The Socionomics of the Russia Georgia conflict

Socionomist and EWI Analyst who predicted Russia-Georgia conflict to appear on Bloomberg TV today at 5:30 p.m. ET.

In November 2007, the Socionomics Institute’s Alan Hall issued the 20-page research report, "Sizing Up A Superpower." It assessed the relationship between Russia's turbulent history and its then-current social mood.

More specifically, he spoke of "Georgia's desire to bring its pro-Russian separatist regions under control, but Russia has military plans to stop any move by Georgia to secure these regions."

Mr. Hall will discuss the developing situation in the region today, Tuesday, August 12 at 5:30 p.m. ET on Bloomberg television. Be sure to tune in! You can stream Bloomberg TV live online here.

See http://pages.tvunetworks.com/ to download their player.

Fear grips banking customers in Venezuela

The march towards nationalization continues unabated. Over the past year the oil, telecommunications, electric, and steel-making sectors have been impacted in President Chávez’s ceaseless drive towards a socialist paradise.

Now the crisis has spilled over to the financial sector as the government seized control of a large Spanish-owned bank, Banco de Venezuela. Nervous depositors lined up seeking reassurance, and many fear a run on the bank in the coming week. Not helping matters, the central Venezuelan bank has been vague in attempting to reassure depositors that the banking system was solid.

Nearly all the companies seized by the government have been run into the ground over a short period of time; productivity has dropped and the feeble earnings have not been reinvested back into the companies.

Venezuelan bonds fell Friday for a second day reflecting “fears over the possible collapse of several banks because of rules forcing them to sell $5 billion of complex securities called structured notes. Banks bought the notes last year at values tied to high black-market rates of the dollar, exposing some of them to huge losses after the local currency, the bolívar, strengthened this year.”

Attempts of individual banks to negotiate their way out of the crisis has not paid returns as the IMF and World Bank have effectively shut off the spigot after being threatened with expulsion by Mr. Chávez.

Even the high price of oil can not cover the cost of large scale programs in Venezuela beyond the next couple of years. Any significant drop in the price of oil will cause an immediate fiscal crisis. At 32%, Venezuela also is experiencing the highest inflation in Latin America. Food-based inflation is above 52%, a crushing level for most of the population. The fiscal crisis and high inflation levels can be directly linked to government policies. This has left the poorest portion of the population, which Chavez claimed would be helped by the government’s policies, in even greater despair.

Global Inflation: The New Crisis

A new monster has raised its ugly head to spook investors. Inflation is accelerating at a rapid pace providing policy makers with a new set of ulcers. Unfortunately basic antacid tablets will not cure the unsettled guts of national regulators.

The spike in inflation gives flashbacks to the dreaded 1970s with stagflation era. Many older investors do not enjoy reminiscing about interest rates above 14%, food rising in price each week, investors hoarding gold coins, and long gas lines. The dilemma is that all the statistics indicate that we are heading towards a scenario with run-away rising inflation worldwide.

Regulators have commented on rising inflation, raised interest rates in hopes of moderation, and are shocked to see the numbers running upward like an out-of-control train down the tracks. With rising commodity costs, pent up wage increase requirements, and tightening credit; there is not very much the regulators will be able to do to apply the brakes.

Certainly the news flow has not been encouraging, the ECB raised lending rates today amid record inflation, while U.S. Treasury Secretary Henry Paulson said inflation was becoming the top economic focus of many countries.

Inflation is a global phenomenon; impacting countries as diverse as Iran (with 26% inflation), the Philippines, Brazil, India, Russia, South Korea, Mexico, and Indonesia. No country is immune and no market is safe. Rapidly increasing inflation is the top concern in most nations, and the situation rapidly appears to be heading towards stagflation.

The immediate question becomes how should an investor prepare for this situation? The first emphasis is that a greater portion of your portfolio needs to be placed in commodities and precious metals, or in stocks focused on these industries. There is also a need to have your income oriented investments placed in vehicles which are inflation indexed in regards to interest rates. The other alternative is the keep cash in shorter term CDs as inflation and interest rates rise, allowing an investor to ride the rising curve.

Successful investing in a rising inflationary environment is difficult. Usually the stock market returns are dismal and many other investments are also victims of an inflationary spiral. Still it is best to keep your focus on the long term, and maintain a diversified portfolio of stocks that have wide economic moats. These companies invariably become stronger in downturns as competitors fall by the wayside.

Investors should pay close attention to news about inflation during the remainder of 2008 and start making appropriate adjustments to their portfolio to ride out the storm.

New Wind ETF

The First Trust ISE Global Wind Energy Index Fund launched this week. The ETF is trading under the symbol FAN – in another example of gimmicky ETF naming.

If oil prices remain high, companies involved in the wind turbine industry may gain significant traction. Wind turbines are common in Europe. The U.S. and Asian markets have huge potential, assuming people don’t get all NIMBY about seeing wind turbines from their backyards.

A couple of recent articles discuss the introduction of this new wind energy ETF:

Should You Buy an Alternative-Energy ETF?

Is Electricity From Wind Just A Lot Of Hot Air?

Venezuela: The slide continues

Hugo Chavez is still running amok in Venezuela. Despite voters rejecting a referendum giving the president sweeping power over the economy a mere few months ago, Chavez has taken steps over the past weeks to seize more businesses.

Chavez is driving the take-over of Sidor, a large, Argentine-controlled steel maker; cement companies owned by Mexican, Swiss and French investors; more than 30 sugar plantations; a large dairy products company; and a sprawling cattle estate on the southern plains…and these firms are just a component of overall list.

As expected these moves have spooked foreign investors and infuriated neighboring countries (whose public companies own many of the assets). The compensation offered by the Venezuelan for these companies is under 20 cents on the dollar. Foreign investment in Venezuela has hit record lows, with only $500 million investing in 2007 as Chavez nationalized electric, telephone, and oil companies.

All this socialist exploitation has tanked the Venezuelan economy, which is now beset with foot shortages, building supply problems, and a lack of many other staples. At a time where many other South American economies are booming, the Venezuelan bolivar currency is in free-fall with the black-market rate climbing over 20% in the past couple of months to 3.4 per dollar. The government moves to prop up the currency have failed miserably. One can only expect that the name-sake of the currency, Simon Bolivar would have been shocked at government policies that are so destructive to the people, if he was alive today.

Only high oil prices are propping up the centralized economy of the nation. Of course this is only a short-term situation because oil production is drastically declining at the oil wells seized by the government. The entire government house of cards will fold as oil prices or production fall, further illuminating the reality of why centralized economies do not work. It is one thing to have social programs in countries that aid the poor, homeless, aged, and disadvantaged; it is another thing entirely to seize companies that your entire productive economy is built upon.

Looking ahead one can only expect further unrest and economic turmoil in Venezuela. This situation is unfortunate since the country is rich in natural resources and formerly endowed with a rising economy prior Mr. Chavez’s administration.

Chávez Seizes Greater Economic Power

A proper stand: Canada will not bail out Investment Banks

The governor of the Bank of Canada says he will take a tough stand with financial institutions that wind up near bankruptcy because of poor decisions.

Maybe it is time that the United States adopted this policy. Mark Carney says the central bank won't bail out Canadian financial institutions like the U.S. government did when the Bear Stearns brokerage, one of the giants of Wall Street, ran afoul of the subprime mortgage mess.

The absurdity of the U.S. Federal Reserve bailing out Bear Stearns simply to avoid a short term financial panic in the credit market is becoming more apparent as further details are being revealed about the situation. The action will only drive more bail-out calls. It teaches a lesson to Wall Street that firms can privatize the gains, and socialize the losses. There is no reason to adopt any type of reasonable risk control if the government will be available to bail out the investment banks every time the bad decisions come home to roost. This will only drive the investment banks to maximize revenue by taking more risk.

The most current variant of the Fed’s flawed policy is opening the discount window to the investment banks in the past few weeks; in the past this lending facility was reserved for commercial banks. The Wall Street banks have been hitting up window for over $38 billion per day far more than all the commercial banks in the U.S. combined. To think that some congressmen squawked and demanded an investigation when Countrywide Financial was provided with $50 billion over several months; these legislators are strangely silent on Wall Street hitting up the Fed for nearly the same amount each day.

Even more shocking is what the Wall Street is doing with the borrowed money. The intent of the Fed action is to inject liquidity into the system in order to ease the credit markets. The Investment Banks have been happily utilizing the low cost Federal loans as capital to fund large scale gambling. The major Wall Street institutions have used the Fed cash to implement international interest-rate “carry trades” with the intent of squeezing profit out of the market. This naturally will lead to hefty bonuses for the Wall Street staff; assuming the positions don’t implode over the coming months. No concern is given to loosening the stranglehold of tightening U.S. loan conditions or unwinding the derivatives that sparked the credit crisis.

If Wall Street is not using the discount window cash for its intended purpose of easing the credit markets then the spigot should firmly be shut off. The Bank of Canada has the right mind-set when it comes to dealing with investment banks – these risk-driven firms should be responsible for their own calamities.

Tax Cut leads to surge in Chinese Indexes

Attempting to tackle a sharp decline in the indexes over the past months, the Chinese government reduced the tax on equity trading. In response the Shanghai Composite index surged 9.3% - an increase that is almost certainly temporary. The broader issues with lofty valuations, lack of transparency, and macro-economic issues driving the fortunes of companies in Asia remain unaddressed by this regulatory action.

Investors were delighted with the government action; however it did not boost the long term confidence in the stock market for most individuals. Smart investors will take advantage of the surge to exit their positions over the next week. Slower earnings growth and higher costs do not bode well for company results in upcoming quarters.

“The government is clearly concerned about the meltdown,'' said James Liu, Shanghai-based deputy chief investment officer at APS Asset Management, which oversees $1 billion. ``It's positive for the market in the short run.''

The primary words to focus on are “short run”. Simply reducing the stamp duty on stock trading to 0.1 percent from 0.3 percent will not eliminate the headwinds facing the market, nor change the primary trend of the stock market which is down.

Despite the optimism expressed from financial pundits, the proclamations that this denotes the market bottom are likely to backfire within the next couple of weeks. Certainly the government is pleased with this cheerleading from the financial sector, because after all markets are in reality a confidence game.

Chinese stocks soar after tax reduction

Few analysts believe share prices will reach a new high this year, but many investors and analysts are hoping the worst is over. Hoping and reality normally run on diverging tracks.

The Meltdown: Iceland

For many recent years, Iceland was touted as the new model for Europe. Investment poured in at record levels, lifting the entire economy of the small island nation. The geo-thermal energy was offered as an excellent power source for heavy industries such as smelting, while the onshore banking industry was presented as the new breed.

The local currency, the krona, was riding high while the government offered an environment where interest rates were much higher than other nations. The nation was splashed across the financial press as the next business center.

It only took six months for all the optimism to dissolve and the island to adopt a siege mentality. Government officials and the local press blame unscrupulous speculators for the meltdown that has left the nation’s financial infrastructure on the brink of ruin. The krona has sunk 25%, the stock market 40%, inflation has sky-rocketed, and the local interest rates sit as an unpleasant 15.5%. It is obvious that the island’s central bank does not have the liquidity strength to bail out any of the nation’s larger floundering banking institutions, effectively leaving banks un-backed. Bear Stearns recently suggested the tiny nation was about as safe an investment as Kazakhstan.

Consumer spending has slowed to a crawl as on-shore prices has risen greatly in the import driven economy. There is increasing recognition that the growth over the past few years was the classic definition of a bubble, however few in power are prone to admit it. Instead the leaders blame the demise on outside speculators with a Vegas mindset who want to make a profit on the pain of the nation.

In the past, Iceland was hailed as the new model of success. Now the fear is that mainland Europe will follow the model of this small nation, and crumble on a mass scale. Iceland may only be the leading edge of a cycle of credit defaults that will rip the European financial system asunder.

Iceland first to feel the blast of global cooling
Tiny country is like a canary in a coalmine signalling crises in toxic economies

Chinese markets plunge 50% in six months

Earlier HingeFire articles outlined the risk of the Chinese stock market (see The Plunge Continues – China, Shanghai Index Double Top, ETFs to short China) and the probability of the bubble would implode. A summary from early April outlined the rapid deflation of the Chinese indexes. In the past week, the Shanghai index dropped another 11%.

The deteriorating situation has caught the eye of the mainstream press. The WSJ outlines the 50% fall of the Chinese market in a mere six months as a front page article. With the P/E ratio of the composite Shanghai index still at a frothy 35, the market still has plenty of downside. To reach a nominal P/E of 20, the index would slide to 1700; a 72% crash from the Shanghai market peak. A situation that is very reminiscent of the NASDAQ in 2002.

Dollar’s plunge enables corporate earnings

The recent round of earnings reports from large companies with international operations on the surface appear to be solid. Coca-Cola, IBM, Caterpillar, eBay, and others all hit the ball out of the park. A more detailed look reveals the weakness; the strong earnings were built on the back of the falling greenback. International sales did not explosively rise, they simply look much better in dollar terms as the greenback continues to steeply slide.

Understandably growth outside the U.S is stronger than domestic increases, with the economy on the brink of recession. The outsized 1st quarter earnings from international sources are more reflective of the greenback’s slide than improvements in non-U.S. sales. In actuality, it is possible to make a case that overall international sales are deteriorating as consumers become more cautious world-wide.

While the profits are reported in dollars on quarterly balance sheets, most of the currency remains offshore and is not converted into greenbacks. In many ways, this serves as paper tiger that helps the quarterly report look solid, while no real benefit is accrued to the company. If the effect of currency rate of conversion was backed out of the earnings, in some cases the international profits would look just as bleak as the domestic situation.

Additionally, most of these overseas profits are difficult to repatriate to the U.S. and put to work. This means that the cash will be put to work internationally or simply sit in offshore accounts; neither scenario helps drive growth or increase jobs domestically.

At some point the trend in the dollar will reverse; at this point many of these firms that excelled in previous earnings will have to mark their offshore cash hordes to market. If not properly hedged in the forex markets, these companies are likely to announce future write-downs in their cash and equivalents.

Dollar's plunge becoming lynchpin in 1Q earnings discusses this situation in more detail.

From across the pond: The Banking Crisis

The mortgage credit crunch has not only impacted banks in the U.S., but has shocked financial institutions overseas. Filmed after the demise of Northern Rock in the U.K., this edition of Dispatches featuring Jon Moulton outlines the financial meltdown. The clip is an excellent educational summary of the greed-driven problems in the credit market that has left the world on the brink of recession.

What is that sound? It’s the market bubble bursting in China

Previous Hingefire articles in 2007 outlined the increasing risk in Chinese stock markets and how the Chinese indexes were not strongly correlated with other world markets. The Plunge Continues – China in June 2007 warned of the risk that the Chinese markets were in a bubble and it was just a matter of time till they burst. The lack of correlation to the world markets was discussed in August. A HingeFire article in November recommended ETFs to short the Chinese market.

Fast-forward the clock to April of 2008, the Chinese stock market has become the world’s leading example of a bursting bubble. The Shanghai composite index has plunged 45 percent from its high, reached in October 2007. While markets world-wide have been down since this time, other major world indexes have all dropped less than 20% in the same time period.

The frenzy that surrounded the upside of the market in China has now dissipated leaving many investors angry and demanding that the government take action. A good number of the speculators lost their entire savings. Many have learned a harsh lesson in how quickly a bubble bursts.

To See a Stock Market Bubble Bursting, Look at Shanghai

“Look,” he said, “it took two years to go from 1,000 to 6,000 but two months to go from 6,000 to 3,500.”

The TED Spread hits 2.0

An earlier HingeFire article talked about the TED Spread being a leading indicator for market drops caused by credit situations. Historically the TED Spread, which is the difference between U.S. Treasury bill yields and yields for Euro deposit contracts of the same maturity as represented by LIBOR, is a better warning signal than VIX when credit liquidity is tight.

Levels above 1.5 historically preceded declines in the stock market. A recent sharp increase to near 2.0 and extreme volatility of the TED spread demonstrates the market is still at risk. The credit concerns have not ended with the failure of Bear Stearns, in fact they have only increased.

Investors should still be prepared for further fall-out from the credit crunch over the upcoming weeks. It may be awhile before an “all clear” is sounded; in the mean time we can expect more bank failures, liquidity concerns, and continued negative contagion to other credit sectors. The latest word on the street is that Britain's largest mortgage lender, HBOS Plc is effectively insolvent following the earlier example of Northern Rock. The entire situation is reminiscent of Bear Stearns one week ago, the bank and regulatory officials have come out denying these “false rumors” while the bank stock dived 17% to its lowest value ever..

The TED spread indicates that the professionals have positioned themselves for a downside scenario. The current level near 2.0 should act as an alarm bell for stock market investors.

Quick Takes: UK Real Estate Update, Consumers Stall, Vista Anyone?

UK Real Estate Update
Real Estate issues are not only a prevalent issue in the U.S., home prices in the United Kingdom fell for the fourth straight month in February, dropping 0.5% from January. Mortgage approval rates remain at the lowest level in nine years as recent rate cuts have not been passed along to mortgage consumers; factors that are likely to cause the continued decline of the housing market.

Similar to the U.S., the U.K. housing boom “powered consumer spending over the past decade”; the decline in real estate prices is likely to cause further consumer economic fallout.

U.K. House Prices Fall in Worst Streak Since 2000

Consumer Spending Stalls
The stall in consumer spending is a likely sign that a recession is in the outlook. Consumer spending accounts for over two-thirds of the economy in the U.S.; the second month of a flat reading is not a positive sign.

Consumer spending stalls in January
Data seen raising new concerns about a possible recession
http://www.msnbc.msn.com/id/23406764/

Who wants this Operating System?

Microsoft plans to cut prices of its Windows Vista operating system with the Service Pack 1 release. Vista has not been well received and still accounts for less than 10% of the installed Windows operating systems. Similar to many others, after experiencing Vista on a PC purchased for my family – my first step was to install Windows XP.

Fortunately, Microsoft will continue to sell Windows XP until June 2008, delaying a forced transition to Vista. Despite hyping the figure of 100 million licenses sold of Vista (many of them uninstalled), and pointing to the strong earnings component related to these sales (many charged for and not used on new pre-purchased systems) – analysts need to start questioning the actual relevance of Vista and if Microsoft will take the necessary measures beyond a price reduction to improve actual uptake.

Microsoft cuts Vista prices to urge upgrades

Quick Takes: World markets remain coupled to US economy

While the U.S markets are closed in observance of the Martin Luther King holiday, foreign markets nose-dived today. European and Asian stock markets plunged on the fear of a US recession. Even the Chinese markets, which many times appear to be uncorrelated with the remainder of the world, recorded the largest percentage drops since the September 11th terrorist attacks. Leading the downside, India’s markets dived 7.4%. Most other markets were not far behind; the DAX index in Germany closed off 7.16 percent and the CAC 40 in France lost 6.83 percent. British stocks fared less badly; the FTSE 100 lost 5.48 percent. Canadian and Mexican stocks were off sharply at midday.

How will Wall Street play this on Tuesday? The U.S. market is likely to open lower, but most traders will attempt to play the market to the long side during the day on the expectation that excess fear has placed the markets in an oversold condition.

European, Asian Markets Plunge

Venezuela Introduces New Currency in Plan to Halt Inflation

Venezuela endures the highest inflation rate in South America. The official inflation rate is over 20%, the unofficial rate is over 100% when taking in account the underground economy and realistic exchange rate to other currencies.

The middle class is pressed as more wealth is transferred to social programs with no associated economic benefit. Businesses are under increasing pressure as the government continues to seize resources, placing productive employment in jeopardy. Business growth has declined rather then risen over the last 12 months, while inflationary pressure strains the Venezuelan economy.

While the government has pushed the new currency as the “strong bolivar”; most of the nation has dubbed it the “weak bolivar”. It is generally helpful to lob off three zeros on currency note from a mass psychological perspective, after all who wants to pay 2000 of a currency unit for a loaf of bread. However attempting to sell a new currency as a cure for inflation and a stimulant for economic growth is far-fetched, if not absurd. Sloganeering with "A strong economy, a strong bolivar, a strong country" will not alter reality that the currency change is nothing more than window dressing.

For the government, Chavez's introduction of a new currency is merely an attempt to conceal the extent of the inflationary problem from the people of Venezuela, a traditional national problem that is difficult to hide. Unfortunately this solution will not really resolve the issue, and the second half of 2008 is likely to see stagflation in the local economy as Chavez continues to push fiscally-irresponsible social policies.

One immediate concern will be if the chill spreads like the flu to other economies in the region. The Latin American countries are interlinked in both trade and stock market performance. Surprising many pundits the Latin American market (as seen by the ILF ETF) has continued to have a hot run despite the rising regional risk.
http://finance.yahoo.com/q/bc?s=ILF&t=2y&l=on&z=m&q=l&c=


Venezuela Introduces New Currency
Venezuela Launches New Currency As Chavez's Government Seeks to Stem Inflation
http://biz.yahoo.com/ap/080101/venezuela_new_currency.html

Quick Takes: UBS

UBS landed at the top of the financial news today revealing a $10B write-down and an emergency injection of cash from sovereign wealth funds. The Government of Singapore Investment Corp and a group in the Middle East are providing a total of $11.5B in fresh capital.

The situation mirrors what was seen at Citi except that UBS went one step further in eliminating their cash dividend for 2007 and replacing it with a stock dividend. Overall this is a lousy deal for the common shareholders in that both their stock is being diluted and more UBS equity is being effectively relegated to the preferred shares column. However it is easy to counter that the common shares would be near worthless if the bank was not able to maintain their capital ratios or was forced to merge for pennies on the dollar (or centimes on the franc). Overall the market took the deal as good news driving UBS shares up nearly 2%.

During the upcoming weeks there is an increasing expectation that more major banks will follow the lead of Citi and UBS. The market can expect to see bailouts from sovereign funds, cuts in cash dividends, dilution of common shares, and further mind-numbing write-downs.

UBS to Sell Stakes After $10 Billion in Writedowns
http://www.bloomberg.com/apps/news?pid=20601087&sid=auWIldY77wRU&refer=home

Where Real Estate is Hot

The good news is – There are still hot real estate markets you can find where prices are expected to rise for the next ten years.

The bad news – You will need to move to the Middle East to take advantage of them.

Real estate sector 'to see continuous growth'
http://www.gulf-daily-news.com/Story.asp?Article=201457&Sn=BUSI&IssueID=30255
"The demand for real estate in the Gulf is increasing as foreign investment is becoming more popular due to the sub-prime crisis in the US," Century 21 Bahrain real estate professional Hind Yassine told the GDN.

U.K. Housing Update

Press reports came out today that emphasize the demise of the U.K. housing market. The cost of homes dived 0.8% from October. Banks have cut back on loans with the volume dropping significantly from September. The Bank of England now views the banking crisis as the top concern according to a statement from Governor Mervyn King while offering emergency funds to impacted institutions today.

U.K. Home Prices Drop Most Since 1995, Loans Decline
http://www.bloomberg.com/apps/news?pid=20601087&sid=a41rAenmuzDU&refer=worldwide
"There are clearer signs that the slowdown in the housing market is gathering pace,'' central bank policy maker Rachel Lomax said on Nov. 22."

King Says Market Rate Increase Caused by Bank Capital Concern
http://www.bloomberg.com/apps/news?pid=20601087&sid=a6zhCIZAiVXk&refer=worldwide

See the earlier U.K. Housing post:
http://hingefire.blogspot.com/2007/11/international-housing-home-prices-drop.html

Increasing Risk: Real Estate in China

There is one real estate market where a meltdown would comparatively make the situation in the U.S. appear to be minor league. Only one country has both the population and rising speculative real estate values to claim this distinction – China.

A number of economists such as Yi Xianrong are sounding the alarm. There are two primary issues, the first being the false data on many mortgage applications. This is somewhat tempered by the requirement for large down payments on many real estate loans in China.

"I estimate that the large majority of mortgage holders would not meet the standards for even subprime loans," Yi said in an interview with the state-run magazine Oriental Outlook.”

The second risk is the speculative real estate spiral. A good number of owners view real estate as a money-making scheme, similar to the “flip this house” phenomena in the U.S.

“Many Chinese families are already deep into speculating on property, a main driver of the surging prices that have Chinese authorities worried that a bubble might be forming.”

It is still an open question regarding how long the situation can continue and how badly this speculative cycle will end. There is still a huge demand for housing in China, this has to be countered with the huge price increases and questionable credit practices for personal housing loans.

Housing market, risk surge in China
http://www.newsobserver.com/business/story/795070.html