TACTICAL VIEW: 
LONESOME JOHNNY BLUES
by Justice Litle
Editor, Consilient Investor
August 22, 2007

No more trouble, send him down the road won't you please
No more trouble won't you beat him up, won't you send him down the road
‘Cause trouble dumped out the trash,
Ransacked the place for cash
And he wound up takin' much more than I owned...
-- Cracker, "Lonesome Johnny Blues"

IN BRIEF

- The Kuala Lumpur Composite Index (KLCI) is notable for being so typical; emerging markets across the board have registered waterfall-type decline patterns as risk capital withdraws.

- The Shanghai Composite is perhaps the exception that proves the rule; in a world of its own, Chinese stocks just keep chugging along. The reasons why aren't exactly comforting though.

- Treasury Inflation Protected Securities (TIPs) have been moving higher, as are treasuries in general, as investors modestly embrace a flight-to-safety stance and question the ability of the Fed.

- The Japanese Yen has been a major benefactor of the recent turmoil, as the "carry trade" begins to unwind in earnest. Depending on what happens next, the move could have a lot further to go.

- The US Dollar has been rising as adventurous investment capital comes home. With emerging markets hit by fears of global slowdown, US-based investors have been pulling in their horns.

- The European Central Bank (ECB) was supposed to be reliably hawkish. After the emergency measures employed, some columnists are already making reference to the "Trichet Put."

- The woes of Wal-Mart are by and large the woes of the American consumer" sluggish home prices, high energy prices, and tightening credit.

- Regional banks are enjoying a spot of contrarian optimism, with various tracking services declaring insider buying -- initially focused on the regionals -- to be at its most bullish levels in years.

- Crude Oil appears to be in a sort of no man's land, caught between bullish and bearish factors. The resulting profile for crude is thus practically a mirror image of Shanghai's.

- Corn futures, in freefall not so long ago, appear to be finding a floor. Strong export demand, the Associated Press reports, highlights the "extreme tightness of global grain supplies."

UNLESS YOU FOLLOW Malaysia closely, the Kuala Lumpur Composite Index (KLCI) probably isn't high on your priority list.

We show the KLCI chart here not because it's extraordinary, but rather because it's so typical. There are many other charts like it. The majority of emerging market bourses have the same off-the-cliff look about them; it's uncanny how correlated price movements can become in a time of upheaval. From Thailand to Buenos Aires, Seoul to Sao Paulo, and Jakarta to Karachi, the waterfall pattern is in effect.

Nor have the richer exchanges been spared. Tokyo, Sydney and Paris are all in similar straits. (As are many more unmentioned.)

We believe there are real bargains to be had in emerging market stocks. It's just a question of how long the sale will last, and how much lower the discounts will go before it ends.

~~

NOT EVERY emerging market has followed the waterfall pattern. Shanghai is proving a remarkable exception to the rule. Chinese investors are still rampantly bullish, bidding the Shanghai composite shares to new heights.

There is a serious question of how long the euphoria can last; as the dotcoms illustrated a few years back, limited float and giddy enthusiasm can only take things so far. The WSJ writes:

China's stock market is less than 20 years old, and investors, many of them new to the game, often trade on rumors or even superstition rather than fundamentals. Other unhealthy trends persist: Many companies have been buying stock and using the rise in prices to boost their earnings -- a trend that could add painfully to any downturn by hammering corporate profits, and thereby fueling more selling.

Not a market to short, perhaps, but not one to be comfortably long either. (Except from much lower levels.)

~~

BASED ON the action in treasuries, it appears that investors are not impressed with the Fed's soothing actions.

Short-term treasury bills recently saw their biggest yield drop in 19 years, the WSJ reports, as safe haven seekers rushed in to buy.

Treasury Inflation Protected Securities, or TIPS, have seen an inflow too, outpacing regular long bonds for upside gain. TIP has shown greater strength than TLT in breaking through late July highs where TLT did not.

Still, the move looks anemic. Investors don't appear ready to fully give up on stocks, or fully pile into bonds, just yet.

~~

THE JAPANESE YEN has been a major benefactor of the recent turmoil, as the "carry trade" begins to unwind in earnest. Depending on what happens next, the move could have a lot further to go.

It isn't just hedge funds who are loaded up on Yen shorts this time. Japanese investors are loaded up too. According to the Economist, small investors account for 30% of Japan's retail forex market; their trading has better than doubled to $15 billion per day, and they are heavily short the local currency (in favor of higher yielding currencies found abroad). The Economist explains:

One reason for the surge is margin trading. Brokers are offering leverage of as much as 200 times the down-payment (though the average is more like 20 to 40 times). In July Japanese retail investors' short positions on the yen (a bet that it would fall) exceeded the amount taken by traders on the Chicago Mercantile Exchange, a foreign-exchange trading hub.

...Strikingly, as the yen appreciated, retail traders, rather than dump their positions, saw a buying opportunity and sold yen for other currencies, softening its rise. "The Japanese government has not intervened-they've not had to, because the Watanabe-sans have been selling yen for them," says James Gow of FXOnline Japan, a retail broker.

This smells like another portfolio insurance type situation, where the conventional wisdom holds right up until the moment it doesn't. Then all you-know-what breaks loose.

~~

THE US DOLLAR has been rising as adventurous investment capital comes home.

With emerging markets hit by fears of global slowdown, US-based investors have been pulling in their horns. Globe-trotting hedge funds have further accelerated this process by "deleveraging" as aggressively as they once levered up.

When emerging markets stocks are sold, the local emerging market currency is sold too, as retreating investment capital once parked in lira, cruzeiros, rubles etcetera is converted back to dollars.

Whither the greenback moving forward? Not an easy question to answer. Further debasement is pretty much guaranteed, but the same can be said of the other paper currencies. This leads to a rubber yardstick problem, or perhaps what one might call the theory of currency relativity.

~~

AS WITH SO MANY others right now, forex traders could hardly be blamed for feeling all mixed up.

The European Central Bank (ECB) was supposed to be reliably hawkish. Thus the ECB's uber-enthusiastic liquidity injections were eyebrow-raising, and have gotten a few observers wondering. Is the European bank situation uglier than expected beneath the surface? Could "Easy Al" Greenspan be secretly advising Jean-Claude Trichet (the ECB's President and fed chair equivalent)?

After the emergency measures employed, some columnists are already making reference to the "Trichet Put." Which just goes to show... at the end of the day, you can't trust any paper currency. The more prepared the world's central bankers are to massage the system with credit, the better gold looks long term... especially in its function as "the only currency not subject to a printing press."

~~

PITY THE BEAST of Bentonville --Wal-Mart's woes are by and large the woes of the American consumer.

WMT shares were dumped over the side by disappointed investors last week, on news of a delayed turnaround and lowered earnings forecast.

Three of the factors Wal-Mart cited for its troubles were sluggish home prices, high energy prices, and tightening credit... precisely the factors hitting Middle America square in the wallet.

~~

THE NEWS ISN'T all bad out there. Regional banks are enjoying a spot of contrarian optimism, with various tracking services declaring insider buying to be at its most bullish levels in years.

The initial wave of buying had a heavy emphasis on the regional banks, Insiderscore.com reports, and then spread more generally across the financial sector.

There's still a fair amount of cash out there, in private accounts and corporate balance sheets alike. It's mainly a question of how and where that cash will be deployed. Time will tell...

~~

CRUDE OIL appears to be in a sort of no man's land, caught between bullish and bearish factors.

With hurricane concerns, geopolitical worries and peak oil factors to consider, the risk of a sudden price shock, and sharply higher oil prices overnight, can hardly be dismissed. At the same time, global slowdown concerns and the unwinding of speculative long positions seem likely to exert further pressure on crude.

The resulting profile for crude is almost the reverse of Shanghai's; a jittery, hair-trigger market that could spike dramatically upwards on the right (or rather wrong) piece of news, but with an inclination to drift lower in the absence of such.

~~

FINALLY WE NOTE that corn futures, in freefall not so long ago, appear to be finding a floor.

Strong export demand, the Associated Press reports, highlights the "extreme tightness of global grain supplies." Last week also saw Iran -- not a usual buyer from Uncle Sam -- purchase 120,000 metric tons of US corn.

We can't grow enough of it to keep up with global growth, we can't grow enough to burn in our gas tanks, and now even America's putative enemies are buying... gotta love agriculture.

Profitably Yours,

Justice

© 2007 Justice Litle
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Justice Litle
Editor, Consilient Investor
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