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):

www.zerohedge.com
Market-Ticker
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.

Bailout blues

It has been a while since I could stand to write about the economy. I've continued reading and paying attention, but the amount of "stupidity in the system" is just painful.

The US has put the taxpayer on the hook for $7.7 trillion dollars, so far, as part of the bailout. That's half of the estimated 2008 GDP. It's probably a bit over half of the GDP for 2009.

The scary thing is that we've still got a long ways to go. Expect rising unemployment until 2010. With that will come more corporate bankrupcies as the US economy is forced to give up the asinine notion that it can be consumer driven. That only works as long as folks are willing to lend you money. We're coming to the point where nobody is that stupid.

Well, nobody, but the Federal Reserve and the US Government.

The Federal Reserve today put together a $200 billion dollar package of financing for supporting consumer finance (credit cards, student loans, auto loans, and Small Business Admin loans). The Treasury will be backstopping it from the $700 billion TARP bailout. The goal seems to be that if the central bank and the US government can get enough debt off the books of banks, things will be okay.

The problem is that much of that debt is going to default. Who would you rather have holding bag when it does, Citigroup, or your nation's central bank?

That's a trick question. You don't get a choice. haha :(

So, hunker down. At this point, the real question seems to be when the US or the Fed are going to be forced to default or effectively default by firing up the printing presses.

Happy Thanksgiving.
Be glad you don't live in Iceland, or Russia, or Europe, or China. Things will be even worse there.

Crazy times

It's 1:00AM, that must mean it's time for a new blog post.

I've been watching the Asia/Pacific markets move up today. I so don't get what is happening in their markets today and the U.S. markets last week.

The engine of the world economy for the past two decades has been the American consumer. We buy stuff. Even when times were bad, we kept spending more money, carrying the global economy through a couple of downturns and recessions. We were the unstoppable juggernaut.

We did this by eliminating our savings (from 10% to 0 and occasionally less than 0), tapping into the equity in our homes (by HELOCs and refinancing), and by running up credit card balances.

But the engine has died.

In September, consumer spending fell by .3% in the U.S. That news came out last week, along with the most dismal report on consumer confidence ever.

Any bets on how the October numbers will look? They won't be better.

I'm trying to understand the thinking that has gone into the purchases in the market last week. There has been precisely zero new information indicating that the economy is going to improve anytime in the near future. In fact, every single bit of new information has been negative. Note that I'm not considering more debt (at the corporate level, or cheaper debt to banks a good thing -- that's like using bad tequila to kill a hangover).

I suppose that psychologically, the upturn in the market is driven by hope. A great many people hold out hope that the worst is over, that their 401(k)s and IRAs will start growing in value again. The baby boomers are going to need their money soon enough that they might be all but dependent on a market recovery coming soon. With all the media coverage asking whether or not the market has "found a bottom", perhaps people are expecting a V shaped market recovery.

I suppose that would be a comforting thought.

But, here's the hangup I have.

What exactly is going to drive the business growth that would warrant higher stock prices? Every step of the economic chain is either stressed or broken. I fully expect that after Christmas we will ring in the New Year by watching company after company go bankrupt. While these bankruptcies are necessary, the opacity in our financial markets today mean that it is nearly impossible which third-parties will be injured in any given corporate bankruptcy.

Market growth is supposed to be driven by a reasonable expectation of earnings growth -- not by the near certainty of unexpected negative balance sheet events.

For a graphical view of last weeks economic news, check out:
http://econompicdata.blogspot.com/2008/10/econompics-of-week-103108.html

This has been an interesting week to have a bear-structured portfolio. If it wasn't for my near certainty in the economic mess heading our way, I would probably be pretty worried. Instead, it's been a good time to pickup a bit more "bearish" holdings on the "cheaper." If I'm wrong, I'll be one of those funny guys who lost money as the market got better.

Hooray, more debt!

Maybe I can't tell good news from bad.

Honda Motor Co. reported a 41% drop in quarterly profit; quite naturally and rationally investors drove the price of their stock up 16%.

On Monday companies sold $232 billion in new debt. This is ten times the normal volume of commercial paper, (a fancy schmancy name for 'corporate debt') issued per day. $67 billion of the debt was longer term issues -- due to be paid back after mid-January.

If you were a thinking person, you might be asking yourself who in their right mind would be interested in buying long term corporate debt given the current state of the economy. You would think long and hard about the odds of getting paid back given that it is really, really hard to tell who is solvent and who isn't these days.

Well, that's what a thinking person would do. As it turns out, YOU bought about $60 billion of that $67 billion in longer-term debt! How is that for irony?

"Wait just a minute here!" you say. You're not a moron, there's no way you would do anything so obviously foolish. Sorry. You see, the Federal Reserve just got their Commercial Paper Funding Facility going, and took on a bunch of debt. Congratulations, now doing your part.

Economists and market strategists are doing all they can to make sure we know that companies going deeper in debt is a good and positive thing -- key to helping the market and economy turn around. I think my favorite quote is from Adolfo Laurenti, a senior economist at Mesirow Financial Inc.:

"That's the very first really good news in quite some time. It's probably something the government can do and the normal investor would not otherwise do."

Do ya think?! At no point could I find anybody asking why this might be the case. Why would a normal investor be uninterested in loaning money to struggling businesses that refuse to fully disclose the condition of their assets and are dependent on loans to survive? I'm sure the reason will come to me.

That wasn't the only good news though. All day long investors were looking forward to the Federal Reserves much anticipated rate cut. Expectations are for the rate to be cut to 1%. This will make credit cheaper. Which, considering we are in the midst of a rather serious credit deleveraging process, is sort of like discounting salt water sales in the Sahara.

I predict that the Fed will announce a rate cut to .75%. I think they'll do this for the psychological impact.

The problem in the market is that somehow or other we have started to go through a period where reason is breaking out in all sectors. Maybe if the Federal Reserve can jolt us enough, we'll be able to get back on the credit-expansion bubble and things will be jolly all-round again.

It wasn't all bad news though. The run-up of markets around the world presents great opportunities for short sellers (through short sales, call options, short ETFs, or bear mutual funds) to pick up even more gains.

The pickings will be even better if this rally can last through the end of the week. I don't think it can, but there's hope. If nothing else, there are literally millions of people who are determined to have a "V" shaped bottom to the market. They're wrong, and they'll pay for their ignorance... Maybe they can pay you.

http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aKbsT.CRaT1Q

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aYnjVgzH3ADA

The Chin -- It blocks the punches!

In an email conversation today, the question of when to start buying equities again came up. Warren Buffet's advice to be, "fearful when others are greedy and greedy when others are fearful" was cited and that's good advice. That's what Mr. Buffet had to say October 16 in an op-ed piece in the NY Times: Buy American. I Am.

I start with that because it's a good counterpoint to the rest of this. Mr. Buffet is undoubtedly smarter than me -- so pay attention to his advice. :) In the long term, stocks will rise, especially in the face of the massive inflation of the money supply over the past year.

For the next several months to year though, I think the market is in for a helluva beating.

What does it look like is coming in the next handful of months?

While the market has taken a beating lately, I don't think it is anywhere near bottoming out. As I mentioned in an earlier post, the Dow is still overvalued when compared with the monetary inflation that has happened since February 1995. "If the Dow had increased in line with nominal GDP since February 1995, it would today be trading at 7,829." In February 1995, the economy wasn't in the tank, things weren't amazing, but they weren't horrible either.

That isn't the case today. Instead, we have an economy that is unwinding 24 years of credit excess. So far, we've had only a single shoe drop and there are at least half a dozen others remaining.

• Sub-prime mortgages -- $592 billion in write downs
• Alt-A mortgages -- big resets starting in 2009 and accelerating through 2011. This market was substantially larger than the sub-prime market, the borrowers involved are getting further and and further underwater, and the borrowers are typically much more wealthy, have higher credit scores, and are the folks that churn through much more money (higher income, and more discretionary spending). Watch Mr. Mortgage comparing sub-primes to the Alt-A mortgages. There are 50% more Alt-A loans than sub-prime and twice the money involved.
  
• Credit card debt -- default rates are rising (up 45% for JP Morgan Chase, Capital One expects their default rates to hit 7% next year). Moody's expects charge-offs at American Express to increase 30% through 4th quarter 2009.
• Commercial real estate -- As consumer spending drops, and it is busy dropping, the commerical real estate sector is starting to feel the heat.
• Corporate bonds -- There's a fair bit of what I would call whining about the corporate bond sector, but as of yet, the volume of issued bonds hasn't gone off any cliffs. The price (interest rate) has jumped though making this a substantially more expensive way of raising money -- but not a bad investment if the company doesn't tank.
• Municipal bonds -- Municipalities have just started to see trouble as they deal with the impact of investment losses (equities and the death of auction rate securities) coupled with the tax-revenue impact of declining property values. Birmingham, Alabama just voted against declaring bankruptcy. The Los Angeles County Metropolitan Transit Authority may be making service cuts because of the AIG collapse. Other metro rail lines may face similar situations in the future.
• State Governments -- Serious problems exist right now for California and New York. Florida, Nevada, and New Jersey are likely to be next (can't find the link right now).
  

The key driving many of these is the increase in unemployment driving US, UK, and Euro consumer spending down, which decreases business revenue, which increases unemployment....

The US has gone well past the point where each new dollar of debt produced more than a dollar of GDP growth. We're now at the point where it takes 5 dollars in debt to produce a one of GDP growth. That rate is getting worse.

The one thing that has barely started to unwind in the current crisis is debt. We are in a solvency crisis created by 20+ years of cheap credit topped off by 4 years of insanely cheap credit.

During the past year, we haven't really seen gobs of price inflation -- at least not to keep pace with the 2 to 3 trillion dollars pumped in by the Fed and Treasury (and the corresponding actions of the European central banks). Perhaps this is because the cash pumped in has been immediately soaked up by the worthless securities so many financial institutions have on their books. Even so, this is another piper that must be paid. And the inflation piper is an indiscriminate killer of wealth.

Until we start to see a wave of bankruptcies, things aren't going to get better. Too many sectors of the nation and world are insolvent today. Until this solvency crisis is dealt with, things aren't going to improve.

So, when is a good time to get serious buying stuff? Probably once we start seeing more than just a scattered handful of bankruptcies.

This is why I think Buffet could make decent judgements about the short term state of the market.

We really haven't gotten started on the "real" economy side of the current crisis. That's coming.

Our representatives should be hearing from us

Our government is set to bail out dozens of companies that acted with reckless, stupid, and wild abandon. An entire legion of drunken sailors armed with limitless credit cards could not have kept up. Taxpayers are being asked, more like told, to pony up $700 billion to pay for this bender and keep the irresponsible companies afloat. This goes beyond stupid.

I am rarely at a loss for words or a crazy metaphor. Some how, I feel like this is the metaphor that I'll be using to describe some Darwin Award attempt somewhere down the line. "Welding a seat to a JATO rocket and going for a ride with nothing but a Barbie helmet and a leather jacket? That's like the $700 billion dollar bailout of the financial sector, only without the collateral damage."

Here's the letter I'm sending to all of my elected representatives. Write to yours. Copy and past mine if you want. If you're silly enough to want them to vote for this bailout, go get your Barbie helmet.

The Honorable Tom Davis

2348 Rayburn House Office Building

Washington, DC 20515-4611

Dear Mr. Davis:

I am writing you regarding the “LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY TO PURCHASE MORTGAGE-RELATED ASSETS.” I believe this bill is both a serious moral hazard and a fundamentally unfair transfer of wealth from taxpayers to financial institutions. I urge you to vote against it.

Unlike the Savings and Loan bailout, the “assets” this plan proposes to purchase are not tangible property. Rather, taxpayer dollars would be used to purchase securitized debt instruments. The highly dubious value of these “assets” is in no small part to blame for the trouble many financial companies are in today. The taxpayers did not force these companies to buy these, and therefore have precisely zero obligation to take them off the hands of the businesses that foolishly bought them.

Even if our government were not $9.6 trillion dollars in debt, it would have no place using tax dollars to bail out irresponsible businesses. As it stands, you are being asked to spend money you do not have. Just because you have a checkbook doesn’t mean you still have money. I will be watching this vote with great interest.

Thank you for taking the time to read my letter.