Archive for August, 2010

What is that sound that investors heard on Friday? It is kind of faint. Oh it is the Federal Reserve Board Chairman Ben Bernanke screaming as loud as he can between that rock and a hard place. I am starting to find that this is all one big joke…that is this thing called investing.

Let’s back track for a moment. Things were as bad a few weeks ago as they are today when Ben Bernanke had his chance to rescue the market by stating the Federal Reserve Board would intervene following the Federal Reserve Board meeting. He should have known that his silence would be deafening and the market would react negatively. Well, guess what, the market did react quite negatively.

The market or drug addict was upset at not receiving assurance that the dealer was going to come through with some more stimulus or drugs. Then Bernanke sees what a tough time the market is having and at his speech at Jackson Hole last Friday he states that he has a lot of actions that they can pull out of the bag to help the economy.

In other words, he didn’t say the right things then so now he is telling the market what it wants to hear. Wall Street, who really wants to drink the kool-aid, puts in an impressive rally on Friday because Big Ben says he is going to save the day. “Don’t worry (wink, wink) I got this one,” says the Fed Chief.

Let’s take a look at what is really going on here. Further actions taken by the Federal Reserve Board will result in one of two scenarios. They wll either add another band-aid to the festering wound they call the economy or they will fix the economy.

For all of those who are bullish on Bernanke, you might want to consider something. They have already pulled out all of the stops and it didn’t work. Further, since the normal routine chemo didn’t kill the cancer we call the debt crisis, then they are just left to try experimental drugs.

The probabilities of them fixing the problem are so very low. This is a sign of desperation. Bernanke is like everyone else in Washington. Just tell them what they want to hear and keep back pedalling and hope that no one realizes that there are no good options with the exception of one.

Let the economy fix itself. Let bad investments go bad. Take it off life support and let it fight through the pain and recover on its own. As we can continue to push that reality off into the future, we are just making the problem worse.

Market Outlook

On the one hand, the contrarian in me doesn’t like the fact that everyone is so negative at the same time. That is typically a contrarian indicator. When everyone thinks that everything is either good or bad, things are about to change and go the other way. That is typically how it goes. On the other hand, maybe things are just this bad and it has never been so obvious. Monitor risk because I believe the probability is high that we did indeed start part III of the bear market back in April.

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It isn’t hard to put a list together outlining the challenges that this country faces. Probably my top 3 on a list would be unemployment and the government’s inability to do anything about it, the trillions of dollars worth of debt not just here but all over the world, and then the foreclosure crisis.

What isn’t getting much attention is the problem that is lurking under the surface. It is also the one issue we want to keep under control. So far, the government had been able to manipulate interest rates to the point where they have been kept under control.

The picture above shows the 10 year treasury interest rate between 1962 and today. You can see how rates went real high during the 60’s and 70’s. Then in 1980, interest rates started to fall. For 30 years interest rates have fallen. In 2008, they hit the lowest level. As of late, it looks like rates could be heading back down to those levels. Currently, we are 20% above those low interest rate levels in 2008. Since April 10th of this year, the 10 year treasury rate has fallen -32%.

Remember that interest rates and the prices of bonds move in opposite directions. While interest rates are falling, bond prices are rising.

As I wrote in this article, my concern is that we have a huge bond bubble forming. A bubble occurs when everyone invests into some sort of investment because collectively they think that this is the best place to be. In this type of environment, investors just cannot get enough. They do it in such a large way that the price of the investment gets way out of line with its true value. At some point, the bubble bursts and prices come back down to their real value. Just think about what has happened to the prices of real estate after the real estate bubble popped.

Here are a few bubble facts for you:

Last year, 375 billion dollars was invested in bond funds. Between 1998 and 2008, 425 billion was invested in bond funds. In one year investors poured almost as much money in bond funds as they did the prior 10 years.

Last Friday, the Wall Street Journal reported that companies are on pace to have a record year in issuing junk bonds. Investors are flocking to the riskiest bonds issued because they can get higher interest rates or yields.

It looks like we are experiencing bond fever on Wall Street. The problem is that if the bubble bursts, then that means interest rates will soar. Soaring interest rates is the last thing that we need in a world plagued with debt. The Federal Reserve Board knows that and because of that fact have done everything humanly possible to manipulate the prices of government bonds. Let’s just hope that this grand experiment works.

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This has been an interesting debate to watch.  Until about a few months ago, inflation was the “in” thing.  The notion has been that since the Government has been printing money and flooding the economy with stimulus inflation would be created. 

My stance has been all along that we will not see inflation for a long time for a few important reasons.  First deflation is often the result of too much debt in the system.  Second, the government can print all the money it wants and not create inflation because the money that is printed is going to absorb losses in the system.  The key is that money is not circulating. 

If you introduce money into the economy and that money circulates through buying and selling of goods and services and is being lent out, you can definitely create inflation.  That is not happening.  That circulation of money is measured by the velocity of money.  If money is circulating at a high rate, we have expanding velocity.  Today we have been watching velocity contract instead of expand.  As the losses on debt continue to mount, it will be tough to expand the velocity of money.  We are on the toxic path of debt.

All of the sudden, it is as if economists are starting to recognize deflation.  Now the “in” word is deflation and not inflation.

Consider the definition of deflation.  Deflation is a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. (Source: Wikipedia)

This is pretty much what we are seeing.   Ironically, during a period of deflation, the dollar is actually strong and gold weakens.  We are also seeing that trend. 

The Federal Reserve Board is now acknowledging we might have a deflationary problem.  Ben Bernanke is regarded as an expert on deflation.  Expert or not, it is happening on his watch. Inflation is something the Federal Reserve Board can tackle head on.  Think of deflation as aggressive cancer whose only cure is experimental medicine. 

This last Federal Reserve Board meeting illustrates how they are shooting in the dark.  In fact, some economists fear that these new steps they are taking could actually backfire and make the situation worse.

Even more amazing is that we could pump 100’s of billions of dollars into the system and almost 2 years later have the same problems on a much larger scale.  As I have said many times before, the politicians and the Federal Reserve Board are useless in this scenario. 

The only solution to our economic mess is letting the system detoxify on its own allowing consumers and businesses to work through it.  In that process you stop creating more debt and allow the losses to occur.  You support small business in an attempt to rebuild what has been destroyed. 

Unfortunately, we are getting the exact opposite out of Washington.

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Not only does the jobs report released last Friday give us a real dose of reality, it also puts an emphasis on the importance of November’s vote to get rid of the socialists that continue to do nothing to help those that are unemployed beyond keeping them on the Government dole through unemployment benefits.   Let’s look at the numbers.

The jobs report showed a loss of 131,000 jobs this past month. Some of that loss is to be expected due to the laying off of census worker jobs that were temporary and never should have been counted in the first place.  Then the Department of Labor went back to June’s numbers and said that those numbers were not quite right.  They stated that June’s unemployment number was actually an additional 100,000 loss in jobs. 

The private sector jobs are the most important.  We couldn’t care less how many jobs the Government is creating.  When we start relying on the Government to create jobs we have a real problem.   There were only 71,000 private sector jobs created which was much less than expected.   The irony is that, in a sense, some of those jobs are government created as well.  Barron’s reported, over the weekend, that the bulk of those jobs “reflect the fact that the auto makers didn’t shut down as they usually do in July to change models.” 

I guess the auto industry, a large majority of whom the government controls, is too busy building those $41,000 electric cars that go 40 miles on a single charge.    So, are those really private sector jobs when the Government owns so much of the auto industry?  

There are a few charts that I would love to share with you if I could get them to load. One chart shows the drop off in employment this go around.  It is the steepest drop since the 30’s.  Then there is the chart that shows private sector jobs revealing an even steeper drop.   Said in another way, this is the worst job situation that we have had since the days of soup lines and the great depression.

So, what is the solution?  I am sure that we will see Ben Bernanke dig in his magic bag of tricks and pull out some more stimuli.  Sorry to be so pessimistic… I don’t know that it matters nor does it fix the problem.   Small Businesses and corporations are not hiring because they don’t trust the White House and this march towards a socialistic state.  If the Obama administration and the rest of the politicians would start supporting capitalism, companies would begin to find that sense of confidence.      What are the chances of that happening?

The reality is that we should be creating 300,000 plus jobs each month.  Said in another way, we need to be creating that many jobs just to start a real recovery.

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Don’t get to comfortable just yet. There is a battle raging between the bulls and the bears that is far from over. It is a high stakes battle. If you look at the chart of the S&P 500, the bears were in control January and most of February. The bulls took over from February until mid April. Then the bears took over between April and June. Since then, the bulls have been in control. Is that about to change?

Well, let’s look at where we are in the calendar year. August through October has proven to be a dicey time for the market. The decline that preceded the October 1987 stock market crash began in August. The meltdown in 1998 actually started the last part of July and then ended in October. The decline that turned into the huge financial crisis drop started in August 2008. Finally, the 2000 bear market right after a September 1st high.

Then you have another interesting pattern that can be found during the tenth years of decades. Tenth years have the worst record within the Decennial Cycle and 2010 is a midterm election year, which has the second worst record of the 4 year presidential election cycle. Of the last 12 occurrences dating back to 1890, the stock market lost money 8 out of 12 times during the 10th year. The average loss has been -7.2%.


% Gain or Loss


% Gain or Loss


% Gain or Loss

1890 -14.10 1940 -12.70 1980 +14.90
1900 +7.00 1950 +17.60 1990 -4.30
1910 -17.09 1960 -9.30 2000 -6.20
1920 -32.90 1970 +4.80 2010 ???
1930 -33.80        


If the conditions outside are ripe for a severe thunderstorm, would you take an umbrella or just assume the weather forecasters are wrong? The conditions of risk are very high right now. We are in the time period that carries the same amount of risk as does hurricane season for the folks living on the coast. Maybe nothing happens and all of the taking heads on Wall Street are right. At the same time, it pays to be prepared by always having an exit strategy.

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