Dr. Nouriel Roubini,
Professor of Economics at NYU and Chairman of RGE Monitor, has become popular in
the financial community based upon an unusually good track record of economic
forecasting over the last several years. In a recent presentation and written
commentary, he describes the outlook for the US and global economy as “extremely
weak.” He dismisses talk about “green shoots” and expects the recession to last
another 6-9 months. He disagrees with the consensus on a number of points
regarding the economic outlook. He believes 1) the recession is not over; 2)
the financial crisis will reduce future potential economic growth; and 3) there
is a risk of a recessionary relapse.
Dr. Roubini expects
conditions in the labor market to remain “extremely weak.” He expects the
unemployment rate to peak at around 11% by year-end. When the recession is
over, employment will follow the pattern of the last two recessions and job
losses will continue for at least another year and a half. Labor income will
grow at a slow rate because businesses are reducing hours worked and attempting
to limit increases in wages for those employees who still have jobs.
The Bureau of Labor
Statistics (BLS) uses a statistical adjustment to estimate the number of jobs
added or lost for businesses that have been recently established. This
statistical adjustment currently adds between 150,000 and 200,000 jobs based on
the BLS birth/death (of businesses) model. Dr. Roubini believes the birth/death
adjustment is too high and that real monthly job losses are closer to 600,000
per month, compared to 467,000 reported by the US Labor Department for June.
Dr. Roubini expects the US
personal savings rate, which reached a 15 year high in May of 6.9% of disposable
personal income, to increase further to 10-11% within the next 12 months. The
complement of a higher savings rate is lower consumer expenditures, reflecting
more conservative spending patterns.
Dr. Roubini expects problems
for the banking system to persist. Job losses will contribute to higher
mortgage delinquencies and foreclosures, even among the lowest risk mortgages.
According to a report by the Office of the Comptroller of the Currency and the
Office of Thrift Supervision, prime mortgages 60 days or more past due climbed
to 2.9% as of March 31, 2009. One year prior to that, the prime delinquency
rate was 1.1%. Based on their analysis at RGE Monitor, Dr. Roubini expects home
prices to “fall by at least another 40 percent, and more likely 45 percent,
before they bottom out.” As a result, of the 51 million households that have
mortgages, about 25 million will have negative equity in their homes.
Dr. Roubini expects
deflationary price pressures to remain dominant for this year and next year, as
demand remains low relative to supply and excess capacity. However, he writes,
“If these (US Government) budget deficits are going to continue to be monetized,
eventually toward the end of next year, you are going to have a sharp increase
in expected inflation … that’s going to push interest rates even higher.”
Regarding the financial
markets, Dr. Roubini writes: “The recent rally in global equities, commodities
and credit may soon fizzle out as an onslaught of worse-than-expected macro
(economic), earnings and financial news take a toll on this rally, which has
gotten way ahead of improvement in actual macro data.”
During the second quarter, I
reduced or sold some equity positions in anticipation of another decline in the
general level of stock prices. The allocation to foreign fixed income has been
increased, as the US budget deficit is ballooning by comparison to almost all
other countries.
Additions
Positions were increased in
fixed income securities that are denominated in foreign currencies. Purchases
were made of the following for selected accounts to increase the foreign fixed
income allocation to nearly 40% of portfolios: Netherlands Government bond,
American Century International Bond Fund (BEGBX), Nuveen Multi-Currency
Short-Term Government Income Fund (JGT), Morgan Stanley Emerging Markets
Domestic Debt Fund (EDD), and the Currency Shares Swiss Franc Trust (FXF).
Maturities for some foreign government bonds have been extended for slightly
higher income and to hedge against the eventual possibility of foreign exchange
controls.
SPDR Gold Shares (GLD) and
iShares Silver Trust (SLV) are exchange-traded funds that invest in physical
gold and silver, respectively. Positions were increased during the quarter as a
hedge against policies of the Federal Reserve and other central banks which are
likely to result in higher inflation.
Montgomery Street Income
Securities (MTS) was purchased for most retirement accounts. MTS is a
closed-end fund that invests primarily in corporate, US government, and US
agency debt. The fund does not use leverage. It has an average credit rating
of AA and the current yield is 5.8%.
PowerShares VRDO Tax-Free
Weekly Portfolio (PVI) was purchased for taxable accounts. PVI is an
exchange-traded fund that invests primarily in variable rate demand obligation
bonds that are exempt from federal income tax with interest rates that are set
weekly. The fund is designed to have a net asset value that does not fluctuate,
although the distribution rate will change to reflect current short-term rates.
Deletions
Shares of the Seligman
Municipal National Fund (SNXEX) were redeemed at net asset value less a 2%
redemption fee. Shares of the mutual fund were received in exchange for the
Seligman Select Municipal Fund (SEL), a closed-end fund.
Genco Shipping & Trading
Ltd. (GNK) was sold. Earnings estimates had declined for the company. At the
time of the sale, the lack of recovery in spot shipping rates implied that the
company’s revenue will decline as time charters expire.
Ashford Hospitality Trust (AHT)
was sold. Given higher unemployment and corporate travel budget reductions,
further deterioration in hotel industry operating results is expected.
Qiao Xing Universal
Telephone, Inc. (XING) was sold after a molybdenum mine was purchased from the
company’s Chairman and CEO for a combination of cash and company shares. The
immediate impact of the transaction is a dilution of shareholders’ equity per
share, while the potential profitability of the mine is difficult to determine.
Positions were reduced for
the John Hancock Patriot Premium Dividend Fund II (PDT) and the Morgan Stanley
Emerging Markets Domestic Debt Fund (EDD). Both closed-end funds use some
leverage and were selling at lower discounts to net asset value than in the
past.
Gramercy Capital Corp. (GKK)
common and preferred positions were reduced to a lower level after prices of the
securities rose from distressed levels.
Trina Solar Limited (TSL)
was sold. Earnings estimates have declined as industry analysts now expect 2009
industry revenue to decline by 40% from 2008 due to a limit on installation
incentives in Spain and lower average selling prices. Industry revenue is
expected to rebound in 2010 and grow rapidly in following years.
Idearc Inc. senior notes
were sold. Based upon a discussion with the financial advisory firm hired to
represent unsecured creditors, the common shares to be received by senior note
holders upon emergence from Chapter 11 will much lower than I had expected.
Tele Norte Leste
Participacoes SA (TNE) was sold. After the acquisition of Brasil Telecom, the
merged company has a higher degree of financial risk due to the higher debt
level of the merged entities.
Arc Energy Trust (AETUF) and
Penn West Energy Trust (PWE) were sold to reduce the allocation to the energy
sector. High global crude inventory levels and lower economic activity are
likely to result in lower crude oil prices.
Updates
Advantage Energy Income Fund
(AAV) announced that it has signed agreements to dispose of assets in northeast
British Colombia and northwest Alberta for a total of C$253 million. AAV also
sold 17 million trust units to a syndicate of underwriters led by RBC Capital
Markets for gross proceeds of $102 million. The proceeds from the transactions
will be used to repay debt and fund development of the Montney natural gas
resources in Alberta.
Shareholders of the Nuveen
Florida Quality Income Municipal Fund (NUF) have approved a merger with the
Nuveen Premium Income Municipal Fund 2 (NPM), a larger national tax-exempt
closed-end fund. The shareholders of NPM must now approve the merger at a
meeting scheduled for July 24. I currently plan to hold the NUF shares in
anticipation of the exchange for NPM shares. NUF currently sells at an 11%
discount to net asset value, while NPM sells at a 4% discount.
Tortoise Capital Resources
Corp (TTO) reduced its quarterly distribution to $0.13 per share from $0.23.
TTO’s distribution was decreased primarily due to reductions in distributions
from two of its portfolio holdings, Eagle Rock Energy Partners, LP (EROC) and
Abraxas Energy Partners, LP, a private company. TTO’s current dividend yield is
now 12.4%. The closed-end fund sells at a large discount from its last
published net asset value of $8.67 per share at the end of February. The net
asset value of TTO is estimated on a quarterly basis because many holdings are
private companies.
Another fund managed by
Tortoise Capital Advisors, Tortoise North American Energy Corp. (TYN), reduced
its distribution in the first quarter to $0.37 from $0.42 paid in the fourth
quarter of 2008. The current dividend yield is now 9.2%.
If you have any questions
regarding your accounts, please contact me.
Sincerely,
Robert G. Kahl
CFA, CPA, MBA
Sabino
Investment Management, L.L.C.