Four more questions that must be answered

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April has been a month for questions with four asked at Passover and then this week Fed Chairman Bernanke asking four related to the ongoing economic and credit contraction. Today we ask four questions that are on the minds of every person that must make crucial decisions this year regarding their personal finances, jobs and investments. Because we only see the future from our own past experiences the past 18 months have caught the majority by surprise and caused a massive loss of wealth cushioned slightly by the fact that most would rather lose in company than win alone. Only those that are willing to change their way of thinking will be able to profit in the next four years as we continue to travel on a path not seen in our lifetime.

1) Has the stock market begun a new bull market that will lead to highs surpassing those seen in October 2007?

The S&P rally that began on March 10th has lifted investors’ confidence levels and wealth by over 28%. At this point it is only a strong intermediate term rally climbing a wall of continued bad economic news. Today all 50 states reported their unemployment rates and 10 states rose to a level of between 9-10% while 8 states are above 10% with Michigan leading the nation at 12.6%. If jobs are not being created it will be difficult for profit growth and a continuation of the recent stock market rally. Bulls are seeing the recent economic decline slowing and hoping that we have reached bottom and the bears are in hiding for a few months waiting to strike again later in the summer. The memories of last year’s massacre won’t be forgotten for many years but in reality we are probably in a broad trading range where rallies that appear to be headed higher should be sold and declines that remind us of last year can be purchased. The average investor should stay far away as there are much better opportunities with less risk in government guaranteed debt instruments.

2) With massive government borrowing isn’t it a sure bet that long-term interest rates will move much higher?

“Never fight the Fed” is one way to stay in the game of investing. $2 trillion of government borrowing has forced the Treasury to issue a massive amount of Treasury bills, notes and bonds every week. The fear is that this debt will eventually go down in price and up in yield as foreign investors keep money in their own countries or gold. During the oil crises of the 1970’s the consensus view was that Middle Eastern countries would liquidate Treasury holdings sending our interest rates soaring at a time of economic stress. It didn’t occur because there is no place safer in the world than the U.S. and probably no market that could handle an influx of trillions of investment funds without a major price distortion. The Treasury is selling notes and bonds but the Federal Reserve is buying these same securities creating a tug of war between those betting on higher rates and the Fed intentionally pushing down rates as they attempt to help mortgage borrowers and consumers lower their monthly payments. It is the equivalent of playing in a poker game where your opponent continues to lose but somehow has an unlimited bankroll. Eventually a lucky hand and he wins the growing pot, it doesn’t ever pay to fight the Fed and they will do whatever is necessary to drive long term interest rates lower.

3) The housing market seems to be stabilizing, is the worst over for real estate prices?

Unfortunately the worst bear market in history is far from over and even the most optimistic agents are learning that in order to survive you must be objective in your analysis. Three years ago I wrote (see archives) that we would not experience a normal cycle but a period that has never been seen before in history. Because real estate prices don’t trade on a centralized exchange (like stocks and bonds) price discovery takes much longer and will stretch this bear market for at least another 4 years. The inability to sell short (bet on lower prices) prevents buyers (who would be covering shorts) from entering bids under the market as occurs daily in the stock market.

The commercial real estate market is in the early stages of its own “mother of all bear markets” as it does not have the same political constituency as the housing market. The securitized lending done for most commercial transactions is in the deep freeze and it will be years before banks have the capacity (capital) to refinance many of the notes coming due in the next 24 months. Retail centers are the hardest hit as job losses cut consumer spending and rents have begun to plunge taking property values down below recent purchase prices. With high leverage that was normal a few years ago most owners will soon have no equity and non-recourse loans will allow them to walk away. Unlike residential lenders commercial lenders are not prepared to take back shopping centers, office buildings and land and will soon need to hire many out of work bankers to help manage and liquidate the properties.

4) Inflation and the U.S. economy

Inflation is NOT caused by an excess of money being printed by the central bank (Federal Reserve) if the $$$ isn’t being used in the economy. Today’s Fed H.8 report shows total bank credit FELL $62 billion last week and is $278 billion lower than it was in October 2008. No economy can grow if credit is being extinguished and this is why the Fed is printing $$$ and using it to buy Treasury and mortgage securities hoping the $$ goes into the banking system. Thursday’s Fed H.3 report clearly shows the $$$ is going back to the Fed for safekeeping because banks don’t want to lend money where the value of the underlying collateral continues to decline (real estate). It’s called pushing on a string and the more the Fed prints the less it is being used by banks to lend to businesses and investors. Banks claim they have money to lend but borrowers aren’t interested because who would want to borrow $$$ to buy an asset whose value is falling? Capacity utilization is under 70% and falling rapidly giving plenty of room for producers to manufacture goods without raising prices. Monthly job losses are increasing and the competition for jobs is fierce with many accepting lower wages to maintain current employment. Everything points to a continuation of DEFLATION and a slowing economy.

The remainder of this year will see periods of what appear to be the beginning of a new trend but in reality is nothing more than a mirage as too many are seeing the world as they need it to be and not the way it is. Survival and prosperity will only come to those not afraid to change their way of thinking and having the courage to separate from the pack. The stock market rally may continue for a few months increasing confidence levels among many investors and consumers.

The big question remains: Do you have the courage to win alone when everyone else is losing? Or do you need the comfort of knowing you have plenty of company when you making decisions that have proven wrong in the past 18 months? Stop using the excuse that no one saw this crises coming….and make the decision to change. If not you will be repeating the same mistakes again and again over the next four years.

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