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Saying Goodbye

(December 23, 2011)

Dear Subscribers and Readers,

I have a very important announcement tonight. There's no good way to say it, so here it is: I have decided to end after over 7 years of investment newsletter writing. It has been a fun and very meaningful journey. I have made many friends along the way, and I certainly learned a lot about the markets (and human behavior) and myself in this endeavor. Research and writing about the markets—along with investing—remains a fun endeavor. While I would definitely keep in touch (I am also offering my research services to various institutional subscribers—please email me), I am choosing to focus most of my professional energy on life/professional coaching instead (you can read more about my coaching services on my website). Yes, I am hanging out my shingle!

I want to thank all of you for supporting and me over the years. The ups and downs have been immense—going forward, I know all of you will invest in a prudent and disciplined manner. Please do occasionally drop me a note at my Twitter profile. Please also email me for my personal address for those that want to maintain a personal or business correspondence.

I will stop writing by the end of January. In the meantime, refunds would be provided on a prorated basis via Paypal for those that have six or 12-month subscriptions. For those with check subscriptions, we will mail you a refund check on a prorated basis, assuming we end service on January 31, 2012. This will give us sufficient time to pen a two-part 2012 outlook. I will definitely miss all of you; and of course, I will miss writing

Let us now get on with our mid-week commentary.

Since the ECB made available unlimited three-year loans to the region's banks (and expanding its list of eligible collateral), short-yields in the Continent have plunged. Combined with the ECB purchases of peripheral debt (even though they were sterilized), what the ECB has engaged in is classic quantitative easing. Alas, this does not solve the underlying competitive/fiscal problems of Greece, Portugal, Ireland, Spain, etc., but it does buy a lot more time for the Continent to muddle through (a la Japan over the last 22 years). I still believe there's a good chance one country will exit the Euro next year; but do not expect a systemic collapse. In fact, as long as the Euro continues its recent descent against the USD and the Yen, GDP growth in the region could be better than expected next year. In addition—while European banks have been reluctant to take advantage of this carry trade (borrowing at 1% from the ECB and buying longer-term peripheral debt)—I expect the region's governments to “strong arm” the banks to purchase more government debt. Longer-term yields should thus decline for the foreseeable future. The European Sovereign Debt Crisis is on the backburner—at least for the next several weeks. As such, I expect financial stocks to outperform.

Despite the latest easing in European short-term yields, the UK is expected to experience near-zero growth in the first half of next year. In fact, Goldman Sachs believes there's a good chance of a UK recession in 2012 (two consecutive quarters of negative GDP growth). This view is consistent with Goldman's UK Current Activity Indicator (CAI), which is hovering right below the zero line, as shown below:

As such, it is almost a given that the Bank of England will raise its quantitative easing target again, which jibes with previous views.  Its current limit of 275 billion pounds was agreed upon in mid-October.  Since then, the Bank of England has engaged in about 5 billion pounds of weekly asset purchases, almost as much as its initial pace from March to early July 2009 (see below chart).  In the meantime, the size of its balance sheet is currently 250 billion pounds, and thus 25 billion pounds below its limit. I expect the Bank of England to announce another QE policy by early February—a further 100 billion to 125 billion pound package that would bring its overall balance sheet size to 375 to 400 billion pounds (US$590 to US$630 billion).

Meanwhile, U.S. bank lending remains decent and consistent with GDP growth acceleration (see below chart).  Year-over-year change in loans and leases is up 2.4% (highest growth rate since February 2011); and up $165 billion (to $6.92 trillion) on a YTD basis (updated to December 7, 2011).  Given the banks' newfound conservative lending standards, this growth in lending should lead to higher profits and higher GDP growth in 2012.  As a result, the U.S. economy should do relatively well next year, and I believe U.S. financials will outperform for the foreseeable future—until the European Sovereign Debt Crisis becomes an issue again (note European banks have 300 billion Euros in funding needs during 1Q 2012).

Finally, “Shadow Banking liquidity” has continued to improve. Indeed, since our March 25, 2011 commentary (“Update of the Shadow Banking System”), the amount of ABS originations has improved significantly, especially on a global basis.  That is—despite more tightening by emerging market countries and the ongoing European sovereign debt crisis—access to liquidity has improved (the slight deceleration during September notwithstanding), especially for consumers tapping into auto loans, credit card loans, and student loans.  Following is a chart showing global issuance of asset-based securities for last year and this year on a YTD basis (courtesy of Asset-Backed Alert):

That said, this “recovery” in global issuance of asset-backed securities remains highly vulnerable, as the asset-backed market will “freeze up” again should the European sovereign debt crisis get out of hand (i.e. if Italian 10-year yield rises above 6.5%).  From a domestic standpoint, both the Fed and U.S. commercial banks thus need to play a big role to revive bank lending and economic growth.  Over the intermediate to long run, both bank lending and the asset-backed market needs to embark on further growth in order to sustain the current uptrend in asset prices and U.S. economic growth.

Signing off,

Henry To, CFA, CAIA

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