Bernanke: Lessons from Emerging Markets

What follows is Federal Reserve Chairman Bernanke's verbatim speech presented last evening before the Cleveland Clinic.

Chairman Ben S. Bernanke

At the Cleveland Clinic "Ideas for Tomorrow" Series, Cleveland, Ohio

September 28, 2011

Lessons from Emerging Market Economies on the Sources of Sustained Growth

Good afternoon. I am pleased to participate in the Cleveland Clinic's "Ideas for Tomorrow" series. My public remarks often concern short-run economic developments, but it is important once in a while to place those shorter-term developments in the context of the powerful long-term trends shaping the global economy. Of these trends, surely one of the most important is the rapid and sustained economic growth achieved by the emerging market economies. Today, by some measures at least, developing and emerging market economies now account for more than one-half of global economic activity, up substantially from less than one-third in 1980. Today I will discuss what the experience of the emerging markets teaches us about the sources of economic growth and conclude with some thoughts about the prospects for future growth in this critical part of the global economy.

Among the emerging market economies, the Asian "growth miracle" is, of course, the most conspicuous success story, with the case of China being particularly dramatic. Over the past three decades, growth in Chinese output per person has averaged roughly 9 percent a year, putting per capita output about 13 times higher now than in 1980. The economy of Korea, another East Asian success story, has expanded, on average, at better than a 6 percent annual rate over the past 30 years. Growth in Latin America has been more moderate, but that continent has made substantial economic progress as well, most notably in terms of lower inflation and greater economic stability. More recently, the pace of recovery in most emerging market economies from the global financial crisis has been impressive. In short, in the past few decades the emerging market economies have made significant strides in raising living standards. Hundreds of millions of people have benefited from this progress, with many millions lifted out of poverty. To be sure, the gap with the advanced economies remains substantial, but it has been narrowed significantly.

These developments raise the question: How have the emerging market economies achieved such strong results in recent decades? The answer is complex, of course, and I can only scratch the surface of these issues today; but I hope to lay out some key themes and provide some food for thought.

Fostering Growth in Developing Economies: The Washington Consensus
Ironically, the rapid growth of the emerging market economies reflects in part the low levels of development at which they began. In the economic-growth derby, in contrast to most types of competitions, starting from far behind has its advantages. For example, all else being equal, domestic and foreign investors are attracted to the higher returns they receive from investments where capital is relatively scarce, as is generally the case in poorer countries. In the 19th century, the United States drew capital from all over the world to finance railroad construction; although not all of these investments paid off, overall they helped generate enormous increases in wealth by reducing transport costs and fostering economic integration within the North American continent. Similarly, emerging market economies in recent decades have attracted substantial foreign investment in new manufacturing capacity, in part to take advantage of low labor costs. Developing countries also have the advantage of being able to import and adapt production technologies already in use in advanced economies. And, indeed, empirical studies have found some tendency for countries that start from further behind to grow faster than those that begin with higher incomes.

However, much of the national and regional variation in growth rates is not explained by initial economic conditions. Notably, emerging Asian economies have tended to outperform, relative to what would be predicted based solely on their levels of income per person, say, 30 years ago. And some of the poorest countries, including a number in Africa, have continued to grow relatively slowly. So what factors--and what economic policies--differentiate the more successful performers from the less successful?

A classic attempt to generalize about the policies that best promote economic growth and development, and a useful starting point for discussion, is the so-called Washington Consensus, articulated by the economist John Williamson in 1990. Writing about Latin America, Williamson outlined a list of 10 broad policies to promote economic development that he judged as commanding, at the time he wrote, substantial support between both economists and policymakers. Because these views were influential at major institutions like the World Bank located in Washington, this set of policies was dubbed the Washington Consensus.

Williamson's original list of recommendations can usefully be divided into three categories: first, steps to increase macroeconomic stability, such as reducing fiscal deficits (which had caused high inflation in many countries), broadening the tax base, and reallocating government resources to build human and physical capital; second, actions to increase the role of markets in the economy, such as privatization of public assets, appropriate deregulation, and the liberalization of trade, interest rates, and capital flows; and third, efforts to strengthen institutions that promote investment, business formation, and growth, particularly by enhancing property rights and the rule of law.

Aspects of the Washington Consensus have stirred considerable controversy over the past two decades. Williamson himself viewed the Consensus as an attempt to synthesize the conventional wisdom of economists and policymakers of the time, not as a roadmap or comprehensive strategy for development. I have introduced this framework here because it is a nice summary of the prevailing views of 20 years ago, a time when the most dramatic growth in emerging markets still lay several years in the future. By comparing current views with those described by Williamson in 1990, and accepted by many, we may learn something about which ideas have held up and which have been modified or refuted by recent events. I will take in turn the three groups of policies that make up the Washington Consensus.

The first group of recommendations, as I noted, comprised policies aimed at increasing macroeconomic stability. In this case there is little controversy. Abundant evidence has linked fiscal discipline, low inflation, and a stable macroeconomic policy environment to stronger, longer-term growth in both emerging and advanced economies. In particular, many emerging market economies in the 1990s emulated the success of the advanced economies in the 1980s in controlling inflation. Over the years, the emerging market economies have also improved their fiscal management to the point that their fiscal positions are now often more favorable than those of some advanced economies. Improvements in macroeconomic management have been particularly striking in Latin America, where large budget deficits and high inflation rates had produced costly swings in economic activity in previous decades. Brazil, for example, suffered hyperinflation from 1986 to 1994, with several years of inflation well in excess of 500 percent, but has maintained an average annual inflation rate of about 5 percent since 2006, while (not coincidentally) reducing the ratio of its budget deficit to its gross domestic product. Disciplined macroeconomic policies have also supported growth in emerging markets by fostering domestic savings, stimulating capital investment (including foreign direct investment), and reducing the risk of financial instability.

The second group of recommendations listed by Williamson emphasized the need for greater reliance on markets: the freeing up of the economy through privatization, deregulation, and liberalization. The basic idea here has held up pretty well; most observers today would agree that carefully managed liberalization--the substitution of markets for bureaucratic control of the economy--is necessary for sustained growth. For example, trade liberalization measures, such as the reduction of tariffs and the removal of other controls on exports and imports, have been a key element of the growth strategies of a number of fast-growing emerging market economies, including China. Openness to inflows of foreign direct investment has helped many emerging economies import foreign management techniques and technologies as well as to attract foreign capital. More generally, greater use of markets improves the allocation of resources, creates incentives for more efficient forms of production, and encourages entrepreneurship and innovation. However, as I will discuss in a moment, experience has also shown that the success of reform programs may depend crucially on how the transition to greater market orientation is managed, and in particular on how market reforms are sequenced, issues on which the Washington Consensus is largely silent.

The third part of the Washington Consensus focused on strengthening property rights and the rule of law--for example, through effective enforcement of contracts. The evidence suggests that these factors too can be important for development. For example, the inability to establish clear title to land or buildings has inhibited entrepreneurship and investment in some poor countries. On the other hand, some critics fault the Washington Consensus for paying insufficient attention to the role in economic growth of a much broader range of institutional factors than property rights alone--stand ardized accounting conventions, political accountability, control of corruption, bankruptcy laws, and capable and transparent regulatory agencies, for example. Moreover, the Washington Consensus provided little specific advice on how to create and sustain a strong institutional framework, nor did it touch on a variety of institutional arrangements--central bank independence being one familiar example--that have been shown to promote economic stability and growth.

Amending the Washington Consensus
Overall, some key elements of the Washington Consensus appear well supported both by basic economic logic and by their successful application by a number of countries. However, the experience of the past two decades also suggests some lessons that augment or modify what we thought we knew about economic development in 1990. I will highlight three specific lessons.

First, the implementation of the Washington Consensus recommendations is important and not so straightforward in practice. In particular, as I alluded to earlier, the sequencing of reforms matters. For example, some developing countries, following the principles of liberalization and deregulation, removed controls on the inflows of foreign capital, and foreign investors responded by pouring in funds. However, the banking systems and the associated regulatory and supervisory agencies in these countries were not always well prepared to manage these capital inflows. Consequently, some of the foreign capital was badly invested, which in turn contributed to emerging-market financial crises, like those in Mexico and emerging Asia in the 1990s. This experience suggests that measures to strengthen banks and bank regulation should be put in place before the domestic market is opened to capital flows from abroad.

Similarly, dismantling controls on the domestic financial industry has proven counterproductive when important complementary factors--such as effective bank supervision, the availability of bank managers trained in market-based lending, or consumer familiarity with financial products such as credit cards--were absent. For example, Korea experienced a mini financial crisis in early 2003, resulting from a massive run-up in household debt. In the wake of policy changes to liberalize and increase competition in domestic financial markets, credit card debt in Korea as a share of its gross domestic product more than tripled between 1999 and 2002, as the average number of credit cards for every adult in the country rose from 1 to 3. Korea's consumers, lenders, and regulators had little experience with credit cards, and institutional arrangements for sharing data on consumer credit, including credit reports, were inadequate. Not surprisingly, at least in retrospect, delinquency rates soared, putting the solvency of a number of the country's major financial institutions at risk. The broader lesson is that institutional arrangements, ranging from accounting rules to regulatory frameworks to tax-compliance tools, must be sufficiently developed to ensure that reforms are successful. Fortunately, even in the absence of a clear consensus on how best to sequence and implement reforms, many countries have successfully promoted growth through a slow and pragmatic but continuing process of liberalization.

A second important lesson of the past two decades involves the pivotal role of technologyin economic development. For emerging market economies, which tend to lag behind in technological sophistication, rapid gains in productivity can be achieved by adapting state-of-the-art technologies already developed by the advanced economies rather than by having to develop these technologies from scratch. But successful importing of technologies does not happen automatically or without preparation. For example, strong educational systems producing increasingly skilled workforces have proven crucial for climbing the technological ladder. In the United States, substantial increases in educational attainment from the beginning of the 20th century through the period following World War II were instrumental in driving economic growth.

In the emerging market world, India's information technology (IT) services industry has thrived in large part because of the country's large supply of well-educated, English-speaking workers. And it is not just higher education that matters. Encouraging basic levels of literacy is critical as well. Promising programs in some emerging market countries, such as Brazil and Mexico, provide modest amounts of money to poor families (generally to women) on the condition that their children attend school regularly and receive basic health care. The evidence suggests that these programs enhance the quality of the economy's labor forcewhile addressing social goals such as reducing gender and income inequality.

Many emerging market economies have also harnessed international trade as an engine of technical progress. Openness to trade has allowed these countries to import state-of-the-art capital goods, and vigorous international competition has increased the efficiency of domestic firms and facilitated the transfer of skills and knowledge. International trade has also helped shift these economies away from basic agriculture toward manufacturing, with substantial benefits for average productivity. These benefits of trade openness do not require large trade surpluses, by the way, only a willingness to engage with and integrate with the global economy. Notably, Korea ran current account deficits through much of its "growth miracle" phase.

A third important lesson that has come into sharper focus, and which was not fully appreciated by the Washington Consensus, involves the capacity to draw on economies of scale to accelerate the pace of technical progress and economic growth. Economies of scale refer to the efficiency gains that can be achieved in some industries when production is run at a very large scale. These gains may arise because of the nature of the technologies involved--as, for example, in steel manufacturing. But in some cases they can also arise because of the need to develop a critical mass of skilled workers and specialized suppliers. It is no coincidence that so many high-tech firms locate near each other in California's Silicon Valley or North Carolina's Research Triangle; these firms benefit from the ability to draw on sufficiently large pools of skilled labor and other resources, while sharing ideas and information in mutually beneficial ways. A single, isolated firm would not likely be as productive. Thus, scale economies can arise in the development of knowledge centers, like research universities, or in the building of large-scale infrastructure, like a national highway system. For example, India's IT industry is clustered in certain regions, such as Bangalore, around some of the more successful and high-quality institutes of technology in the country. Moreover, recent research suggests that the growth of information technology activity in India has increased returns to schooling and has significantly increased primary school enrollment in areas where call centers are located.

Encouraging international trade can also help countries capture the benefits of scale. For many emerging market economies, domestic markets are not large enough to support the amount of production needed to achieve efficiency gains. Access to global markets has enabled production to expand to levels where economies of scale could be more fully exploited. Additional efficiencies can sometimes be gained when countries specialize in particular stages of a good's production. They import parts and components from other countries and use them to produce new products, which themselves may be further processed or assembled in still other countries. At each stage, the production is for the world market rather than for domestic producers or consumers alone. Many Asian economies are interlinked through a network of vertical supply chains; China is often referred to as the endpoint in the global supply chain because the assembly of so many goods is completed there before being shipped to consumers around the world.

The existence of economies of scale may, in some circumstances, also create a rationale for targeted government interventions in the economy--in other words, industrial policy. The premise of industrial policy is that large-scale industries may not be able to get off the ground without government support or protection, given the substantial start-up costs and the existence of more-efficient competitors in other countries. Indeed, government support for certain industries does seem to have played a role in several of the best-performing emerging market economies, including China and Korea. But such interventions can be double-edged swords. The experience of many decades tells us that industrial policies are far from a sure-fire development strategy, as they require that the government be adept at picking winners. One example, the role of government intervention in promoting ethanol production in Brazil, illustrates the vagaries of industrial policies. After being introduced over the mid- to late 1970s, for several years the program was generally viewed as a failure. More recently, however, the sustained upward trend in world oil prices has turned ethanol production in Brazil into a profitable venture. But in many cases, similar interventions have failed or crowded out the development of other, potentially more profitable industries.

Lessons and Implications for the Future
What implications can we draw for longer-term prospects for growth in the emerging market economies? Notwithstanding the recent impressive growth, output per person in the emerging market economies generally remains much lower than in the advanced economies. This fact suggests that the emerging market economies should be able to maintain relatively high growth rates for some years to come, as they continue to catch up to the advanced economies. But over time, as the emerging market countries become wealthier and technologically more sophisticated, they will gradually lose the advantages of starting from behind. Even with continued strong policies, their growth will slow as returns to capital investments diminish and the most profitable opportunities are exploited. For example, over time, rising wages in manufacturing should make production and investment in China and other East Asian nations less attractive. Also, technological progress will slow as the process of importing foreign technologies reaches its limits, forcing greater reliance on innovation in emerging countries themselves. Resource and environmental constraints, as well as aging populations, should also slow economic growth. But in many ways, such a slowdown in growth will be the inevitable result of progress--the culmination of a successful catching up process--and in that respect should be viewed as a consequence of success, not of failure.

Many emerging markets also will be challenged by their reliance on trade to drive growth. As I have discussed, international trade has many benefits. However, generating trade surpluses by suppressing domestic demand defeats the ultimate purpose of economic growth--improving the lot of the country's own citizens. Large and persistent imbalances in trade are also inconsistent, in the long run, with global economic and financial stability. Of course, the advanced economies, like the United States, need to do their part as well in reducing global imbalances, as I have noted on numerous occasions before.

In fact, with the emerging market economies accounting for a large and growing share of global activity, many of them can no longer view themselves as small, open economies whose actions have little effect on their neighbors. With increasing size and influence comes greater responsibility. In response to this new reality, many of our international institutions have been restructured in recent years to give an increased voice to the emerging market economies. For example, the Group of Twenty (which has significant emerging market representation) has largely supplanted the Group of Seven as the premier global forum for economic and financial policy matters, and emerging market economies have been given increased power in setting the policies of the International Monetary Fund. These forums should be used by advanced economies and emerging economies alike to meet their respective responsibilities to the global economy in a spirit of cooperation.

So, what lessons can we draw about the Washington Consensus and, more generally, about the experience of the dynamic emerging market economies over the past decades? Ultimately, the principles that John Williamson enumerated two decades ago have much to recommend them. Macroeconomic stability, increased reliance on market forces, and strong political and economic institutions are important for sustainable growth. However, with the experience and perspective of the past 20 years, we can see that Williamson's recommendations were not complete. Reforms must be sequenced and implemented appropriately to have their desired effects. And a successful development framework must take into account that activities such as the adaptation of advanced technologies and the harnessing economies of scale are often critical to economic growth and depend on a host of institutional conditions, such as an educated workforce, to be fully effective.

Indeed, advanced economies like the United States would do well to re-learn some of the lessons from the experiences of the emerging market economies, such as the importance of disciplined fiscal policies, the benefits of open trade, the need to encourage private capital formation while undertaking necessary public investments, the high returns to education and to promoting technological advances, and the importance of a regulatory framework that encourages entrepreneurship and innovation while maintaining financial stability. As the advanced economies look for ways of enhancing longer-term growth, a re-reading of Williamson's original Washington Consensus, combined with close attention to the experiences of successful emerging market economies, could pay significant dividends.

Article should interest investors in Bank of America (NYSE: BAC), J.P. Morgan Chase (NYSE: JPM), Goldman Sachs (NYSE: GS), Citigroup (NYSE: C), Morgan Stanley (NYSE: MS), Wells Fargo (NYSE: WFC), TD Bank (NYSE: TD), PNC Bank (NYSE: PNC), State Street (NYSE: STT), Janus (NYSE: JNS), T. Rowe Price (Nasdaq: TROW), General Electric (NYSE: GE), Wal-Mart (NYSE: WMT), McDonald's (NYSE: MCD), Alcoa (NYSE: AA), American Express (NYSE: AXP), Boeing (NYSE: BA), Caterpillar (NYSE: CAT), Cisco Systems (Nasdaq: CSCO), Chevron (NYSE: CVX), DuPont (NYSE: DD), Walt Disney (NYSE: DIS), Home Depot (NYSE: HD), Hewlett-Packard (NYSE: HPQ), IBM (NYSE: IBM), Intel (Nasdaq: INTC), Johnson & Johnson (NYSE: JNJ), Kraft (NYSE: KFT), Coca-Cola (NYSE: KO), 3M (NYSE: MMM), Merck (NYSE: MRK), Microsoft (Nasdaq: MSFT), Pfizer (NYSE: PFE), Procter & Gamble (NYSE: PG), AT&T (NYSE: T), Travelers (NYSE: TRV), United Technologies (NYSE: UTX), Verizon (NYSE: VZ), Exxon Mobil (NYSE: XOM).

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.

Industrials Party Crashed by the Bear

Investors celebrated the Durable Goods Orders data for the month of August on Wednesday morning, as non-defense capital goods orders excluding aircraft climbed 1.1%. The segment representing business investment had declined 0.2% in July and raised a red flag on the economy. Thus, this recovery was counter-relative and a relief to market participants, at least until stocks turned sour universally in the afternoon. There are important considerations that might dilute the punch of this data longer term if they prove true in the months ahead. I expose that risk for you herein.

Our founder earned clients a 23% average annual return over five years as a stock analyst on Wall Street. "The Greek" has written for institutional newsletters, Businessweek, Real Money, Seeking Alpha and others, while also appearing across TV and radio. While writing for Wall Street Greek, Mr. Kaminis presciently warned of the financial crisis.

Industrials Party Crashed by the Bear

The first thing I do when reviewing such a data-point is to note if there was a significant revision to the prior months’ data. A sharp revision lower to the prior month can serve to provide illusory growth in the reporting period. However, in this case, and at least for the headline data, the revisions seemed to be minor and served to discount this month’s growth anyhow (they were revisions higher). I could not locate the pre-revision number with regard to nondefense capital goods excluding transportation segment, but the potential impact here should be considered by the reader.

Durable Goods New Orders declined 0.1% on the whole, which was disappointing against the economists’ consensus forecast for 0.2% growth in August. Still, the decline followed July’s 4.1% growth (revised from 4.0%), so the volatility of these irregular high-ticket priced orders is better smoothed when reviewed over more than a month. When excluding transportation, new orders fell by the same 0.1% seen in the headline figure in August, though this time beating the economists’ consensus for a drop of 0.2%. In July, the ex-transportation count increased by 0.7% month-to-month. Excluding defense, new orders also fell by 0.1% in August, though following a 4.8% increase in July.

Shipments fell 0.2% in August, after rising 2.1% in July. Excluding transportation, shipments gained 1.2%, off a drop of 0.6% in July. Excluding defense, shipments fell 0.4% in August, after their 2.5% increase in July.

Let’s get right to the market moving news. Non-defense capital goods orders ex-transportation increased 1.1% in August, following the 0.2% decline in July. In June, these orders rose 0.8%. The result of this news is raised economic hope and lowered expectations of recession, at least for Q3. Macroeconomic Advisors raised its GDP forecast to an annual rate of 2.1% for the third quarter, up from 1.7% previously; several economists did the same, due to this data.

However, there’s one key risk overhanging these projection upgrades and also on investment decisions based on economic gain expectations. Outside of the specific companies benefiting, I am not sure there will be much profiting in America. I expect much of this growth is on exports, goods sold to the emerging world. For as long as there is robust growth in India, China, etc., this data-point will not prove a timely harbinger of economic strife in the United States. Also, let’s not forget that the American manufacturing sector restructured significantly through the last recession, some through bankruptcy and some thanks to the government. Mostly, these improvements came on capacity contraction and union concessions. Thus, the manufacturing sector is more nimble today. And one should question how long the emerging world can sustain robust growth if American consumption retrenches further and European consumers gather into a shell. Christine Lagarde warned of this in a recent address given during her American tour.

Industry Sector Breakdown
Not all industrials saw a stellar August, and that was reflected in the day’s trading of some of the shares through midday. However, since about 1:00 PM Wednesday, stocks started lower across the board, and at 3:15 PM ET or so, the decline accelerated. Growth was certainly celebrated early though in the Aerospace/Defense Industry, which according to Yahoo Finance (Nasdaq: YHOO), was up 1.9% to 2.5%, depending on whether we’re talking about the major diversified companies or those listed in products and services. There was good reason for this, as the Durables Report showed a 22.5% increase in new orders. Still, Lockheed Martin (NYSE: LMT), Rockwell Collins (NYSE: COL) and Boeing (NYSE: BA) ended down about 1% or so. The Dow was off 1.6%, to put this into relative perspective.

Computers and electronic products saw a 1.3% increase in new orders, and the shares of relative firms did well to start the day, but followed the general market track into the close. Of course, Amazon.com (Nasdaq: AMZN), which maintained a gain of 2.5%, had a strong company specific driver. Sony (NYSE: SNE) kept above water too though, rising 0.6%, perhaps on the durables report. However, Apple (Nasdaq: AAPL), which was firefighting against rumors and Amazon’s entry into the tablet market, declined 0.5% on the day. Dell (Nasdaq: DELL), also in the news, fell about 1.9%. Microsoft (Nasdaq: MSFT) was short just 0.4%, which again reflects relative outperformance against the broader indexes.

Manufacturing recorded a 0.7% increase in new orders, but the growth was specific to industry. Primary metals saw a 0.8% decline and fabricated metal products fell 0.5%. As a result, Arcelor Mittal (NYSE: MT) shares dropped 3.7%. Communication equipment orders improved 7.8%, but the shares of Cisco Systems (Nasdaq: CSCO) and Broadcom (Nasdaq: BRCM) fell 1.4% and 2.9%, respectively. Motor vehicles and parts saw an 8.5% drop, and the shares of Ford and GM fell 1.9% and 3.7%, respectively.

Another important sub-metric found in the durables report is the data on unfilled orders, which were up 0.9% for the second consecutive month. Some of these orders may prove to be in error, and when considering the dollar figures involved (a $7.6 billion increase in August), it’s worth noting. For the most part, this data is viewed as a positive, as it represents business in process. Inventory reached record levels (most since 1992), but this has a lot to do with population growth and emerging market development over time. Markets have grown and so have inventories. Still, excess ordering and fat inventories can lead to trouble when sideswiped by surprising economic recession.

In conclusion, the market had reason to celebrate this morning, but I suspect the caution that was reflected in the sharply downward close was likewise due. I expect that with time, we will find that the day’s market enthusing news seen in durables orders will be shown to be due to exports. Furthermore, there should be concern that this economic stabilizing force could soften over time, given consumer sentiment and economic conditions in both Europe and the United States.

This article should interest industrials investors in Boeing (NYSE: BA), Raytheon (NYSE: RTN), Digital Globe (NYSE: DGI), GenCorp (NYSE: GY), General Dynamics (NYSE: GD), Goodrich (NYSE: GR), Northrop Grumman (NYSE: NOC), Honeywell (NYSE: HON), Lockheed Martin (NYSE: LMT), Rockwell Collins (NYSE: COL), L-3 Communications (NYSE: LLL), EMBRAER (NYSE: ERJ), FLIR Systems (Nasdaq: FLIR), BE Aerospace (Nasdaq: BEAV), TransDigm (NYSE: TDG), Spirit Aerosystems (NYSE: SPR), CAE (NYSE: CAE), Alliant Techsystems (NYSE: ATK), Hexcel (NYSE: HXL), Triumph Group (NYSE: TGI), Esterline Technologies (NYSE: ESL), Moog (NYSE: MOG-A), Heico (NYSE: HEI), Teledyne (NYSE: TDY), Curtiss-Wright (NYSE: CW), Cavco (Nasdaq: CVCO), Skyline (NYSE: SKY), Nobility Homes (Nasdaq: NOBH), Palm Harbor Homes (Nasdaq: PHHM), Mohawk Industries (NYSE: MHK), Interface (Nasdaq: IFSIA), Albany International (NYSE: AIN), Unifi (NYSE: UFI), Illinois Tool Works (NYSE: ITW), Tyco International (NYSE: TYC), Cummins (NYSE: CMI), Kubota (NYSE: KUB), Ingersoll-Rand (NYSE: IR), Dover (NYSE: DOV), ITT Corp. (NYSE: ITT), Flowserve (NYSE: FLS), Pall (NYSE: PLL), Dresser-Rand (NYSE: DRC), SPX (NYSE: SPW), Gardner Denver (NYSE: GDI), IDEX (NYSE: IEX), Nordson (Nasdaq: NDSN), Graco (NYSE: GGG), Actuant (NYSE: ATU), Middleby (Nasdaq: MIDD), ABB (NYSE: ABB), Eaton (NYSE: ETN), Nidec (NYSE: NJ), Rockwell Automation (NYSE: ROK), Ametek (NYSE: AME), Regal Beloit (NYSE: RBC), Thomas & Betts (NYSE: TMB), Woodward Governor (Nasdaq: WGOV), Caterpillar (NYSE: CAT), Deere (NYSE: DE), CNH (NYSE: CNH), Joy Global (Nasdaq: JOYG), Bucyrus (Nasdaq: BUCY), Agco (Nasdaq: AGCO), Emerson Electric (NYSE: EMR), Parker Hannifin (NYSE: PH), Roper Industries (NYSE: ROP), Pentair (NYSE: PNR), Waste Management (NYSE: WM), Republic Services (NYSE: RSG), Fastenal (Nasdaq: FAST), Vulcan Materials (NYSE: VMC), MDU Resources (NYSE: MDU), Martin Marietta Materials (NYSE: MLM), Owens Corning (NYSE: OC), Valspar (NYSE: VAL), Precision Castparts (NYSE: PCP), United States Steel (NYSE: X), Reliance Steel (NYSE: RS), NVR (NYSE: NVR), DR Horton (NYSE: DHI), Pulte (NYSE: PHM), Toll Brothers (NYSE: TOL), Hovnanian (NYSE: HOV), CRH (NYSE: CRH), CEMEX (NYSE: CX), Eagle Materials (NYSE: EXP), Fluor (NYSE: FLR), McDermott International (NYSE: MDR), Foster Wheeler (Nasdaq: FWLT), Empresas ICA (NYSE: ICA), Stanley Black & Decker (NYSE: SWK), Timken (NYSE: TKR), Kennametal (NYSE: KMT), Leucadia National (NYSE: LUK), Masco (NYSE: MAS), Weyerhaeuser (NYSE: WY), Quanta Services (NYSE: PWR), Chicago Bridge & Iron (NYSE: CBI), EMCOR (NYSE: EME), Snap-on (NYSE: SNA), Toro (NYSE: TTC), GM (NYSE: GM) and Ford (NYSE: F).

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.

Gold Price Factors

At a time when you would expect gold prices to climb even higher, the shiny metal I call mankind’s inherent currency has dropped along with other asset classes. I’m sure you’ve wondered why, and I believe I’ve got some understanding of the complex forces that are driving gold prices today. These forces have helped to stabilize gold and even quelled the heat around the commodity recently. These latest weeks’ trading have helped us to understand the dynamics of the commodity all the better. Thus, I suspect I can add value to your forecasting.

Our founder earned clients a 23% average annual return over five years as a stock analyst on Wall Street. "The Greek" has written for institutional newsletters, Businessweek, Real Money, Seeking Alpha and others, while also appearing across TV and radio. While writing for Wall Street Greek, Mr. Kaminis presciently warned of the financial crisis.

Gold Price Factors

Gold prices dropped again to start this week, despite a swirling storm about the euro and new concerns about a possible U.S. government budget failure. You would expect gold prices to rise in such a scenario, but the metal was instead down roughly $30 Monday. The spot price of gold was flirting with sub-$1600 per ounce in fact, certainly surprising given the last several weeks of chaos. So what’s up?

Some might point to a previously overextended commodity price now seeking mean valuation, or reverting to its mean. This is certainly the most important factor in forecasting gold price movement, since the market only seeks to estimate true value. To understand how a mean reversion could be underway, we must review recent history briefly.

Gold topped out at about $1890 on the spot price (closing pricing), spurred by a frenzied drive to acquire the metal as the US appeared set to record a technical default on its debt this past summer. A quick study of the one-year chart for spot gold clearly illustrates an insecure price level near $1900, established by the spike in the commodity. Once the US Congress mitigated technical default risk, and while the United States even bore a downgrade of its sovereign credit rating by Standard & Poor’s (NYSE: MHP), investors looked around and saw all was not lost. Suddenly the gold price felt expensive, and so this medium term driver is certainly playing a major role in gold price action today. However, a look at the chart seems to show gold at about a medium term trend line, and a $1500 price would seem a secure floor despite its breaking of that line.

Something else is playing a short-term role in driving gold today though. Popular media, based on analyst interviews, regularly reports that there is a force against gold which is capital driven. This force is the theoretical use of gold-relative profits or positions to cover other positions as asset classes dive. It may likewise be that an unbalanced holding of gold in many portfolios is being balanced with capital seeking value in other segments. But, the drops seen in other investment securities pricing does not support this second idea as a main factor in markets.

Another important factor working against gold and all commodities is dollar strength. This has certainly been a stabilizing control on gold pricing. As the euro has found fewer friends while rumors swirl about an imminent Greek default, the dollar has benefited. As commodities are priced in dollars, the strength of the currency has made commodities cheaper in dollar terms. The funny thing is that as the global economy comes under stress, dollar strength has persevered, and this has certainly acted as a counterintuitive and counteracting force on gold pricing.

Over the longer term though, if the United States continues to find intensifying economic and investment pressures, the dollar could be eventually undermined, at which time gold would be free to fly to greater heights. This untethered scenario is the kind that supports gold pricing above $2000 and perhaps as high as $5000 per ounce. Without it though, I cannot find supporting reasoning to forecast new records for the price of gold.

This article should interest investors in precious metals stocks: Goldcorp (NYSE: GG), Agnico-Eagle Mines (NYSE: AEM), Allied Nevada Gold (AMEX: ANV), AngloGold Ashanti (NYSE: AU), AuRico Gold (NYSE: AUQ), Aurizon Mines (AMEX: AZK), Barrick Gold (NYSE: ABX), Brigus Gold (AMEX: BRD), Charles & Covard (Nasdaq: CTHR), Claude Resources (AMEX: CGR), Commerce Group (OTC: CGCO.PK), Compania Mina Buenaventura S.A. (NYSE: BVN), DRDGOLD (Nasdaq: DROOY), Eldorado Gold (NYSE: EGO), Entrée Gold (AMEX: EGI), Exeter Resource (AMEX: XRA), Gold Fields (NYSE: GFI), Gold Reserve (AMEX: GRZ), Gold Resource (Nasdaq: GORO), Golden Eagle Int’l (OTC: MYNG.PK), Golden Star Resources (AMEX: GSS), Great Basin Gold (AMEX: GBG), Harmony Gold (NYSE: HMY), IAMGOLD (NYSE: IAG), International Tower Hill Mines (AMEX: THM), Jaguar Mining (NYSE: JAG), Keegan Resources (AMEX: KGN), Kimber Resources (AMEX: KBX), Kingold Jewelry (Nasdaq: KGJI), Kinross Gold (NYSE: KGC), Midway Gold (AMEX: MDW), Minco Gold (AMEX: MGH), Nevsun Resources (AMEX: NSU), New Jersey Mining (OTC: NJMC.PK), Newmont Mining (NYSE: NEM), North Bay Resources (OTC: NBRI.OB), Northgate Minerals (AMEX: NXG), NovaGold Resources (AMEX: NG), Richmont Mines (AMEX: RIC), Royal Gold (Nasdaq: RGLD), Rubicon Minerals (AMEX: RBY), Seabridge Gold (AMEX: SA), Solitario Exploration and Royalty (AMEX: XPL), Tanzanian Royalty Exploration (AMEX: TRE), Thunder Mountain Gold (OTC: THMG.OB), U.S. Gold (NYSE: UXG), Vista Gold (AMEX: VGZ), Wits Basin Precious Metals (OTC: WITM.PK), Yamana Gold (NYSE: AUY), Coeur d’Alene Mines (NYSE: CDE), Endeavour Silver (NYSE: EXK), Hecla Mining (NYSE: HL), Mag Silver (AMEX: MVG), Mines Management (AMEX: MGN), Silver Standard Resources (Nasdaq: SSRI), Silver Wheaton (NYSE: SLW), SPDR Gold Trust (NYSEArca: GLD), Market Vectors Gold Miners ETF (NYSEArca: GDX), iShares Silver Trust (NYSEArca: SLV), ProShares Ultra Silver (NYSEArca: AGQ), ProShares Ultra Short Silver (NYSEArca: ZSL), Great Panther Silver (AMEX: GPL), Silvercorp Metals (NYSE: SVM), Paramount Gold and Silver (AMEX: PZG), Pan American Silver (Nasdaq: PAAS) and First Majestic Silver (NYSE: AG).

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.

Shelter Threatened by Apocalypse

End of times sentiment weighed on all asset classes last week and is likely to continue to do so this week. Considering the reporting of five housing relevant data points last week, we thought now might be a good time to review the housing market. We sensed a negative tone to the housing newswire last week, but in reality, the data generally came in about as stagnant as always. There was even a tasting of good housing news, though that bright spot was promptly drowned out by a depressed stock market. That said, there is clearly enough reason now to view any recently achieved real estate stabilization as vulnerable, given the many dangers, both external in nature and domestic that threaten all asset classes. Still, I view no other asset currently more important than shelter, which may soon be hard to come by as well.

Our founder earned clients a 23% average annual return over five years as a stock analyst on Wall Street. "The Greek" has written for institutional newsletters, Businessweek, Real Money, Seeking Alpha and others, while also appearing across TV and radio. While writing for Wall Street Greek, Mr. Kaminis presciently warned of the financial crisis.

Shelter Threatened by Apocalypse

Low and behold, five housing relative reports hit the wire last week, but did we learn anything new? The Housing Market Index offered the latest measure of builder sentiment, while Housing Starts produced fresh data on new home construction. The Weekly Applications Survey reflected the most recent levels of mortgage application activity, while the National Association of Realtors offered a fresh take on Existing Home Sales. Finally, home price data reached the wire from the FHFA.

Eschewing data that contains noise in it, we are leaving out mortgage report analysis here. As the mortgage application activity was compared against the Labor Day period that preceded it, we’re not going to review it here due to the noise it contains. And, I’m going to hold off on home price analysis until after the S&P Case Shiller data is reported. Builders have been down and out for years now, and the latest Housing Market Index reflected more of the same feeling. We covered the HMI in an earlier article found here. Let’s take a look now at real activity, which was reflected in the Housing Starts and Existing Home Sales data reported last week.

Noted for its negative points, August Housing Starts declined 5.0% against the revised July figure, dropping to an annual rate of 571K. Data since June has indicated year-over-year growth in many metrics though, but unfortunately, that was not the case in the August Starts data. Starts were 5.8% short of the prior year mark. Housing Permits though, which offer a more forward looking metric for housing activity, increased 3.2% over July, to an annual rate of 620K. And against the prior year, new permits were 7.8% higher. So we could go ahead and list this as a modestly positive to neutral data point for real estate, despite its seeming softness on the headline.

In order to provide a pure view of things, we consider a second perspective. Since this data includes both multi-family and single-family properties, growth could represent increasing demand for rental property, which might not be the best indicator for housing purists. Thankfully, the government breaks out the data. Housing Starts for single-family properties fell by a lesser rate of 1.4% against July and were 2.3% under the prior year. Permits for single-family properties rose 2.5% against July and were 2.0% greater than in August 2010. Basically the single family activity was not as exaggerated as the overall changes were.

National Association of Realtors (NAR) reported on Existing Home Sales for August last week and offered the brightest bit of news for housing. Unfortunately, the bad brew from Europe and ongoing political turmoil in the U.S. drowned it out. Still, August Existing Home Sales climbed 7.7% over July, to an annual rate of 5.03 million. That was also 18.6% higher than the prior year period.

In the past, we’ve discussed just how easy housing growth would be to attain through the second half of 2011, since the bar is set low. However, given what appears to be developing across the globe, including renewed recession with all sorts of Apocalyptic feeling nuances (US credit downgrade and other unspeakables), it would appear the latest floor for housing may be pulled out from under us soon enough. That said, I pray we all find shelter to weather the storm.

Editor's Note: Article should interest investors in Investors Title (Nasdaq: ITIC), Bank of America (NYSE: BAC), Freddie Mac (OTC: FMCC.OB), Fannie Mae (OTC: FNMA.OB), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Wells Fargo (NYSE: WFC), Toronto Dominion (NYSE: TD), UltraShort Real Estate ProShares (NYSE: SRS), Ultra Real Estate ProShares (NYSE: URE), ING Clarion Global Real Estate Income Fund (NYSE: IGR), Xinyuan Real Estate Co. (NYSE: XIN), Rydex Real Estate Fund H (Nasdaq: RYHRX), T. Rowe Price Real Estate Fund (Nasdaq: TRREX), Toll Brothers (NYSE: TOL), Hovnanian (NYSE: HOV), D.R. Horton (NYSE: DHI), Beazer Homes (NYSE: BZH), Lennar (NYSE: LEN), K.B. Homes (NYSE: KBH), Pulte Homes (NYSE: PHM), NVR Inc. (NYSE: NVR), Gafisa SA (NYSE: GFA), MDC Holdings (NYSE: MDC), Ryland Group (NYSE: RYL), Meritage Homes (NYSE: MTH), Brookfield Homes (NYSE: BHS), Standard Pacific (NYSE: SPF), M/I Homes (NYSE: MHO), Orleans Homebuilders (AMEX: OHB), Vanguard REIT Index ETF (NYSE: VNQ), PNC Bank (NYSE: PNC), J.P. Morgan Chase (NYSE: JPM), Hooker Furniture (Nasdaq: HOFT), Ethan Allen (NYSE: ETH), Pier 1 Imports (NYSE: PIR), Williams Sonoma (NYSE: WSM), Home Depot (NYSE: HD), Lowes (NYSE: LOW), Nasdaq: XNFZX, Nasdaq: FSAZX, Avatar Holdings (Nasdaq: AVTR), Apartment Investment & Management (NYSE: AIV), Equity Residential (NYSE: EQR), Avalonbay Communities (NYSE: AVB), UDR Inc. (NYSE: UDR), Essex Property Trust (NYSE: ESS), Camden Property Trust (NYSE: CPT), Senior Housing Properties (NYSE: SNH), BRE Properties (NYSE: BRE), Home Properties (NYSE: HME), Mid-America Apartment (NYSE: MAA), Equity Lifestyle Properties (NYSE: ELS), American Campus Communities (NYSE: ACC), Colonial Properties (NYSE: CLP), American Capital Agency (Nasdaq: AGNC), Sun Communities (NYSE: SUI), Associated Estates (NYSE: AEC), PennyMac Mortgage (NYSE: PMT), Two Harbors (AMEX: TWO), Simon Property Group (NYSE: SPG).

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.

Homebuilder Sentiment Stinks Like Usual

What should have contributed little to the stock market slide this past week perhaps weighed on the minds of traders as news flow flooded in. Homebuilders have been depressed for years now, but the latest data served as a reminder of the long-standing stillness in housing.

Our founder earned clients a 23% average annual return over five years as a stock analyst on Wall Street. "The Greek" has written for institutional newsletters, Businessweek, Real Money, Seeking Alpha and others, while also appearing across TV and radio. While writing for Wall Street Greek, Mr. Kaminis presciently warned of the financial crisis.

Homebuilder Sentiment Stinks

Homebuilders have been in the dumps for what seems like my entire post-pubescence. The reason is obvious, I hope. Besides the disastrous shake-up of our housing finance industry, the remnants of the implosion remain. Excessive under-employment, a guarded lending environment, a flood of distressed properties and underwater homeowners have effectively drowned the real estate market for several years now.

The Housing Market Index’s sad state, though, has a second driver of doom. It’s the fact that the competitive landscape is made up of a great many small to mid-sized builders, most of which were overleveraged at the height of housing. Their sin of greed has since been replaced by despair as a result. So when the guys weigh in, perhaps from a barstool or a street curb (I can say so, since I’m sitting next to them), the effect is overwhelming on this index.

September’s reading showed a one point decline to a morbid mark of 14; imagine that 50 separates positive sentiment from negative, and contemplate just how far down in the dumps builders are. Yet, there’s nothing new in this data. The index has hovered in the rancid range of 13 to 16 for six months now. The National Association of Home Builders (NAHB) Chairman, Bob Nielsen, added that the recent economic and market upheaval has only served to drive the few hopeful homebuilders into the pessimistic pool. That fact was illustrated in the index which reflects builders’ views for the next six months, as it fell by 2 points to 17. The measure of current sales conditions dropped by a point to 14, while traffic of prospective buyers was seen lower, with that index down a point to 11.

Regionally speaking, the Northeast and South both saw two point declines (to 15), as the West collapsed three points (to 12). However, there was some good news in the homebuilder view, as the Midwest index improved by a point, to a still clearly terrible absolute level of 11. Also, the NAHB chief said that about a dozen metropolitan areas were showing signs of life.

On net, the HMI report would have contributed nothing to stock market activity this past week, since it was simply as bad as usual. But when market sentiment is overwhelmingly negative, well then it piles on.

This article should interest investors in Investors Title (Nasdaq: ITIC), Bank of America (NYSE: BAC), Freddie Mac (OTC: FMCC.OB), Fannie Mae (OTC: FNMA.OB), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Wells Fargo (NYSE: WFC), Toronto Dominion (NYSE: TD), UltraShort Real Estate ProShares (NYSE: SRS), Ultra Real Estate ProShares (NYSE: URE), ING Clarion Global Real Estate Income Fund (NYSE: IGR), Xinyuan Real Estate Co. (NYSE: XIN), Rydex Real Estate Fund H (Nasdaq: RYHRX), T. Rowe Price Real Estate Fund (Nasdaq: TRREX), Toll Brothers (NYSE: TOL), Hovnanian (NYSE: HOV), D.R. Horton (NYSE: DHI), Beazer Homes (NYSE: BZH), Lennar (NYSE: LEN), K.B. Homes (NYSE: KBH), Pulte Homes (NYSE: PHM), NVR Inc. (NYSE: NVR), Gafisa SA (NYSE: GFA), MDC Holdings (NYSE: MDC), Ryland Group (NYSE: RYL), Meritage Homes (NYSE: MTH), Brookfield Homes (NYSE: BHS), Standard Pacific (NYSE: SPF), M/I Homes (NYSE: MHO), Orleans Homebuilders (AMEX: OHB).

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.

Stock Research 09-22-11

Thursday’s stock research highlights moves by Standpoint Research to upgrade a group of names on what looks like pure valuation reasoning given the market slide. The research firm upgraded six names in total, including stocks from various sectors. There were more upgrades than downgrades overall, which I found a bit surprising. It’s been my feeling that at some point there would be capitulation by brokers, as their economists and sector strategists cut the economic outlook, and as that information feeds through to stock analysts. Some firms allow more freedom than others in this regard, and so analysts act autonomously and sometimes inconsistently to their economic and strategic gurus.

Stock Research

UPGRADES

Company	Analyst	From	To
Camden Property (NYSE: CPT)	FBR	Mkt. Perform	Outperform
FedEx (NYSE: FDX)	StandPoint	Hold	Buy
Full Circle Capital (Nasdaq: FULL)	Ladenburg Thal	Neutral	Buy
Lockheed Martin (NYSE: LMT)	Standpoint	Hold	Buy
MetroPCS (NYSE: PCS)	Standpoint	Hold	Buy
Netflix (Nasdaq: NFLX)	Wedbush	Underperform	Outperform
Netflix (Nasdaq: NFLX)	UBS	Sell	Neutral
Prosperity Banc. (Nasdaq: PRSP)	Standpoint	Hold	Buy
Saneamento Basico (NYSE: SBS)	Standpoint	Hold	Buy
Sunpower (Nasdaq: SPWRA)	Kaufman Bros	Sell	Hold
Susquehanna Bank (Nasdaq:SUSQ)	Boenning Scatt	Neutral	Outperform
Tempur-Pedic (NYSE: TPX)	Standpoint	Hold	Buy
Yahoo (Nasdaq: YHOO)	Stifel Nicolaus	Hold	Buy

DOWNGRADES

Company	Analyst	From	To
Comtech Telecom (Nasdaq: CMTL)	Needham	Buy	Hold
Goodrich (NYSE: GR)	FBR	Outperform	Mkt. Perform
Magellan Midstream (NYSE: MMP)	Morgan Keegan	Outperform	Mkt. Perform
Under Armour (NYSE: UA)	Needham	Buy	Hold
Urban Outfitters (Nasdaq: URBN)	Wedbush	Neutral	Underperform

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.