertise. The following are reviews of books by a former SEC Chairman and a former Chairman and Director of the FDIC, respectively. If you have held these posts, I would skip the rest of this article. If not, I hope these book reviews will give you the insight to which these leaders of our financial markets and banking system were privy.

In his book, Take on the Street, the insights and stories of retired SEC Chairman, Levitt speak plainly of the culture that surrounds Wall Street. In a word: GREED. By proposing Regulation Fair Disclosure (FD), speaking out against Wall Street analysts’ conflicts of interest, and setting forth legislation to require corporate options packages to be recorded as an expense to the company, Levitt sought to help the individual investor. “The web of dysfunctional relationships among analysts, brokers, and corporations would grow increasingly worse,” he wrote. In speaking about the many difficulties he encountered in trying to get legislation, which would benefit individual investors, passed Levitt writes of the symbiotic nature of Washington and CEOs. Lastly, Levitt’s comments about mutual fund companies appear just as pertinent today as the time he served as the SEC Chairman. Levitt’s comments are similar to those Jim Chanos made in our research paper, “Riders on the Storm”, when he stated, “Wall Street is a giant positive reinforcement machine.”

While I agree with much of Levitt’s assessment of the incestuous relationships that exist throughout much of Wall Street, his suggestion that the solution is to buy an index fund seems to miss the mark. If the system has many problems and a good number of companies are using the system to benefit themselves to the exclusion of retail investors, investors would be better advised to look for money managers, and companies, with high ethical standards. Levitt also notes, “Investors should give greater weight to the recommendations of independent research analysts.” As such, rather than chasing the fad of indexing, investors would do better to invest with a manager who is tenacious enough to do his own independent research, and, “who considers his client’s interest before his own,” rather than one who, for the sake of his own livelihood, ends up, “taking an action which may not be appropriate or timely to take.”

If you are concerned by the greed, lack of transparency, and lack of regard for retail investors in the stock market, you are likely to be troubled by the recklessness that exists in our banking system today. Most people look at the FDIC sticker on a bank’s door and assume that they are safe and that if there ever is any problem, the government will always bail them out. Few realize the increase in the size and scope of FDIC bailouts since the U.S. came off of the gold-exchange standard in 1971. Fewer still realize that it is completely up to the FDIC’s discretion to decide which banks it will bail out and which deposits it will insure and which ones it will not. Large U.S. banks are considered too big (to be allowed) to fail. Will a day come when these same banks will be too big, with too many bad debts, to rescue?

In his 1986 book, Bailout: An Insider’s Account of Bank Failures and Rescues, former Chairman and Director of the FDIC, Irvine Sprague, who handled more bank failures than anyone else in U.S. history, recounts the three largest bank failures of his day, from 1972 through 1985. More than five separate times throughout this book Sprague speaks to the fact that he and others “feared the domino effect that could be started by failure of [a] large bank with extensive commercial loan business and relationships with scores of other banks. The problem was there was no way to project how many other institutions would fail or how weakened the nation’s entire banking system might become.” Sprague notes that the dollar amounts for covering the failures increased from $1.5 to $9.1 to $41 billion. He also notes the increase in the number of failures. “In 1968, there were three small failures all year. In 1983, we handled six failures in one day. In 1985, there were seven failures over a weekend.” He also notes the increased speed at which banks can fail. “On occasion, the failure of a bank comes with lightning speed. In cases of fraud or runs, the failure can be dramatically fast. Continental [Illinois] succumbed in days.”

Sprague concludes that a “disregard for loan quality” and loans made “without adequate investigation and documentation” were the surface reasons for most bank failures. As to the foundational reason, Sprague states, “The greed factor remains the major – often the only – reason for a bank’s failure. Nothing much has changed, except now the numbers are quite a bit larger. There is no reason to think that the chain has been completed yet.” With our banking system’s current exposure to low/no documentation risky real estate loans, credit card, and auto loans, and with the credit default swap markets soaring, we would all do well to remember banks have not always been synonymous with safety.

TIME FOR THE FEDERAL RESERVE TO CONTEMPLATE PAUSING?

First quarter nominal U.S. GDP expanded at an 8.2% rate (4.8% inflation-adjusted), the strongest pace since the third quarter of 2003. It is worth noting that growth quickened sharply from the fourth quarter, a period notable for 9.5% annualized non-financial credit growth. Year-to-date, bank credit has expanded at a 12.4% rate, a notable acceleration from the fourth quarter. Bank real estate loans have expanded at an 11.0% rate so far this year, with commercial and industrial loans up 15.5% annualized. Wall Street securities firms’ balance sheets are expanding at 20%-plus rates. Commercial paper is expanding at a 14% pace, and asset-backed securities issuance is in line with last year’s booming record pace. Time to pause?

The NYSE Financial Index broke out to a new all-time high this week, sporting a 10% y-t-d gain and a 27% rise over the past year. The NASDAQ Other Financial Index (90 stocks) is up almost 14% in 2006 and 48% over 52 weeks. The AMEX Securities Broker/Dealer Index is up 18% y-t-d and 71% during the past 12 months. And it would be atypical for financial sector managements to observe booming stock prices and not feel compelled to deliver strong profits (by lending and trading aggressively) to The Street. It is also worth noting that the breadth of speculative excess today easily outdoes 1999/early-2000. The small cap Russell 2000 is up 14% y-t-d, the S&P 400 Mid-cap index 9%, and the NASDAQ Telecommunications index 20%. Time to pause?

Federal government Receipts are running better than 10% ahead of last year’s level, with spending up almost 9%. Despite double-digit export growth, our trade deficits grow only larger. The U.S. Current Account deficit will easily exceed $800 billion this year. Gold is up 27% y-t-d to the highest price since 1980, with a 52-week gain of 51%. Silver has gained 51% in less than four months to a 23-year high (52-week gain of 90%). Crude oil is up 18% y-t-d and 38% over the past year, last week trading to an all-time record. Unleaded gas futures prices are up 40% from a year earlier. The Goldman Sachs Commodities Index is up 34% over the past year, closing last week at a record high. International central bank reserve holdings (mostly dollars) are expanding at a 20% clip. After trading above 120 in 2002, the dollar index sits today tenuously at 85.88, not all too far off of its 2005 low of 81.11. Time to pause?

Looking internationally, Canada’s TSX equities index has posted a one-year gain of 32%, Mexico’s Bolsa 68%, Brazil’s Bovespa 65%, Argentina’s Merval 44%, Germany’s DAX 44%, France’s CAC 40 33%, Spain’s IBEX 32%, Norway’s OBX 67%, Poland’s WSE 71%, Russia’s RTS 148%, Japan’s Nikkei 225 54%, South Korea’s KRX 56%, India’s Sensex 89% and Australia’s SPX 31%. Eurozone broad money supply growth has accelerated to an 8.6% pace, with private-sector loan growth up 10.8% y-o-y. China’s money supply has recently expanded at an almost 19% rate. India is in the midst of an unprecedented credit boom. In short, never have global financial conditions been remotely this loose.

After building his career on a revisionist’s view of the 1920’s and ‘30’s – certainly including a lambasting of the late-20s “Bubble poppers” – it should come as little surprise that chairman Bernanke is indisposed to employing real financial condition tightening. His true chairman stripes, perhaps veiled somewhat up to this point, have shone through. The Fed is left hoping that rate increases to date are in the process of imposing meaningful restraint, and they are likely preoccupied with the cooling housing sector. Yet, the reality of the situation is that financial conditions have never been looser, the credit system continues to fire on all cylinders, and inflationary manifestations just keep popping out all over the place.

The Bernanke Fed is in one hell of a predicament. There is today no way to rein in escalating global excesses without a serious bout of U.S. financial and economic tumult. These days, such a scenario is simply unthinkable. Yet the status quo fosters only more problematic monetary disorder. Mortgage credit growth is likely to approach last year’s stunning $1.4 trillion level, while energy and M&A-related borrowings surge. Global leveraging of commodities, securities markets, and real estate is creating unfathomable liquidity excesses. Bull markets create their own liquidity until they don’t. More than ever before, U.S. consumer retrenchment and resulting recession are required for the commencement of the long-overdue and unavoidable adjustment process, although the Fed is more determined than ever to maintain the boom. At this point, boom-time conditions are sustained only by ongoing massive credit inflation (dollar debasement), with this inflation/debasement exacerbating the increasingly destabilizing non-dollar speculative flows.

We are now into year four of the Great Dollar Bear Market. Importantly, the financial sphere has by this point had ample opportunity to adapt and devise myriad instruments, avenues and strategies to profit from a declining greenback (inflating non-dollar prices). Speculators and investors have played and won overseas, and these strategies are now widely accepted as mainstream (a deepening “inflationary bias”). Meanwhile, scores of new mutual funds, ETFs (exchange-traded funds) and other instruments have sprouted up to provide less “institutional” investors easy access to the commodities and emerging market booms. Pimco’s Bill Gross even recommended an Asian ETF (twice) in a Bloomberg interview. I do not believe the ramifications for the powerful and intensifying inflationary bias toward non-dollar asset classes garners the analytical attention it deserves.

The Fed is playing a losing hand and keeps wagering our currency. As buyers of last resort, foreign central bank reserves have ballooned about $1 trillion over the past 18 months. Ominously, this incredible support has only stabilized the dollar’s freefall. Time to pause? With foreign central banks fully loaded to the gills with dollars and not all too tickled about it, it is not an easy exercise to contemplate a backdrop more conducive to a run on our currency. And how ironic would it be if such a run was instigated by our own institutions and citizens, as opposed to our foreign creditors?

Time for the Federal Reserve to contemplate pausing? Of course not. Chairman Bernanke just committed his first mistake. The dollar got clobbered. The flight to the safe-haven (non-dollar) metals intensified. The bond market froze (deer in the headlights?). And, as one would expect, global markets turned increasingly unsettled this week and are surely poised to become only more so.

Bernanke Burned

Gold up, silver up, stocks up, dollar down: This was the news through April, 2006. Then the anti-Bernanke music video hit the Web. It is a parody produced by students at Columbia University’s Business School. It appeared in the final week of April. It nails Bernanke. Within hours, it seemed to be everywhere. The thing is a riot. It is all here: the fear of inflation, the fear of recession (the inverted yield curve), rising interest rates, and doubts about a guy with a Ph.D. and beard. Parody is a way to draw blood gently. The video is funny precisely because Bernanke was an unknown academic until President Bush nominated him as Chairman.

Part of the new investing environment came because of the departure of Alan Greenspan from the Fed. The (misplaced) sense of security began to wane. While gold’s price has been moving up since 2001, the realization of what was happening finally began to register with the investing public. Gold rises for many reasons. One is a fear of war. There is fear that the dollar is overpriced, given the size of the trade deficit. The dollar began moving down within weeks of Bernanke’s confirmation. Then there is price inflation. It began moving up in January, 2006. Silver has raced ahead of gold’s pace ever since 2003. This also seemed to confirm widespread doubts about economic policy.

The Fed must walk the tightrope between price inflation on the one side, which will raise long-term interest rates and mortgage rates, threatening to pop the housing bubble, and a recession on the other side. The yield curve almost inverted in early April, 2006. This is the traditional harbinger of a recession. That would also threaten the housing bubble. There is a clever reference to this possibility in the video. The expansion of the U.S. money supply, beginning in late 2000, created the bubble condition of the housing market. The way to keep gold from going up, other than selling large quantities, is to stabilize the money supply. The FED actually began to follow this policy in January, 2006. But if this policy is extended, the fiat money-induced boom that began in 2001 will bust. Bernanke must find a way to escape from the trap Alan Greenspan set for his successor. This can be done, but only at the expense of a major recession.

The Fed dares not stabilize the money supply for long. Bernanke is famous for his speech in which he compared the Fed to a helicopter full of paper money. He is attempting to overcome that blunder with tight money. But the result of tight money will be a recession. Then it will be a depression. He knows this. He has hailed Milton Friedman for having told the economists in 1963 that it was the Fed’s deflationary policies that produced the Great Depression. What no Fed official admits is that in that same year, 1963, Murray Rothbard showed in America’s Great Depression, that it was the Fed’s inflationary policies in the late 1920’s that produced the boom that turned into the bust, 1929–32. The book is on-line for free. So, we see what lies ahead: more monetary inflation, more price inflation, and a falling dollar.

Historically, gold protects investors against price inflation. It did not, 1980 to 2002, but it does when central banks do not sell their gold to depress its price. The inexorable preference politically for more inflation in preference to recession and falling prices makes gold a hedge that is likely to gain increasing attention as the U.S. government’s deficit soars, its long-term Medicare obligations soar, and the trade deficit soars. Meanwhile, you should watch the Bernanke video.

Bernanke gets a crash course in leadership after dinner remark.

Federal Reserve Chairman Ben S. Bernanke is getting a crash course in what it means to be the head of the world’s most powerful central bank. Financial markets were blindsided yesterday after CNBC anchor Maria Bartiromo reported that Bernanke told her investors were wrong in thinking he is done lifting interest rates. Stocks surrendered gains, bonds fell and the dollar jumped in response to the remarks, which Bartiromo said were part of a conversation at the White House Correspondents Association dinner in Washington on April 29. It is not clear exactly what Bernanke said; a Fed spokeswoman declined any comment. What is clear, Fed watchers say, is that Bernanke underestimated the scrutiny that anything he says, even in a social situation, will receive now that he is chairman.

The confusion over the Fed’s intentions comes at a delicate time for markets and the central bank. After 15 straight rate increases, investors are alert for any sign that the Fed is about to conclude its tightening campaign, the longest in more than a quarter of a century. “We were swept off our feet” by CNBC’s report of Bernanke’s comments, said Richard Franulovich, a currency strategist at Westpac Banking Corp. in New York. “Bernanke is still easing his way into the role and learning what he can and can’t say, and to whom. … He’s probably learned a lesson.”

Bernanke told the Congress’s Joint Economic Committee on April 27 that the Fed may suspend the increases even if economic risks are tilted toward faster inflation. Policy makers meet to decide borrowing costs next week. “I asked him whether the markets got it right after his congressional testimony and he said, flatly, no,” Bartiromo said on CNBC. “He said he and his Federal Open Market Committee members were basically trying to create some flexibility for the Federal Reserve, saying the Fed may pause but the data will really dictate whether more rate hikes will occur.”

Bernanke is not the first Fed chairman to learn the hard way that his words carry far greater import than before. Shortly after taking over the reins at the Fed in August 1987, Alan Greenspan appeared on ABC’s “This Week with David Brinkley” and suggested that inflation could become a problem if consumers and companies thought that it was inevitable. Bond yields rose and stocks fell in response, and Greenspan never gave another television interview on the economy.

Bernanke burns the bulls.

As the rest of the world reveled in the rites of spring, the U.S. markets herked and jerked, weighing the Fed’s commitment to vigilance on the back of more strong economic data – and some backtracking by Ben Bernanke. Bernanke might have had good reason to jump back into the fray. Signs that risk appetite is abating or that the economy is slowing are almost nonexistent, so the Fed’s insistence that its policy is working or that inflation is “contained” is sounding stale. Most indicators are surpassing expectations, and predictions that the germs of a housing market slowdown would curb the U.S. consumer have been dashed at almost every juncture.

Monday, the Commerce Department reported that personal income grew 0.8% and spending 0.6%, beating expectations for 0.4% growth on both measures. Core prices, which exclude food and energy, climbed 0.3%, the biggest gain since October. As evidenced by all the M&A news, corporate spending is hardly a soft spot. Durable goods orders surpassed expectations last week, and the Institute for Supply Management reported that its factory index rose to 57.3 in March, beating expectations of 55.1. With corporate profits expected to grow about 16% in the first quarter, corporate credit spreads tightened against a declining U.S. Treasuries market over the past couple of weeks. Why shouldn’t they? Companies have a record $1.42 trillion of cash on their balance sheets through the end of December, according to Moody’s Investors Service. In other signs of voracious risk appetite, the private equity industry has so much cash it does not know what to do with it. The average price of a triple-C-rated junk bond is currently 92 cents on the dollar, according to Merrill Lynch – a level not seen since 1997, when high-yield credit spreads reached all-time lows.

With risk tolerances this high, maybe this is a good moment to investigate what could give the markets problems. Doomsday scenarios aside, there are a few threats. It could be the “ungluing of the carry trade,” as Leverage World CEO and publisher Marty Fridson notes. Investors looking for an example of such a scenario might consider Iceland, where capital was pulled out of krona-denominated assets in droves after the country’s credit quality came into question earlier this year. The country has a current account deficit amounting to roughly 16.5% of its GDP. If Japan raises its interest rates, the carry trade could take more hits, said Fridson. The dollar’s current selloff certainly does not make U.S. securities more attractive for foreign investors. The dollar slid to a 6-month low Monday against the yen, to 113.35, as fears mounted that the Bank of Japan will raise rates for the first time since 2000. The 10-year Treasury fell 17/32 to yield 5.13%. Meanwhile, light, sweet crude oil rose $1.82 at $73.70 per barrel.

But like functioning alcoholics, perhaps U.S. markets can stay on their feet – even with these risks in place. The proliferation of credit derivatives and hedge funds has given risk a happy home, for example. “There are plenty of things to be nervous about, and it is counterintuitive to people that we’re not sitting on the edge of a volcano,” said Fridson. “But we may be having the same conversation a year from now.” Against such a backdrop, the Fed’s slow and steady monetary tightening may require an unexpected shock to augment the lagging effects of its 15 hikes thus far.

WORLD ON THE MEND?

It seems like eternity since I was last optimistic on the world economy. It was back in 1999 when I argued that “Global Healing” would allow the world to make a stunning comeback from the ravages of the worst financial crisis in 60 years. My enthusiasm was short-lived, however, as the cure led to the mother of all liquidity cycles, multiple asset bubbles, and an unprecedented build-up of global imbalances. While an unbalanced world has yet to shake its hangover from global healing, I must confess that I am now feeling better about the prognosis for the world economy for the first time in ages.

The reason: The world is finally taking its medicine – or at least considering the possibility of doing so. Central banks are carefully adjusting the liquidity spigot – taking advantage of the luxury of low inflation to move very slowly in doing so. This delicate normalization procedure is necessary to prevent wrenching financial market crashes that would spell curtains for an asset-dependent world. Meanwhile, the stewards of globalization – especially the G-7 and the IMF – have finally come to grips with the imperatives of facing up to the perils of global imbalances. They are now hard at work in developing a multilateral solution to a multi-economy problem. At the same time, orderly currency adjustments appear to have resumed – and this time, in the right direction. Ever so slowly, the dollar is being managed lower – in keeping with the relative price shift that a long-overdue U.S. current account adjustment needs. As always, there are still plenty of serious risks – especially oil, geopolitics, fiscal paralysis, and protectionism. But the world now appears to be getting its act together, and that encourages me.

Central banks remain leading actors in this drama. They almost blew it – especially the monetary authorities in Japan and the U.S. By condoning asset bubbles and their concomitant distortions of debt cycles and increasingly asset-dependent real economies, both the BoJ and the Fed flirted with the most corrosive of macro diseases – deflation. While Japan finally seems to be exiting from its long slump, the jury is still out in America, as one bubble (equities) has morphed into another (housing). Central banks have been aided in their post-bubble tactics by an unexpected ally – a persistent disinflation, courtesy of a rapidly spreading globalization of both tradable manufactured activity and once nontradable services. This has provided monetary authorities with the luxury of moving slowly in weaning economies from their post-bubble medicine.

This is a delicate operation, to say the least. We are in the midst of what could well be the mother of all liquidity cycles. Courtesy of an extraordinary monetary accommodation, financial markets have enjoyed open-ended support from central banks. This has been a key role reversal for the tough guys who are supposed to take away the “punch bowl” just when the party gets good. The good news is that all of the world’s major central banks are now on the road to normalization. America’s Fed is furthest along in this process, and is now sending signals that this interim goal may be in sight.

Against this backdrop, the recent breakthrough in long-dormant efforts to reform the international financial architecture is especially encouraging. Global authorities had seemed asleep at the switch. That is no longer the case. I am pleased that they have risen to the occasion – not just by devoting a special annex of the recent G-7 communiqué to global imbalances, but also by empowering the IMF to expand its purview to multilateral surveillance and consultations. That finally puts teeth into the global rebalancing campaign. While that does not eliminate the possibility of a disruptive U.S. current account adjustment, it does mean that an unbalanced world is now taking its collective responsibility more seriously.

The wheels of global adjustment turn very slowly, but at least they do appear to be turning. The dollar is moving lower again after a 15-month hiatus from a multi-year decline that began in early 2002. Like Stephen Li Jen, I am not a believer that a weaker dollar is the cure for global imbalances. But I certainly do not buy the new-paradigm rhetoric of a newly symbiotic world that is built on a foundation of ever-mounting imbalances and a strengthening dollar. By contrast, I view dollar depreciation as part of the solution for America’s excess consumption problem. Another important part of that solution is the end of the U.S. housing bubble and the wealth-dependent excesses of consumer demand this bubble has supported. For that reason, I am also encouraged that the froth now seems to be coming out of the U.S. housing market. As the wealth effects from asset bubbles fade, I continue to believe that pressures will build on income-short American consumers – setting in motion the only realistic fix to America’s gaping current account deficit.

Finally, I am encouraged by what I see elsewhere in the world. I have just returned from my second trip to Asia in the past month, and I sense a major change in the region’s global perspective. That is especially the case in China, where the need to stimulate internal consumption has gained great traction in policy circles. If China pulls this feat off, it would do so considerably earlier in its development than Japan, Korea, and other Asian economies. Export-led Asia is finally coming to grips with the need to diversify its sources of growth. Given the likely consolidation of U.S. consumer demand – long the region’s most important customer – that is certainly a good thing.

As I put all these pieces together, I now believe that the odds are shifting away from a disruptive global rebalancing. That tempers my long-standing concerns over the possibility of a sharp decline in the U.S. dollar and a major back-up in real long-term U.S. interest rates that such a currency crisis might have triggered. Lest I be accused of succumbing to the ravages of terminal jet leg, I assure you that I am still mindful of the ever-present risks that beset a very fragile world. The U.S. is rapidly becoming the global poster child for fiscal irresponsibility – not exactly a constructive development for the world’s biggest borrower.

I am not prepared to give an unbalanced world the green light, but it is time to give credit where credit is due. First, to globalization for holding down inflation. Second, to central banks for collectively embarking on policy normalization campaigns. Third, to the stewards of globalization for facing up to the imperatives of architectural reform. And fourth, to Asia – especially China – for recognizing the unsustainability of export-led growth models. Notwithstanding the risks – all of which need to be taken very seriously – I am delighted that the global economy finally seems to be taking its medicine. Let us hope the cure works.

FORECLOSURES UP IN CALIFORNIA; EXPERTS NOT WORRIED

Increasing foreclosure activity in California may be a sign of worse to come, but for now remains well below historic norms. Lending institutions sent 18,668 default notices to state homeowners from January to March, up 23.4%t from the fourth quarter and 28.7% from the same period a year ago, according to La Jolla-based DataQuick Information Systems. DataQuick analyst Andrew LePage said that the Golden State’s historic average is around 33,000 notices per quarter. “It tends to lurch whenever it’s coming off the bottom like that.”

DataQuick said the main reason default notices are rising is that home value increases are flattening, which makes it difficult for homeowners to sell when they run into trouble. Economist Stephen Levy agreed the jump is not worrisome in itself but said it could be a sign of building stress in the housing market. He said he believes that many home owners will be at greater risk for foreclosure in the coming months, as teaser rates on the adjustable-rate or other riskier loans that helped fuel the recent real estate boom adjust to higher minimum payments. The percentage of East Bay buyers who opted for adjustable-rate mortgages increased from 3.4% in 2000 to 28.2% in 2005, according to San Francisco-based LoanPerformance.

With low interest rates vanishing, homeowners take more cash.

A greater proportion of mortgage refinancers tapped their home equity for cash in the first three months of this year than in any other quarter in the past 15 years, according to an analysis by Freddie Mac. About 88% of people refinancing their homes took out loans for at least 5% more than their original balances, according to the analysis. However, more than half took loans at higher interest rates than they previously paid. In years past, refinancers chased lower rates.

The refinancing activity comes as interest rates are rising. By refinancing, some homeowners can get out of adjustable-rate loans on their first or second mortgages or their home-equity lines of credit and switch to fixed-rate loans. It is the first time in more than five years that borrowers as a group are paying higher interest rates after refinancing, according to the report. “If you are watching and listening, the Fed is telling you interest rates are going to climb,” said Amy Crews Cutts, deputy chief economist at Freddie Mac. “Smart consumers are out there making plans about what will happen. … They are either consolidating debt, or leaving the table with a check, or both.”

“The short story is that everyone has a ton of equity,” said Glenn Schwartz, president of Vision Mortgage LLC in Rockville. He said local homeowners are refinancing to arrange fixed-rate mortgages, get cash for home improvements or, in some cases, to buy beach houses. Ira Rheingold, general counsel of the National Association of Consumer Advocates, said he feared that some people are spending too much of their equity, which could leave them financially exposed. “I don’t want to sound like Chicken Little here, but we’re heading for a big fall. Our policy of using our homes as our banks is bad public policy, and we need to think of the long-term implications of the debt we have. It’s a homeownership economy where people don’t really own their homes.”

Mortgage brokers say that what has been happening is a last single burst of refinancing activity, particularly by people who have adjustable-rate mortgages and want fixed-rate loans. Adjustable-rate loans usually start out at lower interest rates than fixed loans but can shoot up as rates change. The percentage of cash-out refinancings in the first quarter was the highest since the third quarter of 1990, about the time the real estate boom of the late 1980s ended, according to Freddie Mac.

SEC TO REDUCE FEES ON SECURITIES TRANSACTIONS

The U.S. SEC announced that fees on securities transactions and registrations will be reduced by $1 billion in the fiscal year commencing October 1, 2006. The SEC sets registration and transaction fees according to the Investor and Capital Markets Fee Relief Act. In fiscal year 2007, the fees that public companies and other issuers pay to register their securities with the Commission will be reduced by 71.3%, and the fees applicable to most securities transactions will be reduced by 50.2%. “This is terrific news for investors,” explained SEC Chairman Christopher Cox. “Even by Washington’s standards, a billion dollars is a lot of money. Money that ultimately would have come out of investors’ pockets can instead now go to retirement accounts, college savings plans, and other investment goals.”

IT IS FEELING LIKE 1996 IN ASIA ONCE AGAIN

Navigating the roads of Hyderabad is a death-defying feat at the best of times. Things seem even more perilous this week as trucks, motorbikes, tractors, cows and horse-drawn carts compete with a small army of Mercedes sedans. A highly unusual sight in the southern Indian city, the swarm of luxury vehicles is ferrying investment bankers between five-star hotels and Hyderabad’s newly constructed exhibition complex, where the Asian Development Bank is holding its annual meeting. Sightings of Westerners in pinstriped suits tapping away on a Blackberry are becoming more frequent at Asian gatherings, a reminder that the region is hot again. So is the fact that, in U.S. dollar terms, the Morgan Stanley Capital International Asia-Pacific Index, excluding Japan, this week returned to levels not seen since the days before the 1997 financial crisis.

In 1996, speculative capital pumped up economies. A year later, it helped touch off the worst financial crisis the world had seen in decades. Even faster than it flowed into Asia, the money fled, slamming asset prices and living standards from South Korea to Indonesia. The events of the late 1990s seem like ancient history in Hyderabad. Asian Development Bank President Haruhiko Kuroda has predicted developing Asia will grow 7.2% this year. Neither record oil prices nor rising interest rates around the globe are denting Asia’s boom. “Asia is having a big party,” said Andy Xie, Hong Kong-based chief economist at Morgan Stanley.

The catch is that Asia cannot afford to disappoint investors as it did in the late 1990s. So is Asia ready for all the attention it is getting? Yes, and no. There is little doubt financial systems have been strengthened, foreign-currency debt reduced, foreign-exchange reserves rebuilt and efforts are growing to combat corruption. Asia learned a lot from the crisis and its economies have grown up since then. Lost in the excitement is that Asia’s post-crisis recovery is a work in progress. Exports still provide a disproportionate amount of growth relative to domestic demand. Underdeveloped bond markets mean banks still supply too much of the region’s financing. Corruption, to varying degrees, continues to undermine corporate sectors.

Asia has shipped more than $1 trillion of savings to the West, where it is parked in U.S. Treasuries. That is an unfortunate arrangement. Asia should be using the money to fund research and development, infrastructure, education and health initiatives. Geopolitical hiccups still shake markets too frequently. And let us not forget scandals involving leaders of Thailand and the Philippines. For all the capital that is rushing toward Asia, the region lacks confidence. Insecurity can be seen in how quickly finance ministries from Tokyo to Bangkok have begun fretting over rising currencies.

Rising currencies are not Asia’s problem, though. The challenge is using today’s capital inflows more wisely and productively than the region did in the 1990s. Back then, hot money poured in, boosting asset values and making economies seem healthier than they were. It was speculation that was boosting Asia’s markets, not economic fundamentals. Today’s boom is more organic. Investors are betting on Asia’s fast-growing cities, young populations and the emergence of its middle-class consumer sectors.

Perhaps most convincing about Asia’s revival is how the region has become less reliant on the West. In the past, rich nations helped finance Asia’s economic booms. This time around, developing economies are helping the West maintain its way of life via purchases of U.S. debt. It is an intriguing reversal of fortune. Asia cannot afford to let investors down again. It is incumbent upon leaders to use the window of opportunity afforded by today’s growth to stabilize economies and markets. Investors may be willing to forgive Asia for 1997. They are unlikely to forgive again if Asia cannot keep its party going.

Japan’s fiscal situation is “severe”, finance minister says.

Japan’s fiscal problems are severe and the nation’s revenue and spending need to be addressed to find a solution, Finance Minister Sadakazu Tanigaki said. “Our fiscal situation remains extremely severe,” Tanigaki said in a speech to the annual meeting of the Asian Development Bank in Hyderabad, India. “I am determined to pursue structural reform on the fiscal front, both in revenue and expenditure.”

Japanese policy makers are at odds about how to reduce the nation’s budget deficit and stop the expansion of the public debt, forecast to swell to 151% of GDP by the end of March 2007. They are also concerned an increase in interest rates by the Bank of Japan will increase the cost of servicing that debt. Tanigaki has signaled the need to raise taxes, pitting him against some members of the ruling Liberal Democratic Party who do not want to repeat of 1997, when a consumption tax increase pushed the economy into recession.

Japan’s economy has improved over the past year, Tanigaki said, citing its 2.7% economic growth in fiscal 2005 and forecast for 2% growth in fiscal 2006. “The Japanese economy is now enjoying a stable private sector-led growth, after succeeding in eliminating excesses in three areas that used to hamper growth, namely employment, production capacity and debt,” he said. The ratio of non-performing loans of Japan’s biggest banks declined from 8.4% in the first quarter of 2002 to 2.4% in the third quarter of 2005, he said. Japan’s jobless rate was 4.1% in March, a 7-year low.

NON-PERFORMING LOANS NOW A HOT MARKET

A new report by Ernst & Young reveals that the total global market for nonperforming loans (NPLs) is in the midst of its hottest of period of transaction activity in the last 20 years – and the market shows little sign of cooling. In fact, with almost three dozen major NPL sales over the last 24 months by German lenders and the expected pick up in NPL sales activity in China over the next year or so, worldwide transaction activity is expected to quicken, leading Ernst & Young to conclude that the NPL market has clearly evolved from a series of regional market opportunities to become a full-fledged, mature global marketplace.

Born out of the collapse and subsequent government-backed rescue of the U.S. Savings and Loan industry in the late 1980s, the burgeoning investment market for packages of nonperforming loans has now almost completely circled the globe with major NPL sales in Asia and Europe over the last few years. According to E&Y, at its peak, the NPL market totaled $4 trillion, or roughly one and a half times the entire proposed U.S. fiscal budget for 2007. The global market began to develop when NPLs ballooned dramatically throughout Asia following the 1997 financial crisis there. Today, NPLs are traded in more than a dozen global markets – all of which are profiled and analyzed in E&Y’s “Global Nonperforming Loan Report 2006”. These include some of the world’s largest economies including Japan, Germany, China, and India.

According to Jack Rodman, one of the primary authors of the report and a veteran advisor on NPL sales in the U.S., Japan and China, the development of this global multi-$trillion market has resulted in a huge learning curve for banks, regulators and investors alike. “A combination of poor lending practices, inadequate regulation and failures to reform banking systems has created huge losses for banks over the last 20 years. We estimate the average recovery of NPLs worldwide to be about 33 cents on the dollar,” says Rodman. To make matters worse, Rodman says, the economic impact of NPLs created staggering losses for many countries and caused their economies to languish for as long as 10 years. Small wonder, then, that many observers today are concerned about the possibility of large scale loan foreclosures in the U.S. following several years of robust lending activity, particularly in the highly cyclical real estate market.

The 2006 report does point out though that almost every country covered in the 2004 edition of the report, with the notable exception of China, has managed to reduce its “legacy NPLs” (loans made before 1997). There are signs even in China that transaction activity may be on the rise. China is poised to allow foreign investors access to its banking industry and, despite a slow start, the NPL disposition process has accelerated there in the last 12 months. However, considering E&Y’s own conservative estimate of the actual depth of China’s total NPL exposure – at $900 billion, substantially more than any other country in the report – and the large numbers of legacy (pre-1997) loans still to resolve, China’s NPL problems appear far from over. As reported, China’s overheated property markets are certain to produce fresh NPLs in coming years.

Japan, Taiwan and Korea have, according to the report, all successfully addressed major NPL problems in the last few years. “As they have established mature NPL markets, they’ve put their banks on a stronger footing,” says Rodman. The report cautions, however, that regulators need to be on guard for signs of overreaching by banks or they may face the prospect of further NPL problems such as those currently being experienced in Indonesia, where NPL levels rose in 2005, or India, which is expected to become a major market for NPL investors in the next few years. By far the largest NPL market in Europe is Germany where, despite any public acknowledgement of an NPL problem by banking regulators, there is estimated to be more than $300 billion in bad loans in various stages of resolution and 32 separate transactions are reported to have taken place since late 2003. This level of activity makes Germany the most active NPL market in the world, the report says.

Looking to the future, Ernst & Young expects the market to continue to flourish, especially as the convergence of regulatory, accounting and reporting standards and best practices bring even greater transparency to the disposition and management of NPLs. “[W]e expect capital flows to distressed assets will reach record levels over the next few years,” Rodman predicts.

China still vulnerable despite war on bad debt.

At first glance, Beijing would appear to have tackled head-on the mountain of bad debt in its state banking system, debt which has built up over some 20 years since the government began opening the economy in the late 1970s. In 1999 the government established bad-debt disposal companies to sell off sour loans, used bank profits to wipe out more and also pumped in cash from its foreign exchanges reserves to recapitalise the institutions. In all, China cleared about $560 billion of bad debts in a flurry, an amount equal to about half the country’s GDP at the time the funds were deployed.

Therefore, after a period during which China enjoyed boisterous economic growth rates, it is surprising that a series of new reports say non-performing loans (NPLs) remain stubbornly high and may be getting worse. A report issued by Ernst & Young puts China’s total liabilities for non-performing loans at just over $900 billion, even higher than its $875 billion stack of foreign reserves, the largest in the world. The findings of the E&Y survey are broadly in line with a report by professional services firm PwC, issued last week and similar in tone to another lengthy report released this week from McKinsey, the consultancy, on China’s financial system.

“I think the numbers will be a big surprise because China has been giving the impression [with its banks listing overseas] that the problem is behind us,” said Jack Rodman, a managing director with E&Y. “China has not really resolved the issue – they have just moved it from one state enterprise to another.” The three reports say the original stock of bad loans has not been dealt with and that a huge stack of new NPLs has been created. “While there have been improvements in the banking sectors, and the government has sought to address NPLs, the core causes for the build-up have not been fully dealt with,” said the McKinsey report. “Until these problems are addressed, the problem is likely to persist, and the banking system will remain vulnerable to potential liquidity shocks.” The “problems” are familiar – a lack of commercial mindset among banks and skills to assess credit risk, and a sprawling nationwide branch system over which the head office in Beijing has little control.

The bad debt disposal agencies, known in China as asset-management companies (AMCs), have taken on about $330 billion in sour loans since 1999, but have only resolved about $100 billion. Much of the 20% cash recovery rate earned by the companies has been used to fund their operations, with the state receiving little, according to E&Y. The Finance Ministry has had to keep carrying the burden of guaranteeing bonds issued to the banks by the AMCs when they took the loans on to their books.

The disposal market is in an even worse state because the AMCs have been bidding against each other, driving other potential investors, especially foreigners, out of the market. Foreign investors are wary of returning to the China market because of the difficulty of getting clear title to the assets and the artificial reserve prices imposed on the auctions. Holding bad loan auctions almost invariably means setting prices for the sale of state assets, a sensitive issue for a government not wanting to be seen to be condoning firesales. The failure to clarify these issues will haunt China as it seeks to revive auctions of bad loans this year.

China needs more Volcker, less Greenspan.

Moments after China’s central bank shocked the world with a rate increase, Goldman Sachs was telling clients that the surprise move may boost the economy, instead of slowing it. The central bank’s governor, Zhou Xiaochuan, could not have been happy, yet Goldman economist Hong Liang had a point – one to which markets should be paying more attention. The People’s Bank of China last week raised its one-year lending rate to 5.85% from 5.58%, while holding the deposit rate at 2.25%. Liang warned that only adjusting the former increases banks’ lending margins and may boost credit creation, the opposite of what Zhou wanted. “It enhances banks’ incentives to lend,” said Liang, head of China economic research at Goldman Sachs in Hong Kong.

Alan Greenspan was Mr. Gradualism. A quarter percentage-point move here, a quarter point there. Zhou was clearly reading from Greenspan’s playbook when he called last week’s 0.27 percentage-point increase a “moderate adjustment”. Given the risk that rapid credit and investment growth could destabilize the country, it seemed pretty modest. China needs less of Greenspan’s gradualism and more Volckerian monetary gruffness. China’s challenges have little in common with ones facing the U.S. in 1979, when Volcker took the Fed’s top job. With U.S. consumer prices surging 14% and bond yields at 15%, Volcker launched one of the epic battles of modern economics, driving the federal funds rate to 14%. Volcker’s hawkish policies made him arguably the most disliked man in America at the time. They pushed the U.S. into recession and unemployment to more than 10%. When Volcker turned the keys over to Greenspan in 1987, inflation was 4% and the stage was set for the economic boom for which Greenspan got so much credit during the 1990s.

Just as Paul Volcker did more than 26 years ago, Zhou needs to bring fresh thinking, innovation and some unconventional strategies to engineer a soft landing. Beijing’s go-slow approach on the yuan means last week’s rate increase, and any additional ones in the near future, could actually boost lending. That is why some kind of monetary, regulatory and currency package might make sense. China needs to act far more drastically to rein in money growth and investment. The roadmap may have less to do with Greenspan than his less-beloved predecessor.

China stresses FX caution, imbalance concerns grow.

Financial leaders from Asia’s biggest economies voiced concern on about global trade imbalances but China said it could not move too fast on the yuan and that developed nations must do more to fix the problem. Top policy makers gathered for the annual meeting of the Asian Development Bank (ADB) in Hyderabad, southern India, where China’s vice finance minister, Li Yong, said he was quite concerned about global imbalances. “I believe we should share the responsibility. We are all on the same boat and no one can escape if this boat sinks,” he said. “Major developed countries should take more responsibility. We need consultations rather than trade protectionism and we should not politicize trade imbalances.”

China is at the heart of the trade imbalance debate. U.S. critics charge that it keeps its exchange rate unfairly cheap, pushing its booming exports even higher. China’s economic strategy aims to reduce its reliance on exports and Li reaffirmed this aim, saying the country was working to boost domestic demand to help rebalance the economy. But the minister underlined the country’s cautious stance on currency reform, saying Beijing could not move too fast because it needed to create jobs and bolster the fragile banking sector.

THE RATIONALE FOR DOW 36,000 … REVISITED

One of the most memorable expressions of the bull market mania of the late 1990s was the “Dow 36,000” forecast published in the Wall Street Journal in March 1999 (previewing the book by that name). I will not spend time revisiting the big number, given that six years later the outcome speaks for itself. Yet I do want to recall that the authors at least presented a rationale for their analysis. They argued from a simple set of economic fundamentals, and on a perceived psychological trend among U.S. investors.

The economic fundamentals are in this sentence: “Our calculations show that with earnings growing in the long term at the same rate as the GDP and Treasury bonds below 6%, a perfectly reasonable level for the Dow would be 36000 – tomorrow, not 10 or 20 years from now.” For more than three years now (2003, 2004, 2005, Q1 2006), long-term earnings growth for S&P 500 companies has held in the double digits. This more than meets “the same rate as” criterion in GDP growth, which stood mostly between 3% and 4% during the same period. As for the yield on Treasury bonds, it has not seen 6% since June 2000.

Here is their description of the psychological trend: “What has happened since 1982 is that investors have become calmer and smarter. They are requiring a much smaller extra return, or ‘risk premium,’ from stocks to compensate for their fear. That premium, which has averaged about 7% in modern history, is now around 3%. We believe it is headed for its proper level: zero. That means stock prices should rise accordingly.” Apart from the absurd notion that “zero” is the “proper” level for the “risk premium”, there is no doubt that investors have indeed been willing to accept smaller extra returns.

So as far as the specific economic and psychological criteria go that should lead to Dow 36,000, there is no escaping the conclusion: that criteria has been met. What is also true is that the Dow is near – but has not revisited – the all-time high it reached in early 2000. “Economic fundamentals” do NOT drive stock market trends. Psychology does.

EURUSD: GIVE POOR GREENBACK A BREAK

The USD just cannot win lately. Not even this morning’s (May 4) truckload of positive U.S. economic data was able to stop the dollar’s 2-month-long losing streak. Get this: productivity is up, factory orders are up, workers’ hourly compensation is up, consumer spending is up, retail sales are up. “The US Economy Firing on All Cylinders”, says a Reuters’ headline. Even the single “downside” for the U.S. economy that analysts deduced from this morning’s numbers – namely, the “increased risks of a more aggressive Federal Reserve” – for the dollar is not a downside at all! The more rate hikes, the better – is that not forex analysts’ present-day mantra?

Add to that the fact that the European Central Bank left European interest rates unchanged. True, the ECB President Jean-Claude Trichet did say they were leaving the rate hike option on the table – but so did Ben Bernanke about the U.S. rates! And this morning’s strong U.S. data only confirmed that expectation. But apparently, all that does not mean a thing in the bizarro world of currency trading. The dollar lost today – again, and big: 1.5 cents in one day. WHY?

The simple answer is … no reason. No conventional economic reason, that is. By conventional standards, it is the euro that should have gotten pounded into a corner. And the only reason it did not is because the EURUSD’s wave 3 rally was not yet over. Third waves are the most powerful ones in the Elliott wave sequence, and when they get going, watch out.

GOLD AT $635: BUY, SELL, OR HOLD?

Below, I will provide an interesting calculation on gold. That is my main contribution to this subject that I am willing to make public, apart from the intervening paragraphs. If this sounds as if there is far more that I know about gold that I am not revealing, I doubt it. If I do, it has not yet bubbled into my consciousness. I do not make gold forecasts and very few other forecasts, publicly, that is. It is enough of a challenge for me to figure out how things work. My ignorance and shyness shield me from making very many predictions. But I surely appreciate the boldness of those who do make forecasts and lack my character defects. Predictions are great fun. They are useful. We should have them. It is just that I always start wondering what underlies them. I think predictions should be accompanied by some sort of explanations.

This week my banker asked me what I thought the gasoline price would be in September. First I laughed. Then I hesitated. Then I told him it would be the same price as today. Many markets are basically random walk markets. In such instances, today’s price is about the best forecast that an ignorant investor can make. What do I know compared with what the market knows? Very little. Usually. There are times, however, rare instances in which I make a calculation or two. I thought stock prices were absurdly high in 1999 and 2000. Every valuation model showed overvaluation clearly. Some people wrote books about it. I did not. Maybe I told a few people. But that is a difficult venture. If you tell them when to sell, then you have to tell them when to buy back in. First thing you know they are depending on you for their portfolio decisions. I have enough worries. Second thing you know is they are blaming you when you make the inevitable mistakes. I let my relatives and friends make their own mistakes.

By the way, I have not finished about my banker. He insisted that the price would be $4.00 by September and gave me excellent reasons why. These can be found in every newspaper, Chinese demand, the peak driving season, etc. I told him that I thought crude oil would decline at some indefinite point in the future back to $50 or even $25. I mentioned that the last time around crude had plunged from $40 to $8 to $10. When markets crash, they often drop 80 to 90%. If the peak here is $75 or $80 or whatever, a drop of 50% or more is quite likely. Oil producers and explorers will do the same they have always done, I explained: find and produce more oil. You may wish to tell me all the reasons why this time will be different. People always explain things to me. I listen. I may question, even discuss. Then I make up my own mind.

I admit my model for crude oil is crude. Simplicity has its virtues. If I attempted a sophisticated econometric model, it would not work anyway. It cannot. So I hold to the simple idea that high prices bring forth greater supply even as they curtail demand. Industries go through capacity cycles. The bottom line concerning commodity price cycles is that I am reluctant to make a big bet on gold based upon commodity prices. They quite often collapse. Maybe Harry Browne, alev ha sholem (may he rest in peace), was right. Stop worrying about all this and divvy up your money into 4 piles: gold, cash, long bonds, and stocks.

My banker still seemed unsatisfied with my answer, so I told him to put me down for $3.75 in September. He brightened up considerably. I secretly thought, no, the price will decline. If I predict a rise based on my “feeling” or “intuition”, then in all probability there will be a decline. Gasoline will decline below $3 by September. I have learned how to “copper” (go against) my own feelings. By the time I recognize momentum in a market, it is getting ready to reverse, usually after a few months. Mean reversion is what occurs, or what goes up comes down and vice versa, but not until the price move goes much further than one anticipated. Markets make fools of us all. Are there any winners? They do not write articles like this.

Do I know how the gold market works? Absolutely not. I have no special knowledge of the gold market, so do not expect a detailed analysis of the factors that might be influencing the price of gold. I do not know why gold languished for many years. I do not know why it has recently zoomed up. But since I have to decide whether to buy, sell, or hold, I need a theory or two to guide me. I use technical analysis, but without an idea of basic value it is not enough for me. I need to have an idea of what gold’s fundamental value is. If there is a flight from the dollar as the gold bugs avidly hope for and predict, gold will withstand the demise of the dollar. In a world where the dollar declines continuously at a known rate and interest rates are high enough to compensate for the loss, it makes no difference whether one holds gold or dollar assets. The problem is that in the real world we do not know whether interest rates suffice to offset inflation in money. I happen to think they do not. I am not willing to make a big gold bet on the basis that interest rates are too low or too high. My ability to forecast interest rates is negligible. Harry Browne’s four pot strategy is again looking good.

Now for my calculation. The gold price was $20.67 an ounce in 1932 and for many years before. It seems like it was too stable, perhaps because of government price-fixing. But lacking a better number, I will use $20.67. I will not use the $35 an ounce that the government used later in that year because that was a New Deal artifact. I trust the long history at $20.67 more. Now in 1932 the M1 money supply was $20 billion. The American population in 1932 was 125 million and now it is 270 million. This provides a factor of 270/125 = 2.16. If the old M1 was good enough for Americans in 1932, then perhaps it would be good enough for Americans of today. There are more of us, so I will multiply 20 x 2.16 = $43.2 billion. That is a dicey calculation, as any economist will tell you. I will stick with my factor of 2.16. At least you know how I got it. Alter it if you want to. Next, the amount of M1 today is $1,372 billion. Per capita M1 has risen by a factor of 1,372/43.2 = 31.76. Finally, what gold price suffices to monetize this amount of M1? Compute 31.76 x $20.67 = $656.

I confess I was as shocked as you are when I did this calculation sev have always chosen M1. I have always thought that currency and demand deposits are pretty much what people use for money. The Federal Reserve controls the monetary base. Monetarists focus a lot on the base. It is gone up by a factor of 53.19. That implies a gold price of $1,099. However, the banking system and the public have created M1 to use, not the monetary base. The money multiplier between the base and M1 intervenes. Gold bugs fondly point to other M’s, like M2 and the beloved M3, because they have risen by factors that exceed M1. They imply gold prices higher than $635 an ounce. M2 was $45.0 billion in 1932 and today it is $6,775 billion. It is up by a factor of 6,775/45 = 151. That makes gold’s fundamental price today 151 x 20.67 = $3,121. I include M2 here merely to show how a gold bug projects a price of gold of $3,000. If you prefer M2, that is your prerogative. Then you may wish to hold more gold.

I have provided one idea that perhaps gold is neither greatly overvalued nor undervalued at $635 an ounce. This observation will not prevent the gold price from rising or falling markedly after this article is published.

HIGHER METALS PRICES BRING BOOM TO COIN DEALERS

With gold and silver prices at 26-year highs, northern Nevada coin dealers are doing brisk business. Rusty Goe, owner of Southgate Coins in Reno, says he is fielding dozens of inquiries a day from people wanting to know how much their gold and silver coins are worth or how much they can buy. Customers run the gamut. “We’ve got wage earners who save for a couple of months and come in and say, ‘I have got $200, how much gold can I buy?’” he says. “And we’ve got people in the six-figure range. I just got a call Friday from a guy who wanted to buy $100,000 in gold.”

The higher prices are bringing both buyers and sellers into the market, although coin dealers say buyers outnumber the customers wanting to cash in. “They figure if they buy now, they are going to ride the train on the way up,” says Larry Demangate, owner of Sierra Coin in Reno. Kathleen Danforth, owner of Reno Coin Co., says business started picking up at her shop about a month ago when the silver price rose above $10 an ounce. She says most buyers at her business are spending between a few hundred dollars and $1,000 on smaller silver pieces, such as one-ounce rounds and 10-ounce bars.

But the price spike is not the only thing luring investors. Demangate says the eroding strength of the dollar, the federal government deficit, skyrocketing oil prices and the uncertain world political situation have many people wanting to diversify their holdings. “Gold is an insurance policy.” Southgate Coins has people on waiting lists for one-ounce gold bullion coins and bags ($1,000 face value) of “junk silver” coins. The most popular gold coins are American Eagles, Goe says, which feature the image of an American eagle feeding her young. Meanwhile, many people who have been out of the market request Kruggerands because those were the predominant one-ounce gold coin years ago. South Africa began producing them in 1967. Other countries followed with their own one-ounce gold coins, including China, the United States, Austria and Australia.

Junk silver coins are American coins circulated before 1965 containing 90% silver. At last Wednesday’s silver price, a bag of junk silver with $1,000 face value – 715 ounces – was worth $9,237.80. Investors also buy one-ounce silver rounds, which are produced by independent mining companies, silver American Eagles, as well as 5-, 10- and 100-ounce bars. Meanwhile, the collector market is jingling right along, too. The buzz about high gold and silver prices creates interest in rare coins, causing those prices to go up, too, Goe says.

TOP TEN SIGNS OF A PRECIOUS METALS BUBBLE

Recent price spikes and increased volatility in gold and silver markets have many observers predicting a dramatic popping to what they claim to be a precious metals bubble. However, after having sold physical precious metals to the public for the past five years, I can attest that none of the characteristic signs that have typified bubbles in the past are visible in today’s market. Thought metals prices have indeed risen strongly, those gains have come from ridiculously low prices reached at the end of a 20-year bear market. To consider metals prices too high in this market makes as much sense as saying current technology stock valuations are too low relative to their 2000 peaks. In fact, despite the current run-up, precious metals prices remain well below normal levels when measured against other asset classes.

I have owned mining shares in my personal account for years, yet not a single share has split. Despite significant appreciation, the total capitalization of the mining sector remains tiny when compared to the overall market. There are many individual S&P 500 stocks with market capitalizations greater than the combined capitalization of all the gold stocks in the world. In fact, Newmont mining remains the lone gold stock in the S&P 500. I am certain that if we were in the final stages of a speculative blow-off, my gold stocks would have split many times over, and gold stocks in general would be far better represented in the S&P 500 Index and would constitute a far greater percentage of its capitalization. In addition, a much higher percentage of our nation’s wealth would be concentrated among mining tycoons and precious metals investors (hopefully myself included), much as was the case with dot-com billionaires and today’s real estate moguls.

In addition, while it is also true that the financial media has increased its coverage of metals and mining shares recently, what else are we to expect? After all, such performance cannot be completely ignored indefinitely. With the broad markets are flat and uninspiring, would you not expect the media to focus attention on where the action is? Certainly the mere fact that they do is not de facto evidence of a bubble.

As part of our full-service brokerage business, Euro Pacific [the author’s company] launched a precious metals division about five years ago. Until this week that division consisted of a single employee, comprising less than 5% of my total workforce. This week I finally added a part-time employee to help with the increased business, which is up about three fold over the past two years (with about half that gain occurring during the past several months). Brisk business no doubt, but a real bubble would have required staff increases of a much greater magnitude. In addition, a bubble would have brought on new legions of competitors (perhaps bankrupt mortgage lenders reorganized as precious metals dealers).

As I am on record as having accurately recognized both the stock market and real estate bubbles while each was still forming, my track record on bubble spotting is strong. In contrast, most pundits who claim the precious metal market has crossed into bubble territory were blindsided by these prior bubbles. Since many of these doubters do not even understand why the believers are buying, their natural conclusion is that a speculative bubble must be underway. After all, if buying gold was a smart investment, they would be doing it themselves. As has been the case for all real manias, if metals investing were a speculative bubble, it would have migrated from the financial and commodities spheres to make an impact on the broader culture – taxi drivers would be offering tips on mining shares.

For now, the precious metals bull market climbs a classic “wall of worry”. Once fear gives way to greed, there is no doubt in my mind that this major precious metals bull market will ultimately produce a speculative bubble. However, such a development is years from unfolding. To help identify when a precious metals bubble might actually be about to pop, I have composed my list of the top ten signs to watch out for. [#1: Tom Cruise and Katie Holmes name their newborn son Newmont!]

Seasons of Gold

Many are already aware of a resource market phenomenon broadly referred to as the “quiet season”, which we tend to view as the “Shopping Season”. You also might call it summer. Gold typically shows weakness from February to April, rallies in May, then heads down for summer. In August, gold typically begins to rebound and moves up pretty much for the rest of the year. Of course, this is an average pattern, not an invariable one. In 10 years out of the last 30, gold dropped in the fourth quarter. Even so, the long-term data suggests the average pattern is worth paying attention to.

But will the pattern hold up in the current bull market? The historical data is sparse, in that gold has traded freely only since Nixon closed the gold window on August 15, 1971. That triggered gold’s only secular bull market so far, from $35 in August 1971 to $850 in January 1980. For the moment, let us discount that market’s first big leg, to December 1974 (when gold reached $200), as catch-up for decades of currency inflation. The best analogy to our current circumstance is the period from August 1976, when the metal bottomed at $103, to gold’s peak in 1980.

Why should gold bullion have a seasonal pattern? There are several reasons, among the more important being the jewelry market, which accounts for about three quarters of the gold sold each year. What we see for the fourth quarter of each is the impact of the gift-giving tradition associated with the druid Winter Solstice, now known as Christmas. Layered on top of that is the Indian festival season of Diwali, which kicks off in November and continues through the first leg of the traditional wedding season in December. You can see noticeable spikes in both January and September, months when Indian manufacturers typically restock inventories to meet the demands of the two Indian wedding seasons. The first, mentioned above, starts in November and ends in December. The second starts in late March and runs through into early May.

Can Indian jewelry buying be a major driver of gold market seasonality? Probably. Gold, viewed as an industrial commodity, has been in a primary supply deficit since 1990 – more has been used than produced, and the world has been living out of inventory. Now Western central banks are slowing their ill-advised selling, and people in China, Russia, the Mideast and India will be buying in size. Further, in 2005, investment in gold ETFs and similar financial products showed a 53% increase, to 203 tonnes. And things are barely starting to warm up. Given the tight supply and growing demand, this is a market where prices are very much set on the margin, which is where India plays a role. The propensity to lavish gold on blushing brides has kept pace with the country’s rapidly rising wealth. In 2005 Indian gold jewelry sales rose by 25%, and now that country takes credit for about 23% of the world’s consumer gold sales. The U.S., at #2, takes down just 12%.

Jewelry buying is nice and certainly contributes to gold’s seasonality. But what is really going to supercharge the market is buying by central banks and the public, as they increasingly realize that the dollars they are sitting on are melting. The summer dip in gold, needless to say, does not help gold stocks. It is amplified by the habits of Canadian brokers, who deal with their relatively short northern summer by taking relatively long summer vacations. That means fewer stories being breathlessly told to listeners with cash. Even worse, the brokers – wanting to keep their clients safe while they themselves lounge at lakeside cabins – begin telling clients in March to sell and sit aside during the summer months, which sucks more air out of the market. It is worth noting, however, that here we are in April and we see little sign of gold stock weakness. And the people who do the actual exploration generally are busiest in the summer, typically working in remote areas of the Northern Hemisphere largely inaccessible in the winter. The absence of explorers from their offices translates into a dearth of news, made worse by the fact that even if there were new, the companies would want to hold on to it until it would do them some good, i.e., when there are brokers actually sitting at their desks.

To recap, in the summer gold bullion prices soften, resource brokers stop working the phones, and explorers head out to kick rocks and go incommunicado. There is a news slowdown, low trading volumes and a flat to declining market for resource equities from about April 1 to about August 1, give or take a month. And it is during that quiet period that we happily focus on shopping for our favorite stocks. Or at least, that is the way it is supposed to work. I am not going to tell you that things are going to be different this year. But only because the person who tells you “this time is different” is usually wrong and often walks into a disaster. However, when pondering gold’s seasonality, it is better to look at gold’s daily price action from January 1975 through January 1980. While the seasonal pattern generally holds up, the trend is clearly for higher lows and higher highs throughout. That is, in our view, the track we are currently on. While gold’s price reflects the long-term seasonal pattern, the pattern is overlaid on a strong upward trend.

And lest you have any doubt, I am convinced we are now in the gold (and silver) bull market for the record books, a bull market that will surprise even me with its strength. And that is saying something. In the way of evidence that this year is going to surprise and delight, simply look at gold’s price action so far. Instead of the seasonal slump following January, gold has powered ahead and partied on in 2006 and is now trading at over $620, a 17% increase since the first of the year.

I would not be surprised if gold broke even $750 by year-end. As bad as things were in the late 1970s, the last secular bull market for gold, they are much, much worse now, by pretty much every measure. Whether the level of debt, the size of the entrenched and philosophically unsound bureaucracy, the Current Account Deficit, the Forever War raging on a nearly global basis, the entrenched and worsening problems with entitlement programs, the $trillions of perilously perched derivatives. … The list, unfortunately, goes on. It is hard to see a summer pullback for gold, should there be one, in anything other than a positive light.

You can keep your powder dry for the next little while and look to pick stocks for less during dips. Or you can just keep buying, riding the tides and ignoring the dips altogether. Show me a good company, run by good people, working a good project and selling at the right price, and I am a buyer … though at this time of year, being patient to let the market come to you probably makes the most sense. If there was one misstep you could make at this point, it would be to get scared off by the inevitable volatility and step aside until it gets “safe” to come back in. Too often that results in missing major up-moves. Trying to pick the tops or bottoms of any market is a fool’s game.

A final thought: This market trend is solidly in motion. While it may periodically scare you as much as it thrills you, at no point doubt that it is your friend. Treat it accordingly and it will treat you well. In fact, even better than you likely imagine.

OIL CORRECTION

“Crude oil has become one very hot commodity … enticingly hot,” we remarked last week, while suggesting that investors “steer clear” of this market for a while. Immediately after our column appeared, the price of crude oil took investors on a very wild ride – falling three dollars over the final three trading days of last week, then jumping four dollars over the first three trading days of this week. Voila! A one-dollar gain! This sort of hair-raising volatility does not endear us to the crude oil market, especially when several important indicators are flashing amber. Thus, we would repeat our warning from last week: “Go ahead and flirt with this ‘hottie’, if you must. But we’d hate to see you get hurt.” U.S. crude oil inventories remain some 11% above their 5-year average, which is probably reason enough to back away from crude oil and from oil stocks. But options pro, Jay Shartsis, provides a second compelling reason:

“The 21-day dollar-weighted put/call ratio on crude oil futures currently shows about 25 cents in puts traded for every $1.00 in calls,” Shartsis notes. “This is an EXTREMELY bullish reading, which, as a contrary indicator, is very bearish. This option reading shows the most trader optimism in many years. For perspective, 25 cents in puts versus $1.00 in calls is WAY down from readings last December when about $1.75 in puts traded for every $1.00 in calls. (December was, of course, a great time to be BUYING oil and oil stocks). The current reading, however, is exactly what one could expect at a top,” Shartsis concludes. “Given the situation in Iran and elsewhere, I have to admit that it’s hard to imagine that oil is going to drop. On the other hand, this overly bullish options reading suggests that all the well-known bullish factors for oil are already priced into the market. Sell oil stocks? … Probably.”

Most of the commercial crude oil traders seem to agree with Shartsis. In recent days, the “commercials” have been adding to their already-sizeable short position in crude oil. As we have noted in several prior columns, the “Commercials” are considered the “smart money”, based on their tendency to position themselves correctly at important inflexion points. By contrast, the “large speculators” tend to position themselves incorrectly at extremes. Oil bulls, therefore, will find little comfort the fact that the large speculators are buying crude oil aggressively … from the Commercials.

Lastly, we would point out that the price of crude has reached a rare extreme relative to the price of natural gas. Only four times in the past decade has crude oil reached a price that is 11 times greater than the price of natural gas. After each of the three prior instances, the price of crude oil fell sharply over the ensuing weeks. We would not dare to insist that history will repeat itself, but neither would we dare to rule it out.

DOLLARS MAKE PENNIES

The value of a U.S. dollar has tumbled 7% so far this year, but the value of a penny has soared 70%. A couple of recent European news stories shed some light on this monetary mystery, and on why the value of dollars and pennies might continue to diverge. A Reuters news story reports, “Sweden’s central bank became the first among the developed economies to announce a major reserves shift, saying it had raised its euro holdings to 50% of its $20 billion-plus reserves from 37% and cut dollar holdings to 20% from 37%.” Meanwhile, down in France, Agence Presse reports, “A hold-up gang in northern France has been targeting shipments of copper and nickel, hoping to profit as the metals’ prices hit record highs.”

While the Swedes sell dollars and the French steal copper, much of the rest of the world is engaging in a similar sort of arbitrage. A growing number of investors – both governmental and private – are realizing that the supply of dollars is limitless, while the supply of copper is limited, as is the supply of nickel and zinc and natural gas and crude oil. It is perhaps no accident, therefore, that the dollar slumped to a new one-year lows this morning, while copper and zinc are soaring to new all-time highs. Gold, for the record, is hitting fresh 26-year highs.

Although we continue to anticipate a harrowing, short-term sell-off very soon in copper, crude oil and a few other commodities, we also continue to anticipate a harrowing long-term sell-off in the U.S. dollar. Much of the world, apparently, is embracing a similar viewpoint. The central bank of Qatar might not be a trend-setter, but like the Riksbank of Sweden, it is clearly in the vanguard of the shift away from dollars. Qatar’s central bank recently disclosed that it has been buying euros, and intends to continue doing so until the bank’s euro holdings make up 40% of its $4.5-billion reserves. Several other central bankers and financial big-wigs are also kicking the dollar while it is down.

Last week, Russian Finance Minister, Alexei Kudrin, questioned the dollar’s merit as the world’s “absolute” reserve currency, given the size of the U.S. trade deficit. Therefore, Russia’s $61 billion oil stabilization fund is beginning to invest in euro-denominated bonds. “The dollar's dominance of all currency reserves … is basically coming to its conclusion,” asserts David Keeble, head of fixed income strategy at Calyon, “and ultimately this puts a lot of pressure on the U.S, because of its very large current account deficit which has until now been supported mostly by central bank buying.” But while central banks shed dollars, many private investors are buying – or stealing – hard assets.

We would urge the thieves to take up licit forms of base metal exploitation. The thieves may not realize that they could simply buy pre-1983 U.S. pennies, melt them down and book a 140% gross profit. Each of these older pennies contains about 3 grams of copper and about 0.1 grams of zinc. Current metallic value? 2.4 cents per penny. Even newly minted pennies, which contain almost no copper whatsoever, are rapidly approaching metallic parity, thanks to the soaring price of zinc. Post-1983 pennies contain 97.6% zinc and 2.4% copper. Current metallic value: 0.89 cents per penny.

We present this illustration merely to underscore the obvious: A small piece of imprinted paper contains less real-world value than a small piece of copper or zinc. Furthermore, a U.S. dollar is a poor conductor of electricity and combusts near an open flame. It contains no resource whatsoever that could contribute to any industrial application. Rather, a dollar contains little more than a politician’s IOU. A U.S. Penny, on the other hand, contains sizeable amounts of copper and zinc. So much so that its metal content exceeds its stated monetary value. The same nation that issues both dollars and pennies is the same nation that spends more than it earns, that imports more than it exports and that relies upon massive foreign borrowing to sustain its bizarre breed of prosperity. In such a world, it is a darn shame that the dollar contains less intrinsic value than a penny.

THE CALM BEFORE THE STORM

It seems that never before have the bulls and the bears had such strong arguments – the tectonic plates of the markets are intensely balanced in an edgy state of latent eruption. Most investors are actively searching for clues about what might next occur in the stock market – new highs or a correction? Regardless of the direction of the market’s next leg, the move is likely to happen with increased volatility. The historical cycle of stock market volatility has been erratic, yet consistent, for more than five decades. And although the trend in volatility may not be a completely reliable indicator, it does offer key insights about the likely direction of the market. Most of all, portfolios that are best positioned for declining volatility often do not perform well in rising volatility. Therefore all investors can directly benefit from insights about the upcoming conditions.

The charts and discussion that follow will present several ways to measure volatility – all of them reflecting volatility at relatively low levels historically – as well as insights about the implications of volatility rising back to average or greater levels.

It happened this week, but lately, it has not been happening very often: A 1% move in the market. For the Dow Jones Industrial Average (the one that we hear about on the 6:00 p.m. news), that is more than 100 points. On average since 1950, 1% moves have come on average about four times per month. Lately, we are down to twice a month. That places us in the lowest quarter of all periods – a level of relative calm. Figure 1 presents the average number of days when the stock market, measured by the S&P 500 index, has moved more than 1%, up for down, since 1950. There have been a number of periods, including the mid-1970s, late-1980s, and particularly just a few years ago, when 1% days occurred over 10 times per month! Since the markets only trade about 21 days per month, those periods are especially volatile with a super-swing every other day.

We can also measure market volatility using a statistic called standard deviation – the measure that most market researchers and academics use. The standard deviation for returns is expressed as a percentage and measures the magnitude of market changes compared to the average market change – in other words, it reflects whether the market is really choppy or fairly calm. Over time, the average standard deviation on an annualized basis for the stock market has been just under 15%. That does not mean that the average annual change is 15%, rather it means that about two-thirds of the years fall in a range of 15% around the average. As of last month, standard deviation volatility was running 6.9%, vs. average since 1950 of 13.4%. Again, we are now at about half of the historical average. Yet, as reflected in Figure 2, the standard deviation has recently slipped into the lowest seven percent of all periods since 1950.

Other than seeing that the markets are extremely calm right now, what else can we understand about volatility and its cycles? Since 1950, the cycle of volatility has been quite erratic, yet fairly pronounced. Although it has taken a jagged path, volatility clearly has vacillated from lows below 10% to highs of more than 20%. There does not appear to be a longer-term trend toward lower volatility, but rather the cycle has been bouncing around for decades … rarely overstaying its welcome in the lowest or highest ranges. The graph reflects relatively short periods outside of the range from 10% to 20%. Once it passed below the 10% threshold, the time below the line averaged 16 months (with the longest being 33 months and the shortest at 7 months). If we make it past October of this year, the market will be setting a new record. The current 26 months is already the second longest run. A decline below 7% has occurred only times since 1950. The average time below 7% has been 9 months, with none lasting more than 13 months. Once volatility starts to rise from such a low level, a year later the volatility has averaged almost 12% and then on average in about three years it generally peaks at more than 20%.

Still another measure of volatility is the range from low to high during each trading day. In Figure 4, we can also see the cycles, highs and lows, and a current condition near the bottom of the range. This volatility measure is similar to the measures previously presented and reflects the general level of volatility in the stock market.

Why does volatility matter? As reflected in Figure 5, there is a strong relationship between the level of volatility and the performance of the market. As volatility rises, there is a greater propensity for the stock market to experience losses. Volatility tends to decline as the stock market rises and it tends to increase as the stock market falls. You will notice that the least volatile periods have the lowest frequency of down months. As the volatility increases across the quartiles, the frequency of down months consistently increases. Further, as the volatility increases, the magnitude of the loss during down months consistently increases. The probability-weighted expected return consistently declines and becomes an expected loss in the most volatile markets.

Volatility has different implications during secular bull markets and secular bear markets. For this analysis, principles from Unexpected Returns: Understanding Secular Stock Market Cycles will be employed. Secular stock market cycles refer to extended periods of above-average returns and below-average returns that result from trends in the price/earnings ratio (P/E). Over the past hundred years, P/Es for the stock market have tended to cycle from near 10 to somewhat more than 20. There have been eight complete secular bull and secular bear cycles since 1900. When the concepts of volatility are assessed in secular bull and secular bear markets, the effects of volatility on returns are further revealed. The negative effects of volatility surges in secular bull markets can be overcome by a strong bull trend. In secular bear markets, the downside volatility and negative effects of volatility create adverse market conditions.

Figure 6, Volatility in Secular Bull and Bear Cycles, reflects the performance of the stock market during the volatility cycles presented earlier. Green shading has been added to reflect periods of secular bull markets and yellow shading reflects periods of secular bear markets. This will help to show that volatility surges have different effects on the market during secular bull periods and secular bear periods. As measured by the rolling standard deviation, there have been five surges in volatility from extreme low levels since 1951. Each of these volatility surges is noted on Figure 6 with black circles, lines, and arrows. The average change in the stock market during volatility spikes is positive during secular bull periods and negative during secular bear periods, yet the gains and losses can be much more extreme at times within the period.

An additional measure of volatility during secular market cycles is the frequency of years when the market is within or outside of certain percentage ranges. The profile for the current secular cycle reflects an environment of low volatility and downside vulnerability. Figure 7 presents the frequency that annual changes in the market occur either within or outside of two key ranges, plus or minus 10% and 16%. Almost 50% of the years have annual changes between -16% and +16%. So far in this secular bear market cycle, the past six years have been atypically concentrated toward the center. More concerning, however, the frequency of large declines (more than -16%) is unusually low. Based upon the typical secular bear market profile, we appear susceptible to double digit moves, especially large declines.

The current state of volatility is an indicator of a potentially sharp stock market decline based upon (1) the currently low level of volatility, (2) the tendency for upward spikes to follow extreme low volatility, (3) the relationship of market direction to volatility trends, and (4) the propensity for downside volatility during secular bear markets. Volatility could decline further and could remain low for some time longer; however, based upon history, it has not stayed low without subsequently spiking and, as it goes lower, the likelihood of a spike increases significantly.

When volatility does start to rise and the stock market likely declines, the bulls will call it a “pullback” or a “correction” in advance of the next major upward move in the market. The current market conditions are not positioned to provide another secular bull market at this time – it is not a sleeping bull. The current conditions reflect a secular bear or a bear-in-hibernation because the market’s P/E is above its historical average. Without a rising P/E, future returns will be below average and investors are likely to experience an extended, choppy, and often volatile period. It is incumbent upon investors to understand the environment and to seek profit-oriented investments rather than hope that the market will again provide the passive rewards that occurred during the secular bull market of the 1980s and 1990s.

Sell!

The month of May has arrived, which means it is time to pay homage to one of our favorite Wall Street adages, “Sell in May and go away”. For more than 50 years, according to the Stock Trader’s Almanac, U.S. stocks have performed poorly between the beginning of May and the end of October. We are expecting a repeat performance in 2006.

The next six months will play host to three different “seasonal” cycles that all bode ill for the stock market. For starters, stocks generally perform poorly in the May-to-October period. According to Jeffrey Hirsch, who publishes the Almanac, the U.S. stock market tends to produce all of its gains in the 6-month period between November 1 and April 30. Thus, for example, a hypothetical investor who placed $10,000 in the Dow Jones Industrial Average at the end of April each year since 1950 and sold at the end of October would have made no money whatsoever. But someone who bought at the end of October each year and sold out at the end of April would have reaped a bounty of $534,323.

But this year, May-October influence is not the only bearish seasonal factor at work. The so-called election cycle also hangs above the market like a guillotine blade. “Data from S&P shows that in a president’s four-year term, the second and third quarters before mid-term elections are the weakest periods for stocks,” Bloomberg News reports. “The S&P 500 has fallen 2 percent and 2.2 percent, respectively [in those quarters], on average since 1945.” A dismal stock market performance prior to this year’s mid-term elections would not be difficult to imagine, given the plummeting approval ratings of both the president and the Congress.

A third “seasonal” factor suggesting that stocks will be heading lower very soon: “In three of the four instances since 1970 when a central-bank chairman took the helm, stocks fell to a bear-market low within eight and a half months,” Bloomberg News reports. “The market’s ‘Black Monday’ low, reached on Oct. 19, 1987, occurred two months after Greenspan took over.” Bernanke succeeded Alan Greenspan as Fed chairman on January 31, which means that the stock market should be hitting a bear market low no later than September 15th. The volatile, Bernanke-inspired trading action of the last two days shows very clearly why investors should respect this indicator.

To be sure, the auspicious confluence of three negative seasonal factors does not guarantee a selloff in the stock market, but it does provide ample reason to “sell in May”, especially when one remembers that the oil price is twice as high as it was one year ago and the angry rhetoric between Washington and Tehran is ten times as bellicose. Furthermore, the first four months of 2006 have already provided a solid year’s worth of returns in various stock market sectors. The Russell 2000 Index has climbed 13% year-to-date, while the MSCI Emerging Markets Index is up nearly 20%, equivalent to annualized returns of 57% and 70%, respectively. Maybe these two indices will be much higher on October 31st, but the weight of historical tendencies suggests otherwise. Buy in May if you must. But why not check out for a while and hit the road in a Winnebago?