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Archive for August, 2009

I just got back in town yesterday from a trip with my wife Cheri.  We were celebrating 10 great years together.  So, I am a little out of touch with the economic data that has come out last week.  Plus, this is a slow time of the year.  The real action in the stock market should kick into gear following Labor Day.  I wanted to share with you something that I wrote in my letter to my clients this morning.

It wasn’t until last night that I realized how fortunate we were in going to Cabo last week versus this week.  I discovered that a monster hurricane, Hurricane Jimena, is barreling towards Cabo. This could actually be a Category 5 hurricane by the time that it makes landfall. 

While in Cabo we took an excursion into the city.  People were having a great time in Cabo.  In fact, there was not even a mention of the Category 4 hurricane heading their way.  Residents acted as if there was not a care in the world.  One tourist commented to a reporter, “Are you saying it would be a good idea to stock up?  No fear. I’ve been through tornados and earthquakes and everything else, but never a hurricane.”  There was almost an arrogance that came with that reply.  I don’t believe that there is anything to joke about when it comes to Category 4 or 5 hurricanes. 

It is a common attitude with people who are facing the arrival of a hurricane.  There is the notion that it will miss us or it will not be a big deal.  It is almost as if it could never happen.  These things are always forecasted as potentially being bad and they never turn out to be.

I think that the general attitude about the stock market is the same right now.  The attitude is that there is no way we are going to see a steep decline in the stock market.  There is no way that we are going to decline back down to where we were in March of this year.  There is no way that the worst is yet to come.  Don’t you look at history?  Plus, all of the financial press says that the worst is behind us.  These are the types of things that you hear these days.

This is a big bet to make against this financial crisis.  Just like a Category 5 hurricane, there are enormous penalties for those who blow this off and don’t take precautions.  As an investor, I think that it is prudent to face the upcoming months as if a Category 5 financial hurricane were brewing and potentially heading our way.  After all, we are heading into the particularly dangerous months of September and October.  These are two months that have not historically been kind to investors.

I think that Proverbs 22:3 says it best:

 A prudent person foresees danger and takes precautions.  The simpleton goes blindly on and suffers the consequences.

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What motivates the stock market to go up?  Well, lately it doesn’t take anything of real substance. A great consumer confidence number could be the reason (even though the consumer confidence report gets the consensus of only 5,000 households), a reduction in the loss of jobs for a month(even though the Government accounting method greatly distorts the actual loss of jobs),  positive earnings reports that surprise the analysts (even though most of those profits came as a result of extreme cost cutting)…Then there are the times that  Ben Bernanke speak.  Yes, his words can move a market.  He did so just last Friday.

Ben Bernanke said what investors wanted to hear – that the economy is indeed on the verge of recovery – and they responded with a rally that sent the major indexes to new highs for the year (yahoo.com). 

Did it sound something like the following?

“Our forecast is for moderate but positive growth going into next year. We think that by the spring, early next year, that as these credit problems resolve and, as we hope, the housing market begins to find a bottom, that the broader resiliency of the economy, which we are seeing in other areas outside of housing, will take control and will help the economy recover to a more reasonable growth pace.”

As John Hussman points out in his weekly writing, this was what Bernanke said in November 2007 right at the beginning of the bear market.  If you are stock market invested, these shallow reasons are why the market continues to go up. 

I know that my bearishness on the stock market is probably getting old by now.  In fact, I feel a lot like I did back in 2007 when it seemed like you couldn’t find anyone who is bearish.  The market welcomes any positive economic news as the worst is behind us and everything is great going forward.    The headlines are looking better.  However, the fundamentals behind the headlines are awful.  You might even get some positive economic growth numbers here in the near future.  Growth as a result from printing money and the Obama stimulus package is not real good health growth. 

The Bottom Line – As we continue to go up in the market, the risk continues to increase.  Caution is still warranted.

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In 2006, I was writing to my clients in my private client letter about what I felt was occurring in the financial markets.  I described what I felt was coming as a Category 5 hurricane.  I think that I even named it Hurricane Greenspan at the time.  Although he is a distant memory, he had a lot to do with the problems that we are facing today.

It feels like we were hit with a category 5 hurricane last year.  Unfortunately, I think that another one is brewing and might even be getting very close to shore.

Every Friday it seems another bank fails.  Last Friday we saw a sizable bank fail.  The Failure of Colonial Bank marks the 6th largest bank failure in U.S History.  It is a bank of $25 billion and 346 branches in 5 states.  Besides the troubling nature of this story and the fact that the Government cannot bail all of them out, the FDIC insurance pot takes another big hit.  It looks like the 13 billion dollar fund will lose another $2.8 billion because of this bank failure. That insurance fund designed to protect you and me is quickly dwindling.

Another hurricane indication would be the Government’s sale of Government Bonds. The Treasury Department sells bonds to raise money for Government spending.  It is the way the Government borrows money.  Last week the Treasury Department sold 75 billion dollars in bonds.  Do you really think that China and other countries are lining up to lend us money?  No, you would be correct.

So, who is buying these treasury securities and lending money to the United States?  Ok, if you have high blood pressure or a weak heart, please stop reading.

Our own Federal Reserve Board is buying many of those securities and lending money to the US. For a great expose on this, read this article.  I don’t need to tell you how desperate that is and how much trouble we are in considering that is occurring.

I hate to say it but this is going to end badly.  All of this is going on at the same time we are facing an unemployment crisis and a whole list of problems in this country.  Once again, I advise you to watch your risk and don’t fall for the notion that this is just a normal cycle.  In other words, don’t drink the kool-aid.

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The recession is declared to be over or over soon states many media outlets on Friday.  Unemployment was not as bad as expected and it appears that we are starting to lose less jobs. All of that is good news and it took the media and Wall Street no time at all to react positively. 

 

I really do regret taking the opposing view on this one.  I would like for it to be true.  There are just a few problems.  We have 14.462 million people unemployed.  The number is likely higher. This is the estimate from the Department of Labor.  Where are these people going to get jobs?  Unless you are ready to pick up a shovel and get on the Obama job creation bus, you might just be out of luck.  Once again, the Obama administration does not have a plan in place to fix the job situation. 

 

Looking back to 1948 (as far back as records take us), there has never been as big of a spike in the number of those unemployed.  The closest spike that you can find was between 1979 and 1982.  In 43 months, the unemployment numbers jumped 106% to a high of 12.051 million people. Today, in just 33 months the unemployment numbers jumped 125% to 14.462 million.  The following is a chart from www.freelunch.com that illustrates this dramatic rise.

I think that the monthly unemployment numbers could continue to look better.  However, that doesn’t mean that companies are hiring. I think that it means that companies have cut as far as they can cut.  Those lay-offs might start to slow.  Until there is a solution to the problem that over 14 million people are facing, we will continue to have this crisis. 

 

Regarding the market…the 1929 comparison that I wrote about still tracks very closely.  I would still suggest that there is extreme risk on the table.  As long as we stay below 1020 on the S&P 500, that will remain the case.

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“Worst of the housing recession is now behind us” declares one economist.  New home sales rose last month at the fastest clip in more than 8 years.  There is a good reason why home sales are increasing but there is another reason not to get too giddy over this economic data. 

First, prices are falling to the levels where people are motivated to buy and sellers are motivated to dump properties.  Second, the Government has made a sweet deal with the federal tax credits good until the end of this year.  There is a huge fly in the ointment.  Prices are continuing to fall. In addition, there is a tremendous number of homes for sale or supply on the market.  This supply will keep prices low.  People are only looking for bargains. Plus, banks have thousands of homes on their books that they have yet to send to auction. 

In order to say we have bottomed, there is one area that has to get better.  The foreclosure crisis has to start to bottom out.  Here was the latest from Realtytrac who keeps up with the foreclosure crisis.

“RealtyTrac® (realtytrac.com), the leading online marketplace for foreclosure properties, today released its Q2 2008 U.S. Foreclosure Market Report™, which shows foreclosure filings were reported on 739,714 U.S. properties during the second quarter, a nearly 14 percent increase from the previous quarter and a 121 percent increase from the second quarter of 2007. The report also shows that one in every 171 U.S. households received a foreclosure filing during the quarter.”

Let’s backtrack for a second and look at what created these foreclosures.  It all comes down to the adjustable rate mortgage.  Starting in 2007, adjustable rate mortgages starting coming due for 100,000’s of subprime homeowners, causing the beginning of the foreclosure crisis.  Those peaked in the first quarter of 2008.  Through 2008 and into 2009, those adjustable rate mortgages subsided. 

However, now all of the other types of adjustable rate mortgages will start coming due and this cycle will not peak until 2012.  It is a much bigger cycle.  To assume that the housing market has bottomed would be to assume that there will not be a problem with all of these ARM’s that will reset over the next 2 to 3 years.  It is a big assumption. 

This is pretty typical.  The minute the data starts to be positive, economists declare the worst is behind us.  I would describe right now as a period that is in between 2 crises.  Unfortunately, I think that the second wave of crisis might be worse than the first.  Round two involves more housing foreclosure and the upcoming crisis in commercial properties.

Follow up from Last Week

I wrote about the similarity between the first major stock market rebound in 1929 and today.  If you have not read last week’s post, go back and read it so this makes sense.  We are now tracking almost identically in time (146 days) and gain (46% rise).  It will be interesting to see what happens from here.

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