News about a planned U.S. stimulus package helped pull investors into the dollar on Monday but U.S. Treasury prices slumped on fears a price bubble is about to pop in the face of a massive wave of fresh debt.

European equities advanced for the fifth session in a row, spurred by gains in shares of oil companies on the back of rising crude prices. U.S. stocks were mostly lower as investors took profits on the rally that was racked up in thin trading last week.

Oil prices hit a three-week high as Israel’s deepening incursion into Gaza and a Russian gas dispute heightened fears about supplies.

Prospects for a swelling supply of government debt drove U.S. and euro-zone prices down. The U.S. Treasury said it would sell $16 billion of reopened 10-year notes and $30 billion in three-year notes this week.

While the issuance was broadly in line with market forecasts, it underscored this year’s looming surge of debt that will to fund government efforts to rescue the financial system.

U.S. President-elect Barack Obama plans $310 billion in tax cuts as part of a rescue package of up to $775 billion, senior Democratic aides said Sunday. German Chancellor Angela Merkel met her Social Democrat (SPD) coalition partners to discuss a second fiscal stimulus deal worth up to 50 billion euros ($68 billion).

The 30-year Treasury bond fell nearly three full points in price, pushing its yield up to 2.92 percent, up from a record low near 2.52 percent in December.

“The back-up in yields shows a growing sentiment toward questioning the lower rate environment we are in right now,” said George Goncalves, chief Treasury/TIPS and agency strategist with Morgan Stanley in New York.

The euro hit three-week lows versus the dollar, with weaker-than-expected Italian and Spanish inflation data and tax cuts in Germany expected to pressure the European Central Bank to soon cut rates further.

U.S. stocks fell as investors took profits following last week’s sharp gains.

“Right now we’re just watching and waiting to see if there is any news from the new administration and what type of news it will be,” said Frank Lesh, a futures analyst and broker at FuturePath Trading LLC in Chicago. “We got a little bit of profit taking here,” he added.

Shares of Apple Inc rose after chief executive Steve Jobs wrote a letter aimed at dispelling investor concerns about his recent weight loss. Shares of the iPod maker rose 4.4 percent to $94.75 in early afternoon trade.

Before 1 p.m., the Dow Jones industrial average was down 79.09 points, or 0.88 percent, at 8,955.60. The Standard & Poor’s 500 Index was down 3.27 points, or 0.35 percent, at 928.53. The Nasdaq Composite Index was down 8.52 points, or 0.52 percent, at 1,623.69.

European equity markets were buoyed by the anticipation of further fiscal stimulus, drawing flows away from the safer-haven of government bonds.

The FTSEurofirst 300 index of top European shares ended 1.9 percent higher at 873.01 points.

The telecommunications sector was one of the biggest gainers on the index on the first full day of 2009 trading for many, with Swisscom (SCMWY) rising 5.2 percent, Cable and Wireless adding 4.6 percent, Vodafone (VOD) up 4.3 percent and Portugal Telecom (PT) rising 4.6 percent.

Sharp losses for the euro, which was down 2.28 percent at $1.3559, also spread to euro/sterling, taking it to 0.9278, well away from record lows for the pound last week and easing momentum towards parity.

The dollar rose against a basket of major trading-partner currencies, with the U.S. Dollar Index up 1.74 percent at 82.923. Against the yen, the dollar rose 1.31 percent at 93.43 from a previous session close of 92.220.

Longer maturity government debt fell, but shorter-term debt was little changed to higher. The benchmark 10-year U.S. Treasury note fell 34/32 in price to yield 2.47 percent, and the 30-year U.S. Treasury bond fell 102/32 in price to yield 2.94 percent.

Oil rose, and has gained more than 35 percent since Israel launched its attack on Gaza on Dec. 27, increasing concerns about the supply of crude from the Middle East.

U.S. light sweet crude oil rose $1.11 to $47.45 a barrel.

U.S. gold futures dropped, breaking below $850 an ounce, as investors took profits on the back of a dollar rally and signs of slowing physical demand.

Spot gold prices fell $22.45 to $852.60 an ounce.

Asian stocks rose to a two-month high on hopes massive government spending programs will revive a global economic recovery later this year.

The MSCI index of Asia-Pacific stocks outside Japan climbed 1.6 percent to a two-month peak, while Japan’s Nikkei average gained 2.1 percent in a shortened session to reach a two-month high.

NEW YORK, Jan 5 (Reuters)

Asian stocks climbed nearly 4 percent on Monday on renewed hopes the U.S. automaker industry would be rescued, strengthening willingness to take risks and knocking the U.S. dollar to a two-month low against the euro.

Investors have been funnelling capital back to emerging Asia for the last few weeks and word the White House was considering using some of $700 billion meant to rescue financial institutions for the struggling car manufacturers extended the trend.

European stock index futures were also pointing to opening gains of at least 2 percent.

However, worsening U.S. economic data, a rapidly growing fiscal deficit and the likelihood the Federal Reserve will cut interest rates again this week all combined to weaken the dollar.

“The tide seems to have turned around in recent sessions, with bad U.S. economic news now rightfully hurting the U.S. dollar rather than helping it stronger,” said Nizam Idris, currency strategist with UBS in Singapore.

“Further commentary regarding any alternative solutions to the auto sector will be closely followed during the day, and hence be key to risk sentiment,” Idris said in a note.

Oil bounced back $1 to trade above $47 a barrel on signs that OPEC members might make a deep supply cut to boost prices when they meet later this week.

The MSCI index of Asia-Pacific stocks outside Japan rose 3.7 percent on the day and is up about 7 percent so far in December, trying to pull off its first monthly increase since April.

Japan and South Korea led the region in stock performance. The Nikkei share average rallied 5.2 percent, with Honda Motor Corp stock rose 8.5 percent, one of the biggest lifts to the Nikkei.

South Korea’s benchmark KOSPI share average was up 4.9 percent.

The risk of further declines based on earnings downgrades has been clearly outweighed by the cheapness of stocks at the moment. Toyota Motor Co stock is up 9.1 percent even after Japanese media reported the world’s top automaker is likely to further cut its earnings forecasts and report an operating loss of $1.1 billion in the October-March period.

Hong Kong’s Hang Seng index rose 3.1 percent, led by HSBC and China Mobile. China Construction Bank and Bank of China (Hong Kong) Ltd were the only stocks that fell.

“I am surprised that the equity market is still holding up so well in Asia. Mutual funds are probably putting their year end cash balance to work.” said Sean Darby, chief Asia Strategist at Nomura in Hong Kong, on the overall positive market movement.

In the bond market, the Asia excluding Japan benchmark iTRAXX investment-grade index tightened by 20 basis points, after widening sharply on Friday’s news of Senate’s rejection of auto bail out.

Asian benchmark dollar bonds have not kept pace with the rally in equity markets, trading near historically wide spreads, though the cost of insurance against corporate and sovereign debt default slipped as the environment for risk gradually improved.

The White House indicated last week it is open to using part of the bank bailout package for the Big Three car companies — Chrysler LLC, Ford Motor Co and General Motors Corp . A bill that would have provided $14 billion in loans for the firms failed in the Senate on Friday.

TOO EARLY FOR RECOVERY

With some equity valuations at distressed levels, some investors sitting on cash have begun to think about a recovery at some point in 2009. However, JPMorgan asset allocation strategists said it might be too early to let go of recession trades given the global economy is smack in the middle of the worst downturn since World War Two.

“There remains sufficient uncertainty about the timing of a recovery that it is quite easy for credit and equities to cheapen further, and bonds to rally more before we start the real recovery trade,” they said in a note. “We thus stay with a portfolio of recessions trades — long duration in global rates and defensive exposures in credit and equity markets.”

However, Nomura’s Darby said corporate bonds are already cheap, given how much they have sold off this year. For the time being, bond investors are not as worried about high returns as they are about staying safe, he said.

The yen was up slightly at 90.98 per dollar , having rallied to its strongest in 13 years on Friday at 88.10 after the U.S. auto bailout initially flopped.

The euro rose to highs around $1.3490 on electronic platform EBS, the highest in almost two months.

The rally in stocks sucked money out of the bond market, pushing up the yield on the benchmark 10-year U.S. Treasury note , which moves in the opposite direction of the price, to 2.59 percent from 2.58 percent late in New York on Friday.

Kevin Plumberg and Xi Chen

HONG KONG, Reuters

U.S stocks headed for a higher open on Wednesday as news the White House and congressional Democrats reached an agreement in principle to aid U.S. automakers. including General Motors , calmed investors’ worries.

But signs of further deterioration in the world economy and the profit outlook, including big job losses at an global mining company, fueled caution a day after stocks sell-off ended two straight days’ of gains.

Without government help. investors fear that a possible failure or bankruptcy in the auto sector could send shock waves through the economy and worsen unemployment.

Backers of the $15 billion proposal for bailing out U.S. automakers could come to a vote in the House as early as Wednesday, officials said.

“Investors have been concerned about the continued acceleration of the market free-falling with significant bad news events,” said Rick Meckler, president of investment firm LibertyView Capital Management in New York.

But news of the auto agreement should spur “more of a relief rally than the feeling that this is something good for the markets itself.”

S&P 500 futures were 10.90 points higher and were above fair value, a formula that evaluates pricing by taking into account interest rates, dividends and time to expiration on the contract. Dow Jones industrial average futures climbed 84 points, and Nasdaq 100 futures gained 10 points.

Shares of GM were up 3.8 percent to $4.88 in premarket trade and Ford gained 3.7 percent to $3.35.

Also likely to lend support to the market was a rebound in oil prices, which could boost energy shares. U.S front-month crude was up 4 percent to $43.96 barrel.

Earnings news and outlooks continued to cast a pall. Shares of Eastman Kodak tumbled nearly 16 percent to $6 before the bell after the photography company warned 2008 revenue and profit will fall short of expectations.

Video game publisher Electronic Arts shares fell 10 percent to $17.40 in premarket trade a day after the company cut its outlook.

Stocks in Asia rose overnight, sending the Hang Seng index up nearly 6 percent, as investors bet on stimulus measures from Beijing. Hopes for a U.S. auto deal also contributed to the gains, but European shares edged lower.

Global miner Rio Tinto said it planned to cut 14,000 jobs and reduce capital expenditures by $4 billion in 2009. Chinese imports and exports unexpectedly fell in November, which underscored the breadth and the depth the global slump.

Year-to-date the S&P 500 is off 39.5 percent but has gained 18 percent since hitting a Nov. 21 low. From its October 2007 record high, the index is off about 43 percent.

Chuck Mikolajczak
NEW YORK, Dec 10 (Reuters)

“If a loose monetary policy and rapid asset price inflation were the route to economic prosperity, Argentina would be the richest country in the world by now.”

Albert Edwards
Co-Head, Global Cross Asset Strategy
Societe Generale

August is my month off. Every year I go to Mallorca where my favourite pastime is the occasional glance at the sea whilst reading a good book. This year Peter Bernstein’s ‘Against the Gods’ was top of the pile. Not that I hadn’t read it before. But my last encounter goes back about ten years and I decided that it deserved a re-read. After all, the book is about risk management and few books deal with the subject of risk management better than this one.

I didn’t spend many days on the island before I realised that Mallorca was not in its usual ebullient mood. Clearly the credit crunch had started to bite here as well. My friends on the island, most of whom are in the property business, confirmed my casual observation. The banks are tightening they said. Loans which could easily be obtained only six months ago were no longer available.

A few days later I ran into an article in the Daily Telegraph which illustrates the magnitude of the problem (see chart 1 below). Although this chart is based on U.S. data, the behaviour of banks around the world is broadly similar. It is clear that tightening lending standards are no longer a phenomenon exclusively linked to property loans. Consumer loans in general, and credit card loans in particular, are now subject to much closer scrutiny.

Chart 1: U.S. Lending Standards

Source: The Daily Telegraph

From my vantage point in the Serra de Tramuntana, I started to philosophise about the roots of the current predicament. How could it possibly go so wrong? Is the end in sight yet? What can we learn from this mess? These are obviously big questions, although the answer to the first question is pretty straightforward, the way I look at things. It all went so terribly wrong because of hubris combined with excessive use of leverage. It is funny how we always think that this time it is different. This time we really figured it out, or so we thought. However, the ever present invisible hand had other ideas.

In short, not just the United States but the entire world is dealing with the implications of a near perfect storm which has created havoc on three fronts – falling asset prices, a weakening capital base amongst financial institutions and high inflation. It is the interaction of these dynamics which explains the mess we are currently in, but it is also here we are likely to find the answers to our questions, so let’s jump straight into things:

Observation # 1

It all began with housing and it will end with housing.

When U.S. home prices began to skid, the damage inflicted was swift and devastating. We know now that that the quality of many loans was poor, causing large write-offs across the industry. With house prices in the US and the UK still well above their long-term averages relative to disposable income (see chart 2 below), there is no reason to believe that they will not continue to fall for quite some time yet. The write-offs will spread from sub-prime to prime and to many other countries as well, a process which has, in fact, already begun. Two criteria must be met before property will start to appreciate in value again – house prices must reach (or fall below) their long term equilibrium values and the current overhang (see chart 1) must be dramatically reduced. All this will take time – years rather than months.

Chart 2: Current overvaluation of U.S. and U.K. homes

Source: GMO Quarterly Letter, July 2008