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...Some analysts have begun to recognize that U.S. asset and debt markets have not faced such precarious dynamics since The Great Depression. Meanwhile, collapsing U.S. and international interest-rates fuel myriad global Bubbles and inflationary pressures. In short, 2007 has been a continuation of the unfolding “worst-case-scenario.”'
2007 Wrap-UpBy Doug Noland
December 26, 2007
SourceThere’s still Monday’s abbreviated trading session to officially end the year. I thought I would get my 2007 Wrap-Up out of the way a little prematurely. This will be a work-in-progress, as I plan on editing and amending as year-end data come available.
The year was remarkable for the unusual divergences between bursting Bubbles and others continuing to inflate. This was the case both domestically and globally. As an example, the U.S. KBW Bank index sank 24.8%, while the NASDAQ100 surged 19.9%. The AMEX oil index surged 32.8%, while the S&P500 Homebuilding index collapsed 60%. Globally, major Chinese stock indices about doubled in price, while Japan’s Nikkei 225 fell 11%. In Europe, Britain’s FTSE mustered a 4.1% gain, while Germany’s DAX posted a 22.3% rise.
“Decoupled” Asian Bubbles inflated dangerously. The Chinese Shanghai Composite surged 96.7%, inflating 2-year gains to 355%. China’s CSI 300 index, which includes stocks on the Shenzhen Stock Exchange, gained 162% this year. The Shenzhen Composite was up 420% in two years. Hong Kong’s Hang Seng index rose 37.1% this year, with 2-year gains of 81.2%.
Taiwan’s TAIEX index gained 5.7%, increasing 2-year gains to 28.7%. South Korea’s KOSPI index gained 32.3% (up 39% in 2yrs). Singapore’s Straits Times index advanced 15.4%, increasing 2-year gains to 47.4% (up 156% in 5yrs). Thailand’s Bangkok SET index rose 26.2% (2yr gain of 22%). Malaysia’s Kuala Lumpur Composite index rose 32%, with 2-year gains of 61.6%. Indonesia’s Jakarta index surged 52.1%, with 2-year gains of 136% and 5-year gains of 546%. The major Philippine index posted a 21.4% gain (2-yr gain 75.2%). The Vietnam Stock Index gained 23.3%, increasing 2-year gains to 202%.
India’s Sensex index jumped 46.6%, increasing 2-year gains to 118% and 5-year gains to 495%. The Karachi Stock Exchange 100 rose 47.1% (2-yr gain of 56%).
Fourth quarter losses (3.5%) reduced 2007 gains in Australia’s S&P/ASX index to 11.8% (2-year gain 33%). The New Zealand Exchange 50 dipped 0.5%, reducing 2-year gains to 20.7%.
Latin America certainly participated in the Global Bubble Phenomenon. Brazil’s Bovespa index surged 43.7% (2-yr gain of 93%). The Mexican Bolsa rose 12.3% (2-yr 68%) and Chile’s Select index 13.3% (2-yr 56.8%). Argentina’s Merval gained 2.9% (2-yr 40%), and Peru’s Lima General index jumped 36.0% (2-yr 263%).
While December numbers have yet to be reported, better than 25% year-over-year growth pushed International Reserve Assets to $6.06 TN. Through September, China’s reserves were up 45% y-o-y to $949bn. Russian reserves were up 56% this year to $466bn, with India’s reserves increasing 56% to $264bn. Brazil’s reserve assets almost doubled to $162bn. OPEC reserves were up 36% y-o-y to $421bn. “Sovereign Wealth Fund” was added to financial market vernacular. The dollar drifted further away from reserve currency status.
Despite the significant 4th quarter U.S. slowdown, 2007 will post only a modest decline in total global debt issuance. The global IPO market enjoyed a record year approaching $275bn, up from the previous record $242bn set last year. Although second-half deal flow slowed sharply, global M&A activity was still 20% ahead of 2006 (according to Dealogic), led by Asia and the emerging markets.
Gold gained 31.8%, its largest annual gain since the tumultuous year 1979 (when its price doubled) and its seventh straight year of positive returns. Crude oil surged 59%. Heating oil gained 62%, gasoline 54% and natural gas 17%. Despite declining 10% from its recent high, Wheat prices inflated 77% this year. Soybeans prices rose a record 79% this year to the highest level since 1973. After gaining 80% last year, corn climbed another 16% in 2007. Cotton prices rose 20%. The CRB index rose 16.5% this year, and the Goldman Sachs Commodities index surged 40.6%. It was a year when the markets came to recognize that significantly higher energy and commodities prices were having only minimal impact on demand.
During the year 2007, it became clear that the Federal Reserve had lost control of inflationary forces. The year ended with Import Prices up 11.4% y-o-y, the Producer Price index up 7.2% y-o-y, and the Consumer Price index up 4.3% y-o-y. Despite a weakened economy and another year of dollar devaluation, the U.S. Current Account Deficit remained in the neighborhood of $800bn. Coupled with huge speculative outflows seeking profits from global inflation, the world was absolutely inundated with dollar liquidity.
It was, as well, a year of shattered myths: That astute global central bankers have inflation in check; contemporary finance effectively disburses risk to the marketplace, in the process shielding the banking system from Credit and market risk; “AAA” stands for safety and liquidity; nationwide home prices won’t decline; the Federal Reserve controls marketplace liquidity; commercial paper is safe; CDOs make sense; the financial guarantors face minimal risk. Indeed, the entire bullish notion of contemporary risk modeling, structuring, hedging, and financial guarantees (“Credit insurance”) is now in serious jeopardy.
2007 saw the initial bursting of the Great Credit Bubble. To be sure, the enormous Bubble in Wall Street-backed finance abruptly went from runaway boom to astounding bust. Much of the mortgage origination market collapsed spectacularly. Thirty percent annualized broker/dealer balance sheet growth came to an abrupt halt during this year’s second half. “Private-label” MBS issuance ground to a halt. The booming asset-backed securities and CDO markets faltered badly. The banking system’s off-balance sheet structured “vehicles” collapsed in illiquidity, another factor forcing the major lending institutions to balloon their balance sheets. The global inter-bank lending market seized up. The hedge fund industry waited anxiously for redemption notices. Counter-party risk became a very serious systemic issue. The global financial system ends the year on the precipice.
Meantime, U.S. Bank Credit expanded almost 12% during the year, with Commercial & Industrial loans ballooning almost 21%. With Risk Embracement turning to Risk Aversion, the marketplace called upon the Money Fund Complex to Intermediate Risk. Money Fund assets expanded an unprecedented $729bn, or 30.6%. And as liquidity disappeared for Wall Street-backed mortgages, Fannie and Freddie’s Combined Books of Business inflated an unprecedented $600bn (or so). The Federal Home Loan Banking system ballooned its balance sheet by more than $200bn, in the process becoming Lender of Last resort to some very troubled financial institutions. Global central bankers engaged in unparalleled concerted marketplace interventions and liquidity injections.
From the Fed’s Q3 “flow of funds,” total (non-financial and financial) U.S. system Credit growth expanded at an annualized $4.99 TN, sustaining the U.S. Bubble Economy but in an Unsustainable Manner – unsustainable in the quantity and structure of Credit and Risk Intermediation as well as the nature of economic activity. Financial sector debt expanded at an alarming 15.6% annualized pace, with Bank Credit, GSE, agency MBS, and Money Funds all expanding at double-digit rates. Of late, the Wall Street Credit crunch and severe tightening in risky debt markets have instigated recessionary forces. Many housing markets have gone from bad to worse – on the way to much worse. Florida is a mess, while California is an unfolding disaster. Some analysts have begun to recognize that U.S. asset and debt markets have not faced such precarious dynamics since The Great Depression. Meanwhile, collapsing U.S. and international interest-rates fuel myriad global Bubbles and inflationary pressures. In short, 2007 has been a continuation of the unfolding “worst-case-scenario.”