November 2011 Investment Journal
Markets in November were buffeted early on by the failure of a major futures broker and continuing stresses in Europe, but ended the month with a flourish as central banks worldwide, led by the US Fed, agreed to lower the cost and extend the maturities of US dollar loans to European borrowers. Overall, US stocks and bonds finished flat for the month, while commodities shed 2% on the back of weaker Chinese growth and gathering fears of global recession. Likewise, emerging market stocks and other foreign courses were off by 2-3%.
The month began with a major US futures broker, MF Global, declaring bankruptcy. This firm, led by former New Jersey Governor and Goldman Sachs CEO John Corzine, was a significant presence in global futures markets. When they ceased firm operations, several markets temporarily suspended trading, as they and their clients provided liquidity for the bulk of transactions. In Australia, for example, the wool futures markets froze up.
While it is not unusual for financial firms to become overextended and occasionally to become insolvent, it is highly unusual in the case of MF Global for them to be unable to account for over $1 billion of client's money which was supposed to have been segregated according to futures market regulations. MF Global, in effect, commingled client money with its own cash, and the safeguards which were supposed to be maintained and enforced by the futures regulators proved to be worthless. While much has yet to be determined, investors should be very concerned that one of the world's deepest and most liquid markets has been exposed as having such lax oversight and enforcement. We await further developments with great interest, as this body blow to market integrity has yet to be fully absorbed.
Meanwhile, the drama in Europe continued. With S&P and other rating agencies threatening to downgrade Spain, Italy, and other wayward sons for their fiscal misadventures, bond yields in Italy and Spain reached new Euro era highs, an indication of significant concern on the part of borrowers. In Germany, a regularly scheduled bond auction "failed" to produce enough bidders, so the Government wound up buying its own paper. This is a glimpse of what happens to even AAA rated sovereign borrowers who refuse to address their problems (USA are you watching?).
The broad-based rise in yields also spilled over to the short-term interbank lending market, where over-night loan rates rose to levels not seen since the Lehman Brothers collapse of 2008, indicating severe stress in the European banking system. It appears that by late month, the financial condition of some banks in Europe had deteriorated to the point where it became nearly impossible to obtain Euro based loans, so central banks had to act quickly to free up Dollar based infusions of money which could be exchanged for Euros to satisfy maturing obligations.
China started this latest bailout party on November 30 by announcing an easing of their reserve requirements, thus lowering the cost of loans for borrowers. The baton was handed to the US later in the trading day, where the Federal Reserve announced prior to the New York open that, in conjunction with the central banks of Europe, the UK, Switzerland, Canada, and Japan, they would be lowering the cost of short term US dollar loans to European banks and allowing maturities to extend to February of 2013. Markets globally roared ahead on this news, anticipating that new monetary support would revive risk appetites and raise asset prices. This is precisely the effect intended by the central banks.
A careful reading of the announcement would have led investors to a troubling discovery: for the first time ever, bilateral swap agreements were put in place so that any bank could raise any amount in any currency it needed from the other bank. Hypothetically, a French bank in need of US Dollars could ask the Bank of France to arrange a loan from the US Fed without any public discussion or posting of collateral. In effect, central banks globally are re-writing their charters by fiat with nary a whimper from politicians. This is the ultimate arrogance of the "oligarchy of the banks" that Simon Johnson, former Chief Economist with the IMF, has been warning about. We have long shared the view espoused by Mr. Johnson that the "oligarchy of the banks" has distorted and hi-jacked the global regulatory framework by socializing losses (heads we win, tails we win), and that time was running short for leaders and citizens to put this right. They have not.
Instead, the action of November 30 has "upped the ante" to an "all in" bid. Critics of the US Fed see them as far exceeding the powers granted in their Charter by creating and lending new and uncountable amounts of US Dollars to foreign banks and governments. It is no wonder that the "Occupy" movement in the US is gaining strength. (Your Journal editor visited the Occupy camp at the Embarcadero in San Francisco this month during the annual Schwab Advisor Services conference, and even got to pose a question to Tony Blair about this movement during the conference General Session - see photos below).
As we head into year end, markets have gotten a jolt from global central banks, but ultimately the debt problems and insolvency issues remain widespread. We reiterate our long held view that austerity measures will ultimately frame the solution, along with write-downs of debt and currency inflations. Growth, therefore, will be harder to come by in developed nations, leaving the developing world to pick up the slack.
Meanwhile, geopolitical developments have not gotten as much press lately, but the uprisings in Syria share common threads with the discontented everywhere who are not going to tolerate the "same old same old" (even Putin's "United Russia" party suffered big losses this week, despite massive fraud that was captured and documented by video bloggers from Minsk to Moscow!) Change is in the air!
Thank you for reading our journal, and we'll be back to you in the New Year.
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