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WEEKLY NEWSLETTER VOL 2 ISSUE 43
CAVALIERE CAPITAL CORPORATION
WEEKLY PETROLEUM, SUGAR-BASED ETHANOL, and
ECONOMICS NEWSLETTER VOL 2 ISSUE 43.
Jose please visit our website at:
www.cavalierecapital.com
Sunday, November 2, 2008. VOL 2 ISSUE 43.
--WORLD WILL STRUGGLE TO MEET OIL DEMAND.
--RUSSIAN OIL AT ITS PEAK, SAYS DUDLEY.
--PETROBRAS, PORTUGAL'S GALP AGREE TO WORK TOGETHER ON ENERGY PROJECTS.
--CUBA AND BRAZIL SIGN PETROLEUM AGREEMENT.
--TEIKOKU TO RECEIVE 40% OF PETROBRAS ECUADOR.
--VENEZUELAN PETROLEUM RESERVES INCREASE.
--ECUADOR ENDS CONTRACT WITH REPSOL-YPF.
--ENAP REPORTS REFINING LOSSES.
--PEMEX TO DOUBLE EXPLORATION EFFORTS.
--PETROBRAS TO INCREASE NATURAL GAS EXPLORATION IN ARGENTINA.
--BRAZIL TO CHALLENGE U.S. SUBSIDIES.
--BRAZIL TO EXPORT MORE ETHANOL TO U.S. DESPITE DROP IN OIL PRICE.
Add to Address
--BRAZIL SUGAR CANE CULTIVATION UP BY 40%.
--BRAZILIAN ETHANOL PRODUCERS ASK FOR GOVERNMENT HELP.
--MEXICO LOOKS FOR WAYS TO PRODUCE MORE ETHANOL.
--AMERICANS TO INVEST R$ 1.9 BILLION IN BRAZIL ETHANOL.
--ANOTHER SEASON WITH TIGHT SUPPLIES FOR ETHANOL PRODUCERS.
--AUSTRALIA LOOKS FOR SYNERGY WITH BRAZILIAN ETHANOL PRODUCERS.
--VERASUN, LARGE CORN-BASED ETHANOL PRODUCER, FILES CHAPTER 11.
--U.S. CONSUMER CONFIDENCE HITS RECORD LOW.
--GM-CHRYSLER DEAL MAY COST 25,000 JOBS.
--PENSION FUND GAP HITS $100 BILLION.
--OUTLOOK IS BLEAK, SAY U.S. FINANCE CHIEFS.
--BROWN, SARKOZY SEEK "NEW BRETTON WOODS."
--WHEN WILL THE ECONOMY RECOVER? (My opinion)
WORLD WILL STRUGGLE TO MEET OIL DEMAND
RUSSIAN OIL AT ITS PEAK, SAYS DUDLEY
Output from the world's oilfields is declining faster than previously thought, the first
authoritative public study of the biggest fields shows.
Without extra investment to raise production, the natural annual rate of output decline is 9.1
per cent, the International Energy Agency says in its annual report, the World Energy
Outlook, a draft of which has been obtained by the Financial Times.
The findings suggest the world will struggle to produce enough oil to make up for steep
declines in existing fields, such as those in the North Sea, Russia and Alaska, and meet longterm de¬mand. The effort will become even more acute as prices fall and investment
decisions are delayed.
The IEA, the oil watchdog, forecasts that China, India and other developing countries'
demand will require investments of $360bn each year until 2030.
The agency says even with investment, the annual rate of output decline is 6.4 per cent.
The decline will not necessarily be felt in the next few years because demand is slowing
down, but with the expected slowdown in investment the eventual effect will be magnified,
oil executives say.
"The future rate of decline in output from producing oilfields as they mature is the single
most important determinant of the amount of new capacity that will need to be built globally
to meet demand," the IEA says.
The watchdog warned that the world needed to make a "significant increase in future
investments just to maintain the current level of production".
The battle to replace mature oilfields' output could even offset the decline in demand growth,
which has given the industry – already struggling to find enough supply to meet needs,
especially from China – a reprieve in the past few months.
The IEA predicted in its draft report, due to be published next month, that demand would be
damped, "reflecting the impact of much higher oil prices and slightly slower economic
growth".
It expects oil consumption in 2030 to reach 106.4m barrels a day, down from last year's
forecast of 116.3m b/d.
The projections could yet be revised lower because the draft report was written a month ago,
before the global financial crisis deepened after the collapse of Lehman Brothers.
All the increase in oil demand until 2030 comes from emerging countries, while consumption
in developed countries declines.
As a result, the share of rich countries in global demand will drop from last year's 59 per cent
to less than half of the total in 2030.
This is the clearest indication yet that the focus of the industry on the demand – not just the
supply – side is moving away from the US, Europe and Japan, towards emerging nations.
RUSSIAN OIL AT ITS PEAK, SAYS DUDLEY
Robert Dudley, the outgoing chief executive of TNK-BP, said that Russia's oil production
looked set for a protracted decline, in part due to lack of investment.
In only his second public appearance since he was forced to leave Russia in July amid a bitter
struggle for control of TNK-BP between BP and its Russian billionaire partners, Mr. Dudley
said Russian oil production looked to have reached its peak in August.
"There isn't going to be a precipitous decline. It's very mature oil fields and there will
probably be a gentle decline as we move on," Mr. Dudley said on the sidelines of the Oil and
Money conference in London. "But I believe we are . . . at the top of a broad curve or cycle
right now until other things happen."
Mr. Dudley declined to comment on the progress of a memorandum of understanding
hammered out by BP and the Russian shareholder in TNK-BP in September to apparently end
the bitter shareholder row that had damaged Russia's investment climate.
Mr. Dudley had left Russia after he had failed to win a new visa, blaming a campaign of
harassment that had targeted his position as the BP-backed chief executive as the Russian
shareholders sought to oust him, claiming he was running the company as a BP subsidiary.
Mr. Dudley noted only on Wednesday that the agreement sustained the 50:50 ownership
structure of the oil venture and added independent board directors. Mr. Dudley is to be
replaced with an independent chief executive whose name is expected to be announced in
December.
"I think it will be successful," Mr. Dudley said of the agreement. "But they are still in the
process of concluding the language."
Mr Dudley said the production decline in Russia was a "consequence of lower investment over
the past five years" and would last "some time".
PETROBRAS, PORTUGAL'S GALP AGREE TO WORK TOGETHER ON ENERGY PROJECTS
Brazilian state-run energy giant Petroleo Brasileiro (PBR) and Portugal's Galp Energia
(GALP.LB) on Tuesday signed memorandums of understanding to jointly develop energy
projects, Petrobras said.
The agreements were signed at the ninth-annual Brazil-Portugal Summit, which included
Brazilian President Luiz Inacio Lula da Silva and Portuguese Prime Minister Jose Socrates.
Petrobras and Galp signed a deal with the government of the northeast Brazil state of Bahia
to study development of plantations for palm oil and sunflower seed oil, key raw materials for
biodiesel.
The memorandum formalized an investment deal Petrobras and Galp signed Oct. 10.
Petrobras and Galp formed a 50-50 joint venture to produce nearly 600,000 tons of
vegetable oil in Brazil, with the oil used as a raw material to produce 500,000 tons of
second-generation biodiesel. About half of the biodiesel would be produced in Portugal.
Petrobras and Galp also were expected to sign an MOU to evaluate possible partnerships to
develop shallow-water oil exploration blocks in the Campos, Santos and Espirito Santos
basins, Petrobras said.
CUBA AND BRAZIL SIGN PETROLEUM AGREEMENT
The Brazilian petroleum company Petrobras, signed this past Friday a cooperation agreement
with Cubapetroleos (Cupet) for the exploration for crude oil in Cuban waters, during a
ceremony attended by presidents Lula of Brazil and Raul Castro, of Cuba.
The agreement, which calls for an initial investment of $8 million, will allow Petrobras to
begin exploring for crude oil in block 37, one of 59 blocks available for exploration in the
Cuban Gulf of Mexico.
The Brazilian company did some exploration in Cuba in the past, about 10 years ago, but was
not successful after spending about $20 million.
Petrobras is joining the example of other petroleum companies, such as Repsol-YPF of Spain
and PDVSA of Venezuela, that already have agreements with Cupet.
According to the agreement, the area of the block to be explored has 1,600 square
kilometers, with a depth of between 500 and 1,600 meters, and a distance from the coast of
3 to 12 kilometers.
The document was signed in Havana by Sergio Gabrielli, president of Petrobras, and Rafael
Arias, commercial director of Cupet.
The exploration zone is located in the Northern coast of Matanzas, about 140 kilometers from
Havana.
The agreement has a duration of seven years to explore, and 25 years to produce petroleum,
if found.
Petrobras and Cupet signed the document during Lula's second visit to Cuba this year.
Last January, Lula visited the island, where he signed agreements for the construction of a
lubricants factory, as well as the modernization of a nickel plant, among others.
The island consumes 150,000 bpd of petroleum and its derivatives. Of these, 92,000 bpd are
imported from Venezuela, Cuba's main trading partner.
TEIKOKU TO RECEIVE 40% OF PETROBRAS ECUADOR
Petroecuador gave its final authorization to Brazilian company Petrobras to transfer a 40%
interest in its Ecuadorean operations to Japanese company Teikoku Oil Co., announced this
past Friday a high level representative of the Ministry of Mines and Petroleum.
Teikoku is a subsidiary of Impex Holdings Inc. Petrobras and Teikoku had signed a
preliminary agreement in January 2005, regarding the transfer of the 40% interest.
According to the government, Petrobras received an authorization for the transfer in January
of 2007, but it still needed Petroecuador's approval of the new contracts in order to close the
transaction.
The representative stated that Petroecuador gave the final authorization last Friday.
Petrobras operates in Ecuador's block 18, which produces about 32,000 bpd of petroleum
and equivalents. In addition, Petrobras has a participation of 11.42% in the heavy oil pipeline
(OCP).
Petrobras, Teikoku and the Ecuadorean government will sign this coming Friday a temporary
modified contract of petroleum participation for one year, for block 18, after a series of
negotiations. The agreement calls for Ecuador to receive 60% of the production from block
18, compared to 51% presently.
VENEZUELAN PETROLEUM RESERVES INCREASE
The Venezuelan government announced last Wednesday that its proven petroleum reserves
increased to 152.56 billion barrels, according to a release by the Ministry of Energy and
Petroleum (Menpet).
The ministry informed that 10.25 billion barrels from the Iguana Zuata field located in the
Junin Dos block were added to the country's reserves.
In addition to the aforementioned addition of proven reserves, a total of 826.55 million cubic
feet of natural gas were added.
The Venezuelan government informed that total natural gas reserves stand at 9.25 billion
cubic feet, according to a report last Thursday in El Nacional.
Venezuela is in the process of quantifying its petroleum reserves with the help of many
multinational petroleum companies, in order to assure that independent evaluations are
carried out.
The results are being submitted for certification by the international petroleum companies, in
order to be added to the total proven reserves of the country.
ECUADOR ENDS CONTRACT WITH REPSOL-YPF
Ecuador will compensate the Spanish company Repsol-YPF for its investments after
announcing that it will end its contracts with the firm, said Minister of Mines and Petroleum,
Darlis Palacios.
Ecuador decided to end its exploration contract with the Spanish company because the
negotiations to change the existing contract to a service contract were not successful,
according to the minister.
"I have to announce to the country that after not being able to reach an agreement with
Repsol, the state has decided to end its contractual relationship with Repsol," said Palacios to
reporters.
Recently, Ecuador's president warned of reprisals towards Repsol, for "decreasing
production."
ENAP REPORTS REFINING LOSSES
The Chilean state owned petroleum company Enap, reported last Thursday losses of $199
million during the first three quarters of this year, compared to $57 million in profits for the
same period last year, due to lower refining margins.
Enap stated that it had to refine petroleum that it bought at high prices, and then sell it 45 to
75 days later at much lower prices. Enap, which operates in Argentina, Chile, Ecuador, Peru,
Iran and Egypt, said that its consolidated operational results were a loss of $175 million
through September of this year, compared to a $211 million profit for the same period last
year.
"This reduction in the consolidated operational results from one year to the next, which
reached $387 million, is due primarily to a smaller margin in the amount of $374 million, as
a consequence of our losses in the refining sector," stated the firm.
"The refining results were affected by the existing margins in the international market and
for variations in product prices during the period between the purchase of crude, its
transportation to the refineries, the transformation of the crude into products, and product
sales, which takes between 45 and 75 days," it added.
PEMEX TO DOUBLE EXPLORATION EFFORTS
The Mexican national petroleum company Pemex hopes to double its exploration budget
within three years, thanks to energy reforms enacted this past week, said Jesus Reyes
Heroles, a director of the company.
"In the next three years we may double our exploration expenditures," said Reyes during a
press conference.
Moreover, he said that the first incentive contract envisioned by the new law may be signed
in nine to twelve months, which will increase the participation of private companies in the
exploration and production of crude oil.
Pemex is scheduled to begin constructing a new refinery before the end of the year,
according to Reyes Heroles.
PETROBRAS TO INCREASE NATURAL GAS EXPLORATION IN ARGENTINA
Petrobras Energia, the Argentinean subsidiary of Petrobras, wants to intensify its search for
natural gas in the country due to increasing demand, but without diminishing its efforts in
the search for crude oil, stated an executive of the company this past Friday.
As other energy firms operating in Argentina, Petrobras Energia is dealing with price controls
imposed by the government, in its attempt to control price inflation.
Due to an energy shortage, Argentineans are more and more dependent in natural gas
imports, due to a lack of investments during recent crisis.
"It is more likely to find gas in Argentinean areas today than crude oil," said Decio Oddone,
executive director of Petrobras Energia, during an interview with Reuters.
In order to attract more interest in the exploration and production of natural gas, the
government initiated a new program called "Gas Plus", which frees the prices of the gas from
areas not previously explored, and which are destined for the domestic market. "This
program has converted previously un-interesting gas reserves, into very interesting ones,"
said Oddone.
Petrobras' largest production of crude outside of Brazil, is from Argentina. The Brazilian
company entered the local market in 2003, when it acquired the local firm Perez Companc, to
expand its operations to also include a chain of gas stations.
BRAZIL TO CHALLENGE U.S. SUBSIDIES
Ambassador Roberto Azevedo, Brazil's permanent representative in the WTO, said that the
government is still contemplating the possibility of a complaint against American subsidies of
ethanol. "The studies have been performed in cooperation with the private sector," he said.
Marcos Jank, president of UNICA, said that Brazilian ethanol producers are determined to
challenge U.S. subsidies, but the final decision will be made after the U.S. elections.
"We are going to have a talk with the new U.S. government," he stated. Filing a complaint
against the U.S. in the WTO will be our last resort, stated Jank. First, we will try to reach an
understanding in hemisphere negotiations.
"The governments of Brazil and the U.S. signed one year ago a Memorandum of
Understanding: To discuss the ethanol market," affirmed Jank. The U.S. is charging a $0.54
per gallon tariff to import Brazilian ethanol.
BRAZIL TO EXPORT MORE ETHANOL TO U.S. DESPITE DROP IN OIL PRICE
Despite the lower petroleum prices and the financial crisis in the U.S., Brazilian ethanol
producers believe that the U.S. will import record volumes of ethanol from Brazil in 2009, to
say, more than the 3.1 billion liters imported this year.
Plinio Nastari, president of the consulting company Datagro, stated that the lower petroleum
prices will devastate the competitiveness of ethanol made from corn, but not the ethanol
made from sugar cane.
"In order for petroleum the price to affect Brazilian ethanol, it would have to drop below
$45," according to his estimates. Petroleum at lower prices bring worry to American ethanol
producers, not because of reduced demand, as explained by Tarcilo Rodrigues, of Bioagencia.
The worry is whether U.S. ethanol prices will be large enough to cover U.S. producer costs.
"The mixture in gasoline is mandatory and the price does not interfere much with demand.
The big question is whether there will be a positive margin for U.S. producers," said
Rodrigues. Presently, they are losing money.
With petroleum at $60, ethanol in the U.S. market is being offered at $1.80 per gallon (3.785
liters), a price which needs to be at least $2.05 in order for Brazilian producers to be able to
export and pay the U.S. tariff of $0.54 per gallon.
Marcos Jank, president of UNICA, believes that Brazil's exports to the U.S. may not grow
next year, but they will also not decrease. "External sales were always small and very
volatile, independent of the petroleum price," he thinks.
BRAZIL SUGAR CANE CULTIVATION IS UP BY 40%
Even with low sugar and ethanol prices and the recent shortage of credit, Brazil's area
cultivated with sugar cane increased by 40% between 2007 and 2008 in the Central-South
region.
The data comes from project Canasat, which is mapping sugar cane cultivation from space.
The states of Goias and Mato Grosso do Sul were leaders with increases of 39.38% and
36.9% respectively, in area planted between 2007 and 2008, as per satellite images. In
Goias, the area planted increased from 328,390 hectares to 457,580 hectares during this
period and, in Mato Grosso do Sul, it went from 226,960 hectares to 310,710 hectares.
BRAZILIAN ETHANOL PRODUCERS ASK FOR GOVERNMENT HELP
Ethanol producers in Brazil will get together, in the next few days, with the government's
economic team, in Brasilia, to discuss ways for the government to help their industry, which
is facing low capital levels and lack of credit because of the global credit crisis.
According to Marcos Jank, president of UNICA, "we will show the government that this sector
has an important part to play in Brazil's commercial balance and that at present it is
experiencing credit problems as well as difficulties obtaining export financing."
Total yearly exports of sugar and ethanol exceed $7 billion. The producers want operating
capital to carry additional inventory. Otherwise, they will have to sell more product during
the harvest, lowering sugar and ethanol prices even more.
The producers also want that credits already approved by BNDES (Brazilian Development
Bank) be released, as well as financing for maintenance during periods in between harvests.
"The fundamentals for this industry are positive. After two years of low prices, we are
projecting higher prices, due to a lack of product for the 2008/2009 season," said Jank.
MEXICO LOOKS FOR WAYS TO PRODUCE MORE ETHANOL
With a large corn production, but little left over to be used for ethanol production, especially
due to corn's importance as a food in the country, and also facing limitations in its ability to
plant more sugar cane, Mexico is looking for ways to increase the supply of ethanol in its
market in order to reduce gasoline imports, which now amount to 40% of its consumption.
The country's challenges in the energy sector motivated a national forum for the
petrochemical industry, which took place in Mexico City last week. President Felipe Calderon
as well as other government officials, businessmen and representatives of many
organizations took part in the discussion.
UNICA of Brazil was invited to share Brazil's ethanol experience, which is the best structured
ethanol market in the world. Geraldine Kutas, international UNICA representative, was in a
panel with the Mexican secretary of energy planning, Jordy Herrera Flores, as well as the
president of the WorldWatch Institute, Chris Flavin, where Brazilian data impressed the
audience, such as the fact that Brazil has substituted more than 50% of its gasoline demand,
for ethanol from sugar cane, while using only 1% of its arable land.
According to Herrera Flores, under present conditions Mexico will not be able to substitute
more than 20% of its gasoline usage for ethanol. In accordance with the national bioenergy
plan approved in February of 2008, at first the ethanol mixture in gasoline will be used only
in the city of Huaraca, with a consumption of 200 million liters of ethanol per year. The plan
envisions that this consumption will reach 800 million liters by 2012, at which time it will be
already implemented in other large Mexican cities, such as the capital.
According to Unicamp figures (The Brazilian Sugar Cane Technology Center), and Braskem,
one ton of bioplastic removes 2.5 tons of CO2 from the atmosphere, while the production of
conventional – which uses petroleum naphtha as the feed stock – emits 2.5 tons of CO2 for
each ton of plastic produced. "This impressive environmental impact can be obtained because
polyethylene production is integrated to ethanol production, which uses cogeneration of
electricity using sugar cane bagasse in high pressure turbines," explained Kutas.
Presently there are five bioplastic factories being developed in Brazil, according to UNICA. By
2011, these factories will consume 2 billion liters of ethanol to produce "green plastic."
"Even for the petroleum producing countries, such as Mexico or Brazil, the future of the
petroleum and chemical industries lies in the diversification of feed stocks and suppliers," she
concluded.
AMERICANS TO INVEST R$ 1.9 BILLION IN BRAZIL ETHANOL
Although now is a time for caution, and although several new projects will not break ground,
there are some who are determined to go ahead. In the middle of a financial crisis, private
U.S. investors are going ahead with plans to invest R$ 1.9 billion in the construction of five
sugar based ethanol production facilities in Anapolis, Goias state.
The plan is that by 2015 all production facilities of Goias Agroergia will be in operation and, it
intends to crush 10 million tons of sugar cane (two million tons in each plant), for a total
production of 900 million liters of ethanol, 180 million liters per unit.
Their plan calls for the first facility to begin operating during the second quarter of 2010, and
construction is scheduled to begin in February of 2009. Each one of the units has a budget of
R$ 380 million.
ANOTHER SEASON WITH TIGHT SUPPLIES FOR ETHANOL PRODUCERS
The demand/supply equation for the 2008/2009 harvest will again be a tight one, according
to a new study by Job Economia e Planejamento. "Ethanol consumption as a fuel is very
strong. But I don't see a risk of shortages," said Julio Maria Martins Borges, president of the
consulting company.
In Brazil, average consumption rose from 1.6 billion in 2007 to 1.9 billion liters this year, an
18.75% increase, according to Job.
Due to less supply in between harvests and strong demand, prices of ethanol to be used as
fuel between January and April of next year should increase.
"The price of hydrated ethanol should rise from R$ 0.74 to R$ 0.90 – R$ 1 per liter, an
average increase in excess of 20%," stated Borges. Even if these figures are correct, the
prices will not reach those of the 2006/2007 season, when they reached R$ 1.30.
AUSTRALIA LOOKS FOR SYNERGY WITH BRAZILIAN ETHANOL PRODUCERS
Executives of Canegrowers, the association of sugar cane growers of Australia, visited Brazil
last week with the mission of understanding the structure of Brazil's production of ethanol
from sugar cane. The goal is to mirror Australian industry on the Brazilian model and to
implement Brazil's more advanced practices in their country.
Canegrowers is located in Queensland, the Australian state that intends to implement a 10%
ethanol mixture to the gasoline (E10), by 2010. The representatives of the Australian
industry visited UNICA as part of their fact finding tour of Brazil, which included all sectors,
from sugar cane growing, to ethanol, to the cogeneration of electricity.
In comparison to Brazil, the Australian ethanol industry is small, but it will grow because of
the E10 project. Production capacity in the country will have to grow from 130 million liters
presently, to 350 million liters, within two years.
This is the second group from Queensland to visit Brazil this year. Last June, a group of
government officials, also from Queensland, visited UNICA to talk to Alfred Szwarc, their
expert on emissions and technology.
VERASUN, ONE OF LARGEST CORN-BASED ETHANOL PRODUCERS, FILES CHAPTER 11
The recent retreat in corn prices came too late for one of the nation's biggest ethanol
producers, as the twin blows of high costs and less credit pushed VeraSun Energy Corp. into
bankruptcy.
In a statement late Friday, the Sioux Falls, S.D.-based company said it planned to maintain
operations while the company and 24 of its subsidiaries reorganize. VeraSun said it expects
to reach a deal with lenders on additional financing to fund its operations before a hearing
Monday. It also expects to get court approval at this hearing to keep paying employees
without interruption.
Bankruptcy, though widely expected, caps a swift reversal of fortune for the seven-year old
company, which has been one of the key beneficiaries of U.S. policies designed to encourage
the use of fossil-fuel alternatives.
As investors clamored for stock plays on alternative energy, VeraSun shares made a
stunning debut at more than $30 a share in 2006, helping fund the company's rapid
expansion. Its 16 production facilities are scheduled to have production capacity of 1.64
billion gallons of ethanol by the end of this year.
Unprecedented moves in corn prices and a global credit tightening proved the company's
undoing. A run-up in corn prices earlier this year, in part due to increased demand from
ethanol makers, squeezed margins for VeraSun and other ethanol producers.
Corn prices have tumbled to $4.01 a bushel Friday from a record of around $8 a bushel in
June. But because of hedges it entered in July, when corn prices were still high, VeraSun
wasn't able to take advantage of this swift descent. Its corn costs averaged between $6.75
and $7 a bushel for the third quarter, it estimated in September, triggering a loss for the
period.
VeraSun's shares lost nearly 16% Friday to close at $0.48.
The company said in the Friday press release a "series of events" had shrunk its liquidity,
impairing its ability to invest in production facilities and operate its business.
"A dramatic spike in corn costs," partly due to its hedging arrangements and "worsening
capital market conditions and a tightening of trade credit resulted in severe constraints on
the company's liquidity position," the release said.
"Today's filing allows VeraSun to address its short-term liquidity constraints as we navigate
historically challenging market conditions while we focus on restructuring to address the
company's long-term future," VeraSun Chief Executive Don Endres said in the statement.
U.S. CONSUMER CONFIDENCE HITS RECORD LOW
US consumer confidence plummeted to its lowest level on record this month, as the
deepening of the financial crisis made Americans suddenly much more pessimistic about their
current situation and prospects.
The release of the Conference Board index on Tuesday will bolster fears that US consumers
are pulling back on spending in a big way heading into the critical holiday season, driving the
economy into a deep and long-lasting recession.
Consumer confidence fell from a reading of 61.4 in September to 38 this month – the lowest
level since the index was established more than 40 years ago and well below economists'
expectations that it would drop to 52.
The previous all-time low in the index was set in December 1974, when consumer confidence
fell to a level of 43.2.
"Consumer confidence didn't so much descend in October as fall right out of the sky," said
Abiel Reinhart, economist at JPMorgan in New York. The drop in consumer confidence was all
the more jarring because it came even as the price of petrol fell, removing what earlier this
year was one of the biggest drains on the finances of US households.
Most economists are predicting that consumption, which accounts for a large chunk of US
gross domestic product, will shrink in the second half of 2008.
Americans' assessments of their "present situation" declined from 61.1 in September to 41.9
in October. Meanwhile, the "expectations" index collapsed from 61.5 in September to 35.5
this month.
Views of the labor market also worsened, with the percentage of consumers saying jobs are
"hard to get" rising to 37.2 per cent from 32.2 per cent, while those claiming jobs are
"plentiful" decreased to 8.9 per cent from 12.6 per cent.
The bleak report on consumer confidence came an hour after it emerged that US home prices
suffered a record drop of 16.6 per cent over the year to August 2008 – slightly worse than
the annual drop of 16.3 per cent in July.
Although the decline was in line with economists' expectations, it brought the latest reminder
of the depth of the troubles afflicting the US housing industry. On a monthly basis, price
declines accelerated as well – with the 20-city index falling by 1 per cent compared with a
0.9 per cent drop the previous month.
"The downturn in residential real estate prices continued, with very few bright spots in the
data," said David Blitzer, chairman of the S&P index committee.
Economists have been hoping that monthly price declines would slow, eventually paving the
way for a moderation in price decreases on an annual level as well. But there are fears that
the deepening of financial woes over the past month may delay any nascent recovery.
The worst price declines on an annual basis were in Phoenix, where prices have fallen by
30.7 per cent since August 2007, and Las Vegas, where prices have fallen by 30.6 per cent
over the same period.
GM-CHRYSLER DEAL MAY COST 25,000 JOBS
GM-Chrysler deal may cost 25,000 to 35,000 automaker jobs, more at parts makers .
If General Motors Corp. acquires Chrysler LLC, it will cost 25,000 to 35,000 jobs at the
automakers, according to a Michigan consulting firm.
But the Anderson Economic Group of East Lansing said Wednesday the alternative of
Chrysler being sold in pieces would result in many more job losses. A GM acquisition, with
possible help from the federal government, is a likely possibility, Patrick Anderson, the firm's
CEO, said in a conference call with reporters.
"It's a much bigger job loss and a much bigger taxpayer hit if Chrysler simply goes out of
business or is dismantled," Anderson said.
Chrysler employs about 49,000 people in the U.S. and has about 125,000 retirees and
spouses.
Michigan, home to Chrysler's Auburn Hills corporate headquarters, would be hit hardest if
there was an acquisition. The state would lose 8,000 to 10,000 factory jobs, and the bulk of
the 10,000 to 15,000 lost white-collar positions would be in Michigan, Anderson said.
Other Midwestern states would lose 10,000 to 12,000 factory jobs, he said.
GM has been talking with Chrysler owner Cerberus Capital Management LP about an
acquisition, and GM has been lobbying in Washington for the federal government to put
money into the deal.
All three U.S.-based automakers are burning up cash because of an auto industry sales
meltdown due to the U.S. economic downturn, but Chrysler and GM are considered to be in
the worst shape. Industry analysts say Chrysler could go into bankruptcy next year if it
doesn't take on a partner or isn't acquired by another automaker.
Anderson said the prospect of the government's Pension Benefit Guarantee Corp. having to
take on Chrysler's pension liabilities, increased unemployment benefit costs, and the tax
impact on state and local governments are good reasons why the federal government should
get involved in the deal.
But government involvement runs the risk of nationalization of an automaker, which failed
when tried in the Britain.
Cerberus also is talking with the combined Nissan Motor Co. and Renault SA, as well as other
automakers, about selling parts of Chrysler.
PENSION FUND GAP HITS $100 BILLION
US companies will need to inject more than $100bn into their pension funds to cover market
losses, putting them in a cash squeeze at a time when it is difficult to raise money.
The cash payment, estimated by several pension industry executives, would be spread over
this financial year and next year.
Companies' pension fund losses – running at an estimated 20 per cent in the year to date –
also are expected to alter earnings this year, partly because of accounting changes.
The 700 largest corporate plans were more than 100 per cent funded at the end of last year,
but as of last week that had fallen to about 83 per cent, according to estimates by Mercer, a
pension consultant.
John Erhardt, a principal at Milliman, a consulting firm, said: "To bring company funds back
to 100 per cent funding, companies would need to put in about $50bn this year and that
again next year, for the top 100 funds. You could add another 30 per cent to 40 per cent to
that for the rest of the funds."
"Earnings will be impacted significantly. The 2008 year-end balance sheet will reflect that."
Mr. Erhardt said there were about $300bn in fund losses to the end of this month.
After the introduction of the Pension Protection Act this year, that would go "straight on to
the company balance sheet".
A report by Credit Suisse estimated that at the end of September there were 136 companies
that would need to lift contributions to their pension plans by half or more.
It said 76 companies had seen a drop in funded levels for their schemes that was greater
than 5 per cent of their corporate book value.
These included seven companies where the drop was more than 25 per cent of book value:
Unisys, Qwest, Embarq, Ford, Western Union, Dean Foods and Pactiv Corp.
David Zion, who wrote the report, estimated that apart from the cash payout, there were 65
companies whose earnings could be cut by 10 per cent because of an increase in pension
costs.
The change to earnings is separate from the cash infusion necessary to shore up the funds.
The American Benefits Council, which represents corporate pension plans, is lobbying for the
federal government to suspend some of the PPA rules, which require mandatory
contributions if funds fall below a certain level.
OUTLOOK IS BLEAK, SAY U.S. FINANCE CHIEFS
The unfolding credit crisis has taken its toll on corporate America's finance chiefs, whose
confidence in both the economy and their own companies' outlook plunged in the past
quarter, according to a survey.
Wall Street's woes have slowed the pace of economic growth in the US and abroad, forcing
chief financial officers to contend with falling demand for goods and services, limited
financing options and unprecedented turbulence in the world's markets. The CFO Optimism
Index for the US economy slipped 7.19 points, its steepest ever decline, to 41.73. The poll,
conducted by Financial Executives International and Baruch College, also showed that chief
financial officers' outlook for their employers dropped to a record low of 61.74.
"The severity of it took everyone by surprise," said Cheryl de Mesa Graziano, vice-president
of research and operations at FEI.
Two-thirds of the 290 CFOs polled predict they will find it even more difficult to tap the credit
markets in the next six months. Bracing for a prolonged slowdown, they now plan to slash
spending in the next year on capital investments, inventory, technology and new hires.
The survey's findings mirror the sentiments of many US companies' customers – consumer
confidence also slumped to its lowest level on record this month – and may not come as a
surprise to the many investors who dialed into earnings conference calls hosted by some of
the nation's economic bellwethers.
"The developed economies of North America, Europe and Japan are already struggling in
many of the industries we serve in these regions," James Owens, chief executive of
Caterpillar, a manufacturer of earth-moving equipment, said during a call with analysts. "In
fact we expect that next year will be the third year of significant decline in the US market."
Kurt Kuehn, finance chief at United Parcel Service, has warned investors that "it will be
several more quarters" before any turnaround takes hold.
"With consumer confidence approaching new lows, we are concerned that Santa's sleigh may
be a bit lighter than usual this year," Mr. Kuehn said during UPS's call.
Almost three-quarters of finance chiefs surveyed by FEI and Baruch agreed with the steps
the US government has taken to bail out institutions such as American International Group
and Bear Stearns, and restore confidence in the nation's banking system.
More than half gave Treasury secretary Hank Paulson at least a "B" grade for his
performance.
Eighty per cent agreed that the government should impose stiffer regulations and oversight
of the financial services industry.
BROWN, SARKOZY SEEK "NEW BRETTON WOODS"
Nicolas Sarkozy and Gordon Brown have struck up an unlikely partnership ahead of next
week's summit in Washington aimed at overhauling the global financial system.
But there are still big differences between Paris and London about the lessons to draw from
the crisis and a fear in the Elysée that Mr. Brown, the UK prime minister, is still committed to
preserving a light-touch regulatory regime for the City of London.
French officials say the strongest message that should come out of the Washington meeting
on November 15 would be a broad commitment from the US, the UK and other European
countries to abandon competition between regulatory systems in favor of convergence. But
they acknowledge this is unlikely.
Officials on both sides of the English Channel say the two leaders have in fact put to one side
their differences about the need for harmonization of rules so that they can both claim
success at the summit.
Mr. Brown and Mr. Sarkozy, the French president, want agreement from the leaders of the
G20 group of advanced and emerging economies in the US capital for a "new Bretton
Woods", a redesign of the postwar global financial architecture.
Mr. Brown and Mr. Sarkozy will seek EU backing for their proposals at a special summit of EU
leaders in Brussels on Friday. The British do not expect the Washington summit to resolve all
– or even most – of the issues, but to send out a signal of a commitment to act that will start
to restore confidence in battered markets.
French officials say the meeting has two objectives. The first is to take executive decisions on
issues that have been intensively discussed among regulators and supervisors for the past
year.
These include supervision of ratings agencies, injecting flexibility into "fair value" accounting
norms for illiquid assets and taking into account banks' pay and bonus structures when
evaluating their riskiness. "It's time to wrap up this discussion," said an official in Paris.
The second objective is to agree a set of principles underpinning reforms to be discussed at
future summits. France would like to hold a second meeting in Paris in February to be
attended by the new US president.
One of the main themes will be changes to the international financial architecture. Britain
and France both want a better resourced International Monetary Fund to carry out an early
warning function for the global financial system.
But by focusing on the broad outlines of a reformed global financial system and on issues
such as tax havens, officials believe Mr. Brown will be able to skirt round trickier questions
about the standards of regulation in the City. Mr. Brown's vision of a reformed global
regulatory system does not correspond with Mr Sarkozy's enthusiasm for a more harmonized
EU regulatory regime.
"I hear leaders taking a very different stance to the one they took six months ago," said a
senior French official alluding to Mr. Brown. "But have they really changed? If we could have
an agreement that regulatory convergence was more important than the individual interests
of different market places, that would be great. But I'm not sure we are going to get that."
The crisis has made it politically unwise for UK politicians to stand up for the City. The
previous British political mantra of "light touch" regulation has now become a defense of
"effective" regulation. But both main political parties in Britain believe the UK's eschewal of
heavy-handed statutory controls on the financial sector has given London a clear advantage
over its main rival, New York. This is not an advantage that Mr Brown would sacrifice lightly.
WHEN WILL THE ECONOMY RECOVER? (My opinion)
Now that gross domestic product has officially gone negative, focus has turned to how deep
the downturn will be and what needs to happen for the economy to recover. But for now, it
looks like the worst is still to come.
Following the release of a 0.3% contraction in third quarter GDP at an annual rate, most
economists are forecasting at least two more negative quarters. "The drop in third quarter
output is also a harbinger of much worse things to come. We now expect that GDP will
contract at an average 3% annualized pace in the fourth quarter and first quarter of 2009,
generating the worst recession since 1981-82," said Abiel Reinhart of J.P. Morgan Chase.
Economists at J.P. Morgan expect GDP to be flat in the second quarter of 2009, before
recovering somewhat in the second half. However, they continue to see growth remaining
below trend for some time.
Forecasting firm Macroeconomic Advisers expects an annualized contraction of 2.8% and
1.4% in the fourth quarter and first quarter, respectively. MA says a recovery in the second
half assumes there will be additional fiscal stimulus in 2009. However, they warn that if it
does arrive, "it will not do so soon enough to improve materially the GDP outlook for the next
two quarters."
Richard Moody of Mission Residential also doesn't expect recovery until the second half of
2009. "Unclogging the credit markets is a necessary first step, but the damage done to the
U.S. and foreign economies thus far will take time to undo," he said.
Going into the fourth quarter there were three major problems weighing on the broader
economy: rising energy prices, tighter credit and the continued deterioration in the housing
market. The clearer indications of recession have already brought down energy prices, and
there are tentative signs of improvement in the credit markets.
"We continue to believe that the policy measures now in place — along with those that
appear to be in the pipeline — will be sufficient to produce some healing in credit conditions
and eventually lead to some stability in the overall economy," said David Greenlaw at Morgan
Stanley. "However, this process will take time and a collapse in economic activity is just
getting underway."
However, the housing market is a problem that isn't going away. There were some
indications of stabilization in the housing market before the credit crunch moved into full
swing in October. But tighter credit conditions, mounting job losses and a weaker economy
are likely to continue putting pressure on prices. Many economists say that a recovery is
impossible until a floor emerges for home prices.
So even though most economists are forecasting a recovery to begin in the second half of
2009, the risks continue to be to the downside.
The overall index of consumer confidence plunged by a mammoth 23.4 points in October
from last month, to a new low of 38, the lowest reading ever recorded since the survey
began in 1967. Consumers' assessment of present conditions sank to 41.9 from 61.1 last
month, and their expectations slumped to 35.5 from 61.5 in September (last month's
readings were taken before the mid-month meltdown on Wall Street).
"Looking ahead, consumers are extremely pessimistic, said survey director Lynn Franco in a
statement accompanying the release. "This news does not bode well for retailers who are
already bracing for what is shaping up to be a very challenging holiday season."
And it certainly doesn't bode well for consumer spending overall, which drives more than
two-thirds of U.S. economic growth. Although the survey's ability to predict spending isn't
perfect, it echoes forecasts that consumer spending will likely decline in the third and fourth
quarter of this year — if not into 2009 — the first such quarterly declines since 1991.
As a result, some firms, like J.P. Morgan, are expecting gross domestic to decline at a 4%
annual rate in the final three months of this year, which would be the steepest drop in output
seen since the deep downturn that lasted from 1980-82. The deeply worrisome condition of
U.S. households, whose spending slump is a threat not only to U.S. growth but also to
economies world-wide, is partly why calls for a second stimulus package aimed at doling out
more cash to Americans are now gaining traction.
Economists and others weigh in on the plunge in consumer confidence.
The decline in confidence was especially notable given that gas prices had fallen so much
between September and October. Gas prices have fallen by almost a dollar per gallon over
the last four weeks. –Abiel Reinhart, J.P. Morgan
If the expectations index remains at October's 35.5 it would signal real consumers' spending
falling at an annualized rate of about 3-1/2%, even worse than the 3% drop we estimate for
the third quarter. But we think this will not happen, because the drop in stocks won't be
repeated (we hope…) and the astonishing plunge in gas prices will lift sentiment, as it was
before the market turmoil. Make no mistake, though, these numbers are extraordinarily
awful. –Ian Shepherdson, High Frequency Economics
Hopes for job growth and growth in the overall economy over the next six months plunged to
their worst net levels since 1980, and net expectations for income growth — which you might
have thought would have been helped by the plunge in gasoline prices — easily set an alltime record low. –Ted Wieseman, Morgan Stanley
Consumers are feeling the brunt of this recession. Household wealth has evaporated owing to
lower home prices and a sharp sell-off in the stock market. In addition, consumers are
struggling to finance their purchases because of ever-tightening lending standards.
Consumers are growing increasingly concerned about the labor market as well. –Michelle
Meyer, Barclays Capital
The drop in the net reading on labor market conditions to the lowest level since October
1993 signals a significant deterioration in the job market in October (likely reflecting the
tightening of credit conditions to businesses and the consumer) and we are looking at the
largest employment decline thus far in the 2008 recession. –RDQ Economics
A big portion of consumers are expecting simultaneous higher interest rates, lower equity
prices, and elevated inflation. The overwhelming negative sentiment, which is impacting
older individuals more heavily, suggests that the recent plunge in equity values is having a
terrible impact on economic perceptions going forward. –Guy LeBas, Janney Montgomery
Scott
Not surprisingly, confidence declined across all regions, all age groups and all income
categories. The sharp drop in confidence also reflected a marked downgrade of the job
market and business conditions in general. Data on consumer buying plans corroborated the
growing worries that consumer spending will continue to decline. Buying plans for appliance
and motor vehicles fell sharply with the latter slipping to an all-time low. The only thread of
silver in this depressingly dark cloud was a slight uptick in house-buying plans, though the
number planning to buy a new home held steady. –David Resler, Nomura Securities
Bernanke is quickly running out of monetary bullets, with the risk of having to take the
extraordinary step of someday lowering interest rates to zero just a bank run or two away
right now. Japan, which spent five unproductive years at zero between 2001 and 2006 before
boosting to a half percentage point, is now talking about a quarter point cut and possibly a
return to zero, even though it didn't work last time.
The economic theory behind zero rates, called quantitative monetary easing, allows a central
bank to run monetary policy by focusing on money supply instead of the cost of the money,
i.e. interest rates.
It also means that Joe the Plumber and his elderly parents would get nothing on their
savings account or certificates of deposit, which so many people depend on for their fixedincome lifestyles. How's that for an invitation to go out and spend?
Arguably, it was a dramatic easing of interest rates after the tech bubble collapsed that
plunked us into the systemic soup in the first place, allowing people to take out mortgages at
ridiculous rates and Wall Street to make a killing by packaging the mortgages and playing
various rates off each other. But it won't work this time around. Nobody's lending, and
nobody is borrowing.
This week, we'll find out how many Americans bought new cars in October. Estimates vary,
but it's likely to be about the same number of people who attend a Sen. Ted Stevens rally
this weekend. Some analysts predict it will be the worst month ever for the automakers, with
sales falling between 30% and 50% year over year.
Why combining General Motors Corp. and Chrysler, other than to get private equity firm
Cerberus off the hook, is considered a good way to sell more cars is beyond me. Two dogs do
not add up to a beauty queen. Even if people wanted to buy, they can't get the financing.
Interest rates at 1.5%, or 1%, or zero aren't going to get our economy going again. I
suspect even Ben Bernanke realizes that by now.
Big pension funds and young investors might be able to wait the months or years it might
take for the stock market to come back, but for many Americans, it's not about whether to
sell or hold stocks now. It's about getting enough cash to make payments at the end of this
month, now. Just ask the poor savers whose money is still tied up in The Reserve Fund, the
money market fund that froze assets last month after a run.
Insurance companies are also in big trouble:
ING gasping for air: Shares of this global insurance giant ING have plunged nearly 80% this
year. The most recent blood-letting struck after the company announced it lost a staggering
1.6 billion Euros ($2 billion) on stocks, bonds, structured credit and real estate. Result: It's
grabbing 10 billion Euros as part of a large Dutch government bailout package. Its CFO has
resigned in disgrace. And these events raise serious questions as to how long it can survive.
Aegon shares smashed! With its stock also down nearly 80% in twelve months, the Dutch
owner of Transamerica Corp. just announced it will post a huge third-quarter loss due to
investments in Lehman Brothers, Washington Mutual and other assets. It has canceled its
dividend. It, too, had to reach for a lifeline — $3.8 billion from the Dutch government. And it
may soon ask for more here in the U.S. if Washington lets insurers take their turn in the
soup line.
Harford shares killed! Hartford Financial Services has lost almost 90% of its value this year —
and more than half its market value one day last week alone! Why? Because it just posted a
third-quarter net loss of $2.6 billion on write-downs of investments in guess who: Fannie
Mae, Freddie Mac, Lehman Brothers and AIG.
The biggest U.S. and Bermuda-based insurers have piled up a total of $98 billion in losses —
much in still unrealized losses — since the beginning of last year!
Last week the government told us that Durable Goods orders in September increased 0.8%
over August.
Digging Down to the Truth:
When one digs beyond the headlines, one discovers that the vast majority of these Durable
Goods gains are neither durable nor gains, nor are they really good.
Rather, they are almost entirely in the transport column of the report. Demand for
commercial aircraft shot up some 29.7% in September. This is bad for two reasons.
The increase is accounted for by a relatively few number of actual orders received by Boeing,
et al, not planes delivered. No wrenches have spun, nor have any welding torches been lit.
No checks have been written, let alone deposited.
And it is quite possible that none ever will be. These are promises against the future, a
request to get into the queue – as easy to cancel as to make.
The Real Danger…
However, the real danger here is that a spike one month in aircraft orders is almost never
matched the following month. This means that the same report, which is supposed to lift
spirits today, is likely to crush them in some thirty days.
It's really best if we just ignore this volatile sector entirely. Unfortunately, when you take
transports out of the equation, Durable Goods actually fell 1.1% in September.
To make things worse, the most genuine "leading indicator" to be found in the report orders for non-defense capital goods – fell some 1.4%. This is the second month in a row
where this category came in washed in red.
The Fed announced it's now going to funnel a massive $120 billion of U.S. funds into Brazil,
South Korea, Singapore, and Mexico.
And that's on top of the IMF bailouts already committed to the Ukraine ($16.5 billion),
Iceland ($2.1 billion), and Hungary ($25.5 billion)!
Last week, Greenspan told Congress:
"Given the financial damage to date, I cannot see how we can avoid a significant rise in
layoffs and unemployment."
He also called the credit crisis a "once in a century credit tsunami" and said "[it is] much
broader than anything I could have imagined."
Meanwhile, Federal Reserve Chairman Ben Bernanke told the House Budget Committee that
he expects the economy to stay weak for a long time and urged Congress to consider a new
stimulus package. His words:
"With the economy likely to be weak for several quarters, and with some risk of a protracted
slowdown, consideration of a fiscal package by the Congress at this juncture seems
appropriate."
Now, let's take a look at what is going on in Brazil:
In this crisis, both the Central Bank of Brazil and the Brazilian government have acted very
quickly to backstop the liquidity effects against their banks. The Central Bank of Brazil has
been continuously superbly managed, despite changing administrations: and is very
experienced in crisis management. It is currently managed by Henrique Meirelles, a highly
experienced and greatly respected international banker. Meirelles has operated in the
tradition of Brazil's inflation-fighting central-banking pioneer Gustavo Franco. Franco was one
of the economic advisers who put together the Plano Real, which brought Brazilian inflation
down dramatically under former President Fernando Henrique Cardoso. Franco was followed
at the Central Bank by Arminio Fraga, formerly associated with George Soros in the Quantum
Fund, and finally by Meirelles, who was formerly with Fleet Bank.
It's important to note that the Lula administration has many officials who have previously
held senior positions with major international banks. This is a clear indication of
professionalism, transparency and commitment to serious macroeconomic and monetary
policy management.
President Lula has said that the government will buy bank stakes in order to shield its
financial institutions from the global crisis. This is happening today, as the government's
largest banks have been authorized to buy stakes in Brazilian banks. Much like the U.S.
Federal Reserve has done in here in the United States, the Brazilian Central Bank also has
been authorized to enter into swap operations with other central banks in order to restore
liquidity to the Real, which has been under pressure. Recently it swapped $30 billion with the
U.S.
To add further liquidity, the Brazilian Central Bank has reduced minimum reserve
requirements for the banks, extended an almost $2 billion line to the banking system to
finance exporters and injected some $71 billion to ease liquidity. The Central Bank explicitly
requires the banks to lend the money and monitors closely their activities to prevent them
from instead using the capital to buy – and sit on – government bonds.
The Brazilian Central Bank also has had to resort to selling only about $23 billion of its more
than $200 billion in total reserves, in order to cushion the decline of the Brazilian Real. The
upshot: Brazil today operates from a position of macroeconomic strength, like China, India
and Russia.
And the Central Bank has stimulated housing by easing liquidity requirements and
encouraging banks to lend more. This policy will soon gather more strength.
Similarly, the government banks, rather than international investors, are the most likely to
finance a huge electricity project coming for bid. And Brazil's plans for a major infrastructure
build-up should not have problems obtaining financing.
For example, Petrobras should easily be able to finance the estimated $163 billion needed
over five years to continue developing its ambitious mega-oil project out of its own cash flow,
government and bank financing and profit-sharing arrangements where it chooses. Vale and
other major exporters should likewise have little difficulty in moving forward. These
companies, like the government, are committed to continuing with their long-term
investment plans, despite the current problems.
Nor have Brazil's market-supporting measures stopped there. Brazil has required all
companies to report their derivatives positions and even to estimate future potential losses
under certain scenarios on a quarterly basis, starting immediately. This will greatly increase
transparency, dispel fears and increase confidence. Some companies saw their currency
derivatives positions get hit hard in the recent sell-off. But these hits, which in some notable
cases wiped out the quarter's profits, are a one-time effect, so it represents a buying
opportunity in those stocks.
Finally, the Brazilian banking system is sound, with strong capitalization and low
delinquencies. Credit expansion has been strong in the recent years, but not overdone. And
banks like Spain's Banco Santander SA (ADR NYSE: STD), government banks and others are
taking advantage of the crisis to buy loan portfolios from their weaker rivals, as has been the
case in most liquidity crunches in emerging markets.
The critics will refer to this crisis as the first major test for Lula. And many doubt whether he
will resist the temptation to throw monetary and fiscal prudence out the window. But Brazil,
as has been seen for decades, is much more than just Lula. Its technocratic administration
and central bank have decades of experience in crisis management. Brazil's strong local
companies, which are world leaders in many industries, and committed investors, including
major multinational companies, are heavily vested in the country's success.
Going for Growth
As the Brazilian government has done in the past, I expect it to stay the course for the long
term, to maintain its inflation-targeting discipline (as the Central Bank recently announced),
and stimulate its economy as inflation drops markedly. That will keep Brazil in the running to
be one the engines of growth in the world for the next couple of decades.
As we've seen, the country's prudent monetary and fiscal policies, coupled with its solid
macroeconomic position, strong reserve position, and controlled inflation will lead to good
growth. Gross domestic product (GDP) is expected advance at a rate of between 4% and 5%
next year. And since only 13% of GDP comes from exports, Brazil will have lots of room to
maneuver. The slowdown in the advanced economies will give Brazil – as well as India,
Russia and other emerging economies – room to start cutting domestic rates as inflation
abates, just as China is doing right now.
Brazil reduced its foreign debt to about 40% of GDP and kept inflation under control at
around 6% by running an admirably tight monetary policy, with a short-term rate of 13.75%.
Its economy is primarily commodity-based, with a broad range of exports, but it also has a
substantial manufacturing sector. The Bovespa stock index is down 62% from its May peak,
and Brazilian stocks are distinctly cheap.The bounce here should be a healthy one.
So, which country would you rather invest in right now?
Indeed, just a few days ago, Warren Buffet wrote the following in The New York Times ...
"Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted
for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in
value. Indeed, the policies that government will follow in its efforts to alleviate the current
crisis will probably prove inflationary and therefore accelerate declines in the real value of
cash accounts."
France's Sarkozy is feeling pretty smug. In fact, the French are feeling pretty smug...almost
a feeling of schadenfreud, if they had a word for it. They knew the war in Iraq was a waste of
time and money, so they stayed out of it; they were right about that. And they knew, too,
that American-style hyper-capitalism wouldn't work. They think they were right about that
too.
Yes dear reader. We are just at the beginning of this fiasco. There are many chapters left in
this book. The answer to our question is beyond our grasp. The reason for this, is because
our future is not in our hands, but in the hands of our creditors. The rug may be pulled out
from under us at any time. I am sorry if this is not what you want to hear, but I would be
wasting my time if I did not give you my honest opinion.
"Who you are speaks so loudly I can't hear what you're saying."
Ralph Waldo Emerson
"Do not trust all men, but trust men of worth; the former course is silly, the latter a mark of
prudence!"
Democritus
As usual, I stand ready to engage in dialog with you. I hope you intend on voting on
Tuesday, and please make a difference while you are at it. As my mother recently said while
voting early last week, "I am going to do some damage this time." Carpe diem.
My best wishes,
Jose Cavaliere
cavaliere@cavalierecapital.com
Nothing in this e-mail should be considered personalized investment advice. Although our
employees may answer your general customer service questions, they are not licensed under
securities laws to address your particular investment situation. No communication by our
employees to you should be deemed as personalized investment advice.
The information in this newsletter has been gathered from a number of sources including the
mainstream media such as The Wall Street Journal, the Associated Press, the Financial
Times, as well as CCC's own insights, industry relationships, and analysis of this and other
data.
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