Friday, May 30, 2008

Stagflationary Recession

Stagflationary Recession Deepening: Retailers Lining Up In The Crosshairs

By Frank Barbera, CMT | 27 May 2008

Amid the endless gasoline headlines crossing the news this past weekend came the headline from Germany that billionaire investment guru Warren Buffett sees the USA already in recession. According to Buffett, "the US is already in a recession, which will be deeper and longer than many think".

BERLIN (AP)— Warren Buffett, whose business and investment acumen has made him one of the world's wealthiest men, said in an interview published Sunday he believes the U.S. economy is already in a recession. Asked by Germany's Der Spiegel weekly whether he thinks the U.S. could still avoid a recession, he said that as far as the average person is concerned, it's already here. "I believe that we are already in a recession," Buffett was quoted by Spiegel as saying. "Perhaps not in the sense as defined by economists… But people are already feeling the effects of a recession… It will be deeper and longer than many think," he added.

Of course, the good folks at the BLS have managed to make sure that the ‘official data’ have been massaged enough to the upside in this election year so that, despite two consecutive quarters of negative real GDP growth, have been postponing the ‘official’ recession signal so far. In today’s update, we review some of the economic data released today from a bigger picture point of view to illustrate just how ‘spot on’ Mr. Buffett's comments in fact are. The primary focus of the last 12 months has been, and remains, the sinking housing market, where this month's action produced a technical bounce.

Earlier today, the Commerce Department reported that New Homes sales rose by 3.3% in April to a seasonally adjusted annual rate of 526,000 units. At the same time, the government also revised March activity lower to show an even bigger drop of 11 percent to an annual rate of 509,000, which was the weakest pace for sales since April 1991, a 17 year low. Viewed through the lens of a smoothed Rate of Change, we see that New Home Sales are still very close to the lowest levels of the last 40 years, sinking to the depths of the 1980 Carter ‘Stagflationary Recession.’ Appropriate, since today’s unreported inflation rate is running close to 12%.

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Above: Annual Rate of Change on New Home Sales in Deep Recession territory

In addition to the data on Housing Sales, today’s report also reported that inventories of unsold new homes edged down slightly to 10.6 months' supply at the April sales pace, compared with 11.1 months in March. According to CBS Marketwatch and AP, the April level was still about double the inventory level that was normal during the five-year housing boom. In our work, we follow the Ratio of Houses For Sale versus Houses Sold, which remains well above the 8 month upper benchmark that in the past has defined US recessions.

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Above: the Ratio of Houses FOR SALE versus Houses Sold— still in deep recession territory

With inventories still at near record levels of supply, it was also no big surprise that Housing prices remained under heavy downside pressure. According to CBS Marketwatch, the pace of home price declines accelerated in March with home prices in 20 major U.S. cities now down 14.40% over the past 12 months, a record breaking decline. According to the 20 City Case-Shiller Home Price Index, prices fell 2.2% from February to March marking the 16th consecutive monthly decline. Within the 10 largest US cities, prices fell by 2.4% in March, and by 15.3% over the last 12 months.

The combination of falling home prices and rising food and energy prices, stagflation (no growth and rising prices) continued to put a major damper on Consumer Confidence with the Conference Board Index plunging to 57.20 in May, down from 62.80 in April. At this point, there is simply no longer any argument remaining about whether or not the US is in recession, as the Conference Board Index has only declined below the lower +70 benchmark during recessions and is now closing in on some of the worst readings seen in prior recessions.

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Above: Consumer Confidence Survey fell to a 16 year low in May, now well below the +70.00 recession benchmark with a reading of 5.720 in May, down from 62.80 in April.

In fact, if one looks closely at the components which comprise the Conference Board Composite Index, the outlook going forward is bleak. To begin with, we note that the Forward Expectations Index which looks out six months from today, plunged this month to a reading of 50.00 to a value of 45.70. For proper context, that is an ALL TIME LOW since record keeping was started in the 1970’s. Talk about huge, this makes a strong case that the current economy is nowhere close to an important bottom as the Expectations component tends to usually lead bottoms by a year or more. What’s more, the overall Consumer Confidence Composite has actually been benefiting to this point by the Present Situation Component, which has been trending down in consistent fashion, but not falling out of bed.

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Above: Conference Board Index of Forward Expectations (6 months out)

If we look at the Present Situation Component in May the indicator fell to a reading of 74.4, down from 81.90 in April. Historically, this gauge is very likely to dip under the +50 mark, and could even— given today’s circumstances— be expected to fall into the +40 to +30 range. From where it stands at the current time near +75, we are still a long way from the zone where an important bottom could be seen. In our view, this implies that the current recession is simply just beginning to pick up downside momentum, and that the current bout of economic weakness will remain right through 2009.

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Above: Conference Board— Present Situation, still a long, long way from a low

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Above: Ratio of Leading to Lagging Indicators— 12 Month Rate of Change

Paralleling the steep declines in all of these gauges in the last 12 months are a number of other gauges, including the Ratio of Leading to Lagging Economic Indicators, which for the balance of the last two years has been drifting its way steadily lower toward the full recession levels of— 5%.

Again, in very deep recessions this gauge has fallen to readings well below— 10 to— 12%, and thus, for anyone concluding that a bottom has been seen, we would argue that historically what is showing up right now in terms of falling Home Sales, Home prices, and diminished Forward Expectations makes a compelling case that the Ratio of Leading to Lagging Indicators has potentially a long way to go on the downside. To bring things full circle and close the loop, in the chart below we plot the annual rate of change on Home Sales (thin line) and overlay it against the Ratio of Leading to Lagging Indicators (thick line).

What we find is that over a long stretch of time, the directional change of Home Sales has led the Ratio of Leading to Lagging gauges by about 5 to 6 months. That means that from where things stand right now, we could be staring down the barrel of new record lows in the Leading to Lagging Gauge Ratio which would imply a very deep recession, possibly even a depression getting underway. The same time of implication is seen with an overlay of the Conference Board Confidence data versus the Leading to Lagging Indicators. The clear implication from the way some of these ultra leading indicators are pointing is that the downside risk in the US, and likely the global economy, is still very substantial and that at present, we are a long way from the bottom of this downside contractionary cycle.

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Above: Housing sales at Annual Rate of Change lead even the Leading Indicators (Thick line is Leading to Lagging Ratio at Annual Rate of Change)

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Above: Ratio of Leading to Lagging Indicators versus Conference Board Composite

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Above: top clip: S&P rate of change, middle clip: Payrolls rate of change, and bottom: Home Prices— rate of change.

Finally, we view the current decelerating economy through the lens of the stock market as a leading indicator for broader economic conditions. In the chart above, we plot a two year rate of change for the S&P in the top clip. Immediately below the S&P we show the 12 months rate of change on Non-Farm Payrolls, and below that, the 12 months Rate of Change for Real (Inflation Adjusted Home Prices). In both cases, we have lagged Employment and Home Prices by 12 months as the stock market has historically turned down in advance of economic weakness. In all three cases, the rate of change data is now negative with Housing leading the way on the downside over the last few months as the Credit Crisis has had a powerful negative impact on Housing Affordability.

In our view, given what is happening in Housing, it is a very logical outcome to suggest that the Employment Rate of Change will revisit prior lows and that the stock market rate of change may also have another big excursion below zero dead ahead. Again, the implications are powerful that this down cycle still could have a long way to go as neither the stock market rate of change or the Non-Farm Payroll Rate of Change has seen the kind of figures which typically mark major lows; we suspect before this is over, those readings will be seen.

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Above: the S&P 500 (top clip) and lower clip Relative Strength Ratio of Recession Retailers versus Discretionary Retailers

As far as the stock market is concerned, we believe that an extended recession from here will place more downside pressure on both cyclical stocks, and on retailers. In the chart above, we plot the relative strength ratio of defensive retailers, what I call ‘recession retailers’ versus ‘discretionary retailers.’ On the defensive side, we have names like Wal-Mart, Costco, Ross Stores, Big Lots, TJX Corp, and CVS all in rising configuration, while on the downside names like Radio Shack, Pacific Sunwear, Guess, Starbucks, Whole Foods, Urban Outfitters, and Nordstrom all look overbought and vulnerable.

In the chart above, we plot the R/S Ratio of the recession retailers versus discretionary retailers, which is just now breaking out of a multi-week consolidation phase. The vertical dashed line on the chart shows that this ratio bottomed the same week that Sub-Prime Mortgages became headline news in February 2007. Clearly, the defensive tone remains intact within the stock market, a trend which should continue to favor the most basic industries with a special emphasis on commodities, sectors such as Energy and Precious Metals.

We end with the most discretionary of all items, New Cars, where last week Ford Motor guided lower, reversing its prior upbeat forecasts. We continue to maintain that neither GM nor Ford are likely to survive this downturn (in present form) as both companies have severe financial problems unlikely to withstand the Category 4 or 5 storm just now making landfall. On Friday, GM (which owns Rescap/Green Light Financial), Ambac, MBIA, Lehman Brothers, Indymac Bank and Bank America all closed near historic lows, and all are on the high alert watch list for potentially major pieces of bad news.

From CBS Marketwatch— May 22nd
Ford cuts truck production, scales back profit view

SAN FRANCISCO (MarketWatch)— Automaker's coming to grip? Ford Motor Co.'s grand plans for profits in 2009 came to an end Thursday, sending the automaker's shares down more than
8% as plunging demand for trucks and SUVs have combined with rising fuel and steel costs to weigh on the bottom line. Ford Motor Company also cut its outlook for full-year car and truck sales to a range of 15 million to 15.4 million units, down from 15.3 million to 15.6 million previously. And in an effort to align production with the sliding demand, the company now plans to build fewer vehicles. "Unless there is a fairly rapid turnaround in U.S. business conditions, which we are not anticipating, it now looks like it will take longer than expected to achieve our North American Automotive profitability goal," Ford CEO Alan Mulally said.

That’s all for now,

Battlestations! S&P In Topping Mode.

By Frank Barbera, CMT | 20 May 2008

In reviewing the action in various markets over the last few days, it appears as though another juncture is rapidly approaching. Call it the start of "The Great Credit Bubble Phase II." In Phase I, Sub-prime and Alt-A mortgage paper collapsed, Bear Stearns slid beneath the waves, and Gold soared above $1,000 per ounce. The Stock Market tumbled nearly 20% (18.48%) and the Dollar plunged to record lows. For the last few weeks, markets have enjoyed a pleasant hiatus with stock indices recovering and the Dollar strengthening. That is until the last few days, as Gold has revived, stocks have reversed lower as has the US Dollar. While we still believe there is a good chance that equities may not actually break down to new multi-month lows until the fall, there is nevertheless a high risk that prices are at present very close to a major interim peak.

Back on April 22nd in our piece entitled "Oreo Cookies and the Stock Market," we opined:

"Thus, this 1380 to 1400 range becomes a very important zone. If the stock market as measured by the S&P 500 can press above this resistance in the weeks ahead, there is a good chance that prices will continue to extend the bear market rally over the next few weeks into the summer months. Under this outcome, prices could be moving up toward the 1440 level, which represent a .618 Fibonacci retracement of the prior decline."

Since then, the indices have surpassed 1,400 and have managed to stagger their way higher with the S&P hitting a peak of 1440.24 just yesterday. In that same article, we placed a lot of emphasis on one of our favorite indicators, the Medium Term ARMS Index. At the time, the ARMS Index had NOT seen an overbought reading of any material sort, and as a result we concluded that the stock market advance probably had further to run. We stated:

"So where are we right now? With a close of 1.065 last night, the Medium Term ARMS is just slightly above neutral having come down off the deeply oversold values seen a number of weeks back. Of note, we have NOT seen a 0.80 value, a true overbought value on this gauge since last June, and that is becoming somewhat overdue. Even accounting for the fact that Bear Market rallies might not peak as low as bull market values, what I call a bearish upward "scale shift," one would normally expect at least a reading below 0.90 BEFORE an intermediate term B-Wave had run its course. So far, that type of low value has not been seen, and thus, in our view, the important ARMS Index is suggesting that the stock market may try to move still higher."

In that same update, we also included a chart of the ARMS Index which is shown below.

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Above: "THEN"a snapshot of the ARMS Index from April 22nd, "Oreo Cookies and the Stock Market"

Importantly, as stock prices have moved sequentially higher, the ARMS Index has "done its thing" and moved sequentially lower. Remember, this indicator is plotted on an inverse scale, where high ARMS Index values reflect great fear, while low Index values reflect a swing toward optimism. Over the last few days, the Medium Term ARMS Index has plunged to values of 0.864 on Monday the 19th, 0.8730 on Friday the 16th, 0.874 on Thursday the 15th and a recent low last Wednesday at 0.846. We have now not only recorded a value below 0.90, but we have very closely approached the 0.85 to 0.80 window which is usually a very big warning.

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Above: "NOW"— the ARMS Index updated to present, with very low values signaling high risk of a market peak.

So what kind of warning could be at hand? In our view, it seems as though there is a good chance that a medium term peak for the S&P could be cemented into place over the course of the next 10 days within the range of 1405 to 1440. At the moment, today’s sharp S&P decline has not convincingly violated the rising uptrend of the last few weeks, and to that end, a retest of the highs for the S&P is probably still ahead over the next few days. That said, in the larger scheme of things, we have been leaning toward the idea that a large (a,b,c,d,e) triangle B-Wave is unfolding in the stock market, with the recent advance of the last few weeks comprising Wave C, an upward trending portion of the pattern. We outlined this in general terms back on April 22nd in the "Oreo Cookies and the Stock Market" discussion. In our view, much of that same process remains in place, even though the "C-Wave" has pushed a bit higher toward the 1440 zone. In Elliott parlance, this is known as an irregular "C-Wave" and this is fairly common within triangles.

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The bottom line for the stock market as we see it, from a late May high, the S&P could be vulnerable to a trip all the way back down toward the area of the March lows, in the low 1300’s. This type of decline may not be a full on resumption of the bear market, as there could still be a final "E-Wave" advance later this year which would ultimately complete the larger five wave triangle pattern and Wave [B]. Thus, thinking "trading range" is probably a wise approach, and to that end, prices right now may be in the act of defining the ‘high’ end of the range.

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Above: the 20 day Average of Advances less Declines, and Below: the McClellan Oscillator

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Other short-term oriented technical gauges also reflect the market swing back toward overbought territory. In the case of the 20 day Advance-Decline Oscillator, with a close of +93.52 last night, we are now back up to the area where each of the last three peak readings, +91.52 on 2/27/08, +82.88 on 12/26/07 and +108.00 on 10.05.07, were highly problematic for the stock market. Likewise, the McClellan Oscillator has also moved back to overbought territory with a close of +297.63 last night. Importantly, the oscillator has essentially continued to trace out a series of sequentially lower highs throughout the rally, indicating that internally this advance is not robust and most likely of the bear market stripe.

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Above: Operating Company Only Put To Call Ratio

In addition to the recent set of overbought values on key daily oscillators, we also note that sentiment has swung widely in the last few weeks moving from high levels of fear to a now cautious optimism. 'The Worst is Behind Us’ mind set now rules the roost, with the Dollar Weighted Put-Call Ratio for Operating Companies swinging down toward its lower band. Again, this does not mean the market cannot move back up and retest the highs, or even record a token new high in the days just ahead. What it does mean is that traders operating on the long side of the market should be advised that perhaps the lion's share of the rally is now over, and that from a risk-reward point of view, downside risk seems high in the weeks just ahead.

So where are the risks if things get rough? In our view, when we survey the financial world, we still see a dismal road ahead with a lot more problems in front of us rather than behind us. In fact, instead of the "worst being already over," we lean heavily toward the idea that the "worst is still ahead." The price action in stocks like Fannie Mae, Lehman Brothers, and Citicorp is enough to cause us bad indigestion following lunch, if you know what I mean. None of these holds any hint that the worst is over, not fundamentally, and certainly not from the positively wretched price action seen on the charts. In each case, huge degrees of financial leverage are in play, and in each case the ‘light at the end of the tunnel’ is most likely a 100-car freight train on a head on collision rolling down the tracks at 100mph. 'Run, don’t walk for the exits' would be our best advice.

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Above: Fannie Mae— an odds on favorite for leading the parade of Phase Two major problems, way too much balance sheet leverage at work… ultra bearish chart configuration.

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Above: very likely still nowhere close to being "out of the woods," no bargain to be had here. Company survivability potentially still in serious doubt.

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Above: Long term view of Lehman Brothers (LEH) looks ripe for a renewed major decline; many big questions as to whether LEH will have the financial muscle needed to survive this down cycle…potentially another great example of too much leverage in reverse.

Finally, another indication of a trend reversal now rapidly approaching is the Goldman Sachs to Gold Ratio which measures relative confidence. If confidence is high in the financial system, money flows into Goldman Sachs (GS), the bluest of the blue chips, and shuns Gold, and the ratio falls. Alternatively, if confidence is frayed and frightened by the financial system, money flees Goldman and heads for Gold. We note that the ratio has recently undergone a hefty correction as the stock market rallied, but now in recent days, we see the ratio breaking out top side above its declining trend. Gold is regaining the upper footing, and as a barometer of faltering confidence, the rising ratio warns that a more challenging period may be just ahead. For those willing to listen, this breakout is the sounding of an alarm, a call to general quarters, and a warning to review portfolios on the spot. From here forward, odds are high that rallies should be viewed as opportunities to sell and that portfolios should be reverting back to a fully defensive posture.

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Above: the Goldman Sachs to Gold Ratio with 9 day RSI. Upside breakout signals "Battle-Stations" to all who will listen.



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Thursday, May 29, 2008

America's Hottest Investor

America's Hottest Investor:
Never Mind The Rocky Market. After A String Of Supersmart Calls, Mutual Fund Manager Ken Heebner Is Putting Up The Best Numbers Of His Sterling Career.

By Jon Birger, Senior Writer | 29 May 2008

(Fortune Magazine)— The best mutual fund manager around— a.k.a. Ken Heebner of Capital Growth Management— looks restless. He is sitting in a conference room at Goldman Sachs's Boston office, listening to a young analyst pontificate about all the trends he thinks will sweep the markets in coming years. Oil demand outpacing supply. The rapid growth of agriculture. The increased sway of sovereign wealth funds. And on and on.

Heebner couldn't care less. His flagship fund, CGM Focus (CGMFX), has already made a killing on energy and agriculture, and Heebner has no patience for the pet theories of this or any other analyst (or economist or strategist). "I want information, not opinions," Heebner will later tell me. Then, just as the meeting is looking like a washout, Goldman analyst Marc Fox lets something slip that starts Heebner's brain whirling. Fox mentions that sovereign wealth funds are diversifying out of bonds and bank bailouts and into broad portfolios of common stocks. Coming from Goldman, the world's top trading house, this is valuable information. Heebner is one of the few fund managers who routinely engages in short-selling, and the prospect of a couple of trillion dollars flooding the equity markets should be enough to give any short-seller pause.

Immediately Heebner is peppering Fox with questions about where all this sovereign dough is going, wondering, for instance, whether Goldman is now recommending "short-busting" strategies to its worldwide clientele. (Short-busting involves trying to drive up the prices of stocks that a lot of investors have sold short.) "All I can say," Fox replies, looking a tad overwhelmed, "is you're multiple steps ahead of me."

Fox shouldn't feel too bad: Heebner is multiple steps ahead of everyone these days. At an age when most of his contemporaries have either retired or given up the daily grind of running publicly traded funds, the 67-year-old Heebner is putting up the best numbers of an already exemplary 30-year career. He's Barry Bonds without the steroids. "He's a rock star— he's Bono," quips his Irish-born (and U2-loving) analyst Catherine Columb. Given that U2 hasn't put out a good album since Joshua Tree— sorry, Catherine— Bono should feel flattered. (Of course, it's doubtful that Heebner, who by his own admission spends most of his waking hours thinking about the markets, could pick either Bonds or Bono out of a lineup.)

Just how good has Heebner been? We may well be witnessing the most dazzling run of stock picking in mutual fund history. Since May 1998, Focus has an average annualized return of 24%, the best ten-year record of any U.S. mutual fund, compared with only 4% for Standard & Poor's 500. Focus, which has $7.4 billion in assets, is already up 15% in 2008 (as of May 19), but it is 2007 that will be remembered as Heebner's pièce de résistance. Fueled by big bets on energy, fertilizer, and metals, Focus soared 80% last year, vs. 5% for the S&P 500. "I told Ken it was like he was walking between the raindrops," says CGM president Bob Kemp, who oversees sales and marketing at the firm, of the year Heebner had in 2007. "It amazes even us." Last year marked the fourth time since 2000 that the fund returned 45% or better. And it's not as if Heebner has needed the big years to make up for a lot of losses: Launched in late 1997, Focus has had only one money-losing calendar year (2002).

Peter Lynch's 14-year tenure at Fidelity Magellan has long been the gold standard for mutual fund excellence. During Lynch's best ten years— August 1977 to August 1987— Magellan recorded an average annual return of 36%, according to fund tracker Morningstar. It's a remarkable achievement, but even Lynch acknowledges that he was backed by a strong tailwind. The S&P 500 returned 19% a year over the same period. In other words, Lynch beat the market by 17 percentage points a year during his heyday. Ken Heebner has beaten the market by 20 points a year during his.

And Focus isn't the only Heebner-managed fund that's excelling. CGM Realty (a sector fund), CGM Mutual (a balanced fund that owns stocks and bonds), and CGM Capital Development (closed to new investors since 1969 and soon to be merged into Focus) have been standouts too. Realty boasts a 22% annualized return for the past ten years, sixth-best in the mutual fund universe, according to Morningstar. It's also the only fund in its category that's been bucking the real estate slump. Realty's one-year total return: 34%, vs. 6% for its nearest rival.

A True Contrarian

Even more remarkable than the raw numbers is how Heebner has earned them. Heebner is a true contrarian, who says he's most confident as an investor "when everyone else thinks I'm nuts." He works long hours trying to identify emerging trends in the economy. When he finds a promising one, he'll go all in, making huge bets on the stocks poised to benefit. Asked how long it takes him to identify those stocks, Heebner answers, "About ten minutes. I've been at this a long time." It's an investing style that will never be taught in business schools and is definitely not something any amateur should try at home. But Heebner, blessed with uncanny instincts, has managed to see around just about every corner in a market that has befuddled just about everyone else.

Never a fan of technology stocks (or of technology itself— CGM just got its first voicemail system), Heebner shorted tech and telecom stocks with gusto from January 2000 to September 2001, profiting mightily from the bursting of the bubble. In December 2000, he began buying homebuilders like D.R. Horton and Lennar, convinced that falling interest rates would be good for housing. The stocks went on a tear, and by 2004, Heebner's stake in the sector accounted for 19% of assets in Focus and 79% in Realty. But toward the end of 2004 he grew uncomfortable with the spread of what he termed "funny-money mortgages," and by January 2005— mere months before the industry started to collapse— Heebner had sold off every homebuilder share he owned.

Heebner used his homebuilder profits to load up on oil and coal stocks, positions he'd started to establish in 2004. He even bought coal stocks for the Realty fund— a move that style purists might criticize but for which Heebner makes no apologies. "I did it because it was the best thing for shareholders," he says, noting that Realty's prospectus explicitly defines "companies involved in the real estate industry" to include mining companies, which obviously own a lot of real estate.

In August 2005, Heebner doubled down on commodities by taking big stakes in copper miners Southern Copper and Phelps Dodge. The price of copper— and of copper stocks— doubled in a little over a year. In November 2006 he built large positions in fertilizer companies Mosaic and Potash Corp. of Saskatchewan. This time the stocks quadrupled. In October 2005 he shorted mortgage lender Countrywide. Heebner was early on that one, but he stuck with the short for two years, and his conviction was rewarded in 2007 when Countrywide collapsed from $40 to $8. By then, Heebner had short positions in three more drain-circling mortgage lenders: BankUnited, IndyMac, and FirstFed Financial.

Not every one of his moves worked out so well, of course. But Kemp, Heebner's longtime mentor and colleague dating back to their days at Loomis Sayles in the 1970s, says that one of Heebner's many strengths is knowing when to cut his losses. "A lot of fund managers fall in love with an idea and ride it all the way down," Kemp says. "Ken's quick to admit when he's wrong." Heebner actually began 2007 with a quarter of Focus's money invested in five Wall Street banks: Bear Stearns (BSC, Fortune 500), Citigroup (C, Fortune 500), Goldman Sachs (GS, Fortune 500), Lehman Brothers (LEH, Fortune 500), and Merrill Lynch (MER, Fortune 500). The holdings could have proved disastrous, but by June— before the credit crisis really snowballed— he was out. "How do you explain genius?" muses Douglas Pratt, a former Invesco fund manager who was an analyst at Loomis. "Ken just sees things others don't."

A League Of His Own

Spend some time with Heebner, and it becomes clear why. His brain is wired differently. His ideas come faster, his focus is more intense, and his ability to sift through massive quantities of information and zero in on what matters is downright spooky. Pity the Salieris of the investing world who have to compete with this guy.

There's no simple formula that captures his investing principles, and explaining his approach is something even Heebner struggles with— which may be why CGM manages only $13 billion (including private accounts), a relatively modest amount given Heebner's track record. Basically, he's the last of the gunslingers— a go-anywhere manager who can be investing in left-for-dead U.S. value stocks one day and red-hot Brazilian growth stocks the next. But he's not just playing hunches. He knows from years of experience, for example, that when steel scrap prices soar— as they have of late— steel stocks usually follow. And Heebner is a workaholic who's up at 5:30 a.m. reading stock reports and checking business news and who never leaves the office at night without a stack of articles and research that make up his bedtime reading.

CGM is pretty much a one-man show. Heebner's entire investment team consists of two traders— Elise Schaefer and Sue Small— and Columb, the U2 fan. Being an analyst for Heebner is a bit like being a beauty consultant for Halle Berry, so Columb knows better than to try to suggest stocks. She operates more like a sleuth. Heebner will ask her to dig up the latest information on, say, scrap steel prices in China or deep-sea oil rig leases, and within an hour or two her findings are on his desk.

These days Heebner is keeping close tabs on the latest economic data out of China, because China is the key to his enormous bet on commodities. As of March, 64% of Focus's assets were invested in commodities-related stocks. His biggest stakes are in steel (ArcelorMittal, Nucor, and United States Steel) and in oil (Apache, Devon Energy, Petrobras, and Schlumberger). Petrobras, the Brazilian oil company that has announced two giant offshore oil discoveries, is his favorite. "Petrobras could become the biggest stock in the world," he says.

Heebner thinks steel prices could double and oil could blow past $200 a barrel. (He also thinks inflation will hit double digits within the next five years: "I don't know why anyone would buy a bond.") Yet he is constantly on the lookout for any sign that the economic slowdown in the U.S. may be infecting emerging economies abroad. That would deep-six his whole investment thesis, which hinges on China and other emerging nations using more energy and building more infrastructure. "I'm not waiting for Morgan Stanley to tell me there's something wrong in China," Heebner says. "By then it's too late."

One oil expert Heebner has consulted is Matthew Simmons, a Houston-based investment banker who's become the oracle of "peak oil" since his book Twilight in the Desert was published in 2005. Twilight argues that Saudi Arabia is running out of oil faster than we think, and Heebner's own research leads him to the same conclusion.

Simmons says he first met with Heebner around the time Twilight was going to press. Heebner spread out on CGM's conference room table a map of Ghawar, the world's largest oilfield. "I thought, 'Jesus, most of the people in the money-management business don't have any idea what any of the Saudi Arabian oil fields are called, much less where they are or what their production history is. But Kenny Heebner has a blown-up, detailed map of Ghawar that's better than anything I've ever seen,'" recalls Simmons. "Then he says, 'Let me tell you what I'm hearing.' Turns out he'd been digging up retirees from the oil business and finding people who were willing to talk. About an hour and a half later, I walked out and said, 'That guy is amazing.'" (CGM has become one of Simmons & Co.'s biggest clients.)

Mixing Business With Pleasure

Heebner enjoys his job enormously, which is the key to his longevity. "It's not a business for him, it's a pleasure," says his brother Jeffrey, 70, who ran a home-security business before retiring. Jeff says his brother is truly married to his work, which is why he was happily surprised when Ken got married at age 60. (Ken's wife, Renie, a microcap fund manager at another Boston firm, declined to be interviewed.) In fact, the line between pleasure and obsession sometimes gets a little blurry. Heebner doesn't take vacations, he insists he'll never retire, he knows less about pop culture than my 8-year-old twins (which, come to think of it, may be a good thing), and other than sailing and politics, he has few interests outside the investing world.

Even his morning commute— a half-mile walk from his home on Beacon Hill to Boston's financial district— is spent in deep thought about his stocks and the markets. Arthur Bauernfeind, chairman of Westfield Capital and a friend of Heebner's from their days together at Loomis, recalls once bumping into a snow-covered Heebner on the Loomis elevator on the way to work. When Bauernfeind started making small talk about the wintry weather, an oblivious Heebner looked up and asked, "Is it snowing?"

Heebner's intensity and one-track mind used to come with a volcanic temper, but Janine Hermsdorf, Heebner's head trader until her retirement in December, says he's mellowed with age. That said, the one time you still want to steer clear of him is the Friday before any three-day weekend. "It's like clockwork," says Hermsdorf, who otherwise sings Heebner's praises as a boss and friend. "He'll get agitated because he's not going to be trading for three days."

For better or for worse, the hyperactive trading has always been one of Heebner's calling cards. The turnover rate in CGM Focus, which typically holds 20 to 30 stocks at a time, was a whopping 384% last year, which in theory means he traded enough to buy and sell the entire portfolio nearly four times. Indeed, CGM's trading costs are sufficiently high that Hermsdorf was called on the carpet by one institutional client who, despite CGM's superior returns, was livid about its inflated VWAP, or volume-weighted average price, which is a measure of trading efficiency. "I thought the guy was going to eat me, he was so mad," she says.

Jeff Heebner says that his brother has always been a little obsessed with making a buck— even though spending it has never been his thing. Jeff recalls Ken showing up at Thanksgiving one year in a car so beat up that it was leaking gasoline. And Jeff has repeatedly begged his brother to replace the 45-foot sloop Nunaga— purchased used in 1987— with a new sailboat. "I keep telling him to get something bigger," Jeff says. "I worry he's going to drown in that thing someday."

It's the same story with his office. Located on the 45th floor of a tony Boston high-rise, it boasts a million-dollar view of Boston Harbor. On a clear day you can even see Cape Cod. But the interior looks as though he's barely unpacked. Award plaques sit unhung on the floor. There's a photograph near his desk of Acadia National Park in Maine that's been so bleached out by the sun it's unrecognizable. And while Heebner does have a stylish Kieninger clock on his wall, it doesn't work. "I haven't gotten around to getting it fixed," he says.

Heebner grew up in Philadelphia, the son of George Heebner, a building contractor, and Ruth Heebner, a homemaker. His paternal grandfather was a farmer in Pennsylvania Dutch country, where the town of Heebnerville bears the family name. Heebner inherited his work ethic as well as his love of sailing from his dad. George, Ken, Jeff, and youngest brother Donald would go on weekend excursions on their 42-foot boat, but Ken was the only Heebner boy who truly loved being out on the open water. A reluctant sailor himself, Jeff recalls a particularly harrowing voyage across Chesapeake Bay when they got caught in a storm. "I'm looking for the life preserver," he says. "And I look back at Ken, and he's kneeling on the seat with the steering wheel in his hand, smiling ear to ear. My knees are shaking, and he's having the time of his life."

Heebner was also the family bookworm, and his grades were good enough to take him to Amherst College and then on to Harvard Business School. He is one of a handful of business celebrities from the HBS class of 1965— former IBM CEO Louis Gerstner, consultant Ram Charan, and New England Patriots owner Bob Kraft are some others— but Heebner apparently made little impression on his classmates. "Ken was a very quiet guy," recalls fellow HBS '65 alum John Herrell, former chief administrator of the Mayo Clinic. "He didn't stand out." Adds another Harvard classmate, executive search consultant Tony Price: "There's nothing I recall about Ken that suggested the kind of success he's had as an investor. He was relatively quiet in a group of individuals who were pretty dynamic."

"They didn't know him well enough," counters John Henry (a retired Philadelphia businessman, not the Boston Red Sox owner of the same name), who knew Heebner at both Amherst and Harvard. "Ken did march to his own drumbeat, but he was absolutely brilliant. I never, ever doubted that he was going to be a great investor." Henry, himself a long-time shareholder in Heebner's funds, says what first impressed him about Heebner was a little gambit he had going in finance class. Classmates would bring him silver dollars, which Heebner would exchange for dollar bills. Says Henry: "Ken was hoarding silver dollars on the idea that silver was going to keep appreciating, which would eventually force the Treasury to stop issuing new silver coins." And that's exactly what happened. "It was funny as hell— he'd be sitting there with piles of silver dollars on his desk— but Ken had it nailed," Henry says. "He saw something the rest of us didn't. That's Ken— that's always been Ken."

Asked about the silver dollars, Heebner smiles and reveals that it was more than a lark for him. At one point he'd accumulated 13,000 silver dollars and had even taken out a bank loan to help finance his little venture. "The Treasury had these uncirculated silver dollars in bags in vaults. You could walk in with a thousand dollars, and they'd give you a bag of 1,000 silver dollars." It's still the best deal he's ever seen, he says: "You couldn't lose, but you could make a lot." Heebner figures he eventually netted around $15,000, but he was less successful when he tried to parlay his experience into a term paper about why silver prices were going up: "I didn't get a very good grade."

After getting his MBA, Heebner wanted to go to work on Wall Street as an investment banker. Nobody would hire him. "I think my energy level back then was so high that I just made people uneasy," he says. Heebner eventually took a position at the economic forecasting firm A&H Kroeger, where he spent four years and honed his ability to identify trends from reams of data.

Controversial Opinions

Eager to get into the investing world, Heebner thought he'd gotten his big break when Scudder Stevens & Clark hired him as a conglomerate analyst in 1969 and then promoted him to assistant portfolio manager for the Scudder Development fund four years later. Ned Swanberg, who was the fund's lead manager back then, says what he remembers most about Heebner is an idea he never acted on. Heebner returned from a trip to the New Jersey shore with what seemed like a bizarre suggestion: He wanted Scudder to invest in Atlantic City real estate. Atlantic City had fallen on hard times by the early 1970s, but there was talk of bringing in casinos. "I should have listened to him," Swanberg says. "We'd have made a fortune." (Gambling was approved in 1976, setting off a boom.)

Heebner was eventually fired from Scudder, but it had nothing to do with investing. During a three-martini lunch with some colleagues, Heebner made some comments critical of Scudder's CEO, and one of his lunchmates blabbed. "I wasn't a martini drinker," Heebner says. "That was the problem." Scudder's loss proved to be Loomis Sayles's gain. Kemp had just been made chief investment officer at Boston-based Loomis, and one of his first assignments was fixing Loomis's two struggling mutual funds. "Someone told me there was a fellow with some talent at Scudder, but he was loud and talked back," Kemp recalls. "I said, 'I don't care if he talks back, just as long as he has the right answers.'"

Heebner usually did. He took over the Loomis Sayles Capital Development fund (now CGM Capital Development) in 1976 and eventually turned it into Boston's second-hottest mutual fund, after Lynch's Magellan. The investment community in Boston is fairly collegial, and Heebner and Lynch soon became friends. "Peter would talk about Heebner constantly," says Brian Posner, a former Fidelity fund manager who early in his career was one of Lynch's analysts. "Here was a guy with a much more modest organization who kept just punching out the numbers."

In Heebner's early days at Loomis, he was forced to make all his stock picks from a list of 300 names approved by the firm's research department. Heebner was so frustrated by this restriction that he'd occasionally give Lynch stock ideas he wasn't permitted to use himself. Lynch confirms this, adding that in those days he, Heebner, and several other top Boston money managers used to talk stocks at a monthly dinner. Lynch says he even tried to recruit Heebner to Fidelity, an opportunity Heebner says he passed up because he would have been managing separate accounts instead of a mutual fund. "Ken is an incredible fundamental analyst," says Lynch. "He's very thematic, and he stays with things for a very long time, but once he's convinced that something is deteriorating, that's it."

Lynch says he never really thought of himself as competing with Heebner, but evidently that feeling was not mutual. "The day Peter retired, I thought Ken was going to cry," Hermsdorf says. "Ken thought he was catching up to Peter." In 1990, Heebner and Kemp broke from Loomis to form CGM. Or more precisely, they persuaded Loomis's parent company, New England Life, to spin them off. (Natixis, the French bank that acquired New England Life's money management operations, still owns a 50% stake in CGM.) Heebner wanted to leave Loomis largely because other money managers there were piggybacking on his ideas. "I had a good investment record, so obviously if they saw me buying something, they would want to look at it too," he says.

He continued to put up excellent returns until the mid-1990s, when tech stocks started to dominate the market. For Heebner, that was a problem, because he usually shied away from technology. The barriers to entry were too low, and forecasting winners and losers too hard. Focus eked out single-digit gains in both '98 and '99, whereas many rival funds were soaring 40% or 50%. Though Heebner never doubted his decision to steer clear of technology, others (ahem, ahem) weren't so sure. In October 1999, Fortune made Heebner the poster child for fallen fund stars in a story headlined "Where Have All the Geniuses Gone?"

With shareholders pulling money out of his funds, Heebner eventually gave in and bought a handful of tech stocks. But he was always a nervous holder, tending to buy and sell at the wrong times. "I knew it was a train wreck," he says. "The problem I had is that when you go from 50 times earnings to 100 times to 150 times, how do you know when the idiots are going to stop bidding these things up? That's the thing about bubbles— how do you know when they're going to end?"

Of course, skeptics are asking the same question today about commodities. Heebner doesn't see the parallel. He believes that the consensus view on Wall Street is still that the U.S. will drag the rest of the world into a global recession. He thinks that by betting big on oil and steel, he's actually being contrarian. We'll see if he's right. But by the time you read this, it may not even matter. Perhaps one of the Chinese steel prices Heebner tracks will have ticked in the wrong direction. Perhaps one of his Petrobras sources will have told him that the offshore discoveries are so big that they might oversaturate the market. Perhaps by the time you read this Heebner will have done the same about-face on commodities that he did on homebuilders 3 1/2 years ago.

Heebner's friend Bob Molloy, a retired broker from Merrill Lynch, likes to tell the story of the time Heebner took him and some Merrill colleagues sailing after work. "We'd just got out of Boston Harbor and we're about to put up the sails when Ken announces, 'We've got to turn back.' I said, 'What do you mean, we have to turn back? It's a beautiful day.' Ken said, 'Look out there. There's a big bank of fog rolling in.' Well, all I saw was the horizon, but by the time we got back to the slip, you couldn't even see from the cockpit up to the front of the boat— that's how thick the fog was." Like we said, Heebner just sees things before anyone else.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

S&P/Case Shiller Home Price Index

S&P/Case Shiller Home Price Index Reveals Largest Drop In 20-Year History

By RTT Staff Writer | 27 May 2008

(RTTNews)— Home prices plunged at a record pace in the first quarter, data released on Tuesday showed. The S&P/Case-Shiller national home-price index— a closely-watched gauge of housing prices— revealed a 14.4 percent decline from last year. This was the largest drop in the two-decades since the index began recording home prices in 1988. The quarterly index covers the nine U.S. Census divisions. A separate index examining 20-cities around the United States also revealed a decline of 14.4 percent in the first quarter. That index is only 7 years old, making this decline the steepest since its inception in 2001. A smaller, older 10-city index plummeted 15.3 percent— the most in its 20-year history.

David Blitzer, Chairman of the Index committee at Standard & Poor's, commenting on what he called the "steep downturn in residential real estate," adding that "there are very few silver linings that one can see in the data." "Most of the nation appears to remain on a downward path, with 19 of the 20 metro areas reporting annual declines, and six of those now at negative rates exceeding -20%," Blitzer said. The weakest market remains Las Vegas, with an annual decline of 25.9 percent. It is followed closely by Miami and Phoenix, with declines of 24.6 and 23.0 percent, respectively.

On an annual basis, Charlotte is the only market in the 20-city index to see an increase in home prices from last year, gaining 0.8 percent. Fifteen of the 20 metro areas surveyed are reporting record lows, Blitzer said. Eleven of those 20 are in double digit decline. A small dose of good news came from Charlotte and Dallas, which saw monthly price appreciation for the first time in seven months. Charlotte was up 0.2 percent in March over February, and Dallas was up 1.1 percent.

On a month to month basis, nationwide home prices dropped 2.2 percent from February to March, the index showed. The news is the latest in a series of reports that hint at continued problems for the housing market, which is said to be in its worst slump since the Great Depression. Last week, a report from the Office of Federal Housing Enterprise Oversight revealed that U.S. home prices plunged at a record pace in the first quarter. U.S. home prices saw their sharpest decline in the 17 years since the government began tracking home data. OFHEO's seasonally-adjusted purchase-only house price index fell 3.1 percent from last year, and declined 1.7 percent from the fourth quarter— the largest quarterly drop on record. Between the third and fourth quarters of 2007, home prices fell 1.4 percent.

"These substantial home price declines bring positive and negative news," said OFHEO's Managing Director James Lockhart said in a statement. "For homeowners and financial market observers, these declines spell further erosion in home equity levels and potentially more trouble for mortgage markets," he explained. "To prospective home buyers who have been shut out of homeownership because of affordability constraints, these declines may be welcome news, as are continued low mortgage rates." The lingering supply overhang is forcing prices down, the OFHEO's Chief Economist Patrick Lawler said.

"The large overhang of real estate inventory awaiting sale continues to force price declines in many areas, but particularly in places that had seen very sharp appreciation in previous periods," he said in a statement. Last week, Federal Reserve Vice Chairman Donald Kohn warned of further problems for the housing market. "The demand for housing continued to decline early this year, and sales could fall even further in coming months, given the tightness in mortgage lending," he said. The housing market could see further decline, Kohn said, although he noted that eventually low prices will likely lead to increased demand.

"All prominent measures of house prices are now showing declines," he noted. "Although lower prices would eventually help bolster housing demand, the expectations of further declines in prices may currently be exacerbating the difficulties in housing markets." Specifically, Kohn cited the lingering overhang in supply which has weighed heavily on the housing market, dragging down home prices across the country. "The supply of existing homes on the market also remains quite high and is likely to be augmented in coming months by rising foreclosures," he added. "As a result, further cuts in construction appear to be in train."



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Wednesday, May 28, 2008


Crash! (Version 2.0)

By Dr. Housing Bubble, | 27 May 2008

I am a big fan of Frederick Lewis Allen who has written extensively on the historical, social, and economic circumstances of the early half of the last century. For those of you who want to see where we are heading, we need to have a wider scope than just the last few decades. It seems that people don't much care about history yet are quite willing to accept a repeat. This is a chapter titled Crash! that gives an amazing account of the days and time surrounding the crash of 1929:

Only Yesterday: An Informal History of the 1920's (Perennial Classics) (Paperback)
by Frederick L. Allen

[1929] Early in September the stock market broke. It quickly recovered however; indeed, on September 19th the averages as compiled by the New York Times reached an even higher level than that of September 3rd. Once more it slipped, farther and faster, until by October 4th the prices of a good many stocks had coasted to what seemed first-class bargain levels. Steel, for example, after having touched 261 3/4 a few weeks earlier, had dropped as low as 204; American Can, at the closing on October 4th, was nearly twenty Points below its high for the year; General Electric was over fifty points below -its high; Radio had gone down from 114 3/4 to 82 1/2.

A bad break, to be sure, but there had been other bad breaks, and the speculators who escaped unscathed proceeded to take advantage of the lessons they had learned in June and December of 1928 and March and May of 1929: when there was a break it was a good time to buy. In the face of all this tremendous liquidation, brokers’ loans as compiled by the Federal Reserve Bank of New York mounted to a new high record on October 2nd, reaching $6,804,000,000— a sure sign that margin buyers were not deserting the market but coming into it in numbers at least undiminished. (Part of the increase in the loan figure was probably due to the piling up of unsold securities in dealers, hands, as the spawning of investment trusts and the issue of new common stock by every manner of business concern continued unabated.)

History, it seemed, was about to repeat itself, and those who picked up Anaconda at 109 3/4 or American Telephone at 281 would count themselves wise investors. And sure enough, prices once more began to climb. They had already turned upward before that Sunday in early October when Ramsay MacDonald sat on a log with Herbert Hoover at the Rapidan camp and talked over the prospects for naval limitation and peace.

Something was wrong, however. The decline began once more. The wiseacres of Wall Street, looking about for causes, fixed upon the collapse of the Hatry financial group in England (which had led to much forced telling among foreign investors and speculators), and upon the bold refusal of the Massachusetts Department of Public Utilities to allow the Edison Company of Boston to split up its stock. They pointed, too, to the fact that the steel industry was undoubtedly slipping, and to the accumulation of "undigested" securities. But there was little real alarm until the week of October 21st. The consensus of opinion, in the meantime, was merely that the equinoctial storm of September had not quite blown over. The market was readjusting itself into a "more secure technical position."

[It is clear from anyone that has studied the Great Depression, that not one event collapsed the market. It was like a tipping point that finally catapulted the market downward. Interestingly enough, a major financial group had indeed collapsed in England and also, a public utility company was not allowed to split its stock {doesn’t it seem familiar that these two parallel with Bear Stearns being bailed out and also, the proposed splitting up of the monolines?}. Either way, the market in early 1929 had already had a few incidents where the market declined only to be propped back up by massive speculation. The speculation was so spectacular, indeed, that even at the last minute, investors were still pushing stocks up. And of course, it almost seemed unfathomable that the market could or would collapse. Even the prophets of Wall Street couldn’t envision such a scenario.]

In view of what was about to happen, it is enlightening to recall how things looked at this juncture to the financial prophets, those gentlemen whose wizardly reputations were based upon their supposed ability to examine a set of graphs brought to them by a statistician and discover, from the relation of curve to curve and index to index, whether things were going to get better or worse. Their opinions differed, of course; there never has been a moment when the best financial opinion was unanimous.

In examining these opinions, and the outgivings of eminent bankers, it must furthermore be acknowledged that a bullish statement cannot always be taken at its face value: few men like to assume the responsibility of spreading alarm by making dire predictions, nor is a banker with unsold securities on his hands likely to say anything which will make it more difficult to dispose of them, unquiet as his private mind may be. Finally, one must admit that prophecy is at best the most hazardous of occupations. Nevertheless, the general state of financial opinion in October, 1929, makes an instructive contrast with that in February and March, 1928, when, as we have seen, the skies had not appeared any too bright.

Some forecasters, to be sure, were so unconventional as to counsel caution. Roger W. Babson, an investment adviser who had not always been highly regarded in the inner circles of Wall Street, especially since he had for a long time been warning his clients of future trouble, predicted early in September a decline of sixty or eighty points in the averages. On October 7th the Standard Trade and Securities Service of the Standard Statistics Company advised its clients to pursue an "ultraconservative policy," and ventured this prediction: "We remain of the opinion that, over the next few months, the trend of common-stock prices will be toward lower levels."

Poor’s Weekly Business and Investment Letter spoke its mind on the "great common-stock delusion" and predicted "further liquidation in stocks." Among the big bankers, Paul M. Warburg had shown months before this that he was alive to the dangers of the situation. These commentators— along with others such as the editor of the Commercial and Financial Chronicle and the financial editor of the New York Times— would appear to deserve the 1929 gold medals for foresight."

[It is often cited that no one really foresaw the crash of 1929— there were a handful of people that were echoing a warning cry— but how many people listened? Even though their predictions were rather more modest than outright bearish, yet they were still not given the time of day. But of course you now have your perpetual housing bulls.]

Professor Irving Fisher, however, was more optimistic. In the newspapers of October 17th he was reported as telling the Purchasing Agents Association that stock prices had reached "what looks like a permanently high plateau." He expected to see the stock market, within a few months, "a good deal higher than it is today." On the very eve of the panic of October 24th he was further quoted as expecting a recovery in prices. Only two days before the panic, the Boston News Bureau quoted R. W. McNeel, director of McNeel’s Financial Service, as suspecting "that some pretty intelligent people are now buying stocks… Unless we are to have a panic— which no one seriously believes— stocks have hit bottom," said Mr. McNeel.

As for Charles E. Mitchell, chairman of the great National City Bank of New York, he continuously and enthusiastically, radiated sunshine. Early in October Mr. Mitchell was positive that, despite the stock-market break, "The industrial situation of the United States is absolutely sound and our credit situation is in no way critical… The interest given by the public to brokers’ loans is always exaggerated," he added. "Altogether too much attention is paid to it."

A few days later Mr. Mitchell spoke again: "Although in some cases speculation has gone too far in the United States, the markets generally are now in a healthy condition. The last six weeks have done an immense amount of good by shaking down prices… The market values have a sound basis in the general prosperity of our country." Finally, on October 22nd, two days before the panic, he arrived in the United States from a short trip to Europe with these reassuring words: "I know of nothing fundamentally wrong with the stock market or with the underlying business and credit structure… The public is suffering from ‘brokers’ loanitis."

[In these types of situations, be careful whom you listen to. The CEO of Bear Stearns as early as 2 days before his company was bailed out by the Federal Reserve was quoted in the news as follows:

'New Chief Executive Alan Schwartz appeared on CNBC Wednesday to allay fears that the firm faces a liquidity crisis, a perception heightened by the Federal Reserve’s decision on Tuesday to loan up to
$200 billion in Treasury bonds to primary dealers, a move that would allow Bear to swap some of its mortgage-backed securities for more secure debt.'

"Our balance sheet has not weakened at all," said Schwartz, noting that Bear’s
$17 billion cash position was the same as it had been in November. On Monday, the company posted a similar message on its web site: "The company stated that there is absolutely no truth to the rumors of liquidity problems that circulated today in the market."

So much for not having a weak balance sheet. In 2 days Bear Stearns lost
40 percent of its market value. In these times, even those perceived as experts have a motivation to keep the pretense up that all is well. Clearly as CEO, one entitled to expect that you would have a better sense of your company’s situation. I still think we have yet to see the break point where the market trends fully lower. During 1929 that moment came in late October.]

The next day was Thursday, October 24th.

On that momentous day stocks opened moderately steady in price, but in enormous volume. Kennecott appeared on the tape in a block of 20,000 shares, General Motors in another, of the same amount. Almost at once the ticker tape began to lag behind the trading on the floor. The pressure of selling orders was disconcertingly heavy. Prices were going down… Presently they were going down with some rapidity… Before the first hour of trading was over, it was already apparent that they were going down with an altogether unprecedented and amazing violence. In brokers’ offices all over the Country, tape-watchers looked at one another in astonishment and perplexity. Where on earth was this torrent of selling orders coming from?

The exact answer to this question will probably never be known. But it seems probable that the principal cause of the break in prices during that first hour on October 24th was not fear. Nor was it short selling. It was forced selling. It was the dumping on the market of hundreds of thousands of shares of stock held in the name of miserable traders [[today's hedge funds and SIVs?: normxxx]] whose margins were exhausted or about to be exhausted. The gigantic edifice of prices was honeycombed with speculative credit and was now breaking under its own weight.

Fear, however, did not long delay its coming. As the price structure crumbled there was a sudden stampede to get out from under. By eleven o’clock traders on the floor of the Stock Exchange were in a wild scramble to "sell at the market." Long before the lagging ticker could tell what was happening, word had gone out by telephone and telegraph that the bottom was dropping out of things, and the selling orders redoubled in volume. The leading stocks were going down two, three, and even five points between sales. Down, down, down…. Where were the bargain-hunters who were supposed to come to the rescue at times like this?

Where were those investment trusts, which were expected to provide a cushion for the market by making new purchases at low prices? Where were the big operators who had declared that they were still bullish? Where were the powerful bankers who were supposed to be able at any moment to support prices? There seemed no support whatever. Down, down, down. The roar of voices which rose from the floor of the Exchange had become a roar of panic.

United States Steel had opened at 205 1/2. It crashed through 200 and presently was at 193 1/2. General Electric, which only a few weeks before had been selling above 400, had opened this morning at 315— now it had slid to 283. Things were even worse with Radio: opening at 68 3/4, it had gone dismally down through the sixties and the fifties and forties to the abysmal price of 44 1/2. And as for Montgomery Ward, vehicle of the hopes of thousands who saw the chain store as the harbinger of the new economic era, it had dropped headlong from 83 to 50. In the space of two short hours, dozens of stocks lost ground which had required many months of the bull market to gain.

Even this sudden decline in values might not have been utterly terrifying if people could have known precisely what was happening at any moment. It is the unknown which causes real panic.

[Amazingly, it seems like the fire that lit the fuse was forced selling in October 1929. The current catalyst of this market is the forced liquidation of many companies and 'margin calls' are now starting to creep back into the lexicon of the market. Without credit, the system cannot function— just as a Ponzi Scheme cannot go on without increasingly greater numbers of new players [[just like the housing market: normxxx]]. Once the buyers (credit) dries up, the gig is up. It wouldn’t be a problem if companies were adequately capitalized but everone is leveraged to the hilt and really have no viability without access to credit. That [greed] is their mistake. Just like the many unable to save during the good times for the inevitable future downturn. Those that claim we will not have a recession need their heads examined. Even after the "crash" the market had a few short rallies until it finally capitulated.]

The New York Times averages for fifty leading stocks had been cut almost in half, falling from a high of 311.90 in September to a low of 164.43 on November 13th; and the Times averages for twenty-five leading industrials had fared still worse, diving from 469.49 to 220.95.

The Big Bull Market was dead. Billions of dollars’ worth of profits-and paper profits-had disappeared. The grocer, the window-cleaner, and the seamstress had lost their capital. In every town there were families who had suddenly dropped from showy affluence into penury. Investors who had dreamed of retiring to live on their fortunes now found themselves back once more at the very beginning of the long road to riches. Day by day the newspapers printed the grim reports of 'celebrity' suicides.

Coolidge-Hoover Prosperity was not yet dead, but it was rapidly dying. Under the impact of the shock of panic, a multitude of ills which hitherto had passed unnoticed or had been offset by stock-market optimism began to beset the body economic, as poisons seep through the human system when a vital organ has ceased to function normally. Although the liquidation of nearly three billion dollars of brokers’ loans contracted credit, the Reserve Banks lowered the rediscount rate, and the way in which the larger banks and corporations of the country survived the emergency without a single failure of significant proportions offered real encouragement.

[ Normxxx Here:  That was in 1929. The major bank failures were to begin the next year, 1930, with the failure of the N.Y. Bank of the United States, and finally peak by the end of 1932, by which time, every significant state had declared a "bank holiday" of one kind or another— except Nevada, which only had two banks of significance.  ]

Nevertheless the social and economic poisons were there, soon to become readily evident; overproduction of capital equipment; overambitious expansion of business concerns; overproduction of commodities under the stimulus of installment buying and buying with stock-market profits; the maintenance of an artificial price level for many commodities, the depressed condition of European trade. No matter how many soothsayers of high finance proclaimed that all was well, no matter how earnestly the President set to work to repair the damage with soft words and White House conferences, a major depression was inevitably under way.

Nor was that all. Prosperity is more than an economic condition: it is also a state of mind. The Big Bull Market had been more than the climax of a business cycle; it had been the climax of a cycle in American mass thinking and mass emotion. There was hardly a man or woman in the country whose views and attitude toward life had not been enlivened by the booming '20s in some degree and was not now affected by the sudden and brutal shattering of those grandiose visions. With the Big Bull Market gone and prosperity rapidly following, Americans were very soon to find themselves living in an altogether unexpected world which called for new adjustments, new ideas, new habits of thought, and a new set of values. The psychological climate was changing; the ever-shifting currents of American life were turning into new channels.

The Post-WW I war Decade had come to its close. An era had ended."

[It is only a matter of time before our current era of easy credit and new el Dorado ends. The question remains only of when it will happen.]



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

They're Wrong About Oil

They're Wrong About Oil, By George
Rip Up Your Textbooks, The Doubling Of Oil Prices Has Little To Do With China's Appetite

By Anatole Kaletsky, TimesOnline | 25 May 2008

Just as the credit crunch seemed to be passing, at least in the US, another and much more ominous financial crisis has broken out. The escalation of oil prices, which this week reached a previously unthinkable $130 a barrel (with predictions of $150 and $200 soon to come), threatens to do far more damage to the world economy than the credit crunch. Instead of just causing a brief recession, the oil and commodity boom threatens a prolonged period of global "stagflation", the lethal combination of high inflation and economic stagnation last seen in the world economy in the 1970s and early 1980s. This would be a disaster far more momentous than the repossession of a few million homes or collapse of a couple of banks.

Commodity inflation is far more lethal than a credit crunch for two reasons. It prevents central banks in advanced economies from cutting interest rates to keep their economies growing. Even worse, it encourages the governments of developing countries to turn their backs on global markets, resorting instead to price controls, trade restrictions and currency manipulations to protect their citizens from the rising costs of energy and food. For both these reasons, the boom in oil and commodity prices, if it lasts much longer, could reverse the globalisation process that has delivered 20 years of almost uninterrupted growth to America and Europe and rescued billions of people from extreme poverty in China, India, Brazil and many other countries.

That is the bad news. The good news is that the world is not as impotent as is often suggested in the face of this danger, since soaring commodity prices are not the ineluctable outcome of some fateful conjuncture of global economic forces, but rather the product of a typical financial boom-bust cycle, which could be deflated— especially with some help from sensible political action— as quickly as it built up.

The present commodity and oil boom shows all the classic symptoms of a financial bubble, such as Japan in the 1980s, technology stocks in the 1990s and, most recently, housing and mortgages in the US. But surely, you will say, this commodity boom is different? Surely it is driven by profound and lasting changes in global supply and demand: China's insatiable appetite for food and energy, geopolitical conflicts in the Middle East, the peaking of global oil reserves, droughts caused by global warming and so on. All these fundamental points are perfectly valid, but they tell us nothing about whether the oil price will soon jump to $200, stay at $130 or fall back to $60 next month.

To see that these "fundamentals" are all irrelevant, we have merely to ask which of them has changed in the past nine months. The answer is none. The oil markets didn't suddenly discover China's oil demand nine months ago so this cannot explain the doubling of prices since last August. In fact, China's "insatiable" demand growth has decelerated. In 2004 it was consuming an extra 0.9 million barrels a day; in 2007 it was consuming just an extra 0.3 mbd. In the same period global demand growth has slowed from 3.6 mbd to 0.7 mbd. As a result, the increase in global demand growth is now well below last year's increase of 0.8 mbd in non-Opec production, according to Mike Rothman, of ISI, a leading New York consulting group.

Why, then, are commodity prices still rising? The first point to note is that many no longer are. Rice, wheat and pork are 20 to 30 per cent cheaper than they were two months ago, when financial pundits identified Asian and African food riots as the first symptoms of a commodity "super-cycle" that would drive prices much higher. And the price of industrial commodities such as lead, zinc and nickel, supposedly in short supply a year ago, has now dropped by 40 to 60 per cent. In fact, most major commodity indices would already be in a downtrend were it not for the dominance of oil.

But oil is the commodity that really matters and surely the latest jump in prices proves that demand really does exceed supply? Not at all. In the late stages of financial bubbles, it is quite normal for prices to become completely detached from economic fundamentals. House prices in Florida and Spain kept rising even after property developers built far more homes than they could possibly sell. The same thing happened in credit markets: mortgage securities kept rising even while banks created "special purpose vehicles" to acquire vast "inventories" of bonds for which there were no genuine buyers— and dozens of similar examples can be cited from the bubbles in internet stocks and Japan. Similarly, the International Gold Council reported this week that gold demand for commercial uses and investment fell 17 per cent in January, just as the gold price surged through $1,000 for the first time.

Now consider the situation today in oil markets: the Gulf, according to Mr Rothman, is crammed with supertankers chartered by oil-producing governments to hold the inventories of oil they are pumping but cannot sell. That physical oil is in excess supply at today's prices does not mean that producers are somehow cheating by storing their oil in tankers or keeping it in the ground. All it suggests is that there are few buyers for physical oil cargoes at today's prices, but there are plenty of buyers for pieces of paper linked to the price of oil next month and next year. This situation is exactly analogous to the bubble in credit markets a year ago, where nobody wanted to buy sub-prime mortgage bonds, but there was plenty of demand for "financial derivatives" that allowed investors to bet on the future value of these bonds.

In short, the standard economic assumption that supply and demand drive prices is only a starting point for understanding financial markets. In boom-bust cycles, the textbook theory is not just slightly inaccurate but totally wrong. This is the main argument made by George Soros in his fascinating book on the credit crunch, The New Paradigm for Financial Markets, launched at an LSE lecture last night. In this book Mr Soros explains how financial bubbles always start with some genuine economic transformation— the invention of the internet, the deregulation of credit or the rise of China as a commodity consumer.

He could have added the Netherlands' emergence as a financial centre (and world naval power) triggering Tulipmania, or Britain's emergence as a dominant global naval power before the South Sea Bubble of 1720. The trouble is that these initial perceptions of a new paradigm tell us nothing about how far financial prices will adjust in response— will Chinese demand drive oil prices to $50 or $100 or $1,000? Instead they can create a self-fulfilling momentum of rising prices and an inbuilt bias in the way that investors interpret the world. The resulting misconceptions drive market prices to a "far from equilibrium position" that bears almost no relation to the balance of underlying supply and demand.

The people who tell you that commodity prices today are driven by "economic fundamentals" are the same ones who said that house prices in Britain were rising because of land shortages. The amazing thing is that just months after losing hundreds of billions in the housing and mortgage bubbles, investors and governments around the world have reverted to the discredited fallacy that financial markets always reflect economic reality, instead of the boom-bust cycles and misconceptions that George Soros's book vividly describes.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.