Wednesday, October 27, 2010

What would be a good investment in the near term?

Right now is generally a bad time to play in the stock market. The enormous levels of Federal Reserve interference in the markets (as well as either rampant stupidity or malfeasance by most every single financial regulatory body) has resulted in a market where the performance of individual stocks has become highly correlated. On days when the "market" goes up, all stocks tend to go up, largely independent of the fundamentals of the individual companies. For most of last year, the stocks that went up the most were the ones with the worst fundamentals... go figure.

Fortunately, there have been good ways to tell if the market would go up on any particular day. The best strategy was to only buy on days when the Federal Reserve conducted Permanent Open Market Operations (POMO days). That's when the NY Fed creates new money to buy US Treasury bonds back from the Primary Dealers (who are required by law to bid at U.S. Treasury debt auctions). Each POMO day, another couple billion dollars gets dumped into the big banks and has more or less guaranteed an up day for the market. Unfortunately, people have started to notice this and front-run the Federal Reserve... So, it's not as lucrative as it was a while back.

That's what makes the market (as a whole) go up, and since stocks are now way out of whack, in terms of correlation, it makes individual stocks go up also.

There are loads of reasons NOT to buy stocks right now. About the ONLY reason to consider buying stocks right now is if you think that the Federal Reserve will be able to print somewhere north of 1.5 to 2 trillion in new dollars and hand them to the banks which turn around and recycle them into stocks (or more likely, S&P 500 futures market for greater impact).

However, in spite of all the reason that the market should go down, there is one major reason to beware betting that the market will go down anytime in the immediate future -- You're playing chicken with the most powerful central bank in the history of the world, and it is intent in debauching the world's reserve currency. If this strategy actually worked, Zimbabwe and the Wiemar Republic would be held out as examples of monetary genius -- instead of examples of how to completely and totally destroy the middle class and starve anybody on a fixed income.

Here is my take on why one SHOULD NOT be buying stocks (or bull ETFs or mutual funds at this time):

  • Horrific corporate balance sheets that US companies have -- all that "flush with cash" BS ignores the debt they had to sell to get the cash and the way that the items being depreciated aren't getting repaired or replaced.
  • The finance sector would have ceased to exist in 2008 and be replaced by entirely new banks if Congress hadn't extorted FASB to allow the financial sector to carry somewhere north of $3,000 billion in mortgage related assets at mark-to-model/unicorn/fantasy levels rather than mark-to-market levels. There is a market for EVERYTHING if you lower the price sufficiently far. Instead of banks actually having MORE than sufficient assets that can be sold (at any given time) to pay off their liabilities (which just happens to be a key tenant of the Federal Deposit Insurance Act and the only reason why such a little Deposit Insurance Fund could possibly backstop the insured deposits of US banks), the banks are almost universally under-capitalized on a mark-to-market basis. Every single large one is. Most of the smaller ones are. Almost every single Friday for the past 18+ months we get another example of this when the FDIC takes over a bank and has to incur a hit to the Deposit Insurance Fund or enter into a loss sharing agreement with the purchaser. If the banks assets could actually be sold on the market for what the bank claimed they were worth, there would be no loss.
  • Consumer sentiment surveys that for the past 2 years have shown that people's assessment of their current situation is "lousy", but they're hopeful about the future (eventually the hopium wears off and people start to notice they've had flat to negative real wage growth for a decade during which prices of the things that they really actually need (food and energy) have gone up),
  • If unemployment were counted today the way it was counted up to the early 1990s, the unemployment rate is in the 22% range. -- which is awfully close to the 25% it hit in the Great Depression.
  • 40.7 million people in the U.S. are receiving food stamps. In the Great Depression you had bread lines. Now, in the Greater Depression, you can see the same thing by going to WalMart at 11:45PM on the last day of the month (food stamps charge cards recharge at midnight on the first of the month). There's our breadlines.
  • The rampant fraud in mortgages from origination to securitization to foreclosure. This is probably going to kill no small portion of the banking sector all by itself. With lawsuits and criminal charges (every single instance of a falsely sworn affidavit is an instance of perjury -- and typically a felony that packs a handy fine) on the foreclosure front, tax claw-backs from counties and states (MERS was essentially a way to let "Wall Street" (I hate that term) transfer mortgages around without actually having to refile each time with the county and state land offices -- the same counties and states that have budget holes that make MERS self-proclaimed $2.4 billion in tax and fees savings look awfully appealing), and finally pushback suits from MBS investors who were sold securities that contained massive violations of reps and warranties (to the tune of 80+% for at least two of the MBS sets that Deutche Bank sold) that the bank's execs KNEW for a fact were violations (Citigroup's chief underwriter has testified that over 60% of the mortgages sold in 2006 were defective, a level that rose to 80% in 2007).
  • At some point, it seems inevitable that the SEC will be forced to investigate the dealings of the big banks. There's simply too much testimony already extant indicating that the fraud at mortgage origination and securitization time was well known by senior management.
  • Ditto for Sarbanes-Oxley liability for the senior execs.
  • In FY2010, the U.S. Federal government spent $3.4 trillion and the total borrowed by the U.S. Treasury increased by $1.6 trillion. Almost HALF of federal expenditures were borrowed money. That's either ALL of the social services (medicare, medicaid, and social security) or more than ALL military spending. For 2 years now, the Federal government has propped up 12% of the GDP... that can't possibly continue forever, and it hasn't "primed the pump" on an actual recovery.
  • Over half a year of consecutive retail outflows from equity mutual funds. People are either pulling their money out because they need to eat, or because they want to "take profits," or because they've lost faith in the market itself.

None of that paints a pretty picture of the immediate (or medium term) outlook for the US economy. But wait... there's more... :)

The rise of high frequency trading has created a stock market where we have volume (and not much of that to be honest) but very, very little liquidity. The flash crash on May 6 demonstrated that the actual organic bid (an investor looking to hold onto the stock they bought for at least a minute or two) was at least 10% below the market levels at the time. When the HFT engines shut down, the market mostly ceased to exist. With HFTs simply opting to not participate "on the way down," the market suffers significant loss of liquidity at a time when it is needed most. Since the May 6th flash crash, there have continued to be flash crashes in individual stocks multiple times a week.

Over and over again the market is demonstrating that the exit door is very narrow, and the doorway is very sharp. If you buy a stock with the idea that you can always sell it if the price starts to fall, you could be in for a rude shock.

All that said, I actually have some ETFs and mutual fund positions. Every single one of them is bear oriented. And every single one of them is currently below water -- that's the risk of playing chicken with the central bank.

I don't really know how the market will play out in nominal terms. In real terms however, it, like the rest of the U.S. economy faces the enormous headwind of a credit bubble collapse. And, like all credit bubbles that have collapsed before, this one too will bring about a depression since we were unwilling to have the smaller recessions necessary to clear the bad debt earlier.

The good news is that you can see it coming -- if you look in the right places. The bad news is that those responsible for helping regular folks like you and I see this coming are intent on hiding the full extent of the problem from us.

Whenever you see an article or a news program that talks about the intentional filing of falsely sworn affidavits in court as a "document problem" or a "technical problem" rather than what it is, perjury and fraud on the court, you can know for a fact that you have found yet another person who's telling you that's rain falling on your foot.

I get most of my information reading the work of people who have been writing about the mortgage fraud and securitization fraud, and SEC malfeasance and FDIC failure to enforce the Prompt Corrective Action section of the Federal Deposit Insurance Act since back in 2007. But, that means spending a lot of time reading some rather detailed articles from a handful of sites on the web, and it took probably 3 months to even begin to get a handle on the terminology involved -- which is sorta far removed from software development.

The mainstream news media probably can't afford to go into detail, but they could start calling a spade a spade. When the head of our central bank manages to miss the biggest credit event in the past 70 years, maybe it's worth wondering out loud if he's a moron (since a large number of people saw it coming and explained how and why), or he's complicit in creating the problem. Instead, we got some more, "this guy is smarter than all of you so you'd better listen to what he has to say" treatment.

Here are the aggregators and commentators that I read (beware, the first two frequently contain "salty" language and course imagery and metaphors):
Global Economic Analysis

I've tracked others off and on over the past few years, but those guys seem to consistently cover all the major points -- including several that I really lack the expertise to follow.

Naturally, nothing in this post is investment advice. I'm not allowed to give that. Most things in this post actually constitute "don't invest" advice. I think I'm allowed by law to suggest that.

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