Performance of American & European Markets and related Unit Trusts during the Jul - Aug 2007 correction

The correction in the US and Latin America started from a peak on 19 July 2007 and 23 July 2007 respectively to a low on the 16 Aug 2007. Below is a summary of returns of the US markets and related unit trusts during this period (% in brackets are the YTD returns from 29 Dec 06 till 16 Aug 07):

United States
Dow Jones Industrials -11.5% (+2.3%)
S&P 500 -9.1% (-0.5%)

Infinity US 500 Stock Index -8.2% (-0.9%)
Aberdeen American Opps -8.2% (-0.1%)
Fidelity America A SGD -8.8% (-1.0%)

Latin America
MSCI EM Latin America -23.1% (+4.9%)

Schroder ISF Latin America A Acc USD -19.8% (+9.1%)
Franklin Templeton Latin America -19.8% (N.A.)
ABN Amro Latin America Eqty USD -23.6% (+15.1%)
Fidelity Latin America USD -24.9% (+0.3%)

Brazil
Bovespa -17.3% (+8.0%)

ABN Amro Brazil USD -27.1% (+8.1%)

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The correction in Europe started even earlier from a high on 16 July to a low on 16 Aug. Below is a summary of returns of the US markets and related unit trusts during this period (% in brackets are the YTD returns from 29 Dec 06 till 16 Aug 07):

Europe
MSCI Europe -14.2% (-1.9%)
DJ Stoxx 50 -11.3% (-4.1%)

Aberdeen European Opps -12.4% (-1.2%)
Infininty Euro Stock Index -12.9% (0%)
Franklin Templeton European Eqty -12.9% (-1.5%)
DBS Shenton Greater Europe -13.3% (+0.2%)
Fidelity European Gth EUR -13.3% (-1.9%)
PRU Pan European -13.9% (+0.7%)
Fidelity Euro Agg EUR -14.9% (-2.6%)

FTSE 100 -11.8% (-5.8%)
FTSE All Share -12.4% (-5.9%)

Germany
DAX -9.0% (+10.2%)
MSCI Germany -12.9% (+9.5%)

Fidelity Germany EUR -14.5% (+6.2%)

France
CAC 40 -13.2% (-5.0%)
MSCI France -16.3% (-4.2%)

Fidelity France EUR -14.5% (-2.2%)

Spain & Portugal
Madrid Gen -7.4% (-1.0%)
MSCI Spain -9.4% (+1.1%)
MSCI Portugal -12.4% (+8.6%)

Fidelity Iberia EUR -12.2% (N.A.)

The first cut is the deepest

Aug 17th 2007
From Economist.com

The Fed reduces its discount rate and hints at a change in its policy rate too

DOES an interest-rate cut always imply looser monetary policy? That was the question economists were pondering after the Federal Reserve cut its discount rate from 6.25% to 5.75% on Friday August 17th. This is the price at which banks can borrow reserves from the Fed in a pinch. But the central bank kept its main policy instrument—the Fed funds target rate, which sets the price at which banks can borrow overnight from each other—at 5.25%. The cut came after requests from two of the Fed’s regional banks in New York and San Francisco and was the latest attempt by the central bank to lubricate the banking system to prevent it seizing up.

The Fed also announced that, in a departure from its usual practice, it would provide discount lending for up to 30 days. This was a tacit acknowledgement that recent money-market interventions had failed to cap the unusually high rates banks were charging each other for one-month and three-month loans. By extending the terms of emergency lending, the Fed sought to reassure banks that the supply of dollars was not about to dry up.

It was not the only salve on offer. A separate statement from the Fed’s Open Market Committee hinted that policy rates might be on their way down soon as well. Turmoil in financial markets and tighter credit conditions could hurt the economy, it said, and the Fed was “prepared to act as needed” to prevent this. Bruce Kasman, chief economist at JPMorgan, said he now expects the Fed to cut its policy rate from 5.25% to 5% at its next scheduled meeting on September 18th with a further reduction likely on October 31st.

Does the cut in the discount rate mean the Fed has already loosened policy? Lending at the discount window is supposed to be penal to discourage its use. The charge is usually a full percentage point higher than the policy rate. In normal circumstances a bank would be loth to use the discount facility as, by doing so, it reveals that it cannot find funding at a reasonable price from peers—a hint of possible insolvency.

These are not normal times, however. A climate of suspicion in the interbank lending market has driven up interest rates. The creeping way in which losses in the subprime mortgage market have emerged had made banks wary of extending credit to each other. Big cash injections by central banks had helped offset the worst effects of this cash hoarding, bringing overnight lending rates down toward policy targets. But securing funds for longer periods is still difficult and pricey. Three-month interbank rates were more than 1.4 percentage points higher than government bills of the same maturity this week. The spread, which reflects the perceived risk of lending to banks, is usually around half a percentage point.

The charitable conclusion is that the Fed’s actions were necessary to open another channel of liquidity to the money markets, which were not functioning because of fear and mistrust. The discount facility bypasses the money markets and allows a far wider range of depository institutions to borrow cash directly from the Fed, with a broader range of assets as collateral. Reducing the penalty rate does not alter the overall stance of monetary policy. And the changes are temporary. The Fed says they will remain in place until it judges that market liquidity has “improved materially”.

The less charitable interpretation is that the central bank has softened the penalty for banks that have funded purchases of very illiquid assets with short-term paper. If it loosens policy while markets are only in the early stages of adjusting and before the economic risks are real, it will seem like a reward for banks and hedge funds that took on too much risk.

source

Performance of Asian Markets and related Unit Trusts during the correction from 24 Jul 07 to 17 Aug 07

The current correction caused by the sub-prime & credit crisis in the US should not be hitting the Asian markets that hard, but somehow it did, and the Asian markets tumbled even more than the US markets. I've summarized the major Asian markets' and selected unit trusts' performances during this period (% in brackets are the YTD returns from 29 Dec 06 till 17 Aug 07):

Asia ex Japan
MSCI Asia ex Japan -17.6% (+5.2%)

Aberdeen Pacific Eqty -14.4% (+3.8%)
Lion Capital Asia Pacific -16.9 (+4.8%)
UOB United Asia Fund -20.1% (+9.3%)

Australia
All Ordinaries -12.3% (+0.3%)
MSCI Australia -20.8% (+0.4%)

Fidelity Australia AUD -11.0% (+0.6%)
Lion Capital Australia -21.7% (+2.1%)

Singapore
STI -14.6% (+4.9%)
MSCI Singapore -16.3% (+5.7%)

DWS Singapore Eqty -13.6% (+14.8%)
Aberdeen Singapore Eqty -13.9% (+7.2%)
Lion Capital Singapore Trust -14.3% (+9.8%)
DBS Shenton Thrift -16.9% (+8.7%)

Malaysia
KLSE -14.4% (+8.7%)
MSCI Malaysia -17.3% (+10.0%)

Aberdeen Malaysia Eqty -11.6% (+9.3%)
Fidelity Malaysia USD -15.4% (+14.3%)
DBS Malaysia Eqty -18.4% (+7.5%)
Lion Capital Malaysia -25.5% (+17.2%)

Thailand
SET -13.9% (+11.6%)
MSCI Thailand -17.7% (+16.8%)

Aberdeen Thailand Eqty -12.1% (+8.9%)
Lion Capital Thailand -14.0% (+17.7%)
Franklin Templeton Thailand -14.3% (+11.6%)
Fidelity Thailand USD -17.4% (+16.7%)

Indonesia
Jakarta Composite -20.5% (+5.7%)
MSCI Indonesia -22.4% (-1.4%)

Aberdeen Indonesia Eqty -17.3% (-2.5%)
Fidelity Indonesia USD -24.7% (-6.0%)

Philippines
PSE -22.2% (-3.3%)
MSCI Philippines -26.2% (+1.3%)

Lion Capital Philippines -23.8% (+2.5%)

Korea
KOSPI -17.8% (+14.2%)
MSCI Korea -20.4% (+9.5%)

Franklin Templeton Korea -13.1% (+15.1%)
Lion Capital Korea -17.4% (+14.1%)
Fidelity Korea USD -19.3% (+14.7%)

India
SENSEX -10.5% (+2.6%)
MSCI India -12.9% (+9.3%)

Aberdeen India Opportunities -8.7% (+7.0%)
First State Reg India -8.9% (+7.6%)
Lion Capital India -11.2% (+7.3%)

China, HK, Taiwan (Greater China)
Shanghai Composite +10.6% (+74.0%)
Hang Seng -13.2% (+2.1%)
Taiwan Weighted -17.0% (+3.4%)
MSCI China -18.4% (+9.6%)
MSCI Taiwan -18.0% (-3.0%)

Aberdeen China Opp -11.3% (+10.0%)
Fidelity China Focus SGD -12.7% (N.A.)
Lion Capital Taiwan -14.1% (-0.9%)
DWS China -14.5% (+19.4%)
Fidelity Taiwan USD -14.8% (+3.4%)
First State Reg China -15.1% (+16.2%)
Lion Capital China Growth -15.4% (+13.4%)
SGAM Golden China SGD -15.9% (+11.2%)

Japan
Nikkei 225 -15.2% (-11.3%)
MSCI Japan -11.3% (-7.5%)

Lion Capital Japan Growth -9.0% (-7.9%)
DBS Japan Growth -10.9% (-6.5%)

Thus the top ranking markets in the following order for the duration of the correction (YTD returns in brackets):

1. Shanghai Composite +10.6% (+74.0%)
2. India SENSEX -10.5% (+2.6%)
3. Aust All Ordinaries -12.3% (+0.3%)
4. Hang Seng -13.1% (+2.1%)
5. Thai SET -13.9% (+11.6%)
6. KLSE -14.4% (+8.7%)
7. STI -14.6% (+4.9%)
8. Nikkei 225 -15.2% (-11.3%)
9. Taiwan Weighted -17.0% (+3.4%)
10. MSCI Asia ex Japan -17.6% (+5.2%)
11. KOSPI -15.1% (+18.0%)
12. Jakarta Composite -20.5% (+5.7%)
13. Philippine SE -22.2% (-3.3%)

As can be expected, Aberdeen came up tops with their 'value' style investing. When markets rally, Aberdeen will underperform the rest, but when things go bad, you can expect them to outperform. Updated using Aug 17 values.

Colombia says June imports up 20 pct vs yr ago

Aug 17, 2007 - Colombian imports rose 20 percent in June to $2.66 billion compared with the same month last year, the government's statistics agency said on Friday.

Imports for the first six months of the year were up 27.1 percent to $15.3 billion versus the same 2006 period.

Colombia is enjoying strong economic growth driven by foreign investment and domestic demand as President Alvaro Uribe's U.S.-backed security crackdown reduces violence from its guerrilla conflict and draws investors.

Hong Kong Q2 GDP growth 6.9 pct yr-on-yr; 2007 GDP target revised to 5-6 pct

Aug 17, 2007 - The Hong Kong government raised its 2007 gross domestic product (GDP) forecast Friday after the second-quarter reading beat economist expectations, driven by exports and consumption.

GDP rose 6.9 percent in the quarter from the year earlier, above the Thomson IFR forecast for a rise of 5.7 percent.

Merchandise exports expanded 11.3 percent in the quarter while domestic consumption increased 6.6 percent. Investment spending grew 11.1 percent.

For the first half, GDP expanded 6.3 percent.

The government said it now expects GDP to rise 5-6 percent in 2007, up from its previous estimate of 4.5-5.5 percent. The new estimate takes into account the uncertainties in the external environment, it said.

"Indeed, barring any abrupt adverse changes in the external environment, the economy is set for further solid growth in the second half of the year," the government said in a statement.

The government said it's sticking with its inflation forecast for the year of 1.5 percent.

The unemployment rate for the quarter stands at its lowest level since mid-1998 at 4.2 percent. Job vacancies surged to a post-1997 high in March.

Going forward, the government warned of uncertainty arising from the US economy as it struggles with sub-prime mortgage worries and the resultant tightening of credit conditions in many other markets.

"The external environment will also be affected by the movements of exchange rates as well as the macroeconomic adjustment measures in the Mainland," the statement said.

The government expects the economy to receive a boost from the strong growth in mainland China and other emerging markets, as well as the sustained economic expansion in Japan and Europe.

On inflation, the government said higher food prices, the stronger yuan and recent weakness in the US dollar would continue to exert cost pressure.

However, the sustained increase in productivity is expected to provide an offset.

(1 usd = 7.8 Hong Kong dollars)

Weekly Indicators - Aug 16, 2007

Aug 16th 2007
From The Economist print edition

GDP in the euro area rose by 0.3% in the second quarter, a smaller-than-expected increase, leaving it 2.5% higher than a year earlier. The second-quarter increase in GDP in both France and Germany was in line with the euro-area average. Spain's GDP rose by 0.8% in the same period.

Consumer prices in America rose by 0.1% in July and by 2.4% from a year earlier. Prices excluding food and energy rose by 0.2% in the month, the same as in June. Both industrial output and the value of retail sales rose by 0.3% in July.

Japan's GDP rose by 0.1% in the second quarter and by 2.3% from a year earlier.

In Britain consumer prices rose by 1.9% in the year to July, down from a 2.4% rate in June and below the government's 2% target for the first time since March 2006. The unemployment rate was 5.4% in the three months to June, down from 5.5% in the three months to March. Average earnings rose 3.3% in the year to the second quarter, the lowest increase for nearly four years.

China's consumer prices rose by 5.6% in the year to July, the biggest increase for ten years, because of sharp rises in the cost of meat. The inflation rate excluding food prices was a less alarming 0.9%.

Norway's central bank raised its benchmark interest rate from 4.5% to 4.75% on August 15th. The bank said that financial-market turbulence did not warrant a departure from its monetary strategy set out in June.

source

Surviving the markets

Aug 16th 2007
From The Economist print edition

The new financial order is undergoing its harshest test. It will not be pretty, but it is necessary

THE lifeguards had been scanning the horizon for an oil-price shock, a bankrupt buy-out or a terrorist attack. But when the big wave struck last week it surprised them by coming from inside the financial system and threatening to swamp an unlikely shore, the money markets where banks lend to each other to help cover their daily operations. Investors have been asking for years if the frantic innovation in finance, especially the securitisation of just about every form of debt into a tradable asset, was a way to spread risk efficiently, or whether this left the financial system prone to rare—but cataclysmic—failures. It looks as if investors are about to find out.

Over the past week central banks have lent tens of billions of dollars to restore confidence to the markets (see article). But it is already clear that this mess is about more than a bit of rash mortgage lending to Americans who were in the habit of falling behind with their monthly payments. Hedge funds and private-equity firms, kings of the boom, are nursing big losses. Debt markets that once handed out cash to all comers are tight or closed altogether. In almost every asset market, investors are scurrying to reprice risk—which mostly means to reduce it.

The gravest and most immediate threat is to the banking system. For the time being, banks no longer trust other banks enough to lend them money except on onerous terms; equally worryingly, they lack confidence that other banks will trust them if they want to borrow. It is alarming when the very outfits that exist to supply the economy with credit start to hoard it from each other. At best this tightens monetary policy; at worst, a shortage of cash will cripple the payments system and cause runs on otherwise solvent banks and businesses that cannot rapidly raise funds.

Underneath all the new technology and the fancy derivatives with strange acronyms is a dilemma as old as banking itself. Anyone who thinks that lending has been too loose—and many bankers do—should welcome a purge: better now than later when the imbalances would be bigger and the economy probably weaker. But if good banks fail and money for good companies dries up, the purge will wreak huge and wasteful damage on healthy parts of the economy. How likely is that?

Fear of the deep
Financial crises are always about the way people do business, and not just the deals they have struck. Yet this one goes deeper than most. The spreading panic has shown up weaknesses in some of the foundations of modern finance. The past 20 years have created untold wealth. As securities and markets have steadily taken the place of old-style bank managers, the number of potential investors has grown and the cost of capital has fallen. Much good has come of that.

But there is a price that is only now becoming apparent. Because lenders expected to be able to sell on the risk of default to someone else, they lent too easily. After all, they would not have to pick up the pieces. In theory, that risk should have been borne by the people best able to carry it. But with everybody having sold on the risk to everyone else—and the risk often being carved up, repackaged and sold again—nobody is sure where the losses are. The fear is that some risks ended up with those who least understood what they were getting into, and fear is a potent force in this disintermediated world. In the interbank market, every counterparty was potentially vulnerable. Even small amounts of bad credit can drive out good.

In theory, ratings agencies and mathematical models help investors price the risk they are taking on, even if the securities they are buying are scarcely traded. Yet when some supposedly good-quality assets proved to be worth little, people lost faith in the models and the ratings. Across the board, investors had failed to take account of how fast and how far asset prices fall when everyone wants to sell at the same time. Hard-to-sell long-term securities had been bought with short-lived debt, which left borrowers vulnerable to a change in sentiment every time the debt fell due. It does nothing to restore confidence when the biggest model-driven hedge funds had to get in new money. The people at Goldman Sachs lost a packet when something happened that their computers told them should occur only once every 100 millennia.

Reassess, reprice and then rebound
The retreat to a new level of risk was never going to be orderly or free of casualties. Neither should it be. Bankers and investors need to suffer precisely because the methods of modern finance have been found wanting. It sounds Darwinian, but the brutal demonstration that you pay for your sins is what leads the system to evolve. Markets learn from their mistakes. Only fear will spur investors to price risks better and get them to put more effort into monitoring their counterparties.

If these lessons are to sink in, central bankers must stand back—as, by and large, they have done. Every intervention now will be taken as a sign of what the regulators will do next time. If they bail out banks that have mispriced risk, the mispricing will continue. And when the central banks do step in, it should not be to save the financiers. The cost of intervention is warranted only to save the rest of the economy from the financiers' folly. By that test, central banks were right to lend money to the banks in recent days, because it ensured that a liquidity crisis did not become a solvency crisis. They may yet have to take over a failed bank, though only if that is needed to stop a run. It is still far too soon to cut interest rates.

Because this crisis taps so deeply into the newly devised structures of finance, anyone who says the worst is definitely over is either a fool or someone with a position to protect. As risk has become bewilderingly dispersed, so too has information. Nobody yet knows who will bear what losses from mortgages—because nobody can be sure what those loans are really worth. Nobody knows if tighter lending standards will oblige borrowers to raise more capital, triggering more sales in stockmarkets and more pain. Nobody knows how messy the inevitable bankruptcies will turn out to be. What markets need now is time to piece that information back together. Time before the next wave strikes.

source

Argentina economy grew 8.3 pct in June from year ago

Aug 16, 2007 - Argentina's economy grew 8.3 percent in June from a year ago and 0.7 percent from May, beating market expectations and marking the country's 55th straight month of growth, the government said on Thursday.

June's figure for the EMAE economic activity index, which measures most of the elements of gross domestic product, outpaced the 7.5 percent median forecast given by 15 analysts in a Reuters poll.

The higher-than-expected monthly growth came as analysts watch for signs of the impact of the South American country's acute energy shortages, which have led the center-left government to ration natural gas and electricity supplies during the southern hemisphere winter.

"The effect of the energy shortage on the level of economic activity in June was less marked than expected," Buenos Aires-based consultancy Economia and Regions said in a report, adding that strong consumer spending was responsible for the economy's robust expansion in the first half of the year.

Latin America's No. 3 economy grew 8.4 percent in the first six months of 2007 compared with the same period a year ago, the government also reported.

Argentina is in its fifth year of economic growth greater than 8 percent, after a four-year recession. It expanded 8.5 percent in May and 8.8 percent in June 2006.

The official figure confirmed the number that a government source told Reuters earlier on Thursday.

U.S. July home starts, permits fall to 10-yr lows

Aug 16, 2007 - U.S. groundbreaking for new homes fell 6.1 percent in July to the lowest pace in more than 10 years while building permit activity, a sign of future construction plans, sank to a nearly 11-year low, a government report on Thursday showed.

Dealing more bad news to the housing sector and financial markets, the Commerce Department said housing starts set an annual pace of 1.381 million units in July, lower than Wall Street forecasts for 1.405 million units as well as the upwardly revised 1.470 million rate for June. It was the lowest pace since the January 1997 rate of 1.355 million units.

Building permits fell 2.8 percent in July to an annual pace of 1.373 million, their lowest since October 1996 when they reached 1.358 million. Economists polled by Reuters had forecast July permits at 1.400 million after 1.413 million in June.

Compared with a year earlier, July home starts were off 20.9 percent, while permits were down 22.6 percent.

As lenders have tightened credit standards in response to major financial market turmoil in recent weeks, increasing numbers of potential buyers have been denied affordable mortgages, sending the home market into a downward spiral. Analysts said the data will add to market gloom.

"The housing starts number just adds fuel to the fire. You've got financial markets in panic. It looks like fears are overriding the fundamentals and that may continue for a while," said Michael Darda, chief economist at MKM Partners LLC in Greenwich, Connecticut.

The data sent U.S. Treasury debt prices higher, while the dollar fell and stock index futures remained sharply lower.

U.S. home builder confidence ebbed to its lowest level in 16 years in a survey released on Wednesday. The National Association of Home Builders/Wells Fargo Housing Market Index dropped 2 points to 22 in August, while the level of prospective buyers dropped to its lowest level since 1990.

The drop in housing starts was the worst in the South, where they fell 11 percent in July. Starts fell 3.7 percent in the West and 1.3 percent in the Northeast, but they rose 2.6 percent in the Midwest.

Credit contagion

Is the worst over? Fortune's Peter Gumbel offers a 10-point guide to understanding two harrowing weeks - and what's likely to happen next.

By Peter Gumbel, Fortune
August 14 2007: 10:36 AM EDT

PARIS (Fortune) -- Relax! There's really no need to panic! That's the soothing message being put out this week by key players in financial markets after two harrowing weeks in which credit markets in Europe all but dried up, prompting massive injections of funds into the system by the European Central Bank, the U.S. Federal Reserve and the Bank of Japan.

Overnight borrowing rates have come back down after spiking wildly and stock and bond markets have been bouncing back around the world. The European Central Bank, which continued to inject funds into the market on Tuesday, albeit less than one-tenth the amount at the peak of the crisis last week, says that money-market conditions are "normalizing." And Tuen Draaisma, Morgan Stanley's chief European equity strategist, for one, recommended in a note to clients that they should go "overweight" in equities because "we may already be at the point of maximum bearishness and uncertainty, which by definition is the right moment to buy."

So is the worst over? Even the most die-hard optimists concede that it'll take a lot more than a few days of calm to restore confidence among financial institutions and retail investors. "The market is concerned pretty much across the board," says Gerry Rawcliffe, a managing director in the banking group at Fitch Ratings in London.

Here's a 10-point guide to what we know and don't know about the troubles, and what the repercussions are likely to be:

Why did America's subprime mortgage woes have such a big impact on world financial markets?

Because these mortgages were lumped together in packages and sold as asset-backed securities all over the world, particularly in Europe. Often the initial securities were themselves put into new packages, leveraged up and resold as so-called collateralized debt obligations (CDOs). They are a sort of derivative play on the underlying mortgages, just as futures and options are a play on stocks and commodities. Big banks have whole securitization departments who create these instruments. They do so to profit from the difference between the long-term returns these investment vehicles produce and their more plain vanilla short-term borrowing, and to earn fees.

Who bought them?

Everyone, and that's the problem. The CDO market has exploded in recent years: More than $100 billion worth of structured cash CDOs were issued in the fourth quarter of last year alone, according to CreditFlux Data+, a London firm that tracks them (and that doesn't include the even more arcane "synthetic" CDOs). Banks, institutional investors and hedge funds have been the main customers, but some retail investors have also bought into them through the asset-backed securities, or ABS, funds that some of the biggest European banks sell to the public. Everyone who bought these securities was given the same pitch, namely that they were a relatively safe bet, since much of the paper had AAA ratings, but offered higher returns than regular corporate bonds.

So what went wrong?

The number of delinquencies in the U.S. subprime mortgage market has been rising and is now substantially larger than anyone expected - about 14 percent of the total, up from about 10 percent in 2004 and 2005. That means there's a strong likelihood that some of the securities holders, especially those where the underlying mortgages were taken out in the past couple of years, are sitting on losses.

Those troubles have been massively compounded by the aggressive use of leverage in CDO packages. When U.S. blue chip financial players like Bear Stearns and then a variety of European banks began reporting problems, panic quickly gripped the markets. That turned into a vicious circle: These debt instruments have now become impossible to price because nobody wants to buy them any longer. And since they can't be priced, the size of the losses aren't clear, which in turn has given rise to more rumors about financial players in trouble. Banks in continental Europe especially simply stopped lending to one another, which is why the liquidity dried up in the credit markets as a whole and the European Central Bank had to jump in.

How big is the problem, really?

Nobody is quite sure. Patrick Artus, an economist at Natixis in Paris, reckons the total damage inflicted by subprime woes is a relatively manageable $45 billion, which is the difference between the expected rate of mortgage delinquencies and the current much higher rate. Another French bank that is an important player in the derivatives market, Sociéte Générale, reckons that even if things really turn sour, the worst will be losses of about $100 billion. That may sound like a lot, but it's the equivalent of about 1 percent of the total market capitalization of the S&P 500.

Such calculations highlight the real issue here, that the panic has been due more to a collapse of confidence than to any financial cataclysm. "We're still primarily looking at a liquidity crisis rather than a credit or a solvency crisis," says Fitch's Rawcliffe.

Is it really over?

No. The market "remains very, very fragile," says a top executive at one of the leading European banks. Some confidence has been restored into the international banking system and its overnight lending patterns by the big injections of central-bank funds, but nobody has yet dared to start buying that subprime paper in any sizeable quantities. And because there's so little transparency about who is sitting on what size losses, the rumors continue to swirl.

Nouriel Roubini, an economics professor at New York University's Stern School of Business, who has long warned about the risk of financial contagion, reckons some other parts of the U.S. housing market including home equity loans and second mortgages are starting to display what he calls the same "toxic characteristics" as the subprime sector. More optimistically, Neil McLeish, the chief European credit strategist at Morgan Stanley, says that, "we have passed the absolute peak of that anxiety and uncertainty." But even he believes that credit market conditions will be more difficult in the coming months and, "there is still some risk of additional volatility" at least for the next month or so.

Who are the biggest casualties?

Banks and financial market players across the world are starting to come clean about their exposure and losses, partly in order to help restore confidence in the market. The losses incurred by Wall Street titans Bear Stearns and Goldman Sachs, which this week announced it is putting $2 billion into one of its hedge funds, have received the most publicity. Outside the United States, firms such as insurer AXA and BNP Paribas in France have frozen or shut problem funds, while a range of banks including NIBC of the Netherlands and Commerzbank in Germany have detailed their exposure and expected losses.

The biggest international victim to date is a mid-sized German bank called IKB Deutsche Industriebank that its peers, including a government-owned bank, stepped in to rescue earlier this month, taking over $11 billion of credit lines and putting up a $4.7 billion funding package. IKB had been an aggressive player in the CDO market, through two off-balance sheet firms that it used to pump up its commission income and advisory fees. In the end, its exposure to dodgy securities through these two firms far exceeded the bank's liquidity and equity capital.

Is anyone safe?

Not completely, but barring some huge problem nobody yet knows about, major banks seem in the best position to weather this storm because they have the strongest balance sheets and are able to refinance their operations most easily thanks to the extra liquidity that central banks have put into the market in the past week. "Being a bank and having access to the central bank (credit) windows is key at the moment," says the top European banker.

Hedge funds are another story, as the Goldman Sachs-run one that was bailed out this week shows, although some of these funds foresaw the troubles and have been aggressively shorting the subprime sector and any securities relating to it.

Why didn't central banks cut interest rates in response?

Some critics of the European Central Bank, especially in France, are saying that its interest rate policy, which has consisted of regular rate hikes to counteract inflation, has partly fueled this crisis. "One can ask if the ECB isn't becoming a prisoner of its rate-increase strategy," Thierry Breton, the former French finance minister said this week. But bank economists are generally more supportive and say that the ECB acted smartly with its three consecutive days of huge money-market interventions - the biggest of which was a whopping $130 billion injection last Thursday. "It's a demonstration of the financial system operating as it should," said James Nixon, a London-based economist at France's Société Générale, who says that the troubles primarily affect the financial sector rather than the wider economy.

While the Fed did cut rates in 1998 during the last derivatives meltdown, involving Long Term Capital Management, central banks may not need to this time if markets continue to calm down. Indeed, the big question now is whether the ECB and the Bank of Japan will go ahead and raise rates in the next month, as they had signaled before the crisis. Roubini isn't sure, and thinks that the Fed may well move to reduce U.S. rates quite soon. "The likelihood of a cut in rates is now much higher," he says.

What does this mean for the world economy?

So far, not all that much - but keep your fingers crossed. Growth in Europe and Asia remains buoyant, even if the U.S. outlook is unclear. Some borrowing by companies and individuals is bound to get more expensive as markets adjust and restore a risk premium. But "it's not obvious that the repricing will lead to an economic slowdown," says Société Générale's Nixon, although there's a possibility that Britain's economy, which has thrived because of its heavy dependence on financial services, may be vulnerable. Roubini thinks the United States will bear the brunt of what he sees as an inevitable slowdown of consumer spending related to the housing woes, and reckons that this could ultimately spill over to the global economy if it's sufficiently severe. "The effect on the real economy in the rest of the world depends on whether there's a hard landing in the U.S." he says.

Will there be any regulatory fall out?

This is almost inevitable, especially in Europe where it's now clear that many of the purchasers of these securities didn't fully appreciate the risks they were taking. Look for the first moves to come in Germany, where bank bail-outs are exceedingly rare. The last time a bank got into serious trouble there was in 1974, when the Herstatt Bank collapsed after some disastrous forays into foreign-exchange trading that bear some similarity to IKB's woes. Regulators quickly followed up with an overhaul of the national banking system. It's not clear that IKB's rescue will have the same dramatic repercussions, but it's already prompting tough questions about how a mid-sized bank could end up with such an enormous exposure to risky assets via an off-balance-sheet firm.

"I suspect that at the end of this, regulators will ask themselves if this very rapid expansion (of transactions involving asset-backed securities) has been a good thing for banks, or if the risk comes back to haunt you," says Fitch's Rawcliffe. Watch also for credit agencies to come under pressure to do a better job at assessing the market risk of exotic financial instruments.

source

U.S. inflation tame, credit fears spook markets

Aug 15, 2007 - Falling gasoline costs held U.S. consumer prices nearly in check in July and industrial output rose, according to data on Wednesday that suggested the economy was on a sound footing despite financial markets' credit fears.

Other reports showed a slight dip in New York state manufacturing activity this month and a decline in the amount of capital flowing into the United States in June.

Analysts said the latest data, combined with reports earlier this week showing solid retail sales and a shrinking trade deficit, point to an economy that is performing relatively well.

"Things don't look that bad. There is no evidence yet in the data that the economy is on the cusp of losing steam," said Michael Darda, chief economist at MKM Partners in Greenwich, Connecticut.

Still, a gauge of home builder sentiment from the National Association of Home Builders hit its lowest ebb since January 1991, suggesting a housing slump still had a ways to run.

"Builders realize that issues related to mortgage credit cost and availability have become more acute, filtering some prospective buyers out of the market and prompting others to delay their decision to purchase a new home," said NAHB President Brian Catalde, a home builder from El Segundo, California.

The bulk of the data came in close to Wall Street expectations and financial markets focused less on indications of the economy's recent health and more on ongoing worries that credit would evaporate as U.S. subprime mortgage problems widen.

Over the past week, central banks around the globe have pumped money into the financial system in an effort to keep credit flowing, but they have had only limited success calming nervous markets.

Financial markets now expect the U.S. Federal Reserve to lower interest rates at its next meeting on Sept. 18, if not before, to buffer the economy as credit becomes more scare.

Many economists, however, do not expect the central bank to act that quickly.

"To me, the risk remains the economy not inflation, but I doubt the Fed will change course before the Sept. 18th meeting without an even more major deterioration in financial conditions," said Joel Naroff, president and chief economist of Naroff Economic Advisors in Holland, Pennsylvania.

CONSUMER PRICES UP LESS THAN EXPECTED

The Consumer Price Index, a key inflation gauge, rose just 0.1 percent last month as gasoline prices fell 1.7 percent, the Labor Department said. Economists polled by Reuters had expected a rise of 0.2 percent.

So-called core inflation, which excludes volatile food and energy prices, rose 0.2 percent, matching forecasts. Year-over-year, the core CPI held steady at 2.2 percent for a third straight month.

The Fed said last week that inflation remained its predominant concern, although it acknowledged that a wobbly housing market had led to tightening credit terms for some households and businesses.

"The July CPI readings don't make it any harder or easier for the Fed to cut interest rates," said Richard Huber, economist at A.G. Edwards and Sons in St. Louis. "The trade deficit data we got yesterday will drive GDP numbers for the second quarter higher, which will allow the Fed to say that it's still focused on inflation."

INDUSTRIAL OUTPUT UP

Industrial output rose 0.3 percent in July as automotive-related production surged 2.6 percent, offsetting a big decline in utility output, a Federal Reserve report showed.

Manufacturing output rose 0.6 percent.

"Low inventory levels, strong export demand, and ongoing moderate economic growth at home have allowed the manufacturing sector to shake off the depressing effects of the housing downturn," said Daniel Meckstroth, chief economist for the Manufacturers Alliance/MAPI.

Separately, the U.S. Treasury said net overall capital inflows into the United States dropped to $58.8 billion in June from May's revised inflow of $107.3 billion, hurt by a plunge in net purchases of U.S. securities by private investors (details here).

June's net overall capital inflow barely covered the U.S. trade deficit for the month of $58.1 billion.

In another report, the New York Federal Reserve Bank said manufacturing in New York State factories slowed in August. The New York Fed's "Empire State" general business conditions index fell modestly to 25.06 from 26.46 in July.

Are there 'safe' emerging-market currencies?

Are some emerging-market currencies less vulnerable to the credit-market turmoil that has prompted investors to slash exposure to risky assets and cover losses elsewhere?

Most emerging-market currencies pared losses, but remained under heavy selling pressure on Wednesday. The Turkish lira fell 2.5% against the dollar, the South African rand dropped 0.8%, the Brazilian real shed 0.6%, and the Icelandic krona dropped 1.2%.

"There is not conviction that this credit market turmoil has run its course," said Paul Biszko, senior emerging markets analyst at RBC Capital Markets. "We continue to advocate a defensive approach in the very short term."

"If you want to stay defensive, stick to the Russian ruble or the Czech koruna, which are purely defensive plays," Biszko said. Low-yielding currencies such as the ruble, koruna and Chilean peso are in the less vulnerable group, he said.

The Japanese yen has rallied against other major currencies Wednesday, as investors unwound carry trades, in which investors borrow low-yielding currencies like the yen to reinvest in higher yielding currencies.

"Super high-yielders, such as the Brazilian real, the Turkish lira, and the Icelandic krona, suffer when carry trades unwind," Biszko said.

"These currencies are high [volatility] plays," he said. However, "in the event of stabilization, they are the ones that will come back aggressively, especially the Turkish lira and the Brazilian real."

Mid-yielding currencies are the Mexican peso, the South African rand and the Hungarian forint.

"They are selling off, but they are not coming back as quickly as those other [super high yielders] ones," Biszko said.

Current account deficits increase vulnerability

"We don't think it is right to just jump in and buy risky assets back, but there are a couple of ways that we might look to trade," said Steve Barrow, chief currency strategist at Bear Stearns, in a research note Wednesday. "Perhaps an obvious one is to buy 'safe' emerging market currencies and sell 'riskier' ones."

Riskier countries, according to Barrow, are those with large current account deficits and also countries with less depth to their foreign-exchange market.
"The countries that seem most vulnerable are Turkey, Hungary, Iceland and South Africa," Barrow said. "Hence one strategy is to sell these currencies but buy other 'safer' emerging-market currencies rather than the dollar. Candidates here might include the Brazilian real or Singapore dollar."

Biszko of RBC Capital Markets also said that higher current account deficits increase the vulnerability of emerging-market currencies. The South African rand is one of the more vulnerable, since the country is running a big current account deficit, which is mainly financed by volatile foreign portfolio inflows. Turkey is also vulnerable to some degree, but strong foreign direct investment inflows are covering its deficit.

As for Brazil, it is running sizeable trade and current account surpluses, which are coupled with very strong capital inflows.

"The real, of the high-yield currencies, is the best position," Biszko said.

Peru's economy cools as growth tally hits 6 years

Aug 15, 2007 - Peru's economy expanded 6.65 percent in June from the same month a year ago, as it tallied 72 consecutive months of growth, the national statistics agency said on Wednesday.

Production in June was lower than expected as output dropped at mines and fisheries and commerce was tepid.

The median forecast in a Reuters poll of nine analysts was for a 7.5 percent rise in gross domestic product in June.

In May, the economy grew a revised 8.43 percent from a year earlier against a previously reported 8.33 percent.

Officials said the cooling off in June from the prior month would be temporary.

"We expect the situation to return to its normal rhythm," Renan Quispe, head of the statistics agency INEI, told reporters.

The construction sector expanded the fastest in June, growing 22.23 percent.

But production in the mining and petroleum sector, which has been hurt by drops in gold output, fell 4.16 percent.

Fisheries output fell 12.25 percent while commerce grew 3.63 percent, at about half the pace of recent months.

In the first half of the year, the economy grew 7.78 percent from the same period a year ago.

For six years the Andean nation's economy has grown, outpacing many of its Latin American peers. It has been helped by strong exports, especially of minerals, a construction boom and manufacturing activity.

The economy grew 8.03 percent in 2006, the fastest pace in 11 years.

UNEMPLOYMENT

The statistics agency also released unemployment data on Wednesday, saying the May-to-July jobless rate in metropolitan Lima was 7.9 percent, down from 8.5 percent in the same period a year earlier.

Lima accounts for a third of Peru's overall population.

French 2Q07 GDP growth slows to 0.3%

Aug 15, 2007 - Analysts at ING Financial Markets say that French GDP growth slowed sequentially in the second quarter.

In a research note published this morning, the analysts mention that French GDP growth in 2Q07 was 0.3%, lower than the 0.5% in 1Q07. The two main reasons for the downturn were a decline in the investment rate and a 2.1% rise in imports, the analysts say. The industrial sector in France remains weak, although private consumption stayed robust at +0.6% q/q, ING Financial Markets adds. The analysts estimate the French economy to grow by around 2.1% in the full year.

Strong C$ helps cut June Canada factory shipments

Aug 15, 2007 - The strong Canadian dollar contributed to the third consecutive monthly decline in Canadian manufacturing shipments in June, a greater-than-expected 1.8 percent from May, according to Statistics Canada on Wednesday.

The struggling sector, which lost 53,000 jobs in the last year, still managed to post a second-quarter gain of 0.7 percent from the first quarter. But the first half of the year saw an increase of only 0.1 percent from a year earlier.

Motor vehicle shipments in June plunged for the third straight month, by 13.3 percent, the largest monthly loss since August 2003. Statscan attributed it partly to "an appreciating Canadian dollar and soft conditions in the U.S. auto market."

The aerospace sector also fell by 4.6 percent, machinery by 2.8 percent and primary metals by 0.8 percent. However the aerospace sector was also the source of strong unfilled orders. Total unfilled orders rose by 2.0 percent from May; the biggest component of that is aerospace, which went up by 2.7 percent. Year on year, aerospace unfilled orders are up 56 percent.

Analysts surveyed by Reuters had on average expected overall shipments to decline by just 0.2 percent.

Indonesia's Q2 GDP of 6.28% beats estimates

Aug 15, 2007 - Indonesia's economic growth accelerated in the second quarter against a background of falling interest rates, government data showed on Wednesday, reinforcing expectations full-year growth would be the highest in 11 years.

Southeast Asia's biggest economy grew 6.28 percent in April-June 2007 from a year earlier, the strongest rate since 6.5 percent annual growth in the fourth quarter of 2004 and accelerating from the first quarter's 5.97 percent growth.

'The rise in exports was led by non-oil-and-gas products because of increased prices due to strong international demand and the improved economic performance of our major trading partners,' he said.

In the first quarter, GDP rose 2.0 percent from the fourth quarter of last year, and was 6.0 percent higher than a year before.

In the first six months to June, GDP grew 6.1 percent on annualised basis.

Sutomo said private consumption, made up 57.4 percent of second quarter GDP, which amounted to 486.5 trillion rupiah. Private consumption rose 1.5 percent from the first quarter and was up 4.7 percent year-on-year.

He said gross capital formation that accounted for 22 percent of GDP rose 4.3 percent quarter-on-quarter and was up 6.9 percent year-on-year.

He said government consumption, which makes up 7.9 percent of GDP, were 24.2 percent higher than in the first quarter, and was up 3.8 percent from a year before.

Net exports made up 10 percent of GDP in the second quarter.

China's factories slow the tempo in July

Aug 15, 2007 - China's industrial output slowed more than expected in July after tax changes made exports less attractive, suggesting to some economists that the country's politically sensitive trade surplus may shrink in coming months.

The output growth of 18 percent, which came a day after a strong rise in retail sales, could point to softness in fixed-asset investment when monthly figures are released on Thursday, some economists said.

"With external demand and private consumption proving resilient, the modest easing in industrial production momentum could be due to some moderation in domestic investment growth in July," said Qian Wang with JPMorgan Chase in Hong Kong.

Economists said the slower pace of output did not change the broader policy picture. Many expect the central bank, which has raised interest rates three times so far in 2007, to do so again this quarter to rein in inflation, which has jumped to a 10-year high of 5.6 percent because of runaway food prices.

However, policy makers will also be aware of the shadows cast over the world economy by the fallout from the crisis in the U.S. subprime mortgage market. Another worry is the booming China stock market, which keeps defying gravity.

Indeed, economists said unsettled global market conditions could explain why the central bank in recent weeks has halted the yuan's steady climb, making the currency more or less mark time.

EXPECT EXPORTS TO FALL

Factories churned out 18.0 percent more goods than in July 2006, down from 19.4 percent growth in June, the National Bureau of Statistics said on Wednesday.

Economists had expected a rise of 19.2 percent.

"The surprising slowdown in industrial output was partly caused by the reduction in export tax rebates," said Zhao Qingming, an economist with China Construction Bank in Beijing.

China scrapped or cut tax rebates, effective on July 1, on nearly 3,000 export lines, including metals and textiles, to help reduce its record trade surplus and discourage companies from making low-value, energy-intensive goods.

In fact, export growth accelerated in July, but economists said this was due to companies shipping goods that had been ordered before the tax changes were announced.

But with China's official survey of manufacturers showing declines in overseas orders and industrial output for three months in a row, many economists believe exports will lose steam over the rest of 2007.

"As manufacturers expect export growth to decline, they are now cutting their production a month ahead of time," said Gene Ma, chief economist with China Economic Business Monitor, an independent research house in Beijing.

Yet another safety scandal concerning Chinese goods -- this time the recall of millions of toys by Mattel Inc because of small magnets that could be swallowed and cause injury -- may also hurt demand for made-in-China goods.

GLOBAL UNCERTAINTY

Ma, with China Economic Business Monitor, said China would be hit by widening credit market strains if they sap U.S. economic growth and thus reduce demand for Chinese goods. Mingchun Sun at Lehman Brothers in Hong Kong agreed.

"Given the turmoil in global financial markets and uncertainty in the global economic outlook, Chinese exports may be facing tougher times in the future," he said.

"Because of the comparative advantage of Chinese exports, the export growth won't slow down too much, but it should go back to around 20 percent instead of 30 percent," Sun said.

Rainstorms across much of China that triggered floods, landslides and other disasters probably contributed to the dip in output in July, economists said.

Ma said Beijing's campaign for a greener economy might also be having an effect, noting slower growth in output of power, cement, steel and iron.

Still, economists said the slower tempo was not dramatic and had to be seen in context: in the first seven months of the year, factory output was still up 18.5 percent from the same period last year. By contrast, India's factories in June produced 9.8 percent more goods than a year earlier.

For the first time, China, the fastest-growing of the major economies, has contributed more than the United States to global growth so far this year, according to the International Monetary Fund.

Venezuelan economy grew 8.9 pct in Q2

Aug 14, 2007 - Venezuela's economy grew 8.9 percent in the second quarter, the central bank said on Tuesday, but the OPEC nation's all-vital oil sector shrank by 3.9 percent as the state boosted its involvement in oilfields.

Venezuela has witnessed an economic boom under President Hugo Chavez thanks to soaring oil prices and heavy government spending, but inflation and slumping oil production remain nagging problems.

The non-oil sector grew by 10.8 percent, spurred largely by the banking and communications sectors, the central bank said.

But private sector oil GDP tumbled 11.6 percent as Chavez edged out U.S. oil companies ConocoPhillips and Exxon Mobil Corp in the takeover of four oil projects as part of his self-styled socialist revolution.

Venezuela had a second-quarter current account surplus of $5.13 billion, down from $8.54 billion a year earlier, while the financial account deficit grew to $11.53 billion compared to $9.36 billion a year earlier.

The economy grew 10.3 percent in 2006 and 8.8 percent in the first quarter of 2007, but twelve-month inflation to July was the highest on the continent, at 17.2 percent.

Venezuela's official oil production figures show output at 3.1 million barrels per day (bpd), but market watchers say the South American nation is only producing about 2.4 million bpd.

Finance Minister Rodrigo Cabezas said on Tuesday the economy would grow by no less than 8 percent in 2007.

Bulgaria Current Account Deficit Up in June

Aug 14, 2007 - Bulgaria's current account deficit in June increased to euro248 million (US$338 million) compared with euro87 million in the same month last year, the country's central bank said Tuesday.

In the first half of the year, the current account deficit widened to euro2.8 billion (US$3.8 billion), or 10.6 percent of the gross domestic product, the bank said in a statement.

In the same period of 2006, the current account deficit was euro1.8 billion, or 7.3 percent of GDP.

The main reason was the growing foreign trade deficit, which reached euro3.2 billion (US$4.4 billion), or 12 percent of GDP in the 1st half, compared with euro2.2 billion, or 8.8 percent of GDP in the same period of last year.

Direct foreign investment in the first half reached euro2.1 billion (US$2.9 billion), or 7.9 percent of GDP, compared with euro2 billion, or 7.9 percent of GDP, in the same period of 2006.

Mexico industrial output tepid in June

Aug 14, 2007 - Industrial production in Mexico, pinched by a U.S. economic slowdown, rose a tepid 0.1 percent in June compared with the year-ago period, its weakest growth since March.

Industrial output in Mexico was 0.91 percent higher in June than in May, the government said on Tuesday.

Economists polled by Reuters on average had expected 1.7 percent growth, year over year.

Manufacturing, a cornerstone of Mexico's economy, fell 0.30 percent in June over the year-ago period, the government said.

Queretaro-based Tafime Mexico, which makes parts for the U.S. auto industry, has seen its billing fall by half in the past two months and is trying to avoid laying off some of its 135 employees.

"I'm working on preventive maintenance, repairs," general manager Hector Ortiz told Reuters. "If I had 10 machines working, now I have three working."

A slowdown in the United States, which buys almost all of Mexico's exports, is seen reducing Mexican growth to 3.6 percent this year from 4.8 percent in 2006.

The economy is expected to grow only 2.8 percent in the second quarter, according to a Reuters poll of analysts

"June's Mexican industrial production data suggests the economy could pick up less quickly and with greater difficulty than originally expected," Mexico City-based Ixe brokerage said in a report.

The government said mining rose 1.9 percent, of which non-oil production rose 3.7 percent and oil output increased 0.30 percent.

Construction gained 1.1 percent, while utilities rose 2.1 percent, the government said.

Last week, Mexican automakers cut their growth forecasts for production and exports to up to 15 percent from up to 25 percent.

U.S. inflation gauge ticks up; trade gap narrows

Aug 14, 2007 - Rising energy costs drove up U.S. producer prices last month, while the trade deficit unexpectedly narrowed in June on stronger exports, according to reports on Tuesday suggesting the Federal Reserve will remain cautious about cutting interest rates.

The Fed in recent days has been pumping cash into credit markets roiled by fears over the spreading impact of subprime mortgage defaults. But any fresh evidence of inflation or a resilient economy will likely deter the Fed from considering a rate cut, analysts said.

Producer prices -- a measure of the prices paid at the farm and factory gate -- rose 0.6 percent in July, the Labor Department said. Economists polled by Reuters forecast producer prices would rise 0.2 percent last month.

"This report won't alter the Fed's concern about upside risks to inflation. But in light of the growing turmoil in credit markets, the risks to the economy are also piling up," said Sal Guatieri, senior economist at BMO Capital Markets in Toronto.

The Fed said last week that inflation remained its predominant concern, although it acknowledged that credit conditions had tightened for some households and businesses. The central bank showed concern over the fragile financial system by pumping billions of dollars of credit into the banking system in recent days.

Underlying data suggested inflation, while still a concern, was in line with recent trends. Stripping out food and energy costs, producer prices advanced 0.1 percent, even less than the 0.2 percent increase that economists had forecast.

While some analysts welcomed the lower-than-expected core inflation number, others said it was not enough to keep the year-on-year core rate from rising to 2.3 percent.

"While it seems so far that higher commodity prices have not been spilling over to prices of other consumer goods, we remain convinced this development threatens a broader pickup in inflation," said Harm Bandholz, economist at UniCredit Markets in New York.

A clearer picture will emerge on Wednesday when the Labor Department issues consumer price data for July.

EXPORT SURGE

The U.S. trade deficit unexpectedly narrowed in June as a weaker dollar and overseas growth boosted exports to a record. The June trade gap totaled $58.1 billion, down 1.7 percent from a downwardly revised May deficit of $59.2 billion, the Commerce Department said.

The June deficit was below the median forecast of $61 billion from Wall Street analysts polled by Reuters.

Overall goods and services exports rose 1.5 percent from May to a record $134.5 billion, led by a $1.2 billion increase in industrial supplies and materials and record exports of vehicles, auto parts and engines and of foods, feeds and beverages.

Rising U.S. exports are contributing to a narrowing of the trade gap on an annual basis and are helping to underpin domestic growth in the face of a steep housing downturn and credit market turmoil.

Some analysts said the trade data would result in an upward revision to U.S. gross domestic product growth, to 4 percent or more for the second quarter from an initially reported pace of 3.4 percent.

"It was a big month for exports, and that ties in with the strength in corporate profits we've seen," said Societe Generale chief U.S. economist Stephen Gallagher.

"I think there has to be some recognition that the economy is probably stronger than we thought and has a greater foundation to absorb this latest liquidity trap," he said. "If it weren't for this liquidity issue in the markets, the Fed would see this as a strong signal that reinforces their policy decision" to hold rates steady.

U.S. imports in June rose 0.5 percent to a record $192.7 billion as the U.S. oil import bill edged higher to $19.6 billion and imports from China increased.

The average price for crude oil rose $1.59 a barrel to $60.95, the highest since $62.40 in September 2006. Imports from the Organization of Petroleum Exporting countries, however, decreased 4.6 percent to $13.9 billion.

The politically sensitive U.S. trade deficit with China widened 5.7 percent in June to $21.2 billion, despite record exports of $5.9 billion to China. Imports from China rose 6.8 percent or $1.7 billion to $27.1 billion, the highest since November 2006.

China last week reported that its own global trade surplus edged lower in July to $24.36 billion from a record $26.91 billion in June as rebates of value added taxes were eliminated on July 1 for 2,800 export product lines.

Separately, a survey from the Federal Reserve Bank of Philadelphia showed that forecasters trimmed their estimates for third-quarter U.S. growth, to 2.5 percent from a pervious forecast of 2.6 percent.

Aircraft decline narrows Canada June trade surplus

Aug 14, 2007 - A slump in aircraft sales led to a third straight monthly drop in Canadian exports in June, which narrowed the trade surplus to C$5.27 billion ($4.97 billion) from C$5.87 billion in May, Statistics Canada said on Tuesday.

Imports grew to C$34.05 billion from C$33.86 billion, as purchases of industrial goods and machinery and equipment more than offset declines in all other sectors. Exports fell to C$39.32 billion from C$39.73 billion.

Indeed, the surplus was narrower than economists' median forecast of C$5.6 billion in a Reuters survey. The surplus with the United States was unchanged at C$7.65 billion.

Exports in the aircraft sector, which had seen strong gains in January and May, fell by C$388 million to C$1.24 billion. Automotive exports also declined, for a third month in a row, by 1.7 percent, as some plants closed earlier than usual in preparation for new models.

Energy exports edged up 0.1 percent to C$7.9 billion, and exports of chemicals, plastics and fertilizers set a new high of C$3.2 billion, partly on the strength of uranium sales as countries expand nuclear capacities, the federal agency said.

With uranium prices 10 times higher than in 2001, the sector has become increasingly important to Canada, the world's largest uranium producer, the agency said. In the first six months of 2007, exports jumped 162 percent to C$2.3 billion from C$863 million a year earlier.

Statistics Canada said rising exports of crude oil -- due to higher volumes as prices fell 3.1 percent -- and natural gas offset falling exports of refined oil and coal products.

Energy imports fell 1.0 percent to C$3.1 billion, largely on a lower volume of crude imports.

($1=$1.06 Canadian)

Slovak Q2 GDP grows 9.2 pct

Aug 14, 2007 - The Slovak economy accelerated moderately in the second quarter of this year, showing 9.2 pct growth in real prices, according to the Slovak Statistics Office.

The office said GDP amounting to 3.5 bln eur was generated from April to the end of June. This meant an 11.3 pct growth in current prices.

In the first quarter of this year, Slovakia's economy grew 9 pct in real prices.

The accelerated second quarter GDP was linked to the added value growth in industrial manufacturing, mainly in the production of machines, electrical devices and means of transport, the office added.

Sub-prime crisis: Central bank credit has worked for now

But tighter credit, higher interest rates can cause market to slide further: analyst

By NEIL BEHRMANN IN LONDON
Published August 13, 2007

IN the past year, central banks have studied various models on how to cope with a 'systemic' global financial crisis. They are now being tested.
'So far, the first step of central bank credit to banks appears to have worked,' said Brendan Brown, the London-based chief economist of Mitsubishi UFJ Securities International.
But the main worries are that tighter bank credit and higher interest rates could cause a further market slide, he said.

This could lead to further hedge fund and other financial failures. Coupled with a downturn in the real estate market, the US and European economies could slow down or experience recession, he feared. This, in turn, would dampen the exports and economic growth of Singapore and other Asian economies.

In the initial rescue phase, global central banks have pumped more than US$300 billion into financial markets. These loans appear to have eased panic in the European, US and Asian interbank markets. Such were the fears about the financial health of counterparties that banks, especially in Europe, became nervous about lending money to each other. Credit dried up and interbank interest rates soared as lending banks demanded a higher risk premium.

Last Thursday and Friday, the European Central Bank (ECB) supplied US$214 billion to loosen the squeeze on vulnerable European banks. The US Federal Reserve Bank funnelled US$62 billion into the US financial markets. Alongside efforts of the Bank of Japan and Asian central banks, a credit crunch and bank failure has so far been avoided.

After an initial slump of several hundred points, the Dow Jones index last Friday ended up 58 points on the week. With Asian central banks at the ready to support their banks, there is hope that their markets will stabilise and possibly recover today. But the underlying problems are still very serious.

The next step is how central banks, regulators and investors deal with two parallel crises, economists said. The first relates to excessive loans on residential real estate and rising defaults. The most publicised is the so-called sub-prime crisis in the US where figures of potential defaults of US$100 billion are being bandied about. Real estate prices are tumbling.

But there are also huge and potentially doubtful loans to property owners in Britain, France, Spain, Eastern Europe and, more recently, Asia. Some economists believe that Spanish banks are particularly at risk as prices there have already begun to fall.

In England's north and midlands, property prices have already begun to slip. The current debacle has a good chance of ending London's financial boom, which would cap the city's heady property prices.

Parallel to this problem is an acute crisis in the US$1.6 trillion global hedge fund industry. Leverage, or borrowings of thousands of hedge funds, have raised their market exposure to US$3-4 trillion, estimated Dresdner Kleinwort. Economists and other analysts believed the unwinding of these positions are the root cause of the current crisis, the worst since the failure of the hedge fund Long Term Capital Management in 1998.

The inevitable result has been panic among investors who placed money in hedge funds. Many now want to withdraw their money, forcing the managers to dump shares and other assets on the market. This has created a vicious circle, causing stock market falls, further hedge fund losses, more withdrawals, leading to inevitable closures.

The dilemma facing central banks is whether to allow the free market to dish out bad medicine, causing failures and a painful adjustment. They are aware that if they continue to pour money into the market and slash interest rates to save reckless banks and hedge funds, they could spur inflation. That would stem today's financial crisis, but an ultimate one could be much worse.

Carry Trade

What Is it and how Does it Work?

Imagine that you could borrow money at an extremely low rate of interest, or even interest-free.

You could then take that money and invest it in a certificate of deposit, bond, or other fixed income instrument, and collect interest.

Your profit would be the difference between the interest you collect, and the interest you must pay on borrowed funds.

A similar situation exists in the currency markets. Japan's benchmark interest rate was actually zero percent for several years up until 2006. During that same time, the U.S. raised its benchmark interest rate from 1.0% up to 5.25%.

Forex traders could borrow money from Japan at almost zero percent, and invest it in the U.S. at 5.25%.

Because of this, institutional traders piled into long positions in the USD/JPY currency pair to take advantage of this difference in interest rates.

The trouble is, this interest rate differential is now beginning to shrink.

The U.S. ended its campaign of rate hikes last year, and Japan began to raise rates. Now, instead of borrowing at zero percent, traders must pay 0.5% for money borrowed from Japan.
The interest rate differential between the U.S. and Japan is now just 4.75% (5.25% - 0.5%) and will shrink even more if Japan raises rates again, or if the U.S. cuts interest rates.

This makes the Carry Trade less attractive, and as a result, traders have rushed for the exit on USD/JPY.

Similar damage has been done to EUR/JPY and GBP/JPY, as the once weak Yen has come roaring back, reaching three-month highs against the Euro and U.S. Dollar.

Weekly Indicators - Aug 9, 2007

From The Economist print edition
Aug 9th 2007

The Federal Reserve decided to keep its benchmark interest rate unchanged at 5.25% on August 7th. America's central bank acknowledged that financial markets had been “volatile” and that the risks to growth had “increased somewhat”, but insisted that its main policy concern was that inflation would “fail to moderate as expected”.

The unemployment rate in America rose from 4.5% in June to 4.6% in July. Labour productivity in nonfarm businesses rose at an annualised rate of 1.8% in the second quarter, according to first estimates. The annualised increase in unit labour costs was 2.1%.

The Reserve Bank of Australia raised its key interest rate from 6.25% to 6.5%, the highest level since November 1996.

Surprisingly, South Korea's central bank raised interest rates for the second month running. The Bank of Korea put rates up by a quarter-point, to 5%. Lending has been growing rapidly and the memory of a credit bubble, which burst in 2004, is still fresh.

In its quarterly Inflation Report, Britain's central bank forecast that inflation would stabilise close to the 2% target, if market expectations that interest rates would peak at 6% were fulfilled. Britain's industrial production rose by 0.6% in the second quarter.

Germany's trade surplus fell from €17.4 billion ($23.5 billion) in May to €14.9 billion in June, largely because of a surge of imports. France's trade deficit narrowed to €3 billion in June from €3.2 billion in May.

Price/Earnings to Growth (PEG) Value Ratio

The PEG (Price/Earnings to Growth) ratio is a tool that can help investors find undervalued stocks. It's not as well known as its "cousins," the P/E and P/B ratios, but is just as valuable.

When used in conjunction with other ratios, it provides investors a perspective of what the market thinks of a stock's growth potential relative to Earnings per Share (EPS) growth.

The PEG ratio compares a stock's Price/Earnings (P/E) ratio and its expected Earnings per Share (EPS) growth rate.

If the PEG ratio is equal to 1, it means that the market is pricing the stock to fully reflect the stock's EPS growth. Which is "normal," in theory, because the P/E is supposed to reflect a stock's future earnings growth in a rational and efficient market.

If the PEG ratio is great than 1 it could indicate that the stock is overvalued or that the market expects future EPS growth to be greater than what is currently the consensus number.

Growth stocks typically have a PEG ratio greater than 1 because the investors are willing to pay more for a stock that is expected to grow rapidly -otherwise known as "growth at any price." Or it could be that the earnings forecasts have been lowered but the stock price remains relatively stable for other reasons.

If the PEG ratio is less than 1 it could be a sign of an undervalued stock or that the market does not expect the company to achieve the earnings growth that is reflected in the estimates.

Value stocks usually have a PEG ratio less than 1 because the stock's earnings expectations have risen and the market has not yet recognized the growth potential. On the other hand, it could also indicate that earnings expectations have been reduced faster than the issue of new forecasts.

It is important to note that the PEG ratio cannot be used in isolation. Like all financial ratios; in order to properly use PEG ratios investors must use additional information in order to get a clear perspective of the investment potential of a company.

Investors must understand the company's operating trends, fundamentals, and what is reflected in the expected EPS growth rate.

Additionally, the P/E and PEG ratios must also be analyzed in relation to its peer group and the overall market in order to determine if the stock is overvalued or undervalued.

Price / Earnings (P/E) Ratio

After finding the price of a particular stock, usually the next number everyone looks at is the P/E ratio.

P/E is the ratio of a company's share price to its per-share earnings.

A P/E ratio of 10 means that the company has 1 of annual, per-share earnings for every 10 in share price. (Earnings by definition are after all taxes etc.)

A company's P/E ratio is computed by dividing the current market price of one share of a company's stock by that company's per-share earnings.

A company's per-share earnings are simply the company's after-tax profit divided by number of outstanding shares.

A company that earned 5M last year, with a million shares outstanding, had earnings per share of 5. If that company's stock currently sells for 50/share, it has a P/E of 10. At this price, investors are willing to pay 10 for every 1 of last year's earnings.

P/Es are traditionally computed with trailing earnings (earnings from the past 12 months, called a trailing P/E) but are sometimes computed with leading earnings (earnings projected for the upcoming 12-month period, called a leading P/E).

For the most part, a high P/E means high projected earnings in the future. But actually the P/E ratio doesn't tell a whole lot, but it's useful to compare the P/E ratios of other companies in the same industry, or to the market in general, or against the company's own historical P/E ratios.
Some analysts will exclude one-time gains or losses from a quarterly earnings report when computing this figure, others will include it.

Adding to the confusion is the possibility of a late earnings report from a company; computation of a trailing P/E based on incomplete data is rather tricky. (It's misleading, but that doesn't stop the brokerage houses from reporting something.)

Even worse, some methods use so-called negative earnings (i.e., losses) to compute a negative P/E, while other methods define the P/E of a loss-making company to be zero.

Worst of all, it's usually next to impossible to discover the method used to generate a particular P/E figure, chart, or report.
Like other indicators, P/E is best viewed over time, looking for a trend. A company with a steadily increasing P/E is being viewed by the investors as becoming more speculative. And of course a company's P/E ratio changes every day as the stock price fluctuates.

The P/E ratio is commonly used as a tool for determining the value of a stock. A lot can be said about this little number, but in short, companies expected to grow and have higher earnings in the future should have a higher P/E than companies in decline.

For example, if a company has a lot of products in the pipeline, I wouldn't mind paying a large multiple of its current earnings to buy the stock. It will have a large P/E. I am expecting it to grow quickly. A rule of thumb is that a company's P/E ratio should be approximately equal to that company's growth rate.

PE is a much better comparison of the value of a stock than the price. A 10 stock with a PE of 40 is much more "expensive" than a 100 stock with a PE of 6.

You are paying more for the 10 stock's future earnings stream. The 10 stock is probably a small company with an exciting product with few competitors. The 100 stock is probably pretty staid - maybe a buggy whip manufacturer.

It's difficult to say whether a particular P/E is high or low, but there are a number of factors you should consider:

First: It's useful to look at the forward and historical earnings growth rate.

If a company has been growing at 10% per year over the past five years but has a P/E ratio of 75, then conventional wisdom would say that the shares are expensive.

Second: It's important to consider the P/E ratio for the industry sector. Food products companies will probably have very different P/E ratios than high-tech ones.

Finally: A stock could have a high trailing-year P/E ratio, but if the earnings rise, at the end of the year it will have a low P/E after the new earnings report is released.

Thus a stock with a low P/E ratio can accurately be said to be cheap only if the future-earnings P/E is low.

If the trailing P/E is low, investors may be running from the stock and driving its price down, which only makes the stock look cheap.

Understanding TWR on Investment Assets

By Mike Benson

I will start in the same place I did with Internal Rate of
Return; the dictionary definition. I will then dive into what that means for
the rest of us.

“Time Weighted Return - Portfolio accounting method that measures investment performance (income and price changes) as a percentage of capital “at work,” effectively eliminating the effects of additions and withdrawals of capital and their timing that distort Dollar-Weighted return accounting.”
Barrons Dictionary of Finance and Ivestment Terms

The capital at work is your investment, including any reinvesting dividends, capital gains or interest. The latter are all considered investments because you have the option of taking them out of the fund but sometimes choose to have them reinvest. Reinvesting is just a convenient way of putting money in the fund; rather than having a check sent to you that you cash and then sending your check back into the fund it’s all taken care of for you.

The next term we see is “effectively eliminating”. A true TWR is does not effectively eliminate the effect of cash flows, it completely eliminates them. I will give a little more detail later on the use of the term effective.

What we are trying to accomplish with TWR is removing the biggest negative of the IRR; cash flow sensitivity. When you send money into your fund or take it out of your fund that’s not a decision under the control of the manager. It’s not fair to reward or punish a manager for cash flows that the manager has no control over.

In order to compare the performance of two or more manager’s we need to remove the effects of everything that is not under the manger’s control. Any cash flows to or from the investor, any fees that may have been charged by a third party to select and monitor the manager, or any fees the custodian may charge to house the account. None of these are the responsibility of the manager. However, some of these fees should be taken into account when measuring the performance of a third party firm or financial advisor.

Now to the meat of this, how do we calculate a time weighted return? From a formula perspective, the TWR is much easier than the IRR to calculate.

R = EMV / BMV

R = Return
EMV = Ending Market Value
BMV = Beginning Market Value

The astute among you will immediately note that this does not take into account cash flows. You would be correct; you are missing one big piece of information here. You have to do this daily or on the days when cash flows occur. I will walk through the simple example I did in the IRR walkthrough.

01/01/06 Deposit $12,000
06/30/06 Withdraw 4,000
06/30/06 Ending Value 9,000

To complete this, we have to add another piece of information. That is the Value on 6/29/06. Since this is all made up, let’s just say it’s worth $12,997.

01/01/06 Deposit $12,000
06/30/06 Current Value 12,997
06/30/06 Withdraw 4,000
06/30/06 Ending Value 9,000

First we do the first sub-period:
R = 12,997 / 12,000 = 1.083083

Then we do the second sub-period:
R = 9000 / (12,997 - 4000) = 9000 / 8,997 = 1.000333

Now that we have the two sub-period returns, we need to geometrically link them. This is done very simply by multiplying them.
1.083083 * 1.000333 = 1.083443

To get the return as a percentage you simply subtract 1. Your return for the six month period is 8.3%. You can convert this to annual return by either converting it first to a daily return then converting to an annual return using 360 or actual days. The other option of course is to simply assume that six months is half the year and use only two periods.

Using the daily method:
1.083443 ^ (1/360) = 1.000445 – Convert the six month return to a daily return
1.000445 ^ 360 = 1.173849 – Convert the daily return to an annual return
Subtract 1 to get the percentage and your annualized return is 17.4%

Using the two period return:
1.083443 ^ 2 = 1.173849 - There are two periods so we raise it to the second power
Converting it to a percentage is the same as the previous example above.

How did this remove the effect of the cash flow? Well, we did one return before the cash flow and one return after the cash flow. We completely ignored the cash flow; actually we did not ignore it, we removed it from the equation, its not sticking in the middle of it like it was for the IRR.

You may have noticed that I snuck a couple of new terms in on you. One was sub-period and the other was geometric linking. A sub-period is the time between cash flows or valuations. AIMR recommends that you revalue at least monthly. So if nothing happens (no cash flows etc…) you end up linking a bunch of monthly returns. Geometric linking is just a technical way of saying multiply the results.

This whole thing begs the question, if the TWR is superior to the IRR then why don’t we only use the TWR. As you might imagine, this is a complex question to answer.

Sometimes the financial advisor does not know the difference between TWR and IRR; in my experience this is very rare. An advisor may not know all the subtleties of the TWR but they understand the difference between Time Weighted and Dollar Weighted returns.

More often, it’s a much more practical limitation. It is difficult in terms of computing power to continually revalue a portfolio or its individual positions. It requires very clean data which is difficult to come by.

This means that the advisor or more likely the assistant must go through and mark or ensure that every cash flow was marked correctly as impacting the return. If the advisor has to have an assistant go through all the data then that’s a business expense, these expenses are covered by fees from clients – that’s you. So in order to cover expenses advisors would have to raise fees.

There are some ways to help mitigate this, using approximation methods such as Modified Dietz or the Modified BAI approximation methods (more on approximation methods another time). But they just help mitigate the problem, they do not solve it. Remember the term “effectively eliminating”? This is where that term comes from. These alternate methods are ways to sort of skip some of the data so the smaller cash flows may not be taken into account.

Also, there are times when financial advisors do control cash flow’s and you may want to know the impact of that decision on your performance. There are several strategies like Dollar Cost Averaging that have this impact on your portfolio and its performance.

Now, bear with me while I step up on my investment management software political soapbox for a minute. I think that the IRR for use as a means of measuring investment performance for individual investors should stop. I personally feel that the need to directly compare two or more managers or financial planners is much more critical. AIMR by the way agrees (okay, I guess I agree with AIMR)

Strategies like Dollar Cost Averaging (DCA) are risk mitigation strategies so the return is not the main goal, its risk mitigation. If you want to assess the risk of a portfolio you don’t look at the return directly, you look at the return as it relates to risk.

Call your attention to who’s performance is being measured, by using an IRR on a position that you are using a DCA strategy on, you are rewarding or penalizing the fund manager. This manager does not have control of the money, its your financial advisor that has control. Using an IRR pushes the impact to the wrong return number.

You want to push that impact up to the return number that aggregates all fund selection and strategies to your financial planner. The impact these decisions have on the performance within a portfolio will show
because money is sitting in cash earning a different (it
could be lower or higher) return than the money invested in an
individual funds.

You have to use the right measure to determine if your planner is earning their fee, it could be performance, relative performance (compared to an index or goal) or risk. It is your responsibility to use the right measures and the planners responsibility to provide the right data.

Lastly, I kind of glossed over data quality and its impact on selection of a performance measurement method. I think it is the responsibility of the data providing institution (the custodian) to provide clean usable consistent data and the responsibility of software vendors to create methods to calculate performance in an accurate and timely manner.

The biggest mess in this industry is the data; the custodians all provide different data in different proprietary formats and that makes it nearly impossible for the software vendors to accomplish their job. Most custodians do not provide sufficent data to advisors to calculate performance accuately. They provide sufficient data to do the accounting most of the time, but the data for performance and tax calculations is woefully inadequate.

Okay, I’ll step of my soap box and stop ranting. This ended up being much longer than I anticipated. I do hope this was helpful and that you understand TWR more than you did when you arrived here.

Understanding IRR on Investment Assets

By Mike Benson

A major part of my programming and personal knowledge are in the area of finance and financial calculations. I have been in that space for pretty much all of my working adult life (15+ years). I have worked on several production systems for public use and numerous systems for internal (1 firm) use.

I decided that in this version of my blog I would start sharing some of the knowledge in both technical (programming terms) and some of it in personal or business terms. I am writing this post because IRR vs. TWR and when to use each one is confusing to many investors. I will start with IRR then go To TWR and then I may put some code up on how to calculate these. Now on to the post.

“Internal Rate of Return (IRR) discount rate at which the present value of the future cash flows of an investment equal the cash flows of an ivestment equal the cost of the investment.”
Barrons Dictionary of Finance and Ivestment Terms

This may look odd as when you receive the IRR on a mutual fund or from your financial advisor there are no “future cash flows” there are only past cash flows. The definition above is the one you will usually find when you are looking at the definition of IRR and it really applies to something like an annuity or expected income from a business.

When you are looking at the IRR for an investment asset, you need to reverse this definition. It is the constant rate of growth that given your deposits and withdrawals will equal your ending value.

How is it calculated? This is the hard part, it’s calculated by trial and error. To calculate the IRR you use a modified form of the net present value formula.



BV = beginning value
EV = ending value
N = is the number of cash flows
cf[i] = the ith cash flow
t[i] = the time from the inital deposit to the ith cash flow
tt = the total time from beginning to end
r = the rate of growth per period

All cash flows are from the investor perspective. Any deposits into the asset are negative and withdrawals out of the asset are positive. That is, a deposit into the asset is a cash outflow ( - ) from the investor and a withdrawal from the asset is a cash infow ( + ) to the investor. The last term in the equation “+ EV / (1+r)^tt” turns the ending value into a cash flow at the end of the measurement period.

Lets do a quick example:

01/01/06 Deposit $12,000
06/30/06 Withdraw 4,000
06/30/06 Ending Value 9,000

Changing this into our mathematical formula, we get:
0 = -12,000 + [4,000 / (1+r)^180] + [9000 / (1+r)^180]

Now, remember that we are trying to solve for r. If you play around with this (or use the solver in excel like I did) you will find the answer is 0.000444780594724729.

Your first thought may be that this looks terribly low. If you look a little more closely at my formula you will see this “(1+r)^180″, I am raising the rate to the power 180; that means that this return is a daily rate since the total period is also 180.

To convert this into the form of an annual return you have to raise the result to the 360 (assuming 360 days in the year). [(1+r)^360]-1 = [(1+0.000444780594724729)^360]-1 = .17 or 17 percent. (1+r)^360 is your raw return, you then subtract the one out at the end to turn it into a percentage.

Thats not a bad return at all. You started with 12,000 took out 4,000 and ended at 9,000. So you made 1,000 on your investment. You can do a simple test to verify this. Take your initial investment times your annual rate of return. 12,000 * 1.17 = 2040. Remember though that we were only invested for 180 days or half the year. 2040 / 2 = 1020 pretty close to what we expect. Note: this quick method only works when there are no cash flows or the cash flow is at the beginning or end of the period.

Okay, now lets try a slightly more complex example.

01/01/06 Deposit $12,000
06/30/06 Withdraw 4,000
09/17/06 Deposit 18,000
11/03/06 Withdraw 2,000
12/30/06 Value 25,000

Here is what our formula ends up looking like:
0 = -12,000 + [4,000 / (1+r)^180] + [-18,000 / (1+r)^259] + [2,000 / (1+r)^306] + [25,000 / (1+r)^364]

Solving for r, we get 0.000179961. Turning this into an annual rate (using 364 days) we get (1+r)^364 = 1.067692544 or 6.76%.

In the beginning of this, I said that IRR is calculated by trial and error. If you cheated (like I did) and used excel or a financial calculator then this was trivial. But if you put the formula into excel and try to guess the answer you will end up doing something like this. Try 0%, too low, 1% too high, .05 too high etc… you basically have to go back and forth until you get the answer. This by the way is a bisection (or binary) search and there is a whole branch called iteration theory that deals with this. For more on that, recommend that you check out the book Analysis of Numerical Methods by Eugene Isaacson and Herbert Bishop Keller, ISBN: 0486680290.

There are several problems with the IRR as a measure of performance for a personal investment asset:

1. IRR is cash flow sensitive. The amount or timing of deposits and withdrawals change the results. Plug in some different numbers and check it out. A lot of cash flows or highly variable cash flow, such as in a money market checking account can throw the formula way out of wack.


2. There may be more than one solution to the problem. (Remember a negative times a negative is a positive)


3. There may be no solution to the problem, this can happen when a lot of cash flows happen over a long period of time.


4. The manager of the fund really has no control over the timing of your deposits or withdrawals. Your timing should not penalize or reward the manager. The same is true for your financial advisor, if you are making regular deposits or withdrawals to your account your timing is effecting the results and your advisor should not be penalized or rewarded for this.

So whats the answer to this problem? Use a Time Weighted Return.