Bernanke Music Video - "Every Breath You Take" -

Every Breath You Take
Columbia Business School Follies
Spring 2006

Lyrics

[George W. Bush:] "Ben Bernanke is the right man to build on the record that Alan Greenspan has established. I will urge the Senate the act promptly to confirm Ben Bernanke as the fourteenth Chairman of the Federal Reserve."

Every breath you take
Every change of rate
Jobs you don't create
While we still stagflate
I'll be watching you

Every single day
Bernanke takes my pay
When growth goes away
Inflation will stay
I'll be watching you

Oh can't you see?
The Fed's where I should be
How my poor heart aches
With each of your mistakes

First you move your lips
Hike a few more BPS
When demand then dips
And the yield curve flips
I'll be watching you
Since you came supply's lost without a trace
I dream at night that I punch you in the face
Your interest policies I cannot embrace
I feel so wronged and I long for Greenspan's place
I keep cryin': Benny! Benny! Please...

Oh can't you see?
The Fed Chair should be me
How my poor heart aches
When prices escalate

Every move you make
Every oath you take
Hope your models break
Bet that beard is fake
I'll be watching you

CBS is great
Wouldn't change my fate
But we'll be watching you
We'll be watching you

Daily Musing: Sino-Phobia

One of today's business headlines was a surprisingly strong Chinese GDP growth for Q1 2007 (11.1% vs 10.4% expected). The Bloomberg story, Asian Stocks Post Biggest Drop in a Month on China Rate Concern promptly declared that unexpectedly strong growth will prompt Chinese authorities to hike rates - which will slow Chinese growth and also weaken the US$. That could impact the rest of Asia, thus the fallout on Asia equities today.

Let's analyze the facts. Chinese interest rates matter to the world only to the extent that they impact Chinese growth. Chinese growth is very important for global growth and inflation. But a worry about China's growth at this time is unwarranted. China needs to grow, and grow at a high single-digit rate to absorb the vast number of rural migrants pouring into the cities everyday. It is the key to the legitimacy of the Communist Party. Other issues like huge foreign reserve, current account surplus, pollution, human rights et. al. are secondary. So I won't lose my sleep over the China's economy.

Interest rates in China are very low. The benchmark rate, the so-called 12-month lending rate is at only 6.39% compared to 10%+ growth in real GDP (see Figure). A rule of thumb says that equilibrium real rate should be equal to real GDP growth. So if anything, China's rate should be higher (in fact at least double the current rate if we take into account 3.3% CPI) notwithstanding today's strong GDP number. Btw, the Economist magazine argued for higher rate in its Mar 22 issue. The article also discussed why Chinese monetary policymarkers have penchant to change rates in 27bp increments versus 25bp increments by their western counterparts (read the article).

NY Fed Conference on, "The euro and The dollar: Pillars in Global Finance"

"The euro and The dollar: Pillars in Global Finance"

Participants

H.E. Ambassador John Bruton, Delegation of the European Commission to the United States
Timothy F. Geithner, President and Chief Executive officer, Federal Reserve Bank of New York
Joaquín Almunia, Commissioner for Economic and monetary Affairs, European Commission
Richard Clarida, Professor of Economics and International Affairs, Columbia University
Mickey Levy, Chief Economist, Bank of America
Nouriel Roubini, Professor of Economics and International Business, New York University
Charles Wyplosz, Professor of Economics, Graduate Institute of International Studies, Geneva
Andrew Crockett, President, JPmorgan Chase International
William Dudley, Executive Vice President, Federal Reserve Bank of New York
Alberto Giovannini, Chief Executive Officer, Unifortune Asset management SGR
Jacques de Larosière, BNP Paribas
Paul Volcker, Chairman of the Board of Trustees, International Accounting Standards Committee
Pervenche Berès, Chair, Committee on Economic and monetary Affairs, European parliament
Kathleen l. Casey, Commissioner, US Securities and Exchange Commission
William Rutledge, Executive Vice President, Federal Reserve Bank of New York
David Wright, Director, DG Internal Market and Services, European Commission
Jan Hatzius, Chief US Economist, Goldman Sachs
Caio Koch-Weser, Vice Chairman, Deutsche Bank Group
Edwin M. Truman, Senior Fellow, Peterson Institute
Sir Nigel Wicks, Chairman, Euroclear
Jean-claude Trichet, President, European Central Bank

What Spending Slowdown?

The BusinessWeek article adds to the current debate on capex. The debate centers around government data (non-defense capital goods ex-air in M3 release) showing slowdown in corporate capex and the impact it could have on future economic growth and productivity trends. Basically the article argues that one can't take the government's data on face value because the issue has become complex owing to globalization. There is a huge discrepancy between what the government is saying about capex and what the businesses are saying and that ought to give pause to anyone who is worried about the state of capex.

When is a slowdown not a slowdown? On the face of it, the government's statistics tell a very convincing story about cautious companies and weak business investment. For example, so far in 2007 new orders for nondefense capital goods, such as computers, trucks, and machinery, are barely higher than they were a year ago, an omen, perhaps, of tough times ahead for corporate profits.

There's only one problem. Corporate America is still spending big time, just increasingly outside the U.S. A BusinessWeek analysis of financial reports from more than 1,000 large and midsize U.S.-based companies shows that global capital expenditures in the fourth quarter of 2006 were actually up 18.1% over the previous year, a number that includes nonresidential construction as well as info-tech equipment and machinery. The comparable growth for domestic business investment, which is all the government reports each quarter: only 8.9%, without adjusting for inflation. (more >>>)

Debunking Messrs Roubini & Hatzius

Read a blog, "Explaining the Mystery of Why Housing Jobs Have Not Fallen Much...and the Worsening Housing Recession... " by Prof Roubini where he discusses the apparent discrepancy between "dismal" housing sector and "apparently" strong construction employment numbers. He cites two possible reasons (1) according to Goldman Sach economist, Jan Hatzius, homebuilders have not started laying off workers (2) undocumented workers hide the actual job losses in the construction industry. May be I am not looking at the same (correct?) data as Mr. Hatzius and Prof Roubini but I come with different conclusions.

Data I look at do not support Mr. Hatzius' argument. Homebuilders have been laying off workers. If you look at employment in S&1500 Homebuilders (BZH, CHB, CTX, DHI, HOV, KBH, LEN, MDCj, MHO, MTH, NVR, PHM, RYL, SKY, SPF, TOL), they have declined in 2006, to 78,000 from 104,000, a whopping 25% decline (first chart). If you look at the data for the broad construction industry, all the available sources - BLS (second chart), Manpower Survey (third chart), Challenger Survey (fourth chart) - show dismal trends in construction employment. What is interesting however is that the woes in construction sector have not permeated into the broader economy. Private payroll growth in the non-construction sector is ok; hiring is fine; and layoffs are actually trending lower.

Prof Roubini's argument about undocumented workers can cut both ways, so net-net it should have no impact. If undocumented workers were not recorded in the current construction employment slowdown, I bet they were not recorded during the boom time either. The anecdotes from the New York Times article are just anecdotes.

So what's my point? My point is that unlike Messrs Roubini & Hatzius, I believe that the problems in the residential housing sector are well-established by the data. That should not be the debate. The debate should be whether that problem is going to spread to the rest of the economy and when. Of course there are people on both sides of the fence. Homebuilders' stock prices seem to suggest that the worst is over for housing but there are others who think that "we ain't seen nothing yet" by pointing out to the housing inventory data. My gut feeling based on variety of housing data is that housing has bottomed and will start to become less of an issue past the summer. Of course, I could be dead wrong. The current slump could persist for another 6-9 months prompting consumers to curtail their holiday spending, and that’ll be the end of the current cycle.

The Economist - Browsing the bourses

Browsing the bourses
The Economist, 29-Mar-2007

Companies scour global exchanges to find a better price for their shares

BASED in Toronto, Golden China Resources is a mining company with the kind of scary but alluring profile you might expect for a firm that goes prospecting for gold. Established only three years ago, it is still losing money. But it boasts an intriguing technology using bacteria in the refining process, promising rights in China and what appears to be a growing inventory of established reserves.

With bullion prices rising and economic doubts gathering, times should be good for gold producers. But on the Toronto Stock Exchange, Golden China has lost its lustre. Its share price has fallen by half since early 2006. In response, the company has embarked on a different kind of prospecting. It is studying how different bourses around the world value companies like itself. Its findings are a challenge to anyone who believes financial markets are consistent or rational.

Take, for example, the market's view of “in situ” ounces, meaning gold that is in the ground. According to an outside analysis, Canadian exploration companies are valued at $75 an ounce on average. As refined gold now sells for more than $650 an ounce, this leaves some margin for processing and mining risk.

If the deposits controlled by these Canadian companies are in China, the valuation slips to $43 an ounce. This may reflect worries that China's methods of verifying potential assets are less stringent. It may also be a consequence of more general fears about property rights in China.

That would be the end of the story were it not for an odd detail. Golden China then went on to look at the valuation of gold producers listed in Hong Kong or on the Chinese mainland. The results were striking: they were valued at $180-240 an ounce. Sino Gold, an Australian company which on March 16th made a secondary listing on the Hong Kong exchange, is priced at about $190 an ounce.

There may be some simple explanations for these big disparities. For example, the Chinese companies in the study all turn a profit. But investors in gold exploration probably care more about the treasure to be unearthed than the trickle of income from ongoing sales.

In fact, Golden China has hit on a broader seam of market discrepancies: the value of a share often depends on where the stock is floated. The most glaring examples are provided by Hong Kong-listed firms that also list in Shanghai, where they almost always get a better price for their shares. No wonder Hong Kong feels threatened by the migration of listings to its mainland rival.

More subtly, global exchanges disagree about the value they put on everything from food companies to banks, even after taking account of differences in a firm's local prospects. Perhaps investors feel better protected and better informed by some bourses rather than others. Exchanges often claim that stiff auditing and disclosure standards add a premium to the shares listed on them. But strangely, valuations right now seem highest in murky stockmarkets like China's.

Bourses may also attract their own distinctive base of investors, interested in some sectors more than others. America's markets attract the technophiles, China's lure the gold bugs. Like retail arcades, exchanges each seem to draw their own tribe of customers who know what they want, pay a premium for it and ignore bargains that would fetch much higher prices elsewhere. Golden China is like an electronics store trying to sell its wares (cheaply) on London's Savile Row rather than Tokyo's Akihabara market.

To profit from such disparities, enterprising investors have long combed the world's bourses looking for cheap stocks. It makes perfect sense for companies to do the reverse: scour the world for markets that will pay high prices for their shares, thus reducing the cost of their capital.

Unfortunately, bagging a higher valuation is not always as easy as listing on a different exchange. For example, lots of international companies coughed up for a Tokyo listing in the late 1980s, hoping to share in the euphoric multiples then applied to Japanese firms. But they were disappointed; their share prices remained tied to those back home.

Golden China is considering a more dramatic migration. Already most of its 700 employees work in China. The company's executives are thinking about joining them, and shifting their primary listing from Toronto to Hong Kong in the process. At the moment, they reckon the company's $50m market value plus its debt is worth only as much as its plant and outside investments, giving it no credit for its 1.5m ounces of gold. If more appreciative customers for their shares exist elsewhere, why not bring the company to them? It would appear the only rational response to an irrational market.

The Great Inflation - Anatomy of a hump

Anatomy of a hump
The Economist, Mar 8th 2007

What caused the Great Inflation? And what might bring it back?

IF YOU were to draw the path of inflation in the typical big, rich economy over the past half century, your picture would look much like a dromedary's back: a low flat line in the 1960s; a knobbly hump of high and volatile price rises in the 1970s; dramatic disinflation in the 1980s; and low, stable inflation rates since. Japan and Germany, which were quicker to quell inflation, are well-known exceptions. But for the rest, the shape and timing of the Great Inflation bulge look remarkably similar.

This is a bulge that today's central bankers are anxious not to repeat. So it is no surprise that several governors from America's Federal Reserve are attending a conference on March 9th to discuss a new report* on the Great Inflation, written by a weighty group of macroeconomists from academia and Wall Street.

Most scholars agree on a basic explanation of the hump, placing both blame and credit squarely on central bankers. Consumer prices accelerated in the late 1960s because monetary policy was too loose. German and Japanese central bankers realised this earlier than others and tightened policy accordingly. Eventually others followed suit, and general disinflation began in the early 1980s. Since then inflation has stayed under control because central bankers are credibly committed to price stability and far better at their job.

Beyond that broad tale lie several debates about important details. Economists differ on how much non-monetary phenomena, such as closer trade integration, affect the inflation process. They also offer competing explanations for why central bankers botched things so badly a generation ago. One possibility is that they simply got the numbers wrong, consistently overestimating their economies' speed limits. Others blame theoretical misjudgments, particularly the belief that higher inflation could buy a lasting drop in unemployment. A third approach emphasises political pressure. Inflation got out of hand because central banks were under the thumb of politicians who preferred rising prices to higher joblessness.

In this latest report the authors subject such controversies to painstaking cross-country forensics. They show that price stability across the G7 countries has been far more closely correlated than economic stability. Almost everywhere, inflation took off between 1969 and 1970. And every country, except Germany and Japan, failed to tame it until the mid-1980s. Output, however, was less tightly synchronised. Although recessions in many countries have become less wrenching in recent decades, output volatility began to ease in the mid-1980s in America, but not until the early 1990s in Britain, Canada and France.

What to make of these differences? The Great Inflation, because it was felt simultaneously across countries, must have had a common cause. This cannot have been the 1970s oil shocks, because consumer prices started accelerating long before the price of crude did. Easy money is the only remaining suspect. And although the Great Disinflation was also simultaneous across many countries, GDP growth settled down at very different times. This implies that better monetary policy cannot take full credit for today's less painful recessions.

The statistical magnifying glass also casts doubt on some favourite alibis for monetary misrule. Bad data, for example, do not get central bankers off the hook: revisions to statistics on trend growth and unemployment were not big enough to excuse the scale of inflation. Instead, monetary policy was simply too loose. The authors show that the central bankers of the 1970s failed to adhere to the modern “Taylor rule”, a formula that links the appropriate level of short-term interest rates to the deviation of output from its trend and inflation from its target. Of course John Taylor, a Stanford economist, did not formalise his rule until 1993. But even without this guide, central banks should not have flunked the basic tenets of sound money.

Hawks v camels

Neither the Taylor rule, inflation targets nor any other bits of the modern central bankers' toolkit were necessary to end high inflation. But the scholars think these tools have helped to keep inflation down, which, in turn, has spawned a virtuous circle. When inflation is low and stable, a temporary uptick in consumer prices has far less impact on long-term price trends. The economists' model implies that less than 1% of a temporary price surge is translated into a permanent rise in inflation today, compared with 60% three decades ago.

That may give today's policymakers more leeway than their predecessors enjoyed. But since this wiggle-room is the legacy of low inflation volatility, it cannot be taken for granted. Were central bankers to lose their guard, inflation could soon resurge.

More worrying, the economists pour cold water on many a policymaker's favourite gauge of his own performance, namely the public's expectations of future inflation. Central bankers often cite low inflation expectations as evidence that monetary policy is appropriate. That may be a mistake. This paper argues that expectations were a good guide to future price pressure only when inflation was high. But now, if anything, inflation expectations are a backward-looking indicator, lagging measures of actual inflation.

All told, this statistical sleuthing suggests today's central bankers have little room for complacency. Inflation remains low and stable because policymakers are vigilant, not because any deep, structural changes insulate the modern economy from price pressure. If central bankers relax, higher, more volatile inflation could easily return. Rudyard Kipling's camel, remember, got its hump for being “most 'scrutiatingly idle”.

---

"Understanding the Evolving Inflation Process" by Stephen Cecchetti, Peter Hooper, Bruce Kasman, Kermit Schoenholtz and Mark Watson

Fed Governor Mishkin, "Inflation Dynamics"

The Economist - What's it all about, alpha?

What's it all about, alpha?
Mar 22nd 2007

Demystifying fund managers' returns

TOO many notes. That's what Emperor Joseph II famously said to Mozart on seeing his opera “The Marriage of Figaro”. But surely to think of a musical work as just a series of notes is to miss the magic.

Could the same be said about fund management? It is the fashion these days to separate beta (the systematic return delivered by the market) from alpha (the manager's skill). Investors are happy to pay high fees for the skill, but regard the market return as a commodity. Distinguishing the two is, however, difficult.

A fund manager might beat the market because of luck or recklessness, rather than skill, for example. Suppose he packed his portfolio with oil stocks. When the crude price rises that would pay off, but it would be a pretty risky portfolio. More generally, alpha sceptics often attribute eye-catching returns to “style bias”, such as favouring stocks with a high dividend yield.

But should they be biased against style bias? After all, the only portfolio utterly free of bias would be one that included the entire market. Were a Britain portfolio to exclude just one stock, such as BP, it would have a small-cap bias, a sector bias and a currency bias (most of BP's revenue is in dollars). Hence any excess return must stem from some element of style.

Academics have entered this debate, trying to pin down the factors that drive a fund's performance. These might include the difference in returns between small-cap and large-cap stocks (fund managers tend to favour the former) or the level of credit spreads and so on. Bill Fung and Narayan Naik of London Business School have come up with a seven-factor model which, they say, can explain the bulk of hedge-fund performance. After allowing for these factors, the average fund of hedge funds has not produced any alpha in the past decade, except during the dotcom bubble.

This approach suggests the whole idea of alpha might be an illusion. Academics can explain most of it, and the only reason they cannot explain all of it is because they are not clever enough to think of the missing factors.

However, it is also possible to take the opposite tack. This type of analysis gives managers no credit for choosing the systematic factors—the betas—that drive their portfolios. Yes, these betas could often have been bought for very low fees. But would an investor have been able to put them together in the right combination?

It is as if a diner in Gordon Ramsay's restaurants were brave enough to tell the irascible chef: “This meal was delicious. But chemical analysis shows it is 65% chicken, 20% carrot, 10% flour and 5% milk. I could have bought those ingredients for £1.50. Why should I pay £20?” The chef's reply, shorn of its expletives, might be: “The secret is in the mixing.”

This debate matters because people are now trying to replicate the performance of hedge funds with cloned portfolios. Indeed Messrs Fung and Naik have shown that their model would have produced an annual return over the past four years of 11.6%, well ahead of the average fund of hedge funds. Their performance was purely theoretical. But Goldman Sachs and Merrill Lynch have launched cloned hedge funds on the market.

There are two potential criticisms of the cloned approach. One is that it will simply reproduce all the systematic returns that hedge funds generate and none of their idiosyncratic magic. However, this “magic” is hard to pin down. Even if it does exist, Messrs Fung and Naik suggest it may be worth no more than the fees hedge funds charge, so the managers are the only ones to benefit from their skills.

The second criticism is that the clones will always be a step behind the smart money. You cannot clone a hedge fund until you know where it has been. But by then it may have moved on. As a result, the clones may pile into assets that the hedge funds are selling, making the classic mistake of buying at the top. This may not be a fatal flaw, however. It is possible to imagine some clones taking contrary bets, buying the betas that seem temporarily out of favour, in the hope that they will be purchasing what the hedge funds are about to buy.

There are some nice ironies at work here. Hedge-fund managers often rely on secretive “black box” models: the investor puts his money in at one end and sees the returns spat out at the other, but no more than that. Now, armed with just that information, academics are coming up with their own models, which almost match the hedge funds' performance.

Mozart might have sympathised. His operas were more than the sum of his notes. But even if the great composer had no peers, he has had plenty of imitators.

Why hard assets are not easy to find

Why hard assets are not easy to find
By Raghuram Rajan
Financial Times, Feb 12 2007

Signs of extremely benign financing conditions are plentiful, ranging from low long-term interest rates to historically narrow credit spreads on risky assets. Many observers call this a liquidity glut, thereby implicating central banks and their accommodative policies. But in my view, these conditions may primarily be driven by a global shortage of hard assets.

My argument relies on two global ingredients. The first is that, in spite of substantial worldwide income growth, if anything there has been an increase in the desire to save out of it. In emerging markets where income growth is rapid, savings increase. Household consumption in developing countries takes time to catch up with higher incomes – either because households take time to be confident that the increase is permanent or because credit constraints prevent them from borrowing to consume against future incomes.

Also, emerging market governments, including oil producers, not only have higher revenues but have become more careful about expenditure, given past experiences with deficits.

But perhaps most intriguing is the increase in corporate savings, especially in industrial countries. Profitable corporations, made more profitable by lower taxes and interest rates, retain earnings rather than hand them back as dividends to shareholders.

This is where we come to the second ingredient. Nominal corporate investment in hard assets – such as inventories, property, plant and equipment – has been restrained, especially relative to the quantities that might be warranted by the tremendous productivity growth of the past few years. Instead, more corporate savings have been invested in financial assets.

A number of possible explanations exist. Some sectors may have invested too much during the technology boom and be still working it off. A competitive need to improve inventory management and, more generally, utilisation of capital may also be at work. The cost of capital goods has fallen, which implies that less nominal investment is needed to achieve the same level of real investment. Furthermore, the nature of required investment may be changing, especially in industrial countries – from physical capital to human capital.

Perhaps the key factor, though, in holding back investment in hard assets may be economic uncertainty – ranging from corporate takeover threats to the increasing cost-competitiveness of emerging markets. Indeed, it makes less and less sense for corporations in industrial countries to make large domestic investments in the manufacturing sector. But as they look to invest in non-industrial countries, they become subject to the uncertainties of policy there. Not only do they have to worry about whether China is a better place to invest than Vietnam but also whether it will continue to be better 10 years from now. No wonder many corporations are focused on trying to improve the efficiency of their existing capital and stock of knowledge.

The mismatch between unabated global desired savings and lower realised investment has led to a financing glut, particularly pronounced in debt markets. With subdued investment in hard assets, there are fewer assets that can be used as collateral on which to base corporate debt. Given that a substantial portion of the world’s desired savings are put to work by central banks and financial institutions, many of which have statutory requirements (or matching considerations) to buy debt, we have many buyers for debt but too few debt instruments being issued.

Consider some implications. First, given that markets are integrated, the glut has spilt over into areas such as property and pushed prices higher. Especially affected have been the most illiquid markets and assets that have a debt-like character, such as utilities, which pay a steady dividend. Some of these markets are frothy, given the long-term prognosis for the savings-investment balance.

Second, while corporations may have learnt to be cautious through recent experience, builders and households have not faced adversity for some time and may have a greater propensity to over-invest. Third, sophisticated financial systems such as that of the US, have been particularly adept at creating instruments the market wants. This has helped the smooth financing of the US current account deficit and may be partly a cause of the deficit.

Finally, easy financing conditions the world over are not primarily because of the accommodative policy followed by the Group of Three central banks in recent years, though clearly monetary policy can add or subtract at the margin by affecting liquidity conditions and carry trades.

What is hard to forecast is how financing conditions will change. As capacity constraints tighten and as the policy environment in emerging markets becomes more clear, more investment will naturally be undertaken, reducing the financing imbalance and pushing up long-term interest rates. If this happens smoothly, the froth in exchange and asset markets will dissipate without much disruption. If long-term rates move more rapidly, for instance because of an inflation scare, the ride could be far more volatile.

The writer is a professor of finance at the Graduate School of Business at the University of Chicago

Some Interesting Stories I Read Today

New Jersey Lottery May Trump Turnpike for Corzine Asset Sale
Rehlaender Bets on Asia Real Estate After Europe Made Him No. 1
Loss at Goldman Hedge Fund Racks Duo at Secretive Global Alpha

Some Interesting Stories I Read Today

Bernanke's Conundrum: Job Market Refuses to Slow With Economy
Bill Gross - 100 Bottles of Beer on the Wall
The Collapse of Amaranth (Commodity Hedge Fund)

Bernanke's Conundrum: Job Market Refuses to Slow With Economy

Bernanke's Conundrum: Job Market Refuses to Slow With Economy
Bloomberg, 2007-01-30
By Scott Lanman

Call it the Federal Reserve's new conundrum: If the U.S. economy has slowed as much as some data suggest, why is the labor market still so strong?

Chairman Ben S. Bernanke and his colleagues are debating the significance of an unemployment rate that's near a five-year low and 2006 job growth that's almost as strong as the prior year's. Either the labor market is lagging behind the slowdown by a few months, or the economy is stronger than official numbers suggest.

Better-than-forecast growth would increase the danger that the Fed, whose policy makers meet today and tomorrow to set interest rates, will lose ground in its fight against inflation. San Francisco Fed President Janet Yellen, calling the situation a ``puzzle,'' says there's a ``serious risk'' of faster price increases.

``The labor market has proved surprisingly tight in the face of what has been a decent slowing in growth,'' said Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, who predicts the Fed will raise interest rates by year-end. It's the ``key issue in the inflation outlook.''

Minutes from the Fed's last Open Market Committee meeting cited the labor market as members' chief inflation concern, and economists expect a similar signal in the Fed's statement tomorrow. The strength in employment is dashing some investors' hopes of a rate cut anytime soon.

Last month, policy makers left their benchmark lending rate at 5.25 percent for the fourth straight meeting after ending two years of increases in August, betting that economic growth was slowing enough to bring inflation down. All 107 economists surveyed by Bloomberg News forecast the Fed will again leave the rate unchanged.

`Gangbusters'

There is little dispute among Fed officials and economists about the demand for labor. Yellen, 60, told an audience in Scottsdale, Arizona, on Jan. 17 that the labor market is ``going gangbusters,'' language she repeated in Reno, Nevada, five days later.

Employers last month added 167,000 workers, capping a year in which growth averaged 153,000 a month compared with 165,000 a month in 2005. The December unemployment rate of 4.5 percent was the lowest year-end level since 2000 and was down from 4.9 percent a year earlier.

The chief U.S. economic-growth indicator has been giving the opposite signal. Expansion in gross domestic product slowed to a 2 percent annual pace in the third quarter from 2.6 percent in the three months through June and 5.6 percent in the first quarter.

Expanding Economy

The signal may change this week. The government's initial estimate of fourth-quarter GDP, to be published tomorrow, will show growth accelerated to a 3 percent rate at the end of 2006, according to the median estimate in a Bloomberg survey of economists.

Economists raised their predictions this month after higher- than-forecast retail sales and a narrower trade deficit bolstered the notion that the economy may be in better shape than earlier figures indicated.

``This disconnect story looked much more compelling several weeks ago, when the fourth quarter looked weaker,'' said former Fed Governor Laurence Meyer, now vice chairman of forecasting firm Macroeconomic Advisers LLC in Washington.

Labor Costs

A report tomorrow from the Labor Department may show its employment cost index, a measure of compensation costs, rose 1 percent from October to December for the second straight quarter, the fastest pace in more than two years. That comes as average hourly earnings last month jumped 4.2 percent from a year earlier, a gain last exceeded in 2000.

Yellen says she doesn't consider such readings troubling. Over the past year, increases in the employment cost index have been ``remarkably restrained,'' she said in her January. 22 speech. Overall, the labor market shows ``at best a mixed picture'' and the situation is more likely to be ``benign,'' she said.

One economist who agrees is Jim O'Sullivan of UBS Securities LLC in Stamford, Connecticut.

``We do think ultimately that growth is going to weaken enough to push unemployment up,'' he said. ``I don't think there's any doubt that if real GDP stayed as weak as 2 percent, that the unemployment rate will start going up.''

UBS expects the jobless rate to rise to 5.1 percent in the fourth quarter and real GDP to increase at a 2.2 percent rate for the full year.

This would ease the Fed's main inflation concern. Other economists reckon unemployment is likely to fall.

`Tight Resources'

``If the unemployment rate falls further, as I'm thinking, later on this year, that will create additional tight resources; workers will demand greater wages; and that can push up inflation in the future,'' said Christopher Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``That's why the Fed would want to restart its rate hikes.''

Some economists say the job market's strength may not be a puzzle at all; instead, it could be evidence that borrowing costs are still low enough to stimulate investment. In fact, this conclusion is shared by analysts with opposing views on whether there's a tradeoff between inflation and unemployment.

``When the Fed gets easy, typically, but not always, you'll see a tightening labor market and a more rapidly growing economy,'' said Brian Wesbury, chief economist at First Trust Advisors LP in Lisle, Illinois, and a former economist for Republicans in Congress.

Assistance From Fed

Jared Bernstein, an economist at the union-backed Economic Policy Institute in Washington, said the Fed's rate stance is ``absolutely'' helping the labor market by not being too restrictive.

The extent to which the job market's tightness generates inflation may depend on something outside the Fed's control: productivity. Richmond Fed President Jeffrey Lacker, the only official to publicly favor higher interest rates in the second half, said on Jan. 19 that productivity growth will keep any wage-inflation in check.

Bernanke, 53, doesn't see a productivity slowdown yet. He said in an August speech that ``strong'' growth in productivity will probably go on for ``some time'' as companies make better use of computers to raise workers' per-hour output.

``The key unknown is projections of what productivity is going to be,'' said New York University economics professor Mark Gertler, who taught Lacker in the early 1980s at the University of Wisconsin and has collaborated on research with Bernanke. ``The economy can weather high wage adjustments if they're accompanied by high productivity growth.''

Junk Bonds are Overvalued, Defaults to Rise, NYU's Altman Says

Junk Bonds are Overvalued, Defaults to Rise, NYU's Altman Says
Bloomberg, 2007-01-25
By Caroline Salas

High-yield, high-risk bonds are overvalued and may tumble as default rates in the U.S. more than triple this year, said Edward Altman, a New York University professor who in the 1960s created a widely used mathematical formula that measures the risk of bankruptcy.

Altman predicts 2.50 percent of the $1.1 trillion junk bond market will default this year, up from 0.76 percent at the end of 2006. The rate will climb to 2.72 percent in 2008, he said last night at a Fixed-Income Analysts Society Inc. event in New York.

With companies having little trouble meeting interest payments, investors have pushed yield premiums on speculative- grade bonds to the lowest in a decade. Junk bonds yield 2.63 percentage points more than Treasuries on average, down from 3.54 percentage points a year ago, according to data compiled by Merrill Lynch & Co..

Even with a ``modest spike'' in defaults, ``it's hard to see how this market is going to do well,'' Altman, 65, said. Some investors predict default rates will remain below 1 percent this year and ``they have to say that'' to justify why they are buying bonds at such narrow yield spreads, he said.

Junk bonds are rated below Baa3 at Moody's Investors Service and below BBB- at Standard & Poor's. The securities returned 11.8 percent last year, including reinvested interest, their second- best performance since 1997, Merrill Lynch index data show. Bonds rated CCC and lower did the best, gaining 18.6 percent.

Z-Score

Altman in 1968 created the Z-score, a mathematical formula that measures a company's bankruptcy risk. Ratios such as working capital, or the amount of money available to run a business, to total assets are used in determining the Z-score. The lower the score, the higher the risk of bankruptcy.

Money from hedge funds and private equity firms are giving the riskiest borrowers access to capital and keeping default rates low, said Altman, who predicted in January 2005 the rate would rise to 4.27 percent last year from 3.37 percent.

``Just about everybody who forecast defaults was wrong,'' said Altman. ``I don't know if I am eating humble pie.''

Cheap debt has helped fuel a record amount of leveraged buyouts, where takeover firms use a combination of their own funds and debt issued in the target's name to fund the acquisition. Private equity firms and management announced more than $700 billion of takeovers last year, a record.

``We're able to borrow at unusually low spreads,'' Steven Rattner, co-founder of buyout firm Quadrangle Group LLC, said in an interview at the World Economic Forum in Davos, Switzerland. ``I'm not sure I'd want to be the buyers of that high-yield paper. The world isn't pricing risk appropriately.''

Record Sales

Companies sold a record $184 billion of junk bonds last year, and loans with below-investment-grade ratings reached an all-time high of $682 billion, according to data compiled by Bloomberg.

``There's an incredible amount of liquidity, primarily coming from non-bank institutions,'' Altman said. He estimated hedge funds account for as much as 40 percent of all trading in high-yield bonds.

Sales of the riskiest junk bonds, those rated CCC, may spur defaults, Altman said. Junk bonds that were rated B- or lower when they were issued accounted for 42 percent of high-yield sales last year, according to S&P.

Open Solutions Inc., a provider of software for financial- services companies, last week sold $325 million of 9.75 percent eight-year notes to finance its $1.4 billion takeover by the Carlyle Group and Providence Equity Partners Inc. The debt is rated Caa1 by Moody's and CCC+ by S&P.

`Very Disturbing'

``These chickadees are going to come home to roost,'' Altman said. ``But they're very happy eating in their barnyard, and they haven't. Which is very disturbing.''

The percentage of bonds considered in distress fell to a record low of 1.3 percent this month from 1.6 percent in December, S&P said this week in a report. Seventy companies had bonds trading at distressed levels, down from 97 in December, according to S&P, which defines distressed bonds as those with yields more than 10 percentage points above Treasuries.

Merrill Lynch's index of distressed bonds has shrunk to a face value of $6.5 billion from $27.4 billion at the end of 2005 and $161 billion in 2002.

``Every time there is a big bankruptcy we do open a bottle of fine wine in my household,'' said Altman. ``It's been a real dry spell. I am hoping for a more liquid situation going forward.''

Cohen, Granville, Acampora Don't Move Markets Anymore, Do They?

Cohen, Granville, Acampora Don't Move Markets Anymore, Do They?
Bloomberg, 2006-11-29
By Daniel Hauck

Joseph Granville and Ralph Acampora aren't moving the U.S. stock market as they used to, and no one has come along lately to take their place.

When Granville told newsletter readers to ``Sell Everything'' on Jan. 6, 1981, the Dow Jones Industrial Average fell 2.4 percent the next day. The average rose after a similar forecast on Oct. 26 this year. Acampora helped boost the Dow to a 1.1 percent gain on Jan. 8, 1999, by saying a rally was beginning. This year, the average fell when he wrote in an Oct. 30 report that the worst was over for stocks in 2006.

Forecasts from fellow 1980s and 1990s pundits Elaine Garzarelli and Abby Joseph Cohen don't have the impact they once did either. And bearish projections from top-ranked strategists Francois Trahan of Bear Stearns & Co. and Merrill Lynch & Co.'s Richard Bernstein this year failed to dent stocks' rally.

``It's gotten a lot more difficult to make that call,'' said Warren Simpson, who helps manage more than $3 billion at Stephens Capital Management in Little Rock, Arkansas. ``It's kind of passe, isn't it? There's too much risk.''

Making accurate forecasts is harder than it was 20 years ago because the rise of hedge funds has created a bigger pool of money, muting the impact of any one strategist, said Cummins Catherwood, who helps manage $700 million at Walnut Asset Management in Philadelphia.

Pundits also are dealing with a more fickle audience that is ``privy to much more information than they used to be,'' said Simpson. ``In the old days, you were dependent on your broker to tell you what the market was doing. Now people have it on their desks all over the country.''

`Sell Everything'

Investors now have more and faster information about markets from the Internet. Microsoft MSN Money, Yahoo Finance and AOL Money each attracted more than 10 million people in the U.S. in October, according to ComScore Networks Inc., a market researcher in Reston, Virginia.

Granville, 83, and Acampora, 65, helped pioneer technical analysis, or the study of price charts to make buying and selling decisions. Their influence diminished after they maintained for too long the positions that made them famous.

Granville, who got his start at what was then the brokerage E.F. Hutton in 1957, correctly forecast the bear market of 1977- 78 before his ``Sell Everything'' call.

``Joe was extremely powerful,'' said Robert Stovall, global strategist at Wood Asset Management Inc. in Sarasota, Florida, who worked with him at E.F. Hutton. ``If he gave the thumbs down to a market, it was like the emperor in the coliseum. The market would go down.''

Granville's Call

Granville later failed to foresee the rally that started in 1982 and lasted for five years. He also called for losses in 1995 before the so-called Internet bubble began.

Not all his most accurate calls were long ago. On March 11, 2000, a day after the Nasdaq Composite Index peaked at 5048.62, he wrote that investors in technology stocks ``will soon be burned.'' The index, which now gets 42 percent of its value from computer-related shares, sank 78 percent through Oct. 9, 2002.

Now he predicts the Dow average will fall as low as 7100 within six to 18 months. He draws on the observation that only five of the Dow's 30 members reached new 52-week highs when the Dow closed above 12,000 on Oct. 19 and none set records.

``When I make a prediction or a statement, it's coming from somebody who's gone through 50 years of markets,'' he said in an interview from Kansas City, Missouri, where he's based.

Dow 10,000

Acampora, a 40-year Wall Street veteran, became known for his forecasts during the 1990s at what's now Prudential Equity Group LLC. When the Dow stood at 7600 in June 1997, he correctly predicted it would reach 10,000, a level breached in March 1999.

After that happened, he said the average would climb to 18,500 by 2006. The Dow industrials closed above 12,000 for the first time on Oct. 19.

He hasn't yet released his official forecast for 2007, though he said the current four-year advance in the Dow average may be extended at least through 2008. He wrote in a note last month that 21 stocks in the Dow are ``attractive technically'' and ``buys for the long-term.''

Knight Capital Group Inc., the second-biggest matchmaker for trades on the Nasdaq Stock Market, hired Acampora in October 2005 after Prudential closed the technical research department he headed. This year, he ranked third among technical analysts in Institutional Investor magazine's annual fund-manager survey.

Acampora's Following

``Acampora currently has more of a following, more credibility, than Granville,'' said Stovall, who also worked with Acampora at Prudential. ``But they're both very serious students and the early Granville books written in the early 1960s added a lot to technical analysis.''

Garzarelli, who is 55 according to Marquis Who's Who, correctly predicted the 1987 crash as a Lehman Brothers Inc. strategist. In a June 2005 Bloomberg article, she estimated the S&P 500 would surge 25 percent in the next year. The index rose 2 percent in the 12 months, and her call didn't move the market.

``I don't have a platform,'' Garzarelli said in an interview from Springfield, Pennsylvania. She said her work, Granville's and Acampora's gets less attention from the media because they no longer are at ``major'' firms.

Since 1995, Garzarelli has headed her own firm. She uses a 14-indicator model to predict the market's moves, and expects the S&P 500 to reach a record in 2007.

Market Forecasting

Cohen, Goldman Sachs Group Inc.'s chief U.S. investment strategist in New York, made her name with bullish forecasts amid the Internet bubble. She was the top-ranked strategist in Institutional Investor's survey in 1998 and 1999.

She lost influence after underestimating the plunge that began in March 2000. In this year's survey, she wasn't listed among the top seven strategists.

Cohen, 54, was traveling and unavailable for comment, according to a Goldman spokesman, Ed Canaday. Her role has changed since the 1990s, Canaday said, as she focuses more on a ``longer-term, macro view'' than predicting daily market moves.

This year, Cohen has been a more accurate forecaster than Bear Stearns's Trahan and Merrill's Bernstein, the strategists now at the top of Institutional Investor's poll.

She said on June 13 that stocks had fallen too far and the S&P 500 would rebound to 1400 by year end. The index set its low for the year that day and has since risen 13 percent to 1386.72. Trahan has a year-end forecast of 1200, while Bernstein said at the start of 2006 that the index would slip 1.9 percent to 1224.

Pundits ``make calls and they're right sometimes,'' Stephens Capital's Simpson said. ``When they're wrong people don't listen to them as much anymore.''

Record Share Repurchases by U.S. Companies May Aid Stock Rally

Record Share Repurchases by U.S. Companies May Aid Stock Rally
By Hilary Johnson
Bloomberg, 2006-09-05

U.S. companies are spending record amounts of money on their shares, and the repurchases may help stocks exceed the five-year highs reached earlier in the year.

Microsoft Corp., the world's largest software maker, bought back $3.8 billion of stock last month. Realogy Corp., the real- estate broker spun off from Cendant Corp., offered last week to pay as much as $736 million for some of its shares.

The offers followed $116 billion of repurchases in the second quarter, the most ever, according to Standard & Poor's. Buybacks announced in 2006 already exceed the record amount for a full year, according to Birinyi Associates Inc., a money- management and research firm. Record levels of cash and relatively low interest rates have spurred buying.

``Supply's shrinking,'' said Kenneth Fisher, chairman of Fisher Investments Inc. in Woodside, California, who oversees $32 billion. ``That's got to be bullish.''

Stocks rose last week as data on inflation, job growth, manufacturing and consumer confidence reinforced the Federal Reserve's view that economic growth is slowing gradually.

The S&P 500 ended the week 1.1 percent below this year's peak of 1325.76, reached May 5, when the index climbed at the highest level since February 2001. U.S. markets were closed yesterday for the Labor Day holiday.

Reports tomorrow may provide more evidence that the economy is meeting the Fed's expectations, suggesting policy makers may be done raising interest rates after 17 increases in two years.

Advisers' Optimism

The Institute for Supply Management may say banks, builders, retailers and other service companies expanded last month, according to a survey of economists by Bloomberg News. Productivity probably rose in the second quarter at a faster pace than first reported, another survey showed.

Speculation that the Fed won't lift rates sent optimism about U.S. stocks to a five-week high, according to the latest survey by Investors Intelligence, a New Rochelle, New York-based financial newsletter.

The number of bullish newsletter writers rose during the week ended Aug. 25 by 2.1 percentage points, to 42.1 percent. Bearish, or pessimistic, writers fell to 33.7 percent, a six-week low, from 34.7 percent.

The S&P 500 advanced 1.2 percent last week to 1311.01. The Dow Jones Industrial Average added 1.6 percent to 11,464.15 and the Nasdaq Composite Index increased 2.5 percent to 2193.16.

$40 Billion Plan

Microsoft has risen 20 percent since June 13, when the S&P 500 reached its low for the year. The Redmond, Washington-based company announced plans in July to repurchase $40 billion of stock, including $20 billion through a tender offer.

Investors tendered only $3.8 billion of shares. To make up the difference, Microsoft boosted its repurchase program to $36 billion on Aug. 18. That day, its stock gained 4.4 percent, the most in a month.

Realogy, the company behind the Coldwell Banker and Century 21 real-estate brokerages, offered to buy as many as 32 million shares on Aug. 28. The company agreed to pay $20 to $23 a share in the so-called Dutch auction, allowing shareholders to set the price they will accept. The offer expires on Sept. 26.

A week earlier, Realogy authorized a buyback plan for a maximum of 48 million shares. The company, based in Parsippany, New Jersey, said the purchases may add as much as 10 percent to earnings per share next year.

`Being Pushed'

U.S. companies spent 16 percent more on their shares during the second quarter than in the prior three months, according to Howard Silverblatt, a senior index analyst at S&P in New York. They also beat the record of $104 billion set in last year's fourth quarter, S&P data showed.

Buyback announcements in the first eight months of 2006 totaled $507 billion, up 88 percent from the year-ago period, according to Birinyi, based in Westport, Connecticut. The full- year record of $470.7 billion had been set last year.

Boeing Co., the world's second-largest maker of commercial aircraft, said on Aug. 28 that it would buy back as much as $3 billion of shares. Amazon.com Inc., the world's biggest online retailer, authorized $500 million in repurchases that day.

Companies are making these plans after amassing record amounts of cash. S&P 500 members had $614 billion available as of Aug. 30, according to S&P, whose total excludes utilities and financial and transportation companies.

``They're being pushed to do something with the money,'' Silverblatt said. Buybacks enable companies to return cash to shareholders without committing themselves to future payments, as dividends do.

`Too Cheap'

Relatively low interest rates have also been a boon for buybacks, Fisher said. S&P 500 companies will earn $87.17 per ``share'' this year, about 6.6 percent of the index's current level, according to the average estimates of analysts surveyed by Thomson Financial. Ten-year U.S. Treasury notes, a benchmark for borrowing costs, yield 4.72 percent.

``What they're really saying is that the cost of the stock is too cheap relative to the cost of borrowed money,'' he said, referring to companies.

Repurchases can increase per-share earnings by reducing the amount of stock outstanding. Analysts see profit growth slowing through the second quarter of 2007, providing an incentive to make repurchases.

After surging 16.3 percent in the second quarter, S&P 500 profits will rise 14.3 percent in the third, 13.4 percent in the fourth and 11 percent in next year's first quarter, according to Thomson. Second-quarter profit is projected to rise 8.9 percent.

`Lack of Confidence'

``Companies buying back their own shares may well reflect a lack of confidence,'' said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, who helps manage $150 billion. ``They feel they don't have any good investment opportunities.''

Announcements don't always lead to purchases. Since 2000, companies have bought only 65 percent of the shares they said they would, according to Birinyi's data.

Still, many investors can't help but be optimistic about what the increase in buybacks may mean for the market.

``How much can you shrink the denominator before it explodes the price?'' asked Kevin Bannon, who helps manage $116 billion as chief investment officer at Bank of New York. ``We're getting closer and closer to that point.''

Bloomberg Tickers
TNI US BBK BN To see Bloomberg stories on share repurchases
CACT 50 US For a table of U.S. companies that have announced repurchase programs.

Al Gordon, Wall Street Icon at 105, Is Bearish on U.S. Stocks

Al Gordon, Wall Street Icon at 105, Is Bearish on U.S. Stocks
By Christine Harper
Bloomberg, 2006-08-30

Albert H. Gordon took over Kidder, Peabody & Co. in 1931, turned it into an underwriting leader on Wall Street, and saw opportunities overseas before many rivals.

He's still looking abroad at the age of 105.

After eight decades as an executive and investor that spanned from the roaring 1920s to the age of terrorism, Gordon says he's ``bearish'' on U.S. stocks partly because of the $8.41 trillion national debt. He prefers shares of companies such as Canada's EnCana Corp., Wal-Mart de Mexico SA de CV and Petroleo Brasileiro SA.

``At least three-quarters of whatever I own is foreign stocks,'' he says from his Manhattan apartment overlooking the East River.

Gordon, who has outlasted Kidder as well as Wall Street staples like ticker tape, is a role model even to octogenarian elder statesmen such as former Goldman Sachs Group Inc. Co- Chairman John Whitehead and ex-President George H.W. Bush. This year, Gordon stopped going to the office at Deltec Asset Management, where his son John is a senior managing director.

A marathon runner into his 80s, Gordon now has a hearing aid and walks with a cane and assistance from a nurse. His opinions are still sought because he's one of the few living Wall Street investors who worked in the years leading up to the stock market crash of 1929.

While his three current favorite stocks each climbed at least 13 percent this year through yesterday, almost triple the 4.5 percent gain in the Standard & Poor's 500 Index, Gordon built his reputation as a salesman rather than as an investor, says Whitehead, 84.

Presidential Role Model

``He was a famous business-getter,'' says Whitehead, a former rival. ``Work hard and never give up -- those were very valuable lessons I learned from trying to compete with him.''

Whitehead, who joined Goldman Sachs in 1947, remembers vying for clients against the more experienced Gordon at Minneapolis- based 3M Co., where Gordon's relationship was so close with then- Chief Executive Officer William McKnight that Whitehead says he focused instead on cultivating the next generation of executives. It didn't work right away, he says.

When McKnight died, Whitehead says, his will stipulated that Gordon and Kidder should handle any sales of McKnight's stake in 3M.

Gordon's influence extended to the highest levels of the U.S. government. He befriended Prescott Bush, a U.S. senator from Connecticut from 1952 to 1963 and grandfather of President George W. Bush, and served as a role model to George H.W. Bush, the 41st U.S. president.

``He taught me a lot about ethics and values,'' says George H.W. Bush, 82. ``He's a very energetic man of great character.''

Harvard Benefactor

Gordon, the son of a successful leather merchant in Boston, graduated from Harvard University in Cambridge, Massachusetts, in 1923 and from Harvard Business School two years later.

Today, one of the main roads into the business school bears a plaque calling it ``Albert H. Gordon Road'' in recognition of his advice and donations over the years. Harvard declined to comment on the amount Gordon has given to the school.

``Al Gordon was a master salesman,'' says Samuel Hayes, 71, an investment-banking professor emeritus at Harvard Business School who met Gordon in 1961. ``He was an effective rainmaker long after he ceased to manage the firm on a daily basis.''

As a bond salesman at Goldman Sachs in the 1920s, Gordon says he considered stock values excessive and steered clear of the market before it crashed. That helped him a year later in 1930 to capitalize when a Harvard classmate, Edward Webster, approached Gordon to help rescue Kidder, a brokerage based at the time in Gordon's hometown of Boston.

Planes and Trains

They moved the firm to New York, and Gordon, who would go on to become the firm's senior partner and biggest shareholder, built up its sales and underwriting divisions. Gordon expanded across the U.S. and overseas, taking airplanes to see clients when his competitors were more comfortable on trains like the 20th Century Limited to Chicago, he says.

``People wouldn't fly,'' he says. ``So there was virtually no competition.''

With the advent of jet travel, he flew to Japan with his wife ``to see if the people were friendly,'' paving the way for an expansion in Tokyo.

``We did a tremendous amount of business in Japan,'' he says. That followed expansions in Asia and Europe in the 1950s, he says: ``We were the first people to have an office in Hong Kong, the first people to have an office in England.''

Gordon began turning over chief executive officer duties at Kidder to Ralph DeNunzio in the 1970s, staying on as chairman. In 1986 Gordon helped engineer the firm's sale to General Electric Co. and remained at the firm until 1994, when GE sold the company to PaineWebber Group Inc., now part of Zurich-based UBS AG.

`Gold Mine'

Kidder's final years included criminal inquiries. Martin Siegel, who had been the firm's top merger banker, pleaded guilty in 1987 to one count of conspiracy to violate the securities laws and one count of tax evasion for failing to report payments he received from arbitrager Ivan Boesky.

The firm fired bond trader Joseph Jett in 1994, accusing him of manufacturing $350 million of false profits. On March 5, 2004, the U.S. Securities and Exchange Commission ordered Jett to pay $8.4 million and barred him from the securities industry after concluding he committed fraud and created phantom profits. Jett maintained his innocence after the order.

Kidder should have spotted the activities sooner, and the inquiries hurt the firm's reputation, Gordon says. Until that time, he says, ``it really was a gold mine.''

Growth Strategy

When it comes to investing, Gordon looks for companies that will grow for years, says Arthur Byrnes, who is co-head of Deltec Asset Management with Gordon's son John.

``Despite the fact that he's an old man, he buys things not for a quick trade,'' Byrnes says. ``Al is a long-term investor, if you can believe that someone who's 105 years old can be a long-term investor.''

Gordon favors countries with economies that will support growth, and he says the U.S. has too much debt. He says he liked Petroleo Brasileiro partly because South America had been successful for Kidder. Wal-Mart de Mexico and EnCana, Canada's largest natural-gas producer, may grow, he says.

``I read that Wal-Mart was stationary but Wal-Mart's Mexican subsidiary was on the move so that was enough for me so I bought quite a bit of Wal-Mart Mexico,'' he says. ``EnCana was owned by the Canadian Pacific Railroad and so you knew that its background was business, not government.''

Sleep and Run

A non-smoker who says he used to pay people to give up cigarettes, Gordon ran in the London marathons for the two years after his wife died in 1980. He credits his long life to exercise and at least nine hours of sleep a night. He would often walk or run between city centers and airports in New York and Los Angeles. He has three sons and two daughters, all between the ages of 70 and 55.

When it comes to investing, at least one of Gordon's contemporaries agrees that overseas stocks can provide more robust returns than U.S. shares.

``Al Gordon is right,'' says Irving Kahn, 100, chairman of New York-based investment firm Kahn Brothers & Co. He says global wealth imbalances and the rise of extremists should give investors pause: ``You don't have to be too alert to see how much terrorism is spreading.''

Highlights of the FOMC Minutes

Highlights of the FOMC Minutes
The Detailed Minutes
Aug 29, 2006

The staff forecast prepared for this meeting indicated that real GDP growth would slow in the second half of 2006 and 2007, and to a lower rate than had been anticipated in the prior forecast. The marking down of the outlook was largely attributable to the annual revision of the national income and product accounts, which involved downward revisions to actual GDP growth in prior years and prompted reductions in the staff’s estimate of potential output.

The rate of new home sale cancellations, which was identified as an important leading indicator by some contacts in the construction industry, had spiked higher.

Although business fixed investment in the second quarter was a little lower than had been expected, participants noted that this development appeared mainly to reflect the timing of purchases, particularly of transportation equipment, and not weakness in the underlying trend.... However, it was noted that if the reported slowing of increases in retail sales continued, businesses might trim capital spending plans.

Several participants took note of the revisions to historical data that painted a more worrisome picture of cost trends; measures of unit labor costs had been marked up, reflecting upward revisions to labor compensation and downward revisions to labor productivity.

The recent pickup in price increases appeared to be broad-based, and a number of business contacts reported greater ability to pass through higher costs. However, some types of price pressures were not likely to continue to increase. The recent acceleration in shelter costs, which contributed substantially to the increase in core inflation this year, could prove short-lived. Moreover, while energy prices had risen further in the intermeeting period, energy prices could well level out in coming quarters. Also, the anticipated moderation in aggregate demand implied that pressures on resource utilization likely would not increase and could abate to a degree going forward. Finally, inflation expectations appeared to have remained contained despite adverse news about prices. In light of these factors, most participants expressed the view that core inflation was likely to decline gradually over the next several quarters, although appreciable upside risks remained.

In view of the elevated readings on costs and prices, many members thought that the decision to keep policy unchanged at this meeting was a close call and noted that additional firming could well be needed.

All members agreed that the statement to be released after the meeting should convey that inflation risks remained dominant and that consequently keeping policy unchanged at this meeting did not necessarily mark the end of the tightening cycle

Chinese Economy - Progress on Strategic Petroleum Reserve for Chin

Chinese Economy - Progress on Strategic Petroleum Reserve for Chin
G7 Group, Aug 29, 2006

China is in the process of building extensive storage capacity for a strategic petroleum reserve (SPR). The capacity goal is 90 days of net import volume, which is about 400 million barrels, but this is a long run target. China has not yet begun to fill the reserve (although it plans to start before year end), and the rate at which it supplies the reserve is dependent on petroleum prices. Large purchases of oil from the international market for the SPR are unlikely anytime soon unless the oil price drops significantly (say to under $60 a barrel). What is behind this effort?

Soaring oil prices combined with China’s increasing dependence on imported oil products have spurred the government to expedite the pace of building its strategic petroleum reserve. The purpose is to secure oil reserves in case of a supply shock and to cushion against the impact of oil price on China’s economic growth. China is aware that in the absence of a petroleum reserve it is increasingly susceptible to economic sanctions triggered by international conflicts and general supply interruptions. Currently, China's commercial petroleum storage can only meet the nation's consumption needs for 21.6 days, compared with about 160 days for the US and Japan. At what stage is the overall SPR project?

- Four reserve bases are currently under construction: Two at Zhenhai and Daishan in Zhejiang province, one at Huangdao in Shandong province, and one at Dalian in Liaoning province.

- After these four bases are put into operation in 2008, China’s total petroleum storage (including existing commercial storage) will be able to satisfy the nation’s 30 days consumption. The NDRC recently disclosed that all 52 oil storage tanks (16 of them already completed in October 2005) at the Zhenhai oil reserve base, the largest among the four, will be completed for use by the end of October this year. The total capacity of storage is
5.2 million cubic meters. The other reserve bases are expected to be completed in 2007-2008.

- But China’s buildup will go further than this. When the whole project is completed, China expects to have petroleum storage capacity of 400 million barrels, or equivalent to about 90 days of net import volume. The government is already starting to select the new sites for the second phase of the SPR. And after that, additional sites are expected to be built in the hinterland of the country (Phase Three). Total planned storage of strategic petroleum is 10-12 million tons during Phase One; 28 million tons at the end of Phase Two; and another 28 million tons at the end of Phase Three.

China plans to start filling the SPR this year, but it is expected to take a long time to complete. Some of the newly-found oilfield output is likely to be incorporated into the SPR; however, China is unlikely to choose this time to import large additional amounts of petroleum to build the SPR, because it does not recognize the current oil price as a good deal.

Moreover, the country’s new oil windfall tax does not encourage additional imports. Domestic oil producers will be charged a tax of 20% or higher when the price of crude oil stays above US$40 a barrel. The tax rate is 40% when the price rises above US$60 per barrel, which is indicative of how the policymakers perceive oil prices. Hence we may expect that the filling of China’s SPR to be a gradual process.

Large purchases of oil from the international market are unlikely at this point and may remain so unless the price of price drops significant (say, to under $60 a barrel). Obviously, this price point estimate is based on a current assessment of the likelihood of supply interruptions. If the geo-political environment becomes more risky for oil supply, the pace of supplying the SPR can change.

Bottom Line: China is building capacity for an ambitious SPR. But it is not filling the capacity yet and when it starts -- probably later this year-- it will not do so aggressively, given the high price of imported oil. The capacity building will take at least several more years, and filling will obviously take longer, perhaps much longer.

Asset – Credit Market

Asset – Credit Market
New World's Banker
WSJ, Aug 26, 2006

Some fear the U.S. credit markets are about to be submerged under a flood of leveraged buyouts. With a number of large deals seeking financing, that could mean higher borrowing costs and smaller profits for private-equity investors. The buyout kings have found a way around this potential crisis, however -- they are turning to Europe.

This year U.S. companies have raised $20 billion of leveraged loans outside America, according to Standard & Poor's Leveraged Commentary & Data. That's almost double the amount from the comparable period last year. The financing for HCA's record $33 billion buyout adds to this trend. More than a tenth of the institutional loans for HCA are expected to come from Europe. Yet only a small part of HCA's revenues originate in Europe.
Not long ago, American firms shied away from the European syndicated loan market. In the old days this market was dominated by banks, whose rigid practices made loans more expensive. Emsurope has since become more competitive. Several U.S. debt specialists, including Bain Capital's Sankaty Advisors, have set up shop there. European investment firms have also established specialist funds for leveraged loans. This influx of new investors has improved the position of borrowers. American firms often pay less on riskier dollar loans raised in Europe than at home.

The U.S. trade deficit is another reason why Americans are looking abroad. With a lot more cash going out of the country than coming in, U.S. leveraged buyouts could face financing constraints if they were restricted to domestic credit markets. Europe runs a trade surplus and, with lower interest rates, liquidity remains abundant. With a large number of leveraged loans in the pipeline, other issuers are likely to follow the example of HCA and head across the pond.

Citigroup, Bank of America Squeezed by Bond Market

Citigroup, Bank of America Squeezed by Bond Market
By Mark Pittman
Bloomberg, 2006-08-29

Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. are among the biggest losers in the bond market, where the largest U.S. banks' relative borrowing costs are the highest in three years.

A slowing economy has prompted investors to demand an additional 11 basis points of interest, or $1.1 million for each $1 billion face amount, on bank bonds since February, according to data compiled by Merrill Lynch & Co. The widening yield premium amounts to a loss of $7.3 billion on bondholders' principal the past six months and a profit squeeze for banks, which make money on the difference between their borrowing and lending charges.

Bank bonds, which account for almost one fifth of the $5.2 trillion U.S. corporate bond market, are heading for their worst year since 1999 after the Federal Reserve increased interest rates 17 times, the government reported a 4.3 percent slump in new-home sales in July and oil prices rose 14 percent since January. Slower growth may cause bond defaults to quadruple by 2008, adding to bank losses, Standard & Poor's says.

``Whenever you see some weakness in the economy, that has to get into investors' minds,'' said Alvaro de Molina, chief financial officer of Bank of America, in an Aug. 24 interview. Some fund managers may be questioning whether the Fed has pushed the economy into a recession, de Molina said.

Investors are demanding 81 basis points more than the yield on similar-maturity Treasuries. The spread was as high as 83 basis points on Aug. 11, which was the most since 2003. The spread has widened twice as much as the 5 basis point increase in yield premiums, or spreads, for investment-grade bonds, according to Merrill. A basis point is 0.01 percentage point.

Falling Prices

Bank bond prices have fallen on average 2 percent this year, according to a Merrill index that tracks the performance of 579 securities worth $365 billion. By contrast, the Merrill index of AA rated debt declined 1.8 percent this year.

The total return on the bank index, including both capital appreciation and reinvested interest, is 1.64 percent this year, the worst since it declined 1.73 percent in 1999.

Citigroup's $1 billion of 6 percent bonds due in 2033 have fallen 7 cents per dollar of face amount this year to 99 cents as the yield climbed to 6.06 percent from 5.6 percent, according to Trace, the bond-price reporting service of the NASD. The spread has widened 10 basis points to 1.11 percentage points since Jan. 1.

Citigroup spokeswoman Shannon Bell in New York declined to comment.

JPMorgan's $1 billion of 5.875 percent notes due in 2035 have fallen 6 cents per $1 face amount to 94 cents since the first of the year, according to Trace. The bond's yield has gone up 45 basis points to 6.31 percent.

JPMorgan spokeswoman Brooke Harlow declined to comment.

Threat of Default

A slowing economy also may cause a growing number of borrowers to default, requiring banks to set aside more money for losses and leaving less for debt payments. Defaults will rise to 4 percent from their current record low of 1.03 percent by the first quarter of 2008, according to S&P.

``We're probably at the top of the mountain for loan quality, and it's going to start falling pretty soon,'' said James Hannan, who oversees $3 billion in fixed income at MTB Investment Advisors in Baltimore.

Hannan, whose holdings include bonds of Charlotte, North Carolina-based Wachovia Corp. and Mellon Financial Corp. of Pittsburgh, said he is seeking debt of banks that make money from trading, underwriting and advisory services. He's avoiding companies that focus on housing loans, such as Calabasas, California-based Countrywide Financial Corp., the biggest U.S. mortgage provider.

Investors now demand 23 more basis points in yield over government debt, or 1.36 percentage points, to hold Countrywide's $1 billion of 6.25 percent notes than when they were sold in May. The securities mature in 2016.

Yield Premiums

The average yield premium for banks has widened 11 basis points from the low this year of 70 basis points in February, saddling bank bond investors with the biggest losses, Merrill data show. Bonds sold by companies in the telecommunications industry lost $5.3 billion because of declining prices.

Banks have $30.7 billion in debt coming due by year-end, more than any other industry, according to data compiled by Bloomberg. Bank of America has the most, or $5.7 billion, just ahead of the $3.5 billion for Minneapolis-based U.S. Bancorp.

Higher borrowing rates have contributed to shrinking lending margins, a measure of profitability. S&P said earlier this month that those margins are at their lowest since 1991.

Interest Margins

Citigroup's net interest margin, the difference between the average rate the bank pays to borrow and what it charges in interest, fell to 2.8 percent in the second quarter, the lowest since at least December 2000.

The net interest margin at New York-based JPMorgan has shrunk to 1.96 percent, the smallest since September 2001. The rate at Charlotte, North Carolina-based Bank of America is 3.02 percent, the lowest since at least March 1999.

Lending margins are ``a key factor in their earnings, and they're continuing to see some pressure,'' Baylor Lancaster, a Coconut Grove, Florida-based analyst from debt research firm CreditSights Inc., said in an interview. ``We view a future deterioration in credit quality as pretty much inevitable,'' Lancaster said in an Aug. 8 report.

Commercial banks make about two thirds of their income from the difference between their borrowing and lending costs, according to James Moss, an analyst at Fitch Ratings in Chicago. He said a 1 percentage point increase in benchmark interest rates could reduce profit on average by 4.6 percent.

Sell Bank Bonds

Investors ought to sell bank bonds or buy derivatives that would benefit from a decline in the price of debt issued by Wachovia and Citigroup, said Barclay's Capital analysts Melody Vogelmann and Julie Schultz in an Aug. 17 report.

Wachovia, the fourth-largest U.S. bank, has few operations outside the U.S., so it would be hurt by a slower U.S. economy more than other competitors, Vogelmann and Schultz said.

``No question, it's a headwind with regard to revenue growth,'' said Bank of America's de Molina. Higher borrowing costs won't hurt credit quality because the bank can make up the lost revenue in other ways, he said.

By de Molina's estimate, the worst-case scenario for interest rates next year would cost Bank of America about $600 million. The bank will earn $20 billion this year, according to the average forecast of 16 analysts surveyed by Thomson Financial.

``That's a pretty small number in comparison to a $20 billion revenue stream,'' de Molina said

Target Rate

Fed policy makers this month decided not to raise borrowing costs after pushing their target rate for overnight loans between banks to 5.25 percent from 1 percent in June 2004. New-home sales in July fell more than forecast and the number of unsold houses climbed to a record, according to a Commerce Department report released last week. Purchases of new homes dropped to an annual pace of 1.072 million.

The central bank should have stopped earlier, according to Robert Shiller, the Stanley B. Resor Professor of Economics at Yale University in New Haven, Connecticut. Shiller, the author of the book ``Irrational Exuberance'' that in 2000 predicted a slump in the stock market, said this month that a slowdown in the housing market will likely cause a recession.

``Banking spreads are going to widen much more meaningfully than they have now,'' said Nouriel Roubini, a professor of economics at New York University. ``The banking system as a whole is hugely vulnerable to the risk of recession.'' Roubini says there is a 70 percent chance of a recession.

Consumer Confidence

Confidence among consumers this month fell to its lowest since October because of concerns about terrorism and high gasoline prices, the University of Michigan said Aug. 18. The school's preliminary index of sentiment dropped to 78.7 from 84.7 in July.

Almost 30 percent of banks said they anticipate residential mortgages will deteriorate over the next year as the housing market cools, an Aug. 14 report by the Fed said.

``Banks will tighten their lending standards by increasing loan spreads and by simply refusing to lend to some at any spread,'' said Paul Kasriel, director of economic research at Northern Trust Securities, in an e-mail on Aug. 18. ``This, in turn, will create even more drag on economic growth.''

The three biggest U.S. banks all reported record profits last year led by Citigroup's $24.6 billion. Bank of America's net income totaled $16.5 billion and JPMorgan had $8.5 billion.

Corporate Lending

Bank of America has scaled back its corporate lending exposure to $35 billion, less than one-fourth of the $130 billion in company loans that the lender and its predecessor companies had in 2000, the last time the Fed ended a series of rate increases, de Molina said.

``If you look at the amount of corporate credit risk that we have in this cycle versus the last cycle, it's much, much smaller,'' de Molina said.

An expanding economy allowed borrowers to tap banks for cash with little trouble even as the Fed was raising rates. The lending environment is still favorable for banks.

Debt deemed uncollectible by U.S. banks fell to 0.4 percent of all loans and leases in March, the least since before 1985, according to the Fed. Borrowers defaulted on high-yield, high- risk, or leveraged, loans at a 3.2 percent rate in the first quarter, down from 10 percent in 2002, according to S&P.

SunTrust's Loan

Atlanta-based SunTrust Banks Inc. was stuck with a non- performing $200 million loan because the borrower's business deteriorated before the bank had a chance to sell the loan to investors, said Richard Bove, who follows the bank for Punk Ziegel & Co. in Pinellas Park, Florida.

The loan was to ``a large corporate client whose operating fundamentals are deteriorating,'' SunTrust Chairman and Chief Executive Officer Phillip Humann said Aug. 14 during a presentation at Keefe, Bruyette & Woods Inc.'s bank conference in Kohler, Wisconsin. He declined to name the borrower, saying it was ``very legitimate company'' that lost a major customer.

SunTrust spokesman Barry Koling said the loss on the loan isn't connected to the economy. The bank is working with the company to try to recover the money, he said.

``SunTrust is definitely a bellwether,'' said Tanya Azarchs, managing director and coordinator of global research at S&P in New York. ``We're going to see a lot more of this.''

Story of the Day - Make Money When U.S. Congress Is Out of Session

Make Money When U.S. Congress Is Out of Session
Bloomberg, 2 August 2006
Amity Shlaes

Weekdays in August are a good time to own stocks. The end of October isn't bad either. Christmas can be fine for equities as well.

What these dates have in common is that they are times when Congress isn't in session. Back in 1991, a Wall Streeter named Eric Singer noticed that equities that year tended to do better when lawmakers weren't in Washington. He published an op-ed in Barron's proposing that the correlation was no coincidence.

Later, he looked at a wider timeframe and went around the squash courts of New York telling people he might write a book about his thesis. Now Singer is going one step further. He has created a hedge fund, Singer Congressional Fund. Its goals include making money from the Congressional calendar.

Neat idea, and one bound to appeal to doctrinaire free-market thinkers. But market people disdain ideologues. Their question is: Do Congressional holidays and the market's movements truly correlate?

As it happens, yes. Choosing the Standard & Poor's 500 Index as his measure, Singer reviewed 40 years of stock data and government calendars. At least one chamber is in session for more than half of the 250-odd trading days of the year. Yet the index made a greater share of its price gains when Congress was in recess -- at least two to three times greater per day.

Singer isn't the only one to find a relationship. Economists Michael Ferguson of the University of Cincinnati and Hugh Douglas Witte of the University of Missouri at Columbia reviewed four indexes: the Dow Jones Industrial Average, the S&P 500, the Center for Research in Security Prices value-weighted index and the CRSP equal-weighted index.

Congressional Effect

For the Dow, the results were dramatic. Since 1897, the year after the Dow was created, an impressive 90 percent of the gains came on days when Congress was out. Their charts show that a dollar invested in 1897 with the strategy of going back to cash every time Congress met was worth $216 by 2000.

But an 1897 dollar invested on the reverse strategy was worth only $2 after a century. The big gap between performances began to show up after World War I, when it became clear that Washington would play a bigger role in the country.

Other indexes also reveal what the scholars call ``the Congressional effect.'' In all indexes but the Dow, daily volatility was lower when Congress wasn't in session. The
popularity of Congress mattered as well. Looking at Harris and Gallup polls, Ferguson and Witte found that market returns were yet lower when unpopular Congresses were in session. The two economists controlled for weather and seasonal behavior. The Congressional effect was still strong.

`Talk Is Not Cheap'

Both Singer and the Ferguson/Witte team suggest uncertainty is causing the difference. Politicians have long noticed that markets don't like regulation. What they sometimes fail to notice is that markets don't like even the prospect of regulation. (Chuck Schumer and Hillary Clinton, this is for you -- New York senators seem to specialize in ignoring market anxiety.)

Market guru Burton Malkiel once wrote: ``It is not so much the direct cost of regulation that has inhibited investment but rather the unpredictability of future regulatory change.'' Or as
Singer puts it, ``talk is not cheap.''

Since Democrats are perceived as more unpredictable when it comes to regulating business, the Congressional effect should be stronger when Democrats control Congress. And Ferguson and Witte found that to be the case. Franklin Roosevelt was one of the most unpredictable of presidents. It therefore comes as no surprise that the 1930s were the most volatile decade for the Dow.

To be sure, there is a certain circularity to all these arguments: Congress may be active because things are bad, rather than causing trouble by its activity. And there are exceptions that don't show the Congressional effect.

``The rule does not work well in a blow-off bubble,'' Singer says. ``It works better in bear markets.''

Clinton Scandals

Even some exceptions fit a variant of his thesis. 1998 was a good year, though Congress was in session. Singer tries to explain it was clear in 1998 that Congress wasn't going to do much. By forcing President Bill Clinton to defend himself in scandals, Republicans effectively prevented both him and themselves from undertaking any major legislative initiative.

How to profit from the effect? To ensure your money is in stocks during all Congressional holidays and all in cash when Congress is in Washington, you'd have to go in or out of the
market 15 or 20 times each year. Singer doesn't say how he's addressing such challenges, or share his results.


Still, the facts are there: If you applied his thesis from the end of 2000 through 2005, and stayed out of the S&P 500 while Congress was working, you earned close to 7 percent a year. If you stayed in the S&P 500 the whole time, the annual total return (including dividends) was less than 1 percent. There may be money in ideology, after all.

You don't have to buy into any political philosophy to find the Congressional effect interesting -- if only as an explanation for why some people stay at their terminals right up to Labor Day. Congressional breaks are short, but to investors, they feel like an endless summer.