DEFLATION – good for some and bad for others

November 25, 2008

Can you really afford not to subscribe to my daily update? On November 12th at 10:38pm my daily readers received the following e-mail: “Despite billions of new Treasury paper each week, long-term rates (10-year = 3.85%, inflation component = 0.91%) are stubbornly refusing to go higher and many traders have big bets on higher rates. A short squeeze will occur if they don’t cover soon in upcoming auctions. Don’t be surprised if we see 3.00% or lower on the 10-year when upcoming inflation stats confirm we have entered a period of DE-flation.” Eight days later (November 20th) I followed with: “Today the 10-year fell to 3.01% (lowest since 1958) and the inflation component declined to an all time record low of 0.01%. Long rates have fallen 84 basis points in one week and it was triggered by yesterday’s negative CPI report (-1.0%) showing we have entered a period of DE-flation. Investors now see 0.01% inflation over the next 10 years.” How many people forecast this BEFORE it occurred? For $1 a day you can have the same information sent five nights a week.The above picture shows the preferred safe place for investors’ money in today’s scary economy. Three month T-bills are trading at 0.11% as the return of capital becomes much more important than the return on capital. This morning the Fed announced they would begin to purchase long-term mortgages in an effort to drive down long-term borrowing rates for suffering homeowners. The Fed has correctly determined that home borrowers are a “too big to fail” entity like the banks, insurance companies and other corporations the government has bailed out. I have forecast for months that short-term rates were headed to 0.00% and now the Fed will be forcing long-term rates lower giving homeowners a badly needed break on their monthly mortgage payments. Lower long-term rates will also make home purchases more affordable for buyers and should lead to a temporary leveling off of home price declines in 2009. Will 2009 represent the bottom of the credit crises? Not a chance as we will have a minimum of four years of sideways to slightly lower economic activity before reaching the final bottom in January 2013. Next year will see record high unemployment for states like California (10%+) and a possible bankruptcy. Government spending is a first step in the long process of rehabilitation but it’s impossible for a patient to come out of ICU and then get back on the running path without severe setbacks. Patience will be required by investors and homeowners in the next few years as they anxiously await an economic rebound much like the child in the back seat of a car that constantly asks the parents “are we there yet?”

DEFLATION – Are you ready?

History does repeat itself but not when we expect and many comparisons are being made with the Great Depression of the 1930’s. Record unemployment and food lines with history book pictures reminding us of a time we never want repeated motivate the government (Bernanke) to fine tune policies that make sure this time will be different. Remembering that we only see the future from our own past experiences has placed thousands of investors’ wealth in jeopardy as portfolio managers did NOT use stop losses for fear of missing the next move higher in stock prices. Now these same investors are frozen and of course their money managers/brokers are afraid to suggest anything else for fear of being sued or losing the client. Bernanke and Paulson are also acting on memories of the past (and history books) as they place hundreds of billions of dollars in corporations that theoretically will grow and lend and keep the economy from falling further. The BIG problem is that we have a very serious and long lasting period of deflation where asset values and prices levels decline and very few are able to profit. The only asset that grows in deflation is CASH and very few are sitting on a pile of money except the lucky individual in the above picture.

The simplest example of deflation and its effect on wealth begins with the average wage earner that has not been able to save due to past inflation rising faster than their paychecks. For someone making $10 an hour, 40 hours per week their gross paycheck is $400. After taxes and other deductions this wage earner will take home $300 per week and let’s also assume their rent is covered by their spouse and they are only responsible for the purchase of gasoline each week for both drivers. When gasoline was at $4 a gallon they used their wages to purchase the required 75 gallons a week and has nothing remaining for other purchases or savings. With gasoline on its way to $1 ($1.34 in Kansas City)  this wage earner is now able to purchase the same 75 gallons per week for $100 giving them $200 remaining for savings or other purchases. Deflation is like hitting the weekly lottery or receiving a pay increase. Deflation makes the average worker wealthier and gives them a big boost in spending power.

For those not on a fixed salary or heavily in debt deflation can be a very painful experience. Many building owners will have retail tenants ask for rent reductions or move to different shopping center or worse just go out of business due to a lack of sales. Those in the stock market will suffer as corporations cut or eliminate dividend payments. The only investors that will not suffer will be those that own “C” level apartment buildings in areas of strong economic growth (Texas). Most of these multi-family buildings have tenants that earn a fixed wage and will have increased savings due to deflation and might even be able to pay small increases in monthly rent. For those on leverage deflation will be costly as declining price levels added to positive interest rates create record high “real” borrowing rates. In the next four years we will witness a massive shift in wealth from wealthy asset holders to wage earners. Investors that are able to change their way of thinking and breakaway from seeing the future from the past will profit. The vast majority will lose much of their wealth and justify the change as “no one saw this coming” and “everyone else lost as much as me” as they continue their lifetime membership in the Losers in Company club. The real question is do you have the courage to break away from the pack and “win alone” by changing your way of thinking about the economy and the new DE-flation.

Stocks and interest rates

My best bet for 2009 will be a “back up the truck” bet on a widening Japanese yield curve (2yr-10yr.) where the spread should widen from its current 82 basis points to at least 250 bp over the next 1-2 years. The U.S. stock market has entered a trading range for the next two months and those that didn’t exit (because their money managers don’t believe in stop losses) should exit on any move in the S&P 500 towards 990. The Fed will continue to reduce its overnight rate with a final destination of 0.00%. Long rates (10-year) will see a move under 3.00% as the inflation component nears 0.00%. Inflation is gone for the next few years but 10-year TIPS are another “back up the truck” buy at levels above 3.00% for on the run bonds only (retirement accounts only). If your broker doesn’t understand these investments feel free to send an e-mail and I will refer you to an expert. (I receive NO fees for my referrals)

Have a great holiday and please give serious thought to how you can profit from the new era of DEFLATION which no one has seen in over 75 years. The old way of investing is not working and those that won’t change are certain to lose a major part of their hard earned wealth. Do you have the courage to change?

Would you….would you like to…..would you like to dance?

November 14, 2008

My last and most important class of the year will be held on Wednesday, November 19th from 6-9pm. I will discuss the best and safest places for your hard earned $$$ and give a detailed forecast for interest rates and the economy in 2009. Can you really afford not to be there?

The above picture is a perfect representation of why the federal government’s massive injection of capital into banks is not working. Asking banks to lend money to borrowers that are afraid is not going to happen unless there are incentives. Tell the boy and girl in the picture they won’t have any homework for a month and they will dance all night long. The government is involving itself in every aspect of business and has become the only lender in the financial arena and has driven borrowing rates lower (except mortgages). Why should banks lend when they can take their new found capital and invest in Treasury notes and other riskless vehicles? 2009 will bring a new administration, fresh ideas and guarantees of no losses to banks that lend to borrowers. Once lenders are sure that they have no risk on a loan they will again solicit borrowers and open credit spigots but never to the level of the past few years. Banking used to be a risk taking business where profits were the rewards but the credit contraction has taken all but the most simple decisions away from banks and onto the growing government bailout program. Our capitalist free market system has entered the repair shop where it will take many years before it again runs at optimum speed. The kids will dance but it will take patience from the parents (consumers).

Have you had enough pain yet?

Each week I see the raging bear tear into families life savings and continue to eat away at hard earned assets that took years to build. Investment advisors and managers continue to tell us on financial TV to have patience and that eventually prices will rebound. They also advocate buying more of what has already fallen (40%+) but who has any money? One of the worst investing strategies of all time is to add to losing positions and yet the majority are lead to slaughter and never complain. Pain is one of the greatest motivators to change but often too late to make a difference and causes investors to freeze and use hope as a strategy for lost wealth. The problem with this buy and hold forever or reversion to the mean strategy is that many investors need to live off the soon to be cut dividends or use the stocks as collateral for loans or reserves. Or maybe they need to sell for a child’s education or a relative’s health care. The biggest tragedy in this bear market of the century is that 99% of these “experts” only see the future from their own experiences and their forecasts of low risk are heavily influenced by time frames that are irrelevant for today. Investors continue to fear missing the next move up instead of realizing good objective decisions can only be made when all assets are in cash and then you start again. True bear markets don’t end until everyone has left the arena and there are far too many remaining despite the fact their portfolios are bleeding huge losses. The answer is simple for those who remain long using hope as their main strategy: STOP LOSSES. I know your investment advisor never uses them but it is YOUR money they are playing with and at the end they still get paid (why?) for losing your money. These same managers continued to purchase shares in Fannie Mae, Freddie Mac, Bear Stearns, WAMU and AIG all the way down using the excuse the fundamentals hadn’t changed despite declining share prices. At the end the market was right (as usual) and these managers moved on to the next client without much more than a simple “sorry” which doesn’t help increase your dwindling net worth. The only comfort I hear every day is from investors who say “everyone else lost” or “no one saw this coming.” For anyone who believes that please visit our archives where you can read everything I wrote about the coming disaster two years ago. The real problem is that the majority of investors would rather lose in company than win alone. How much do you have to lose to change the way you feel about losing in company? Think about it hard because your advisor is hoping you remain more clueless than him. Life is relative, as long as you are a little more knowledgeable than your clients you appear to be a genius…..Have you had enough pain? I continue to offer a free objective analysis of any reader’s assets/portfolios. I am NOT an investment advisor and you will not be solicited for the purchase of any services or products.

Interest rates

The U.S. Treasury continues to issue billions of new securities each week and has helped to keep long-term rates high. The U.S. 10-year is at 3.73% with the inflation component at 0.87%. The 5-year is at 2.33% with the inflation component at a MINUS 0.09%. Investors are expecting DE-flation in the next five years and less than 1% inflation in the next 10 years. Once we see negative numbers from the monthly consumer price index inflation expectations will fall to negative and that will drive long-term rates to levels not seen since the mid 1940’s. Monthly economic stats are irrelevant at this point and only tell us what we already know…the economy is in the most serious economic contraction since the early 1930’s and like the rolling blackout I wrote about a couple of weeks ago is coming to your house and assets soon. Hoping that it doesn’t rain at your house when a storm is pouring down on every house in the neighborhood is something no one would ever assume and yet everyone believes their portfolio isn’t going to be affected in this hurricane…..wake up everyone, we are not getting out of this crises for many years…and house prices are not going to rebound for many years….and unemployment will soar for many years….Now the only question for each reader is: ARE YOU REALLY PREPARED or using hope as your strategy?

I will have the answers to 2009 and beyond at my class on Wednesday, November 19th at 6pm. Where will you be that evening?

A Repeat of the 1930’s?

November 7, 2008

My last and most important class of the year will be held on Wednesday, November 19th from 6-9pm. I will discuss the best and safest places for your hard earned $$$ and give a detailed forecast for interest rates and the economy in 2009. Can you really afford not to be there?
The picture above is from the early 1930’s but could soon be seen in many U.S. cities. I run a non-profit in Hollywood that has fed, clothed and found jobs for the homeless and poor for over 13 years. In the past few weeks we have seen a dramatic increase in the number of people we feed each week and today’s jobs report tells us we are in the beginning stages of a dramatic increase in unemployment. By the time our new President takes office on January 20th we will officially be in the worst economic setback since the Great Depression. October jobs fell 240,000 after declining a revised 284,000 in September and an also revised 127,000 in August. Last month’s number includes a phantom increase of 71,000 due to the government’s mythical birth/death model. One of the ways we measure the severity of the job environment is by watching the direction of monthly revisions and September lost an additional 125M and August 54M. The government always receives thousands of late replies to its monthly survey and they clearly show momentum picking up on the downside. When factoring in a constantly growing population today’s unemployment rate of 6.5% is sure to hit my 8.0% target in early 2009 with California leading the way at 10.0%. Retail payrolls fell 38,000 last month and are indicating a severe problem for owners of shopping centers who may soon find vacancy rates soaring as competition for tenants becomes intense. Temporary job services fell 34,000 after a 28,000 decline in September and shows employers are nowhere near the point of increasing their payroll because consumer demand is tepid at best. A key leading indicator points to large job losses in 2009 with those holding part time jobs because they couldn’t find a full time job soaring to a record high. The really bad news is that these job losses will soon put tremendous pressure on state and local governments as they attempt find new sources of revenue to pay for spending programs already in place. Governor Schwarzenegger announced on Thursday a 1.5 cent increase in the California sales tax but sadly this will actually drive revenue down as consumers continue to cut spending on everything except essential items. Michigan is a great example of a state that has increased taxes only to see thousands leave the state and thus create the opposite of the intended effect. With a growing list of companies that are being given loans/investments by the federal government it is only a matter of a few months before we see every mayor and governor head for Washington D.C. to ask for a share of the expanding bailout pie. Finally for those seeking full-time employment the federal government announced this morning it is in need of people to help manage the bailout program in the area of equity and debt. It might be a good place for mortgage brokers, real estate agents and investment managers to seek full time, secure employment because they tend to be good with numbers and the government is adding zeros every day to the deficit and bailout plan. 

Real estate prices and mortgages

Two years ago I wrote bear markets last longer than anyone expects or can tolerate and this version would be no exception. Unfortunately many in the real estate and mortgage industry are trying to hang on under the mistaken assumption that the good years of high income can be repeated again. (Sorry not in your lifetime). Hope has become a costly strategy for those that don’t like change but eventually they will learn the bear leaves few survivors in his once in a century visit to investment markets. The Federal Housing Finance Agency today announced the conforming loan limit (residential) in 2009 would remain at $417,000 with the jumbo conforming limit reduced to $625,500 from this year’s $729,750. Homeowners have seen the value of their homes decline and now have to suffer as the limit for Fannie & Freddie purchased mortgages are lowered. DE-flation creates lower asset and debt values but at least these mortgages are in dollars and not foreign currencies which have created massive margin calls for those speculators that moved their mortgages to lower rates in strong currencies (Hungary, etc). The next four years are going to be difficult for a society that is used to spending because credit was available and not saving because inflation is the best friend of borrowers except in a DE-flationary environment.

Yield curves

In my January 2008 forecast issue I recommended readers “back up the truck” for a once in a lifetime opportunity to bet on a widening yield curve with the spread between the 2 year Treasury and 10 year Treasury increasing to historic levels. This has been a home run call and created HUGE profits for those that jumped on board this non-stop train ride engineered by the Fed. The Bank of England’s historic move this week (not seen since 1854) of cutting the overnight rate by 1.50% to 3.00% has moved the English yield curve to its widest in many years. The one remaining yield curve that has not yet moved dramatically but offers the best risk return for the next 12 months comes from Japan. With the 10-year JGB rate slightly below the 2-year a breakout will occur when this relationship jumps above the 1.0 level. It’s amazing that so many have lost so much of their hard earned wealth this year in the stock market when the easy money is there for those that are willing to look beyond the typical investment arena of stocks. These same money managers continue to play the “reversion to the mean” trade as they continue to purchase stocks on the way down and add to losing positions without the use of stop losses. How much pain do investors need before they come to the painful conclusion that losing in company is not the answer to increased wealth. For those with the courage to “win alone” and leave the pack of those in the stands and take your place on the field of play the rewards are bountiful.

A year end stock market rally?

The Dow, S&P and NASDAQ rose 3%+ today in the face of awful economic news from the job market. A market that rallies on bad news is sure to rally even more on good news as investor expectations are reaching levels of extreme pessimism. Even the most severe bear markets have violent and sizeable rallies and U.S. stocks are set up for a good year-end rally that presents opportunities for traders only. Unfortunately very few investors have cash as they are completely “frozen” with their positions that have fallen in value this year and suffered massive losses because their advisors never recommended stop losses. Isn’t the excuse “I have never seen anything like this before in my lifetime” getting old? Or how about the manager that tells you the S&P is down 35% but you only lost 25% so you really made 10%….Can you spend the $$$? Of course not…but at least you can commiserate with your neighbors and friends who all lost a great deal of their wealth and retirement savings. Can you handle being at a dinner party where everyone lost but you won? Think about it and if the answer is yes, I suggest you try it; you might find it more difficult than you think. We are all swayed by public opinion and the news media and need these sources of information (usually not very good) to justify our investment decisions. In the next 12 months very few investors will make $$$ because of poor planning and a lack of discipline. Are you ready to change and do what is necessary to win in 2009?

2009

The key to the U.S. economy next year is the consumer and the confidence needed to spend our way out of this economic crises. With a historically low savings rate of less than 2% and no availability of credit the average worker will be spending only what is earned and that brings a new era to anyone not alive in the 1930’s. Government funds invested in banks will not be used to lend unless guarantees are given that offset potential loan losses. The real question for 2009 is how will the government know when to stop giving handouts? Libor and commercial paper rates have plunged in the last couple of weeks due to massive injections of capital from the government but without this $$ these markets would again be frozen. The government can easily force interest rates lower but it can NOT force upon its people the confidence needed to invest and borrow. Only time can heal the wounds from the past three years and that is not something that comes easy for most Americans. We have learned to embrace inflation, borrowing and spending what we don’t have and have little patience when it is not available. 2009 will bring a call for inflation targeting by the Fed but NOT the old kind of limiting inflation but a cry for a return to the old days where rising prices covered the mistakes of investors who succeeded despite their lack of due diligence. The next decade will see a HUGE transfer of wealth from those that used leverage in the 90’s to those that understand how to profit from the DE-flation of the new era. History does repeat itself but only those who study hundreds of years instead of what they have experienced in their own lives were ready for 2008. The only thing good about getting old is that you have more experience than most of society, it’s time we begin listening to those that have the life experiences. President Obama’s first move should be to select former Fed Chairman Paul Volcker (81 yrs. old) as Treasury Secretary. It will bring back the man who curbed runaway high inflation in the 80’s back to financial markets that will soon be desperate for any inflation.