Never, ever fight the Fed …

Even though many “experts” told us that a bet on higher long-term interest rates in 2009 was close to a sure thing, Fed head Bernanke showed us today why it never pays to fight the Fed. For weeks I have warned daily update subscribers that the Fed would step up and defend its lower interest rate position. Today’s announcement that the Fed would purchase an additional $750 billion of mortgage backed securities and $300 billion of Treasury notes sent those betting on higher interest rates running for cover. The FOMC also announced the Fed would concentrate Treasury purchases in the 2-10 year sector of the yield curve which should help to widen the spread between the short and long end. Longer term bonds and TIPS will be purchased but not in the same quantity as the shorter end notes. The $300 billion is about 20% of the anticipated Treasury borrowing of these notes this year but could easily be expanded later in the year if Mr. Bernanke feels he needs to use more ammunition. For homeowners it insures that borrowing rates will remain low for many years. If you have a high rate mortgage please do NOT rush to refinance as the Fed has made it clear that mortgage rates have much further to fall later this year. Today’s announcement confirms the Fed’s war against De-flation will be won no matter the eventual cost (massive deficit) to the nation. The key quote from today’s FOMC statement was: “The Committee sees some risk that inflation could persist for a time BELOW rates that best foster economic growth and price stability in the longer term.” The Fed is reacting to its greatest fear and screaming to the world that it will print $$$ for everyone to spend and invest until we see an inflation rate above current levels and that won’t be easy to accomplish. After the Fed’s announcement, all financial markets immediately rose with the exception of the dollar which was pounded by fears this new round of quantitative easing would eventually lead to a resurgence of inflation. Mr. Bernanke’s latest moves are clearly meant to spark a return to inflation but I’m not sure he will be successful immediately and the inflation he desires is only in the 2-3% annual range not the double digits we saw in the early 1980’s. The dollar’s weakness is also a by-product of the Fed’s move as an increased supply should offset recent demand for the U.S. currency as the safest place in the world. The U.S. stock market presents a different problem that won’t be solved soon. Lower long-term interest rates will increase the demand for home mortgage refinances which gives consumers more spendable dollars. But consumer confidence is at lows not seen for decades and any extra dollars are being saved not spent despite the best intentions of the federal government. The stock market’s initial reaction to news is often in one direction and after more thought changes to the opposite. I have to wonder if stock traders are considering the fact that the Fed Chairman’s dramatic move is because he is convinced the economy is NOT responding to the initial stimulus package and needs more help. The Fed did NOT say it was buying equities and the assumption that the savings from lower borrowing costs will be used for stock investments might not be correct. Investors shouldn’t make the mistake of confusing an intermediate term rally with the end of a bear market.

Today’s Fed action shows that interest rates are now a function of government intervention more than the future expectations of inflation and economic growth by investors. This is something we haven’t seen since the 1940’s and remembering that we only see the future from our own past experiences many will be slow to change their style of investing. The 3.00% level on the 10-year Treasury is now the demarcation line that should be used by investors to buy with impunity knowing that the Fed has created a wall that will serve as a backstop for anyone buying long-term Treasury notes. The good news is that homeowners and other borrowers can be assured lower rates for the foreseeable future and as a result there is NO need to rush in and refinance for fear of higher rates. The bad news is that it is never good when market prices are set by government fiat and not the natural forces of supply and demand. The repercussions of this will not be felt for years but a price will be paid with higher spreads for U.S. Treasuries due to credit concerns from foreign investors.

The bottom line is that we now have another “back up the truck” investment opportunity courtesy of the Federal Reserve. Using the 3.00% level on the 10-year and 1.00% on the 2-year investors can purchase Treasury notes on leverage as long as you borrow at the overnight repo rate currently at 0.25%. The amount of leverage will depend on your tolerance for risk but with the Fed’s announcement it is highly unlikely they will raise the overnight funds rate this year or in 2010 and the Fed wants everyone to follow their strategy and make money which theoretically will be spent thus giving the U.S. a much needed boost. I agree that it is an incredible opportunity for investors to make $$$ at the expense of the US government but am skeptical that investors will spend and not save until they are sure of a sustained economic rebound.

Daily update subscribers will be alerted when the 2-year and 10-year yields rise to just under the “key” 1.00% and 3.00% levels that will represent the best investment in 2009/2010. It never pays to fight the Fed and today they are paying you to invest along with them, it’s time to get off the sidelines and take advantage of this historic opportunity.

More dark clouds with little chance of sunshine this year

Only 15 days until my first interest rate/economic forecast class of the year that will be held on Tuesday, March 24th and is sure to sell out. The class will be held from 6-9pm and seating is very limited. Registration details: http://www.earlywarningwire.com/PDF/interestrateclass2009.pdf

Friday’s jobs report was the disaster that was advertised and is another reason it will be years before we can rebound from the worst economic crises since the 1870’s. The unemployment rate soared to a 25 years high (8.1%), 651,000 jobs were lost in February, January and December were revised down another 161,000 and temporary jobs declined 78,000 last month. The seasonal adjustment for February (birth/death model) added 134,000 jobs (how could that be?) and made the real loss closer to 1 million jobs. In the past five months the net loss is near 3 million and according to my estimates March could see over 900,000. This is no longer a recession but bordering on the worst economic crises in our history and shows no signs of ending. Spend a couple of minutes with the following chart and you will see why the U.S. unemployment rate is headed for 10%+. The number of people working part time jobs because they can’t find a full time job has risen to record highs and the only category showing growth is the government and health care industry. The good news is that because of population growth the current decline in jobs (-3.1%) is not yet as bad as we saw in 1957 (-4.1%) and 1948 (-5.2%) but fpr those out of work the pain and fear increases daily. Unless the government is planning on hiring hundreds of thousands to help oversee its various bail out plans it will be impossible to overcome the decline in private payrolls this year. Less jobs mean less spending and less spending creates fewer jobs and that is why the “negative feedback loop” that I have been writing about for the past year is so dangerous and difficult to end once it picks up momentum. If you are looking for a job Fed Ex is offering free printing of up to 25 black and white resumes on March 10th.

Will the federal government allow a BIG bank to fail?

Sunday, Alabama Senator Richard Shelby told a national television audience that “I don’t want to nationalize the big banks, I think we need to close them.” Mr. Shelby’s opinion is in the minority but might find a few friends in the next few months as more $$ is injected into banks without any noticeable increase in lending.

Friday Kansas City Fed President diverged from his fellow Fed members with a speech titled “Too Big Has Failed” and addressed the question of whether the government best use of resources is too save institutions whose failure might cause a ripple effect in the economy similar to the Lehman Brothers collapse in 2008.

The country is not suffering from a liquidity crises and banks have ample money to lend but with asset prices declining why would anyone want to borrow to buy something that is declining in price and why would a lender want to take a risk that 70% LTV (loan-to-value) becomes 100% LTV in a couple of years. The banks are NOT the problem, it’s the lack of confidence that prices will rise in the near future. Once DEFLATION becomes part of every day thinking consumers delay purchases waiting for lower prices and investors remain in cash knowing better opportunities will arrive at a later date.

Non-bank mortgage lenders days may be numbered

U.S. House Financial Services Chairman Barney Frank is proposing that mortgage lenders be forced to keep a portion of every loan they sell. This could have HUGE ramifications for the residential lending business that has operated with far less capital than it will need if this proposal becomes law. Mr. Frank is a very powerful congressman and almost always gets his way. I alerted daily readers to an article in the Boston Globe two months ago in which he said the conforming/jumbo limit would be part of any stimulus bill. If you are involved in the mortgage arena you must read this article because there will be very little opposition in Congress to this idea and unless the government is going to give the lenders the capital needed to hold a portion of these loans banks will soon be the only originator of mortgages.

The housing crises is not even close to ending according to a story in Sunday’s Washington Post about FHA loans which appears to be the next disaster for our government that wants everyone to buy a house, borrow to buy the house and then assume the homeowner will make on time mortgage payments. Recent statistics show the number of borrowers failing to make a single payment before defaulting has tripled and is running at a rate higher than the loans are being issued. Another must read for anyone who is hoping that the bottom of the economic contraction is near.

U.S. stocks and a long-term view

Last week President Obama told the country that if investors have a very long-term view then stocks could be a good buy. Not exactly a ringing endorsement of our capitalist system. The only investors with a long-term view today are those that are “frozen” in positions that have fallen 50% or more and failed to use stop losses. Many “experts” pointed out a few months ago that stocks were at a historic point offering incredible opportunity because the dividend yields on many solid companies were now equal to or higher than those on long-term Treasury notes and bonds. Because dividends are not guaranteed many of these dividends have been cut to near zero as corporations realize the world isn’t the way they thought it would be this year. Most business television programs have aggravated a bad situation by constantly interviewing bullish analysts and asking them about their best bets for an upside market. If these analysts bought their own recommendations they would be in line for a government bail out. Hope and denial have become the most popular strategies for those who remain invested and dark days are ahead for the brokerage business. Traders will be using low cost firms to go in and out of the market on a daily basis while “structured products & hedge funds” that were sold to investors the past couple of years become unwanted at any price by individuals that would rather remain in cash under their mattress or in insured CD’s. Commissions on these instruments are virtually zero and many who have made fortunes in the past decade will leave the business searching for better arenas. Unfortunately many will hang on with the excuse many mortgage brokers used a couple of years ago when the business turned down: “I don’t know where else I can make this much money.” They will soon learn they can’t ever make this much money again and be forced to leave or end up in a food line.

Time, time and more time

The amount of damage to the U.S. economy, stocks and other asset values in the past year has been extraordinary and taught many a lesson they will never forget: History does repeat but not when it is expected. Many investors followed the trend of leverage, inflation and seeing the immediate future from their own past experiences. It will be a decade or more before most recover a portion of their net worth and confidence levels. The government is trying to use short-term solutions to fix long-term structural problems and sadly that will only stretch out the healing process. Helping homeowners lower their payment when they don’t have a job is a waste of government funds. Homeowners that have little or no equity are better off renting to preserve their hard earned savings. My solution would be for the government to purchase all of the mortgages that are selling at a discount (60 cents on the dollar?) and sell them back to individual homeowners at that price and then finance the purchase of the mortgage through Fannie and Freddie. If you had an opportunity to buy your mortgage at a discount wouldn’t you be interested? This plan will immediately give homeowners increased equity and a reason to make monthly payments at current market interest rates.

Investors should be in 100% cash or insured CD’s or T-bills and not looking to buy the next dip in the stock market. If and when stocks bottom, there will be plenty of time to take part in the upside action. Bear markets never end until the majority of players stop asking “Is this the bottom?” and this one will be no exception. I wonder if the bottom will appear when one of the business television shows goes off the air because of a lack of viewers but in the meantime readers should remember that 90% of stocks decline in a bear market so why would anyone want to buy. Hasn’t that been shown to be a sure way to guarantee a decline in your net worth?

Can you afford not to be at my class on March 24th? I will discuss my outlook for the remainder of 2009 and give everyone easy to use tools to help guide them through the maze of opportunities available for their savings.

The future looks dim for a world that is a ball of confusion

My first interest rate/economic forecast class of the year is only three weeks away and will be held on Tuesday March 24th and is sure to sell out. The class will be held from 6-9pm and seating is very limited. Registration details: http://www.earlywarningwire.com/PDF/interestrateclass2009.pdfCan you afford not to attend? Did your financial advisor warn you two years ago of the credit crises, economic contraction and deflation? Did you use stop losses to exit from stock and mutual fund positions? Are your investments in a state of “frozen shock” and hope is your only strategy? How many newsletters leave all of their past issues on their site and encourage readers to review? 2009 will be a very difficult year as jobs disappear and asset values continue to plunge but assuming that you can’t change your strategy will insure a dismal financial future. Three hours on March 24th will change how you see the remainder of the year; do you have the courage to hear the truth?

The picture above clearly shows the situation the world faces today with the overwhelming presence of deflation represented by the sumo wrestler versus the much smaller U.S. government and consumer trying so hard to push back. What so many believed was just another ordinary business has turned into the most severe contraction since the 1930’s and more similar to the long depression of the 1870’s. Every economic statistic is worse than the previous release and one of the problems that we have now that didn’t exist in the 30’s is the never ending optimism from the pundits on business television. Hope is an expensive strategy that has made investors believe the bottom is near instead of using stop losses to exit positions that have now all but ruined many people’s retirement plans. The U.S. stock market has fallen 55% since the top on October 9, 2007 and the primary topic discussed in the media is what to buy for the next rebound. These networks are more concerned with their ratings than helping investors cut their losses and worry that if they suggest investors go to 100% cash (always a good strategy in a bear market) they would lose viewers. Because we only see the future from our own past experiences it is not surprising that so many are “frozen” and have rationalized that losing in company is better than winning alone but in a few years the financial pain from a lack of decisive action will hopefully prevent these people from making the same mistake again. There will be rallies that have everyone convinced the worst is over but the reality is that it will be years (2013) before we hit bottom and many more before we can begin a sustainable recovery. It took decades to build up the leverage that has caused the problems and the unwinding will be a longer process than many want to endure. The stock market today pierced the 50% retracement point for the advance that began in July 1932 and ended in October 2007. An intermediate term rally is overdue and investors should use it to sell positions and not try and hold on until a breakeven point is reached. Bear markets always give investors opportunities to head for the exits but the rallies are accompanied by those “experts” who tell us to remain seated for a ride back to the promised land of profits.

Ball of Confusion

Markets can handle bad news as long as it is clear and concise but confusion is the big enemy and sellers appear quickly when the sky becomes cloudy. Deflation has taken over the world economic landscape and investors are slowly realizing that debt and leverage accelerate the decline in asset values. Banks are reluctant to lend despite having funds supplied by the federal government for loans because the underlying collateral continues to decline in value. If you loan someone 70% of the value of a house or building and the value goes down by 30% you have very little margin for error. Unfortunately the private sector caused much of the current credit crises and now must rely on government assistance. The government’s biggest asset is its ability to print an unlimited amount of money but its biggest liability is in the execution of effective strategies that will help business get back on its feet. It can lower tax rates for business as an incentive to take the risk that is needed to create jobs and profits that will be required for an economic rebound. The message coming out of Washington last week that a balanced budget and higher taxes are coming soon has the stock market in a total state of confusion. On the one hand the government is trying to help with bail out money but increasing taxes and limiting deductions creates a message that has investors confused and reminds me of the 1970 hit song by the Temptations called “Ball of Confusion.” Many of the verses could easily be written today. “Vote for me and I’ll set you free. Politicians say more taxes will solve everything. Where the world is headed, nobody knows. Fear in the air, tension everywhere, Unemployment rising fast. People all over the world shouting ‘end the war,’ ball of confusion, oh yeah, that’s what the world is today.” Investors and consumers are confused as the economy heads south with prices falling and my theme for 2009 remains that the rich will get poorer and the poor will get richer. If taxes are raised in a deflationary environment the incentive to take risk will be extinguished and the U.S. economy will suffer a decade or more of annual declines in activity with very little if any growth in wealth. I wonder if that is not the new President’s intention as he seems to be focused more on creating a safety net for those suffering and very little on what is needed to create the engine of growth needed to create private sector jobs. Could we be looking at a lost decade similar to what Japan saw in the 1990’s?

Important speeches that are must reading for all readers

Monday, FDIC Chairman Sheila Bair addressed a Washington audience of International Bankers and gave insight into where the government is headed in terms of more possible bank bailouts. The key quotes were: “I don’t see the U.S. government operating a large institution (Citibank?) for an extended period of time. I would be surprised if the FDIC had to step in as conservator or receiver of a large, systemically important institution. (Takeover by another bank?) The main hurdle is that there’s no clear process for resolving a large financial holding company with multiple affiliates. We have a process for dealing with large banks, but not financial conglomerates. There is a very real question of whether our current funding mechanism is adequate to deal with the failure of a very large institution.” She concluded her remarks with a truth that everyone must realize and the sooner the better. “If you’re looking for a quick fix, you’re not going to get one. It’s going to take time and patience.” Americans have not been a very patient society with its buy it now and pay for it later attitude. This has ended and the head of the FDIC told us it is going to take a long time to fix the broken banking system. Although the President believes the problem can be fixed through more bank lending he will learn that the real problem is declining asset values for the assets that make up the collateral for the loans. In the end the government is going to have to guarantee the banks against losses or they won’t loan enough to get the economy growing again.

The other important speech given on Monday was by the Comptroller of the Currency John Dugan who was warning the nation three years of the impending credit crises. He criticized banks for decreasing loan loss reserves as the economy recorded record profits. These reserves are supposed to act as a counter cyclical force for banks but because this recession/depression is not cyclical but secular the banks and examiners weren’t prepared for the turndown in prices and increase in delinquencies by borrowers. Banks are now using very conservative assumptions in their underwriting process for new loans. This is another reason why it is doubtful we will see an increase in lending anytime soon. Borrowers have also begun to change spending habits as incomes decrease and fear for their jobs increases every month that the unemployment rate sets new highs. The savings rate rose to 5% in January after spending many years near or below zero. Consumers realize their world has changed and we must wait for investors to see the world is not as they need it to be (inflation) but the way it will be for at least the next 10 years.

Interest rates

Long-term interest rates continue to hold in their 2.50-3.00% range (10-year Treasury) but as inflation expectations decline it will be easier for these rates to go back to lows seen earlier this year. The Fed remains the buyer of last resort in the Treasury market but would rather wait on the sidelines hoping that investors realize inflation is not a worry for many years and that positive Treasury rates with negative inflation (deflation) create a very high “real” rate of return. The dollar continues strong against all currencies except the Japanese yen and foreign central banks continue to see the U.S. as the safest place for funds and receive a decent return (including currency appreciation).

Bottom Line

The world has changed and the real question is have you changed with it? The bear market in stocks needs a breather but has already done enough destruction that most investors will hide in the safety of CD’s and Treasury bills for the next ten years. Opportunities do exist but they are centered around assets that rise in value during a deflationary period and real estate is NOT one of the chosen few.