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Archive for March, 2010

How does the market keep going up when we are racking up all of this debt?  How can the market be positive with a shaky future of trillions upon trillions of dollars of debt?  Well the key word has always been in the future.  That big debt problem has always been looked upon as a problem that our kids are going to have to contend with.  

As long as the Government continues to finance the deficits, everything will be OK.  What if we are getting to a point where financing debt becomes the problem?  Well, I see it becoming a problem in 2 phases.  The first phase has to do with our potential lenders.  In the past, other countries have been willing to lend to us.  Today, they are demanding higher interest rates for loaning the US money.   The second problem occurs when even higher interest rates do not even matter.  A serious loss of confidence has occurred.  We just cannot get enough money borrowed to cover the problem.
 
I think that last week we saw phase 1 occur for the first time.  Last week, we had 3 big treasury offerings.  The demand to buy our treasury bonds was very weak.  As a result, we started to see interest rates climb.  Rising interest rates in a debt-filled world is problematic.  For one thing, this has an indirect effect on mortgage costs.  In order to lessen the severity of the foreclosure crisis which has a direct effect on whether or not the real estate markets ever bottom, interest rates need to stay down and not rise.
 
One other interesting development is that investors are being paid more for holding treasuries than in corporate bonds.  You see this in the interest rate swaps market.  This signals that investors feel more confident and that they are taking less risk by holding corporate bonds rather than those of the Government.
 
One of the downsides of this healthcare bill passing is the publicizing of the additional financial burden this is going to create in the future.  This brings the reality of our trillions of dollars of debt to the fore-front.  Don’t for a minute believe that this will cut the deficit.  The CBO’s analysis is performed using government accounting and “estimates.”   When has the Government ever gotten an estimate correct?   Then you have Greece showing us what our future more than likely looks like.  All of that gives investors a reality check and makes them think twice before loaning more to the government.   
 
Watch the interest rate on the 10 year treasury bond.  Below 4% we are fine.  Above 4% creates a dicey environment.  As I write, we are dangerously close that level. 
Incidentally, the Government has to raise 1.6 trillion dollars to cover the short-falls for the year.  That is on top of the 2 trillion that needs to be refinanced this year.  
 
On a Lighter Note…
How about this for a vote of confidence for the politicians?  Since 1897, a year after the Dow Jones started, 90% of gains came on days when Congress was out of session.  This body of research also looked at how investments would have performed while investing in the days that Congress was in session and out of session – The out of session investments strategy had investment returns 100 times greater than when Congress was in session.
 
 
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Every intervention into our life by this government creates a new and uncharted course.  Big government and an ever increasing debt load on our country.  The absolute arrogance of this government to think that they can tinker with the future of our country in this manner and that everything will be just fine.  In the good old days, you really couldn’t see through the charades.  Politics were played behind closed doors.  Today, they are going to rob you blind right in front of your face.

It is a joke to think that these politicians are going to take the numbers from the Congressional Budget Office as reality.  Once these numbers came out last week declaring that this healthcare reform bill will reduce the deficit, there was a swing in the NO votes to YES.  Something that you need to know is that these estimates are based on fairy tale assumptions and in no way reflect reality.  It is the ultimate insult to intelligence that these politicians will use the CBO numbers as validation for voting on this healthcare reform bill.  One politician referred to being “giddy” in reference to them. 

OK, I will refrain from ranting about this abduction of our future and address the ultimate question.  How will this affect the markets?  It is so tough to say.   We have never lived in a time where there is so much agenda attempting to control.  You really have to look at the price levels of the stock market, separate yourself from the news, and see how investors feel. 

We haven’t talked about price levels in a while.  Price levels are important to watch because they tell you how the market is reacting to risk.  So, the current price level on the S&P 500 to watch is 1150.  This is the line in the sand.  As long as the stock market stays above 1150, then that signifies that the markets are OK with our debt-laden world.  However, the inability for the S&P 500 to stay above that price level indicates problems on the horizon. 

Last week, the S&P 500 confidently climbed over that level.  This week will test that confidence level.  I have learned (the hard way) one simple fact.  You can read the news and look at the world around us and draw conclusions as to what should be happening in the stock market.  You can look at all of the debt accumulating and the debt that we have yet to take on (see healthcare reform) and come to the conclusion that this is not sustainable and not good for the stock market.  However, the market might or might agree with that conclusion today.  Tomorrow might be another story. However, today the markets are focusing on other things.

 So, we have reached the line in the sand, which is 1150 on the S&P 500, and will watch to see how the stock market reacts in this environment.  Today is a new day in America as we continue to go through uncharted waters.  It started a few years ago as the Government hijacked capitalism using the financial crisis as the ultimate excuse.  Today, this agenda filled Government has just taken one more huge step.  This continues to create enormous risk in the markets.  However, it will not matter until the moment that the markets wake up to reality.

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Spring Break

We will post the next market outlook on Monday, March 22.  We are off during the week of Spring Break.  As always, thank you for reading my daily writings.

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Please excuse any typos.  My assistant is out today and she normally proofreads my writing. 

There are so many facets of a debt crisis.  Unfortunately, there are many categories of debt that make up a debt crisis.  We have looked at the potential debt crisis in foreign debt.  Next week I am going to write an update on what is happening with mortgage debt.  This week I want to talk about municipalities.  Cities and states appear to be in trouble when it comes to debt. 

Last week, Jamie Dimon of JP Morgan made the statement that California was a worse problem than the country of Greece and is closer to being on the brink.  Of course, the big difference between a debt problem with Greece and a debt problem with California is that we can print money and save California (as if that is a good long-term solution).

Cities and states are feeling the financial squeeze.  The Rockefeller Institute of Government recently confirmed that state revenues fell through the first 3 quarters of 2009, the largest drop in 46 years.  The fourth quarter report showed even deeper declines in tax revenue, extending the decline to 5 straight quarters. 

California faces an estimated 20 billion dollar plus budget deficit.  California represents the 8th largest economy in the world.  By the way, Greece only represents the 34th largest economy in the world.

It is estimated that 43 of the 50 states are in financial trouble right now.  Twenty-one states have already put a number on their 2010 budget shortfall which totals over 60 billion dollars thus far. 

Some of the more noted states that are in trouble:

Budget Shortfalls

New York        $5.5 billion

Florida             $5.1 billion

New Jersey      $2.5 billion

Arizona            $2 billion

Nevada            $1.2 billion

The money has to come from somewhere.  States cannot claim bankruptcy.   As with any type of debt scenario, if the money cannot be paid back, a loss must be created.   Who is going to take that loss?  This is where it might become tricky for municipal bonds.  Bondholders could be at risk.  Through a municipal bond, an investor has essentially become a creditor by lending the city or state money and in return receiving a bond for it.

Would you feel comfortable lending money to a municipality?  By investing in a municipal bond, you are lending money.  With the problems that we are seeing, I don’t know that municipal bonds are such a great bet.

Incidentally, what we are seeing with states and cities is classic deflation.  These budget deficits and debt potentially create enormous losses due to the destruction of debt.  Once again, it is tough to see where inflation is going to come from with all of these debts waiting in the wings.

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If I were a banker, I would dread Friday’s.  It is the day of the week that the federal regulators walk in and shut banks down.  This past Friday there were 4 more banks in Texas, California, Illinois, and Florida bringing the total bank closures for 2010 up to 20.  This is on the heals of 140 being closed in 2009, 25 in 2008, and 3 in 2007.

The troubling part of this whole process is that last year banks were able to push the problems aside as the Government allowed them in short to hide these bad loans on their books through an accounting adjustment.  In other words, all of those toxic bank killing loans are on the books and have not been dealt with. 

It gets better.  The FDIC gets to pick up the tab each week through the FDIC insurance fund.  Currently, the fund has $21 billion left.  They estimate $100 billion of losses will have to be covered over the next 3 years.  Oh, don’t worry – they have a credit line that can be tapped up to $500 billion dollars through the Treasury. 

Don’t forget, a massive foreclosure problem still lingers as we start a huge wave of adjustable rate mortgages re-setting over the next 3 years.  In 2009, we were in the calm of the storm as the first wave of adjustable rate mortgages which were sub-prime based were finishing up with their adjustments.  This next wave which represents Alt-A and Prime mortgages is much bigger.  In addition, the fun is just getting started in the commercial space where corporations are having to refinance debt on commercial properties and are having no luck because no one is lending money. 

John Mauldin writes this week in his www.frontlinethoughts.com newsletter “Bank loans are being written off at staggering rates. Over 700 banks (I think that is the figure I saw) are officially on watch by the FDIC, with more banks being closed each week.  There is at least $300-400 billion in losses on commercial real estate waiting to be written down. Housing foreclosures are rising and hundreds of billions have yet to be written off.”

He goes on to write that in January, “Foreclosures rang up at 4300 and Notice-of-Defaults at 5100 per day nationally.”

Think through with me what this could look like.  This last Friday’s 4 bank closures cost the FDIC approximately $1 billion.  That’s an average of $250 million per bank.  If we continue at this pace, we could be looking at 100 more bank closures this year.  That could be as much as $25 billion.  That would deplete all of the FDIC money and force the FDIC to borrow from the Treasury before year end. 

This can’t have a happy ending. 

This week the Sovereign Debt Problem will be front and center as Greece attempts to borrow money through a bond offering.  As I wrote last week, this could be a real problem in the event that Greece defaults.  Also this week we have the unemployment numbers that will be released.  It is a critical number each month.  Watch the risk!

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