A Tug of War has begun…

January 30, 2009

Can you afford NOT to subscribe to my nightly update? The number of subscribers increases every week as I send my thoughts five nights a week (Sunday –Thursday) at 11pm that cover the world’s financial markets with tips on how to preserve wealth and stay ahead of the rapidly deteriorating economy.Almost thirty years ago a group of bond traders became “vigilantes” as they became the guiding force for long-term interest rates and the fight to lower double digit inflation expectations. Paul Volcker was Fed Chairman and nowhere near as revered as he is today for he hiked short-term interest rates to record levels and thus created a roller coaster ride for businesses, consumers and borrowers. Today we are at the complete opposite end of the curve but those same inflationary expectations are becoming the worry among those who invest in U.S. Treasury bonds. Long-term interest rates are near historic lows but the government stimulus package and massive printing of money to fund these programs is worrying global investors as they seek shelter in gold. The U.S. 10-year is closed today at 2.85% up 65 basis points in the last 11 trading days with its inflation component climbing to a high for the year at 1.14% up from 0.17% on the first day of the year. This, despite the fact the Fed announced in December and repeated this week a plan to purchase long-term government bonds and mortgages to drive borrowing rates lower for consumers, homeowners and businesses. Each side of the tug of war is sure they will win the battle driving the other team over the magical line of demarcation. The “inflationistas “ see the world from a too much money chasing too few goods point that will drive prices higher and force the Fed to raise short-term rates similar to Volcker in the early 1980’s. Those betting on the home team (Fed) see the power of the printing press enabling the Fed to hold down long rates through the purchase of billions (and trillions?) of bonds and remind those on the opposing team that frequently the market’s expectations of future inflation are not realized. We have clearly entered a period of DEFLATION as asset values and consumer prices fall and create a period of uncertainty for everyone. The inflation team is underestimating how difficult it is to start a fire when the logs are wet (deflation) and lending is declining not because of a lack of funds BUT because lenders continue to see a decline in the value of collateral they are being asked to use for loans.

The past is not coming back

Borrowing rates are low for those who can qualify for a loan and Congress is desperately seeking the key to jump starting lending from banks. Unfortunately the world is about to learn that patience is needed before anything can turnaround and we haven’t even hit bottom yet. Each day’s news reads the same with everyone wondering how we can put the toothpaste back in the tube instead of realizing that it is time for a new dispenser. Because we only see life from our own experiences those with great wealth desperately want the old times to be repeated because that is what created the wealth the first time. If life was only that simple! The most feared word for most people is CHANGE and we fight and scratch and claw to hold onto our stubborn beliefs even if they are no longer applicable or relevant. Why else would so many have lost so much last year in the stock market and rationalize their losses with the “everyone lost just as much” instead of changing their behavior and vowing always use stop losses. Every week I speak with someone who has lost enough wealth where now they will have to work an extra 10 or 20 years to be able to retire. The fear of winning alone is too great and the majority travel along in packs losing great amounts of wealth as long as it is the company of others.

Gold shines brightly

One of the key lessons in observing markets for over 40 years is to pay close attention when long standing relationships break down and we are seeing that this year from the price action of gold. Normally gold will rise when the dollar is weak and commodity prices are strong with the implication being that inflation is rising. This month the dollar has continued its runaway bull market against almost all major trading partners and commodity prices languish far behind. It never pays to fight a trend and the markets are sending a powerful message that gold’s rise is due to massive deflation and the consumer slowdown in the U.S. Without U.S. demand our trading partners are witnessing a slump in sales and their currencies are falling rapidly. Many countries are seeing a run on their currencies with Russia leading the way as the ruble has fallen dramatically against the dollar. I watched on TV former Russian president Putin’s indignant reaction to a simple question from Michael Dell in Davos, Switzerland and it was painfully obvious he is under tremendous pressure to keep the Russian juggernaut moving ahead despite falling oil prices. It was announced today that Russia’s central bank sold $100 billion of Fannie and Freddie debt but not because it was afraid of credit risk. When you need to raise money fast you sell what you can not what you want and U.S. agency debt is liquid and the values have been steady. The price of gold priced in rubles is hitting new highs daily as it is with almost all world currencies. Gold appears ready to break out to new U.S. highs past the $1000 level as buyers are rushing into what is perceived to be the only safe hedge against a greater credit crises and/or a default on government debt of a major trading nation. This is clearly not the time to ask why because by the time we have the answer the market will have moved substantially higher.

U.S. economy fell in 4th quarter 2008 but 2009 will be worse

This morning’s news that the 4th quarter GDP fell only 3.8% brought few cheers from traders as the stock market (Dow) fell 148 pts to close at 8000 and end its worst January in history. Normally when a market receives better than expected news it rallies as GDP was forecast to have declined by 6.0%. Once we delve into the actual report it becomes obvious that the small decline was a result of IN-voluntary inventory accumulation by businesses that were not expecting the crash in consumer demand. When you are stuck with merchandise after the holiday season you reduce prices to move it off the shelves and that is called DEFLATION. Consumers are spending less and falling further behind in paying off debt and the percentage of outstanding credit card debt paid fell to 16.1% in November The average household with at least one credit card owed $10,728 in 2008 and that number is sure to increase this year.  The 1st quarter GDP number will now show a 6.0% + decline and that will “seal the deal” for those forecasting a rebound due to the stimulus package that should pass Congress and be signed into law by the President around February 17th. The best news for those trying to refinance homes is that the conforming/jumbo limit will be raised to its 2008 level of $729,750 for those in high value areas. (See page 234 of the American Recovery and Reinvestment Act of 2009.)

Are you ready for the future?

The next four years will see a massive transference of wealth from the rich to the poor. Risk taking will be minimized as rewards will not be enough for investors and those with wealth will be hiding aware the President has told the world that 2008 bonuses are “shameful.” We have entered a historic period of socialization for this country and those that do business with the government will be the only ones able to increase their wealth. The old way of making $$$ through leverage and purchase of assets that rise due to inflation is gone and those that keep going back to that well will die of thirst. The savings rate will increase as fear of the future not being a repeat of the past dominates the decision making process of US consumers, businesses and investors. Patience and a willingness to separate the ego from the wallet will be the secret sauce of success for the next four years. The question remains: Do you have the courage to change or will you be one of the record number of unemployed that longs for a return to the past or begging for a government bailout?

2009 Forecast Issue – Part 2

January 23, 2009

       

The new year has brought us a new President and renewed hope for an end to the current economic downturn but unfortunately it doesn’t matter who is leading our country the real answer lies in the above calendar. The 1968 hit song by the Chambers Brothers brings back memories of another era but the words are most appropriate for the current environment. “Now the time has come, there’s no place to run, I might get burned up by the sun (credit), but I had my fun (borrowing).” Those words will ring true for years to come as the patient remains in ICU and expectations of full recovery this year are more about hope than reality. It took years (decades) to build the credit bubble and it will take longer than anyone can imagine before we hit bottom and then more time before we begin a slow grind higher. Get comfortable and pull up a chair for a seat at the longest running saga in U.S. history.For many this year will bring financial pain with asset values declining and net worths devastated as leverage increases the holding cost while income levels decline. Many have made their fortunes in real estate (especially apartment buildings) due to interest rates lower than the rate of inflation and rising property values. Because we only see the future from our past experiences and every price dip in the last 50 years has turned out be an excellent buying opportunity many are eager to line up for what they consider to be the purchase of a lifetime. It’s too bad we don’t live for more than 80+ years as very few people were around in the 1930’s and no one from the long depression that began in 1873. Every society lives on hope when unemployment rises and spending drops but most periods of weakness last only a couple of years as the government rushes in and spends money to support the system from collapse. But what if the money just sits? What if people are so afraid they save instead of spend? Has this ever happened? Of course, just look at Japan for the past 18 years. A 1932 NY Times article shows the same frustration we are seeing today regarding banks unwillingness to loan $$. Why would any bank loan $$ when the value of collateral declines year after year. The big question is are we ready as a society to accept the fact that the past 10 years will not be repeated and the new economy is one that will grow without much debt and assets will rise in price because of added value (productivity) NOT inflation. 2008 was the year where everyone justified losing because is was easier to lose in company than win alone.  Are you ready to leave the pack this year?

2009 will be the beginning of a new era in America where the rich become poorer and those without assets who live on their salaries see an increase in their spending power. When you earn minimum wage and own no real estate, stocks or bonds the price level of necessities become the important determinant of your lifestyle. If your major expenditures are rent, gas, food and clothes deflation becomes equal to hitting the lottery. Your weekly pay check buys more of these important items and gives you money left over to save (in case you lose your job), go to a movie? Or something special that would be impossible when gas was $4 a gallon and food prices were much higher. Rental rates are declining in many areas (Sacramento, San Diego) as the competition from empty houses and other new construction drives down occupancy rates. Economics 101 applies as demand remains constant but supply continues to grow. The rich that own these apartment buildings see their income decline and the value of the buildings fall as personal balance sheets drop to new lows. For those that own “A” and “B” buildings the pain will be intense as appreciation was the main ingredient that enabled owners to pull out more equity each year that could be leveraged into more purchases. “C” buildings generally see their profit coming from cash flow and with tenants that see deflation as a positive development will not be resistant to higher rents each month because they have new savings from the lower prices for necessities. With the majority of Americans benefitting from deflation it will be hard for the new administration to fight for those that live off their wealth and investments. If you are an officer of a public company and receive a big bonus or salary this year I doubt if you will want any publicity. Is this the new socialism? No but we are returning to a time where risk taking is NOT rewarded and debt is NOT encouraged and just surviving becomes the goal of everyone.This year will prove difficult for most state and local governments. Today California reported a 9.3% unemployment rate for December and my 10.0% forecast (see archives) will soon be met with much higher levels later this year. The actual number of people who lost their job in December numbered 166,000 and 653,000 over the last year. Imperial County leads the state with a 22.6% unemployment rate and Merced not far behind at 15.5%. The state may soon have to pay vendors (and legislators) with IOU’s and it will be interesting to see if a market develops for borrowing against this paper. Normally states turn to gambling and alcohol taxes when trying to shrink a deficit but this downturn is different, the average consumer “gets it” and Las Vegas is seeing a dramatic drop in gaming revenue and alcohol consumption.

The next FOMC meeting will be held on Tuesday/Wednesday (1-27 & 1-28) but is receiving very little media attention because the normal role for the Fed (lowering interest rates) is impossible because the overnight Funds rate is effectively at 0.00%. The long end of the bond market is playing a game of “chicken” with the Fed as these rates have increased almost 60 basis points since the beginning of the year. The Fed announced it would buy long-term bonds (and mortgages) and now they will have to step up with action soon which will squeeze many traders that are making a bet on future inflation. Never underestimate the strength of a trend once in motion as Wall Street is littered with the capital of traders that were correct on a coming direction change but being too early wiped them out. The Fed is closely monitoring the inflation component of the long end of the yield curve and as long as the 10-year remains below 1.00%, it will be full steam ahead on the current policy of quantitative easing (purchase of bonds). Gold’s explosive advance this week is more a bet on worldwide uncertainty than a future rise in inflation.

Hopefully the great lesson learned in 2008 for investors is that stop losses are always to be used in all investments. Cash is the best investment for the new year even though short-term interest rates are near zero. The stock market will spend most of the year in a broad trading range with a short term rally expected soon but the market has lost many players and volatility has increased which means only nimble traders should play in this arena and a small percentage of capital should be used. There will be a couple of “back up the truck” ideas this year for investors with the first being a long play on the Japanese yield curve. This won’t be easy for most players as the typical brokerage firm won’t allow small investors entry to this market. The second idea is in the incubation stage and comes from the TIPS arena where we may have a chance to purchase the 10-year at a 3% or better yield. These are great for retirement accounts and not purchased on leverage.

There will be other great ideas during the year and daily subscribers are always alerted immediately. The cost is only $1 per day and you receive the update five nights a week (Sunday thru Thursday) and the best news is that the entire subscription fee goes to Food on Foot which is feeding a record number of homeless and poor each week due to the deteriorating economy. If you want to see a sample past issue, send an e-mail.

2009 Forecast issue – Part 1

January 9, 2009

We begin the year with some important changes that every investor must make to insure profits this year and an increase in net worth. Last year we emphasized that people would rather lose in company than win alone and 99% suffered major loses with the justification that everyone else lost. Why is it that all businesses work hard to never have a losing year but individuals accept poor performance as long as everyone loses as much or more? The key to surviving 2009 is to trade/invest in the market environment you have, NOT the one you wished you had. Throughout 2008 we heard from market forecasters, real estate agents, etc. that the credit crises was limited to only certain areas and most would not be affected by the slowing economy. Much like a business studies possible markets before entering new locations for stores everyone must do an analysis of past results before creating a strategy for this year. If a shoe seller purchases a huge amount of green shoes that don’t sell he immediately lowers the price and gets rid of the unwanted inventory without excuses that the price will come back or I can’t sell because my purchase price is higher or some other emotional reason for not facing reality. But individual investors spent last year frozen as their investment managers created excuse after excuse about the market coming back so that you wouldn’t have to take a loss. If a company used that strategy they would soon be out of business. Because investors bought into the buy and hold for life strategy they were crushed last year and 2009 promises to be a trading range year for almost all markets. This year will represent a pause for the worst economic bear market since the recession that began in 1873. Unless you are willing to be a disciplined trader that is not afraid to buy weakness and sell strength AND use stop losses on ALL positions I strongly urge a 100% cash position. Although everyone is worried about the inflationary implications of the government bail out there is very little chance of seeing any inflation for many years as unemployment is soaring and capacity utilization levels are far below what would cause a shortage of production of goods and services. As I warned two years ago this bear will be long and slow and won’t end until all players have left the arena.

Hold on tight if you have a job

Today’s jobs report showed another rise in the unemployment rate (7.2%) as we will arrive soon at my projected 8.0%. 524,000 jobs were lost in December and this number includes an additional 70,000 from the government’s birth/death model that hopefully will be put in storage by the new administration. December’s losses are sure to be revised higher as almost all revisions in the past few months have been worse than the original figures. The November job loss was revised up 51,000 and the October number down 103,000. One of the best indications of the severity of the employment situation comes from the temporary help services sector which lost another 81,000 positions in December following the 86,000 decline in November. 74.6% of private industries showed job losses and the unemployment rate would have been higher if not for the fact the labor force fell by 173,000 and the labor force participation rate fell to 65.7%. Finally the number of people working part time because they couldn’t find full time work rose 715,000 as employers continue to down size in an effort to stay in business. If the new President is able to create 3 million new jobs (doubtful) as planned it will represent only six months of job losses using today’s data. The individual state employment numbers will be released in two weeks and are sure to show dramatic increases led by California which is rapidly running out of funds for daily operations and closing most state offices on the first and third Friday’s of every month.Consumers are clearly worried about their future and spending on credit has all but ended as Thursday’s report of a $7.9 billion decline in consumer credit for November was the largest on record since data began in 1943. As spending continues to decrease we will see a sharp rise in the household savings rate but that will take many months and lengthen the pain for retail businesses.

2009 – Part 1

My 1st best bet for the year is the Japanese yield curve (2yr-10yr) will widen from its current level of 92 basis points to over 200 as the Japanese economy is the first to rebound from the global credit crises. The Japanese government announced plans this past week to lower the current 40% tax on capital gains for foreign investors to 0.00% effective April 1st. This should increase capital flows but the Bank of Japan will have to deal with the consequences of a stronger yen. Remember that many investment decisions are based on relative performance and Japan may not see a sharp increase in sales and production but it will show relative strength to many other industrialized countries of the world. I will be monitoring this investment idea frequently for nightly subscribers.

The 2nd best investment is more of a trading idea and comes from the land down under, Australia. The Aussie dollar has shown excellent relative performance against all currencies in the past couple of months and will offer excellent opportunities during the year for traders to play a move back to at least 80 cents. Stops must be used at all times to make sure that a winning trade NEVER turns into a losing trade or keeping losses small and manageable.

The 3rd best bet is not yet at the price I would consider “backing up the truck” but should be watched carefully over the next few months. TIPS or Treasury Inflation Protected Securities are a great buy at a 3.00% or greater yield for newly issued bonds with 10-year maturities. These should ONLY be purchased in retirement accounts (due to tax issues) but will be a great hedge against future inflation if held to maturity.

The U.S. economy will see a continuation of the deflationary trend that began last year. With unemployment soaring a wave of street crime not seen since the early 80’s will be an unfortunate consequence of this change in our economic structure. The good news is that deflation of both prices and asset values will hurt the lower income workers less than those who live off income generated by assets. A minimum wage worker who rents a “C” class apartment and has no assets (stocks, bonds, real estate) will see his spending power increase as his fixed wages give him more purchasing power with gas and food prices continuing their decline in 2009. Stock market investors will be hurt as they continue to try and pick a bottom only to realize that we have entered a broad trading range where volatility soars due to a lack of liquidity as a result of many traders and investors retreating to the sidelines due to a lack of funds or frozen investors that don’t want or can’t exit positions with big losses. Money managers have become similar to residential real estate agents who only look for the upside in price action because they don’t make $$$ when prices decline. The only asset that increases in value during deflation is CASH and 2009 will see many de-leveraging because it is required to survive financially. Others will continue to go back to the place that created wealth in the past because we only see the future from our own past experiences. 2008 was a hard lesson for those that would rather lose in company than win alone and hopefully this year will see many investors understand that stop losses must be used on all investments despite the protests of money managers that lost 30-40% of YOUR hard earned assets and retirement funds. Just because you lost less than the S&P last year is nothing to be proud of as a loss is a loss.

I urge all readers to carefully watch the reaction of markets to news this year and NOT focus on the news itself. Bad news that does not lead to lower prices is a market that has discounted the news and is ready to rally. Conversely good news that doesn’t produce higher prices is a market that is ready for lower prices. Most will find the year to be treacherous and only those that are disciplined traders can survive many of the markets that have discounted this year’s economic decline BUT not the deflation of 2011 and beyond.

It will be many years before the U.S. economy hits bottom (January 2013) and then another 5-10 more before we can sustain any kind of economic and credit growth. The federal government will not allow any major financial institution or corporation to go under BUT that will be accomplished by making sure that corporations are not allowed to grow at a rate the government can’t support. This could easily mean lower than normal profits or a break-up as a corporation grows too fast or far. Government regulation and size is the only growth industry for 2009. If you are seeking a job and have any skills in financial supervision or regulation send your resume now. I expect an increase in pay at many levels of government as their need for qualified personnel is at an all-time high and Congress will be very willing to spend money to build government infrastructure.

The Fed

Short-term interest rates hit zero as I wrote early last year (see archives) and Fed policy is now all about quantitative easing and those making big bets on sharply higher long-term rates will be disappointed because the Fed has the ability to print $$ to buy bonds issued by the Treasury. It will be like being in a card game where your opponent can see your cards but you can’t see theirs, you might win a few hands but in the end they will win all of your chips. For those that like to get up early each morning Fed Chairman Bernanke will be giving a speech in London on Tuesday, January 13th at 5am (Pacific Time) and most importantly will be taking questions from the audience. A live webcast can be found at: http://www.lse.ac.uk/. I will be watching live and taping for later analysis that will be sent to daily update subscribers.