Thursday, July 31, 2008

Stuffing The Mattresses

Even The Pros May Be Stuffing The Mattresses

By Gail Marksjarvis, Chicagotribune.Com | 29 July 2008

If you saw dark clouds drifting from St. Charles last week, they were probably coming from the dreary mood at the CFA Institute's annual investment seminar for professional investment managers. Every year, the respected chartered financial analyst investment education group brings money managers from around the world together in the Chicago area and exposes them to provocative thinkers on investment strategy and market conditions. And with most of the world's stock markets down 20 percent or more from their highs, economies slowing throughout the world, and a credit crisis toying with the flow of money, this year's speakers were gloomy.

"I am officially scared," GMO investment manager Jeremy Grantham told professionals from as far away as Abu Dhabi and Malaysia. "In 2000, we had a technology bubble. But this is massive, a massive credit crisis and a bubble in global housing, global equity and global land." Grantham is sometimes referred to as a "perma-bear" because he's a stickler about avoiding overpriced stocks. Two years ago, he warned his audience that U.S. stocks were too expensive, even after recovering most of the ground lost from the 49 percent drop to correct the bubble in technology stock prices in 2000. But back then, Grantham was cautious; not fearful. While he was avoiding U.S. stocks, he thought fast-growing emerging markets still held promise.

Now, after a tremendous surge of investor money into Asia, Latin America, Africa and the Middle East, he is concerned about the prices of those stocks, as the world works its way through what he called the "first truly global bubble." In the last few weeks, economies throughout the world have slowed sharply, and Grantham said corporate profit margins must decline as the trend continues. But he does not think investors have adjusted their expectations.

For investors expecting 7 percent annual returns in the U.S. stock market, Grantham said the price-earnings ratio would either have to go to 35, or "profit margins would have to go off the chart." The price of Standard & Poor's 500 stocks is currently about 22 times earnings. When asked by a money manager what he would buy now, Grantham said he was, "long mattresses"— jesting about the stereotypical nervous behavior of hoarding cash. He seriously suggested: "Put money into something incredibly safe, like a high-quality hedge fund."

Grantham said rather than buying stocks for the long run now, he would only "short" them, or bet that they will decline in price. He sees "nothing interesting in quality corporate bonds," and he has been shorting oil. "Commodities had a good run, but that's over," he said. Although downtrodden 'quality' mortgage-related bonds might be a good deal now because some are selling for 59 cents on the dollar, he said he wonders if the price will seem compelling if home prices fall another 20 percent or 25 percent.

He confessed to the group that "I bought my first gold last week, and I hate gold. It doesn't pay a dividend. I would only do it if I was desperate." Grantham said part of his angst comes from a lack of leadership. He criticized U.S. Treasury Secretary Henry Paulson for failing to force banks to raise capital when it was warranted two years ago. And he added: "Just imagine, we have chosen to borrow money from China so we can buy oil from the Middle East and use it to wage war in the Middle East and to pollute the planet."

Marc Faber of Marc Faber Ltd. blamed former Federal Reserve Chairman Alan Greenspan for failing to acknowledge the Fed's role in repeatedly inflating dangerous bubbles. By keeping interest rates low, "the Fed has created a bubble in everything— stocks in emerging market, real estate everywhere in the world, commodities, art," he said. "The only asset class that is down is the U.S. dollar."

Generally, when bubbles burst, the asset prices stay down for lengthy periods. Grantham isn't expecting the stock market to hit its low until 2010. [[Note: it is a universal human failing to expect the things we anticipate to occur far earlier than they actually do, because we fail adequately to take into account the effects of attempts at mitigation and other countervailing forces.: normxxx]] Farouki Majeed, the senior investment officer for asset allocation and risk management for the giant California Public Employees' Retirement System, noted that with the tech bubble bursting in 2000 and the current bear market, investors in stocks have seen virtually no return for the last 10 years. That's unusual, but typical of "boom and bust" cycles, he said.

Calpers reduced its exposure to stocks from 60 percent of the pension fund to just 54 percent this year. Faber said, "It is quite likely that the current synchronized global economic boom and the universal, all-encompassing asset bubble will lead to a colossal bust." And with commodity prices so inflated, he expects an "increase in international tensions" over resources.



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.

NY Governor Warns Of Crisis

New York Governor Warns Of Economic Crisis

By Mike "Mish" Shedlock | 31 July 2008

The New York Times is reporting Paterson Warns of Economic Crisis.

In a rare, brief televised address, Gov. David A. Paterson announced on Tuesday afternoon that he would call the Legislature into an emergency session on Aug. 19 to address what he called an economic and budget crisis confronting New York State as a result of plummeting revenues and rising costs. The new governor avoided any mention of new taxes, instead arguing forcefully for austerity. He said he was calling on the Legislature to reduce the size of the state workforce; cut agency spending; reduce property taxes for homeowners; aid New Yorkers with the soaring costs of home energy; and even consider public-private partnerships that would take over state assets.

"Revenues are dropping dramatically," the governor added. "At the start of May, the state budget office projected a cumulative deficit of $21.5 billion over the next three years. Now, just two months later, that estimate has risen to $26.2 billion— a staggering 22 percent increase in less than 90 days." Mr. Paterson offered another example of the rapid deterioration in the state's finances. In June 2007, he said, the 16 banks that pay the most on their business profits remitted $173 million to the state treasury. "This June, just a month ago, they sent us $5 million— a 97 percent decrease," he said.

He vowed,
"We will cut spending. Government will learn to do more with less." He called for help from business and labor leaders and New York's representatives in Washington to support him. He added, "It is time for New York and other governments to cut up our credit cards. The era of 'buy now and pay later, and later' is over. The faster we address this crisis, the faster and stronger we will emerge from it."

Era Of 'Buy Now And Pay Later, And Later' Is Over

New York is the second state in five days to declare a fiscal emergency. See Schwarzenegger Announced Intention To Slash State Workers' Pay Till Budget Passes for more on the crisis in California. The most stunning thing about Paterson's announcement is how rational it is. He is not begging Washington for handouts, asking for higher taxes, or praying for miracles. This is pretty stunning too: In June 2007, the 16 banks that pay the most on their business profits remitted $173 million to the state treasury. "This June, just a month ago, they sent us $5 million— a 97 percent decrease."

Unlike Schwarzenegger who has for years resorted to floating bond or proposing various lottery schemes to "fix" the budget, Paterson has the correct solution. Of course Schwarzenegger has at times vowed to "cut up the credit cards" but in the end has delivered nothing but promises and schemes of floating $500 billion in bonds to "rebuild California the way it needs to be rebuilt".

Can Paterson Deliver?

I hope Patterson can, but the state legislature is likely to resist all the way. However, saying these things is one thing, and doing them is another. Regardless, of whether or not all of those things happen, some forced austerity is all but assured. The same goes for California as well. And the word that describes the process best is the one word nearly everyone is in denial over: deflation.



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, July 30, 2008

Recession-Proof Stocks?

Conventional Wisdom: Rethinking Recession-Proof Stocks

By Joshua Lipton | 30 July 2008

The conventional wisdom says to buy defensive stocks when the economy slows down. But with factors other than U.S. growth to thank for solid global growth, and with rapid advancements in technology, it may be time to rethink what it really means to invest defensively.

Or is it?

The tried-and-true strategy for stock-market investors during tough times is to move to companies making products people need: consumer staples like toothpaste and toilet paper, medicines and utilities. recently checked in with some market pros to see whether this time-tested game plan still holds up. Our big picture professionals by and large continue to favor the traditional game plan, though they also argue that defensive investing requires a bit of fine-tuning in the current climate. Let's start with a sector that screams "safety first"— consumer staple stocks, which provide cover during down periods in the economy and markets. Douglas Cliggott, chief investment officer at money manager Dover Management, believes consumer goods companies are still reasonable investments.

"They sell products people buy, whether they're excited or concerned about economic prospects," Cliggott says. But there is some concern that consumer-goods firms could get their profits pinched, as they struggle with higher energy and raw materials costs. Cliggott acknowledges the risk. He argues, though, that companies selling products around the world can diversify away some of these potential problems.

In Pictures: 10 Defensive Buys

"A lot of raw materials costs are in dollars, and sales are in currencies that are rising against the dollar," he says. "There is cost pressure. But there is less cost pressure for them than a firm that is primarily dollar-sales based. So it doesn't eliminate the issue. But it mitigates it." In the sector, Cliggott favors Procter & Gamble (nyse: PG).

"P&G has broad global exposure, tends to sell products people need, like diapers and toothpaste, as opposed to gadgets people want, like iPods and iPhones," Cliggott says. "Most importantly, it now has an implied earnings growth rate of less than 7%, which means its current share price is based on a medium-term EPS growth rate of less than 7%. But, during the past 10 years, P&G has averaged EPS growth of about 10.5% per year."

Cliggott is a bit more lukewarm right now on another traditional safe haven: health care, given what he calls that sector's "extremely clouded outlook." Specifically, Cliggott isn't a big fan of the large cap pharmaceuticals, citing relatively thin new drug pipelines. Cliggott isn't the only one feeling cautious. Standard & Poor's fundamental outlook for pharmaceuticals is now "neutral".

While recession-resistant drug stocks have generally outperformed during past economic downturns, S&P analyst Herman Saftlas thinks the 2008 outlook for drug stocks is clouded by uncertainty, given the impact of November's elections and research and development productivity issues. On the plus side, he does think companies with well-defined growth prospects and generous dividend yields should hold up relatively well over the coming quarters.

Free Download: Forbes Gurus' Best Investment Ideas for 2008

But the health care sector is big and broad, including not just drug stocks but also medical device makers and managed care companies. Robert Doll, vice chairman and chief investment officer of global equities at BlackRock (nyse: BLK), acknowledges the concerns, given the uncertainty about the elections and pipelines, but he still likes health care. "The stocks are cheap relative to earnings, so you need to ask yourself: Do you think those concerns are priced into these stocks? We do."

Doll favors the stability of the sector, and prefers to play the service companies, like the HMOs, because they have better pricing power and healthier balance sheets, he says. His picks here include Express Scripts (nasdaq: ESRX), Medco Health Solutions (nyse: MHS) and Aetna (nyse: AET).

Chuck Carlson, chief executive officer of Horizon Investment Services and editor of DRIP Investor, agrees. He favors managed care names like Humana (nyse: HUM) and Coventry Health Care (nyse: CVH). Carlson is less enthusiastic about another go-to defensive sector: utilities, a sector that investors ran to in 2007, attracted to steady earnings, decent dividends and solid demand. In the past 12 months, the Utilities Select Sector SPDR (amex: XLU) is up more than 8%.

"They are OK," says Carlson. "But they are pricey. They had a good year last year. Now they are stretched." Brad Sorensen, director of sector research at Charles Schwab, currently weights the utilities sector as "neutral," staying cautious, he says, because of valuations. Instead, Schwab is bullish on tech. Some pros disagree with that strategy. Jim Stack, editor of Whitefish Montana's InvesTech Research and Portfolio Strategy, points out that information technology is one of the highest risk areas in a bear market.

In a recession, Stack notes, an easy way for businesses to save money is by cutting back on technology upgrades ( See: "Forbes Gurus: Best Investment Ideas For 2008"). Schwab currently rates the tech sector "overweight" because of, at least partially, its exposure to overseas markets. "We believe that, with the weaker dollar and stronger economies worldwide, that helps them maintain profitability," Sorensen says.

Even if the U.S. economy slows down or there is even a mild recession, Sorensen argues, tech will continue to hold up well because the sector generates so much of its revenue outside of the U.S. That thesis changes if the U.S. economy takes a more pronounced nose dive. "We would then reduce our allocation to tech," Sorensen says. "But we don't forecast an extended, severe recession in the U.S. that would cause global recession." [[It's already doing so!: normxxx]]

"They [tech companies] will have earnings that hold up," Robert Doll says. "These companies learned the lessons the hard way in the tech bubble. They now have healthier balance sheets and excess cash flow." Doll likes IBM (nyse: IBM), Hewlett-Packard (nyse: HPQ) and eBay (nasdaq: EBAY) in the tech sector.

Free Download: 8 Must-Own International Stocks & Funds for 2008

Jim Swanson, chief investment strategist at MFS Investment management, says he would play tech through the software side. "Remember, that's linked directly to job creation," Swanson says. "In the emerging markets, job growth is high, running at 5% or so. A lot of them are hired in tech industries, and they need software." Pullbacks, viewed strategically, are a time to load up on stocks you want to own for the long term.

"Don't disengage," says Carlson. "There will be another bull market. So position your portfolio for that." Carlson says that now is when the smart long-term investor, the one willing to roll up his sleeves and do some work, should be able to find quality stocks at attractive valuations. "That may not pay off instantly," he says. "But, when the market does turn, you will be in the stocks you want to be in. Don't bury your head in the sand. Work hard and be in the best stocks possible. That will pay off. Maybe not now, but it definitely will later."

Free Download: 3 Best Buy ETFs for the Current Market

Another non-traditional defensive area, which was coincidentally a great buy during the last recession, is energy. Doll likes the sector. "We don't need oil prices screaming higher," Doll says. "If prices consolidate some of the gains, that is still OK for oil stocks. It's a global cyclical." His picks in the sector include Exxon Mobil (nyse: XOM) and ConocoPhillips (nyse: COP).



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.

Income Expert Prefers 'Preferreds'

Income Expert Prefers 'Preferreds'

By Richard Lehmann | 23 June 2008

We have been lamenting for the last few years about the shrinking supply of preferred issues for individual investors. No more; from famine we now have a feast before us.

In my Forbes/Lehmann Income Securities Advisor, I said 2008 will likely go down as the year of the preferred. Here, we look at new high-yielding preferreds from Fannie Mae (NYSE: FNM) and Bank of America (NYSE: BAC).

We are seeing large investment grade companies putting out multi-billion dollar issues and paying upwards of 8%, a yield they have not had to pay since the early 1990s. Now why would AA and A rated banks, insurance companies, finance companies and brokerage houses pay such a premium yield when they could raise capital by issuing bonds yielding more like 6%? The answer is that they need to raise ‘statutory capital’ a benchmark of the ratio of permanent capital to debt which regulated financial institutions need to have in order to maintain their license to do business.

The mortgage debt crisis and the subsequent mark to market writedowns which these financial institutions suffered impaired their regulatory capital and thus, forced all of them to seek statutory capital at the same inconvenient time. Hence, the 8% yields. This search for statutory capital is world wide and is not limited to straight preferred stock. These companies are also issuing more common stock and convertible preferreds.

In fact, these convertible preferreds that yield 8% and are being issued at a time when the stocks of these entities are depressed and represent a major buying opportunity. Fannie Mae 8.75% Series 08-1 Preferred (NYSE: FDRNP) has a par value of $50.00, a current price of $49.88 and a current yield 8.95%. On May 13, 2011 these non-cumulative preferred shares will automatically convert to 1.5408 shares of common stock if the common is at or above $32.45. If the common is at or below $27.50 the conversion rate will be 1.8182 shares. Between the two common prices, holders will receive $50.00 worth of common.

Fannie Mae, a public company operating under a federal charter, is the nation’s largest source of financing for home mortgages and is the largest non-bank financial services company in the world. The company buys loans from lenders, holding some and packaging others for resale thereby providing greater credit availability. Fannie Mae has gone through several years of investigations and Senate hearings because of questionable accounting and reporting and now they are deeply entangled in the sub prime mortgage dilemma.

The company reported for the first quarter 2008 a net loss of $2.19 billion. For the same period in 2007, they had net income of $961 million. This issue qualifies for the 15% dividend (QDI) tax. Fitch has this issue rated AA. Based solely on ratings, this issue would be ideal for low-risk investor, however, due to the uncertainty in the credit and capital markets as well as the housing market, I suggest conservative investors stand aside. Medium to high-risk investor buy this preferred at or below $52.00.

Bank of America 8.20% Series H Non-Cumulative (NYSE: BAC H) has a par value of $25.00, a current price of $24.94 and a current yield of 8.22%. The issue is rated A1/A+. Bank of America is the second largest bank in the country with 6,100 locations in 30 states. In addition to banking services BAC offers asset management and other financial and riskmanagement products, global corporate and investment banking and equity investments.

For the first quarter 2008, BAC reported net interest income of $9.99 billion and net income of $1.21 billion. For the same period last year, net interest income was $8.27 billion and net income was posted at $5.26 billion. First quarter provision for loan loss was $6.0 billion compared to $1.24 billion in 2007. This is a good issue for lowrisk income portfolios. Buy at or below $25.35.

It is likely that these securities will sell at a premium once the current financial crisis abates and the earnings of these financial organizations recover. I can’t remember the last time I got paid 8% to wait for an investment grade issuer to also deliver a capital gain. Happy days are here again. Indeed!



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.

NEW House Price Time Bomb

America's NEW House Price Time Bomb

By Michael Robinson | 30 July 2008

With the American housing market in its worst crisis since the Great Depression of the 1930s, President Bush is authorising new legislation to pave the way for massive new government intervention designed to slow the slide.

The intervention would come as a little known quirk of US law threatens to drive down house prices even faster. Faced with seemingly never-ending falls in the value of their properties, some American home-owners are taking radical action; they are choosing to walk away from their homes and mortgages. In May 2006, at the height of the housing boom, Karen Trainer bought a $500,000 apartment in California— with money borrowed from her bank.

By this year, Karen still owed $500,000 on her mortgage, but her apartment was worth $200,000 less. So she was deep in negative equity and, to make matters worse, the interest rate on her loan was about to increase. "I thought 'this is crazy'," Ms Trainer says. "It just does not make financial sense."

Take The Hit

As a successful professional, Karen could comfortably have managed the higher mortgage payments her bank demanded. Instead, she decided to stop her mortgage payments altogether and let her bank repossess her apartment. Her credit record will be badly damaged by the decision, but Ms Trainer expects this to recover soon. "Generally speaking, within 5 years you are about back where you were, so my husband and I decided we'll take the hit and live with it."

Over To The Bank

In California and much of the rest of America, there is a powerful incentive for homeowners such as Ms Trainer to walk away from their mortgage obligations. Though banks can repossess and sell the homes of borrowers who stop paying their mortgages, under a legal quirk originating in the Great Depression of the 1930s, banks cannot easily pursue borrowers for any balance outstanding on the main mortgage on their homes. Consequently, by walking away from her apartment, Ms Trainer has also walked away from the loss on her property. Her bank gets stuck with that.

Unthinkable Option

Traditionally in America there is a social stigma attached to those who default on their debts, which should be a deterrent to walking away from your home. But according to Susan Wachter, professor of real estate and finance at Wharton School of Business, in the depth of this crisis the social attitudes to such actions are changing. "This is the kind of conversation that's going on at cocktail parties, at swimming pools," Professor Wachter says. "And suddenly this option which was truly unthinkable in the past becomes thinkable."

Worrying Development

Ms Trainer says she feels no moral obligation to go on paying a loan on a property that is going to go on losing her money. She says her friends support her decision. "I think people are taking a more cold-hearted look at it," Ms Trainer says. "Is the bank going to pay for my retirement because I was a good girl and paid my mortgage, even though legally I didn't have to?"

Professor Wachter believes that, to date, most people have had their homes repossessed because they could not manage the repayments. [[That is, mostly the sub-prime loans.: normxxx]] The trend of people now positively choosing to walk away because it makes financial sense to do so is a worrying new development. [[It would involve virtually all of the Alt-A and Prime loans!: normxxx]] "The dangers are extraordinary," Professor Wachter says. "If all that is needed is that the house value is less than the mortgage value, there is a very large number of homeowners in the United States who are in that situation".

No Renegotiation

"This is becoming a tsunami of voluntary defaults," said Professor Nouriel Roubini, New York University, one of the first economists to warn of the dangers of the American house price boom. According to him, walking away has become commonplace. "I would say it's probably 70% of the volume of our foreclosures right now," he says. "It's a business decision for their family that the smartest thing they can do is walk away from their home." As a sign of the changing times, some 60% of borrowers do not even bother to contact their banks to attempt a renegotiation of their loan. "They stop paying and they stop talking." "They just mail in the keys and plain walk away."

Total Disaster

It is impossible to know for sure how many of the people who are now walking away from their homes could have gone on paying their mortgages. But Professor Nouriel Roubini believes the number of people positively choosing to walk away is growing rapidly.

"The losses for the financial system from people walking away could be of the order of one trillion dollars when the entire capital of the US banking system is only $1.3 trillion. You could have most of the US banking system wiped out, so this is a total disaster." Which is why it is not just US policymakers who are hoping America's new, multi-billion dollar initiative to stabilise the housing market will succeed in its aims and thus make walking away less attractive.

Because if it fails, the economic fallout could be felt far beyond America's shores.



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.

"the Letter"

Investment Strategy: "the Letter"

By Jeffrey Saut | 29 July 2008

Last week I received the following letter:

"I know you’ve been hearing from Barrie about concerns he has for the future of the economy; I’m equally concerned and wondered how my portfolio is positioned for what I see coming. Here’s what I’m worried about:

In what seems like a very short period the U.S. has gone from the world’s largest creditor nation to the largest debtor nation. The country continues to spend vast amounts of borrowed money on consumption but very little on infrastructure or productive investments. Employment numbers don’t distinguish between service jobs and manufacturing jobs; that is, manufacturing jobs are disappearing overseas and being replaced by lower paying service jobs. As a country we seem to produce very little than can be exported.

The GDP, which is often touted by our government as an indicator of how well our economy is doing, seems to me misleading as it doesn’t make a distinction between productive spending and consumptive spending. For example, spending on building new factories would be desirable while spending to clean up after Katrina or Exxon Valdez would be undesirable, but as I understand it all three would figure equally into increasing the GDP. I’ve read that the consumption makes up over 70% of our current GDP. If this is true then the GDP is more a measure of how fast this country is going broke than how fast it is gaining wealth.

I also don’t think the consumer price index is really a representative measure of how the economy is doing. We’re told that core inflation is low, but this doesn’t include food / energy or I think housing prices, all of which are going up. If these were figured in the inflation number would be far higher than reported. In summary, I think the picture mainstream economists like to paint is of a healthy economy chugging along. But behind the facade I see reckless consumer and government spending camouflaged as economic growth.

I hope I’m wrong, but I’m both very pessimistic about the future while also mindful that huge opportunities exist and could be exploited. I see high inflation and perhaps a collapse of the economy if too many dollars return to this country at one time. I think the worst places to be would be in U.S. dollars or currencies of other countries that are largely consumers, whereas producing countries like China and India would be safer places to be. In the short term I would think that U.S. companies that have a large export business would be good bets; as the dollar declines they would sell more overseas.

I also think commodities such as energy and precious metals would be good bets as well as those companies that are in the business of new energy (solar / wind) or mass transit. The demand for energy and precious metals is not likely to decline and the demand for alternative energy sources and mass transit can only grow. I also worry about big box store stocks like Wal-Mart (WMT/$56.83) that exist on low margins and high sales; in the past people were willing to drive further to get to these and save a few bucks, but with the cost of gas this strategy makes less sense and we may see a revival of the neighborhood store.

Sometime in the next few weeks could we discuss where my portfolio is positioned and the risk / benefit ratio of where we could be."

I reprise this letter today because it speaks to many of the concerns investors are currently voicing. To the first point that our country is now the largest debtor nation in the world, I have no response other than to say it’s true. The nation appears to be "eating its young" as we saddle our children with ever increasing debt that is likely sinking the footings for a generational "war." Yet, the problem lies in a lack of leadership with our politicians; I mean where are the 'statesmen'?!

As Charlie Reese wrote in his excellent article "545 People Responsible for America’s Woes," "Politicians are the only people in the world who create problems and then campaign against them. Have you ever wondered, if both the Democrats and the Republicans are against deficits, why we have deficits? Have you ever wondered, if all the politicians are against inflation and high taxes, why we have inflation and high taxes?" Indeed, where are the statesmen?! Lee Iacocca actually does Charlie Reese one better when he writes:

"Am I the only guy in this country who's fed up with what's happening? Where the hell is our outrage? We should be screaming bloody murder. We've got a gang of clueless bozos steering our ship of state right over a cliff, we've got corporate gangsters stealing us blind, and we can't even clean up after a hurricane much less build a hybrid car. But instead of getting mad, everyone sits around and nods their heads when the politicians say, 'Stay the course.' Stay the course!?! You have got to be kidding. This is America— not the damned 'Titanic'. I'll give you a sound bite: 'Throw all the bums out!' You might think I'm getting senile, that I've gone off my rocker, and maybe I have. But someone has to speak up."

Speaking to our letter writer’s manufacturing jobs point, an amazing thing is beginning to happen. The cheap dollar, combined with soaring transportation costs, is causing U.S. companies to bring manufacturing jobs back inside our boarders. While said movement is in the nascent stage, it should build into what our letter writer terms "productive spending" on new factories, etc. As for inflation, anyone that lives in the real world knows the government’s figures are a joke.

We have argued for some time that the "core" inflation numbers (ex-food/energy) should be totally ignored in lieu of the "headline" inflation numbers. While even the "headline" numbers understate the inflation picture, they clearly are more in sync with what’s happening in the real world. And that, ladies and gentlemen, is why we continue to avoid fixed income in favor of stocks.

Consider this, since 1968 the "headline" inflation number has averaged 4.6%. That means the cost of many of the things we buy doubles every 15 years. If a couple decides to retire at age 60, statistically one of them will live to be 90 years old. The implication is that over those 30 years they will lose 75% of their purchasing power to inflation. Plainly, fixed income will not be able to maintain your purchasing power, which is why we continue to favor stocks, preferably stocks with a dividend yield.

Late last week, however, stocks fell out of favor again as profit-taking reigned after the previous week’s huge rally. Also clouding the environment were shockingly weak economic figures from Europe, worse than expected U.S. home sales, and a prediction by PIMCO’s Bill Gross that U.S. bank losses will be at least one trillion dollars. We have warned investors that the U.S. dollar to euro exchange rate was having deleterious effects on Europe, so last week’s news should have come as no surprise.

As for homes sales and Bill Gross’ prediction, the statement– that the financial disaster won’t improve until housing prices stabilize— is now legion. Lost in the noise, however, is that while existing home sales have indeed collapsed, median prices have actually been moving "up" for the past four months ($215,100 in June versus $195,600 in February)! Whether this marks "the turn" for the economy is questionable, for while we don’t think the news will get a whole lot worse, we also have a difficult time believing it will get materially better either.

Meanwhile, the long-standing "trade" of shorting the financials and going long materials/energy has unwound rather dramatically over the past few weeks. To be sure, various financial indices rallied more than 30% in just six trading sessions, while crude oil is off 16% and natural gas has crashed 30%. We think the ferocity of the sector rotation is overdone in the near-term, which is why we recommended selling some of the financial indices we tranched into for trading purposes a few weeks ago. The quid pro quo is that last week we also recommended buying energy stocks for a short-term trade. Our vehicle of choice was the ETF ProShares Ultra Oil & Gas (DIG/$86.49).

The call for this week: According to Richard Russell, "Yesterday (7/24/08) Lowry's Selling Pressure Index rose to within one point of its July 15 all-time high. That tells me that big money has been selling into all rallies, and that's just plain bearish. Selling Pressure should be declining rapidly when the market rallies. That's not what is happening."

Still, as long as the S&P 500 (SPX/1257.76) remains above 1240, we are constructive on stocks. [[Guess you can forget that! : normxxx]]



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.

Dr. Doom Speaks

Dr. Doom Speaks

By John Heinzl | 29 July 2008

When CNBC or Fox needs a guest who can be counted on to deliver a thoroughly gloomy outlook for the U.S. economy, they call on "Dr. Doom."

To say Peter Schiff is bearish is like saying Tiger Woods is an okay golfer, or China has a small problem with air quality. The president of Connecticut-based Euro Pacific Capital Inc. is so pessimistic about the U.S. economy that he lives in a rented house and keeps the vast majority of his and his clients' money outside the country, a healthy chunk of it in gold and energy stocks.

"America is finished. We are going to destroy this country. Our economy is just going to unravel," he told me yesterday. "The question is how much money is the world going to lose before it writes us off?" Apocalyptic forecasts are a dime a dozen these days, so why should anyone pay attention to Mr. Schiff? Because his past predictions have proved uncannily accurate.

When dot-com stocks with no earnings were shooting skyward in the late nineties, he was advising clients to stay away and instead putting money into the unloved energy sector, just in time for the great oil bull market. A few years later, when the housing bubble was inflating, he was warning about the dangers of reckless mortgage lending and the precarious state of Fannie Mae and Freddie Mac. "If it looks like a bubble, walks like a bubble and quacks like a bubble, it's a bubble," he wrote. That was in 2004, when speculators were still lining up to buy investment properties in Las Vegas. Ever the contrarian, Mr. Schiff made a bundle shorting the subprime mortgage sector.

So, one year into the credit crunch and with more than US$400-billion [[since raised to ~US$1.6 TRillion, give or take a half trillion: normxxx]] of mortgage losses piling up on company books, where does Dr. Doom see the U.S. economy heading now? Unfortunately, into an even deeper hole, one from which it could take years to emerge. Far from rescuing the economy from the housing debacle, the government's efforts to prop up Fannie and Freddie— which own or guarantee nearly half of the $12-trillion in outstanding U.S. mortgage debt— will only compound the problem by delaying the inevitable day of reckoning. The same goes for plans to help hundreds of thousands of homeowners refinance into more affordable mortgages.

Apart from encouraging the very moral hazard that got the U.S. into this mess in the first place, the government bailout will come with an enormous price tag in the form of soaring inflation, Mr. Schiff argues. He believes government figures vastly understate the true rate of inflation, which he estimates is now running at 10 to 12 per cent. Before long, it could be north of 20 per cent.

"The government doesn't have the balls to raise taxes. It's just going to print the money. It's going to destroy the currency," he says. During the Depression of the 1930s, at least people who held cash made out okay. Because prices were falling, their money actually bought more. But, if Mr. Schiff is right and the U.S. is heading into a period of hyperinflation, then even the most prudent savers could see their wealth eviscerated.

With the walls closing in on the U.S. economy, where is an investor to turn? Apart from gold and energy producers, which benefit from a plunging U.S. dollar, Mr. Schiff likes conservative, dividend-paying stocks such as pipelines and utilities. He's especially fond of Europe, Asia, Australia and Canada, where his holdings include Barrick Gold Corp., Goldcorp Inc., Crescent Point Energy Trust, Baytex Energy Trust and Pembina Pipeline Income Fund.

He has two words for Canadian investors thinking now is a good time to shop for bargain-priced U.S. stocks: "Stay away."



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.

Monday, July 28, 2008

The Past Happens Over And Over Again!

Being Street Smart: The Past Happens Over And Over Again!
Click here for a link to complete article:

By Sy Harding | 25 July 2008

As Paul Harvey once said, "In times like these it helps to recall that there have always been times like these."

Yet the world hardly ever comes to an end. The future arrives. The cycles continue. Sunny weather still follows stormy weather, winter still follows summer, spring still follows winter— every time. For investors there’s nothing more important than recognizing that business, the economy, and markets also move in cycles, not endless straight lines. Recessions follow boom times, bear markets follow bull markets, bull markets follow bear markets— every time.

There are two cycles, one of intermediate-term duration, the other longer-term, which can be of significant importance to investors. The first is the annual seasonal cycle. It has been proved beyond doubt (through 60 years of back-testing, and nine years now in real-time) [[academic studies have detected this tendency as far back as the early 17th century in English records, and in 34 of 36 countries, currently— but, unmodified by Sy's use of the MACD, it is too weak to trade: normxxx]], that the stock market makes most of its gains each year in a winter and spring favorable season, and suffers by far the majority of its corrections, crashes, and bear markets in its unfavorable summer months [[and, especially, in the months seperating the two periods: normxxx]]. I refer to the Seasonal Timing Strategy I introduced in 1999’s Riding the Bear— How to Prosper in the Coming Bear Market [[still a GREAT read, if you can get hold of a copy: normxxx]].

Over the nine years since, its total return has been more than double that of the Dow, and triple that of the money-manager’s ‘benchmark’ S&P 500. The details are on my Street Smart Report website (see above link), and in my books. But I want to use this column to discuss the longer-term cycle, since I expect it will be of more importance than usual over the next few years.

It is the Four-Year Presidential Cycle. Its history is extremely consistent. The economy and stock market tend to have serious problems in the first two years of each new presidential term, and then to be recovered and strong in the final two years of the term.

What causes the pattern? It’s clear in the history that each Administration takes heroic steps in the 2nd and 3rd year of its term to make sure the economy is strong by the time re-election time comes around. The efforts typically include higher government spending, lower interest rates, and even economic stimulus plans if necessary.

The problem is that almost always by re-election time that excessive stoking of the economic fires has created excesses, including over-priced stocks. Those excesses are then allowed to correct in the first two years of the next term, and then the cycle is repeated. Thus the historically consistent cycle takes place, of economic and market problems in the first two years of each new presidential term, followed by boom times in the final two years of each term.

History also shows that the pattern does not often occur when a president is serving his second and final term, (perhaps because his administration’s interest in the next election is not as great). For instance, no economic or market corrections took place in the first two years of the second terms of Reagan, Clinton, or Bush. (Because the excesses are not corrected in the first two years of second terms, the problems tend to come later in the term. For Reagan it was the 1987 crash in the 3rd year of his second term. For Clinton the 2000-2002 bear market began in the 4th year of his second term. For President Bush, the current bear market began last October, the 3rd year of his second term).

However, for first terms, the pattern of significant lows in the 2nd year of each term is so powerful that since at least 1918, even the conservative Dow has experienced a super rally from the low in the 2nd year to the high in the following year, its average gain in those rallies being 50%.

Now consider that no matter which candidate is elected in November, the next four-year presidential cycle will be that of a new first-term president. Then consider the conditions his administration will inherit and the likelihood they will not be solved in the first year of the term. The largest budget deficit ever, a record trade deficit, an expensive war that both candidates expect will continue well into 2010, still rising home foreclosures, an economy likely to be in recession, and so on.

Therefore, the Four-Year Presidential Cycle has me expecting the current bear market will not see its final low until sometime in 2010, the 2nd year of the next administration.

In the meantime, the annual seasonal pattern has me expecting there will be significant bear market rallies and corrections from which to make substantial profits until then. In the 2000-2002 bear market there were several bear market rallies in which the S&P 500 gained more than 20%. The Nasdaq experienced three bear market rallies, in each of which it gained more than 40%, each followed by an even larger decline.

If I am right in my expectations, buy and hold investors are likely to continue to be disappointed over the next two years, while opportunities should be exceptional for those willing to go after gains from both the upside in the bear market rallies, and from the downside when the rallies end and the next down-leg in a continuing bear market takes place.

Sy Harding publishes the financial website Street Smart Report Online, and a free morning blog at In 1999 he authored Riding The Bear— How To Prosper In the Coming Bear Market. His latest book is Beating the Market the Easy Way— Surprising Seasonal Strategies that Double the Market's Performance.

FOR MORE STREET SMART commentaries, charts, etc. click below on Home and then the Library link.

  M O R E. . .


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.

Sunday, July 27, 2008

UK, Eurozone Horror Movie

Economic Horror Movie In Britain And Eurozone

By Mike "Mish" Shedlock | 21 July 2008 | 25 July 2008

Things are rapidly deteriorating In the US, UK, and the Eurozone. Let's take a look at a couple of top stories starting with Hundreds Of Thousands Face Job Loss In UK, says top economist. Britain's economy is tipping headlong into a recession that could last more than a year and cost hundreds of thousands of jobs, warns Professor David Blanchflower, a member of the Bank of England's interest rate committee, in an interview with the Guardian today.

Blanchflower says the Bank must cut interest rates rapidly to prevent the downturn being too painful, and thinks the UK could be in for a worse time than even the United States, where interest rates have already been slashed and taxes cut to stimulate the economy.

The economist said the recent rises in unemployment are "the tip of the iceberg". The number of people out of work and claiming benefit is 840,000 but the broader measure of unemployment is 1.6 million, 5.2% of the workforce. Blanchflower said it could climb to more than 7%— a figure that would mean several hundred thousand people losing their jobs.

His warning comes days after the chancellor acknowledged that the slowdown could be "profound" and hinted he would change the Treasury's fiscal rules as the slowing economy looks set to bust them. Today a leading thinktank, the Ernst & Young Item Club, says the economic outlook for Britain is like a "horror movie" as a result of the credit crunch and tumbling house prices.

Deflationary Hurricanes In US And UK

I agree with Blanchflower, having previously stated Deflationary Hurricanes to Hit U.S. and U.K. In fact, I believe the US is in deflation now. However, Blanchflower is mistaken if he thinks lower rates are going to be some kind of magic bullet. One look at the US should be proof enough.

Ugly Picture In Eurozone

Ambrose Evans-Pritchard is writing about European Recession Looms As Spain Crumbles. The eurozone is tipping into a deeper downturn than America itself despite the tremors in the US mortgage industry, and may already be in full recession for the first time since the launch of the single currency. Industrial production for the EMU bloc fell 1.9% in May, according to fresh Eurostat data. It is the sharpest one-month decline for the region since the exchange rate crisis in 1992. Officials in Berlin have warned that Germany's economy could contract by as much as 1.5% in the second quarter as export orders crumble.

Industrial output in both Italy and Greece has slumped 6.6% over the past year. Portugal is off 6.2%. "It is a very ugly picture: we're on maximum alert," said Emma Marcegaglia, head of Italy's business federation Confindustria. Rome is now lobbying for a "New Deal" to revive Italy's economy through massive infrastructure projects.

Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said a "reverse decoupling" is now under way as Europe goes down harder than the US— just as it did after the dotcom bust. "There is loss of momentum across the board. We can't exclude a recession," he said.

Spain is now spiralling into the worst crisis since the Franco dictatorship. "The economy is in dire straits," said Dominic Bryant, Spain expert at BNP Paribas. The global economy has clearly peaked [[and is now rapidly sliding down the slippery reverse slope: normxxx]]. Clearly the US, UK, and EU are not prepared for it. Is any country?



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.

Corporate Bond Sales Collapse

Corporate Bond Sales Collapse

By Mike "Mish" Shedlock | 21 July 2008

Last week all eyes were on the Short Squeeze In Financials, triggered by a SEC Order To Protect Those Most Responsible For Naked Shorting, and fueled by nearly everyone going ga-ga over fabricated earning reports at Wells Fargo and Citigroup.

However, most missed the quiet but extremely important action in the corporate bond market. Please consider Bond Sales Slow to $5.3 Billion as Spreads Approach March Highs.

Corporate bond sales fell to $5.3 billion this week as the yield over benchmark rates that investors demand to own the debt approached the highest levels of the year. Sales compare with $11.7 billion last week, according to data compiled by Bloomberg. Issuance slowed as the average spread on investment-grade bonds climbed to 7 basis points shy of its 2008 high and junk— bond spreads surpassed 800 basis points for the first time since March.

Overall corporate sales compare with a weekly average this year of $21.2 billion.

The extra yield investors demand to own investment-grade bonds rather than U.S. Treasuries climbed 9 basis points to 297 basis points as of yesterday, compared with 305 basis points reached on March 20, according to Merrill Lynch & Co.'s U.S. Corporate Master index.

The strong rally brought out the 'bottom callers' in financials who made an appearance for the umpteenth time. And, if oil prices keep falling, perhaps the rally will continue for a bit more on the misguided notion that lower energy prices will help the economy. They won't.

Falling oil prices will be a result of falling demand and a weakening global economy. Weakening job prospects will come on on top of it. The key point however, is the odds of a sustainable rally in the wake of such poor action in the corporate bond market is highly unlikely regardless of what oil prices do.



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.

$1.6 Trillion And Counting

$1.6 Trillion In Losses And Counting

By John Mauldin | 11 July 2008

It seems that with each passing month the estimates for losses in the international banking system keep rising. This time last summer the largest estimates (from credible sources), if memory serves me correct, were around $400 billion, give or take a few months. By the end of the year it was in the neighborhood of twice that. Then last quarter we saw estimates approaching $1 trillion. Last week, the number being broached was $1.6 trillion, by Bridgewater Associates, one of the top, and more credible, analytical firms in the world. In this week's letter we look at the implications of that projection, analyze recent lending patterns by banks, briefly touch on the implications of the recent unemployment numbers, and end with a few comments on the bear market. It will make for an interesting letter. Warning: remove sharp objects from your vicinity before reading.

But first, I need your help, and in return I would like to give you a link to a recent speech I gave, where I speak about what I think is the development of an important new asset class, one which will come about precisely because of the problems I am writing abut today. I have not yet written about this topic in public, and the speech has been well-received. I think you will like it. Now, as to how you can help me ...

I get to travel a lot with my daughter and business partner Tiffani (actually she runs the business) and meet new people. Over the years, she has become as fascinated as I have with their individual stories. Everyone has a story to tell or a lesson to teach. We have decided to write a book about those stories, looking at the differences in perspective between old and young, retired and working, those who are wealthy and those who aspire to wealth. What are the differences in attitudes, in work habits, in how you manage money, in how you look at the future, and a score of other items? How do all of these things correlate?

We have created a totally anonymous online survey seeking answers to these questions and more. We hope to get at least 10,000 people to fill out the survey; and we are eager to see what we find as we pore over the resulting data and engage in a lot of in-depth analysis. Are the rich really different? Is there a difference in people from Europe, Asia, Latin America, Africa, and the US? I think we will find some very interesting information. Please note: this is not just a survey for millionaires. We want everyone, of all income levels and ages, to take the survey, so we can get a true representative sample.

You can get to the survey page by clicking here. It will take about ten minutes to complete, and I think that going through the questions will make you think about your own situation. Some have told us the survey is quite thought-provoking. If you have attempted to take the survey and had problems, we think we have worked out the bugs.

At the end of the survey, you will be sent to a page with the speech. If you cannot listen to it immediately, then simply save the page or the address. And of course, you can just take the survey to help us.

Also, Tiffani and I want to do live (mostly by phone) interviews with 200 millionaires, of all shapes and sizes and locales. We will interview you for about 30 minutes, and then you can have equal time asking me anything you want. Since I will have learned a lot about you, those questions can be as detailed or as general as you like. We want at least 20% of the interviews to come from outside the US.

We will use those interviews in the book, but will attach no identifying items or real names. If we use something from your interview in the book, we will let you see it first. If you are interested in being one of the interviewees, just drop Tiffani a note at and she will get back to you and work out the details. I am really excited about this project and even more so about working with Tiffani. We will report back to you on what we find. Thanks for your help.

$1.6 Trillion in Losses and Counting

One of the great privileges I have is getting to read a wide variety of economic research. While I get a lot of material direct from the source, I also have a wide network of people who read other sources and send me what they think is important. When Ambrose Evans-Pritchard wrote this week about a report done by Bridgewater Associates, it got my attention, and fortunately this report was sent to me by a few friends. In my book, Bridgewater is one of the top analytical groups in the world. I pay attention and give strong credence to what they write. And this report is quite sobering.

First, let's look at what Evans-Pritchard wrote in the London Telegraph:

"Bridgewater Associates has issued an apocalyptic warning to clients that bank losses from the worldwide credit crisis may reach $1,600bn [$1.6 trillion], four times official estimates and enough to pose a grave risk to the financial system. The giant US hedge fund said that it doubted whether lenders would be able to shoulder the full losses, disguised until now by 'mark-to-model' methods of valuing structured credit.

" 'We are facing an avalanche of bad assets. We have big doubts as to whether financial institutions will be able to obtain enough new capital to cover their losses. The credit crisis is going to get worse,' said the group in a confidential report, leaked to the Swiss newspaper Sonntags Zeitung.

"Bank losses on this scale would have far-reaching effects. Lenders would have to curtail loans by roughly 10-to-one to preserve their capital ratios. This would imply a further contraction of credit by up to $12,000bn [$12 trillion] worldwide unless banks could raise fresh capital."

Let's look at some of the details in the report. First, these losses are not all subprime. In fact, more than half of it is from corporate liabilities, around $800 billion. About $550 billion of the corporate losses have yet to be written off. As an example, Bridgewater estimates losses on commercial loans to be as much as $149 billion, none of which has been written off.

Better than 90% of the losses from subprime assets that are on the books have already been written off. That is good. But Bridgewater estimates that there are losses lurking in the prime and Alt-A loan portfolios that could be much bigger than the subprime problems, as those loan books are more than six times the size of the subprime. Quoting:

"The US commercial banks are in a position to suffer the greatest losses, because the core of their portfolio is risky US debt assets. In order to get a sense of their expected losses we examine both their loan book and their securities portfolio and price each type of asset out based upon a reference market. If we use this current market pricing as a guide, there is a long way to go, as these institutions have only acknowledged about 1/6 of the expected losses that they will incur as a result of the credit crisis."

I could go on, but the details are not important. The bottom line is that they estimate there is at least another $1.1 trillion of losses that will have to be written off by institutions all over the developed world, including very large potential write-offs from insurance companies.Banks and investment institutions worldwide may need another $400 billion in capital infusions. But where they are going to get it is the problem.

They have burned through the usual suspects, and burned is the correct word. Any sovereign wealth fund or large investor who has put money into an investment or commercial bank has watched their investment take large losses in a very short time. How likely are they to be willing to belly back up to the bar with more money, on anything except very dilutive terms to current shareholders? The answer is obvious.

And let me be clear. There are some very large commercial and investment banks which are simply going to be absorbed, as regulators move to keep the entire system working. Bear Stearns is not a one-off deal. I think it is likely we will see at least one European bank nationalized [[UBS springs to mind.: normxxx]]. Losses the size that Bridgewater describes are beyond ugly. They are life-threatening for more than one major institution. More on this later.

Banks Start To Reduce Their Lending

Further, let's revisit a theme I have written about on several occasions over the past year. As banks incur losses, they either have to find new capital or reduce their lending in order to maintain their capital ratios, or some combination of both. And what we are seeing is that lending is starting actually to decrease.

Earlier this year lending rose as normal, even though anecdotal reports told of tightening lending standards and reduced loan lines. The tightening of standards did not seem to be affecting actual loans being made, which was odd. But this was partly illusion, as banks were taking back loans they had spun off in SIVs, taking capital away from their traditional loan business. This gave the appearance of expanding loan capacity. Evidently, this bringing back of off-book loans is now being worked through, as evidenced by this analysis by good friend and analyst par excellence Greg Weldon, who slices and dices the data to give us this view:

"[looking at the chart below] ... FOR SURE, the recent decline strongly suggests that the risk of a US recession has intensified CONSIDERABLY, as defined by what amounts to one of the largest nominal credit contractions in DECADES, at (-) $154.3 billion, and a clear-cut violation of the uptrend in place since at least 2001."

Click Here, or on the image, to see a larger, undistorted image.

Greg goes on to suggest that bank credit could contract a further $6-700 billion over the next nine months, which is a contraction of about 8%. Healthy economies have a rising rate of bank credit, which is one source of expansion. When banks have to reduce their lending, it reduces the growth of the economy or can put it into outright recession.

And if the Bridgewater report is anything close to right, Greg is being an optimist, which is not his normal milieu. Now, do I think worldwide credit will shrink $12 trillion, as Evans-Pritchard suggests? (Note, that was not a suggestion or conclusion by Bridgewater.) Not in my worst nightmares. Capital will be raised, and the various central banks of the world will do what is necessary to give banks the time to work through their problems.

But in the meantime, the trend toward lower lending is likely to continue. And lower lending is going to be a huge headwind for an economy that is already struggling. This week Ben Bernanke suggested that the "temporary" Term Auction Facility might be extended into 2009. Let me suggest that it will be extended into at least 2010 before it is no longer needed. Banks are going to need to be able to take their illiquid paper and convert it into liquid Treasuries against which they can make loans and continue to function.

As I have written for a long time, it is all about buying time. In 1980, every major bank in the US was technically bankrupt, as they all had large amounts of Latin American bonds in their portfolios, at a size far larger than their capitalization. When the Latin American countries started to default, if the Fed had made the banks mark their portfolios to market, it would have been a disaster of biblical proportions. There would have been no American banks left standing. The US economy would have gone into a deep depression.

Instead, with a wink and nod, they let them keep the bad bonds on their books at face value, which they all did. Then in the latter part of the decade, starting with Citibank in 1986 (cue the irony), they began one by one to write off the bad loans, but only when they had enough capital to do so. It took six years (or more) of profits and capital raising to get to where they could deal with the problems without imploding themselves and the economy of the US at the same time.

Today is only different in the details. The Fed and central banks around the world are allowing banks to buy time to work through their problems. There really is no other option. That extra $1.1 trillion that the research by Bridgewater says will have to be written off? You can take it to the bank, pardon the pun, that it will not be written off this quarter. This is going to be an ongoing process that will take several years at a minimum. Just as in 1980, the regulators are going to allow banks to write down their losses as they can, except in the most egregious of circumstances, in which case those banks will be "absorbed," à la Bear Stearns.

Treasury Secretary Paulson said Thursday that no bank is too big to fail. That is for public consumption. The fact is that there are any number of banks that are too big to fail, depending upon (and borrowing from my favorite linguist, Bill Clinton) what your definition of fail is. If by fail you mean that shareholders are wiped out, then he is correct, there is no institution too big to fail. If by fail you mean that the operations and debt obligations will be allowed to collapse, then there are institutions whose collapse would pose major systemic risk to the world markets. They cannot be allowed to collapse.

Take Freddie Mac. Please.

(Cue Henny Youngman) Take Freddie Mac. Please. Its shares are down almost 90%. "Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair-value accounting rules. The fair value of Fannie Mae [down 78%] assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, former St. Louis Federal Reserve President William Poole said." (Bloomberg) Poole asserted that these institutions are essentially on a short path to insolvency.

But in the same story, Senators Schumer and McCain both said Freddie and Fannie would not be allowed to fail. Even curmudgeonly former Fed Vice-Chairman Wayne Angell (someone whom I sincerely respect), said on CNBC yesterday that the government regulator of the GSEs (Government Sponsored Enterprises) ought to get some money from Congress to buy preferred stock and then get even larger amounts from the public through an offering of preferred stock. He said that Congress ought to learn about its responsibilities with regard to a GSE; and the public ought to realize that we are in for a long, tough fight. (He also expects the second half of 2008 to be no better than the first half, and he sees 1% growth in 2009.)

I wrote the above paragraph, and a few I deleted below, on Thursday, as I am on a plane to Las Vegas and need to finish the letter in order to attend a conference. I wrote with suggestions about how a collapse of the two Government Sponsored Enterprises might be handled. Last night, the New York Times broke a story that government officials are looking at how to go about taking over operations at Freddie and Fannie, should worse come to worst. Then this morning, the Wall Street Journal in its lead story elaborated on this theme.

The basic problem is that both Fannie and Freddie need more capital, and perhaps far more than their current market capitalization. Where to find it? What investor wants to try and catch this falling safe, without government guarantees? The Journal article quotes numerous people with various ideas about what to do. Most of their ideas will potentially cost US taxpayers.

And make no mistake. The problems with Fannie and Freddie have to be solved. They are now doing 80% of the mortgages in the US. Without them the housing market would grind to a halt quickly and housing prices would drop even beyond Gary Shilling's pessimistic views. Not to mention that the world has assumed the implicit backing of the government in buying the paper of Freddie and Fannie. How easy would it be to finance US debt if this paper was allowed to default? The implications are serious [[it's beyond serious; it's potentially mortal: normxxx]]. I understand the arguments for allowing them to fail, and I think shareholders should bear the risk they take on when buying equity.

A very reasonable idea was broached by Steve Forbes on a BizRadio program this afternoon, which Dan Frishberg graciously allowed me to co-host. He suggests breaking Fannie and Freddie into eight smaller companies, giving them whatever backing they need in the form of public financing to start business, and then cut them off to sink or swim on their own, with much tighter capitalization controls. Remember, this is one of the more free-market conservative thinkers.

The authorities are slowly losing control. All they can do is crisis manage. There are no good solutions, only expedient ones. And we must all hope they choose the best among a handful of not particularly pleasing options. Allowing the system to devolve into chaos is not an option. The Fed and whatever administration comes in will do the same as the current group, which is to buy time so that the wounds can heal, and hopefully put in place rules to prevent another such occurrence.

(Sidebar: I will go into greater detail in a later letter, but regulators need to move NOW to create a Credit Default Swaps Exchange. A problem/crisis in that unregulated market is actually a far bigger problem than the current subprime crisis. Why do you think Bear Stearns was not allowed to go into bankruptcy? There are banks that are too big to fail, despite what Paulson says for public consumption.)

There are a lot of conflicting opinions, which you can read here if you care to. Some say Fannie and Freddie will have to lose $70 billion before the regulators step in. Poole says they are insolvent now, using fair market accounting methods. I don't know, and neither do 99.9% of the shareholders. At this point Fannie and Freddie are not an investment, they are a gamble. Sitting here at Caesar's in Vegas, and reading the opinions, makes me think I have better odds at the tables below me.

I hope that when (not if!) taxpayer money is used, it is at market rates and means that shareholders are last in line, if at all, to recoup any money. For those of us who for years have called for tighter regulation and increased capitalization of the GSEs, as well as a clear removal of any government backing, implicit or explicit, being able to say "I told you so" [[in return for truckloads of taxpayer money: normxxx]] does not feel all that good. But, Freddie and Fannie cannot be allowed to go out of existence. They are too tightly wound into the core and fiber of the US economy.

What can and should happen is that shareholders bear their losses, taxpayers pick up the bill, and when they are healthy again, as they will be at some point, another public offering should be done to hopefully recoup the losses to taxpayers. Or perhaps an auction with some guarantees to a potential buyer, but a complete removal of implicit government guarantees on future loans, and higher capitalization requirements. There are any numbers of ways to lessen the ultimate cost to the taxpayer.

What I fear is that politicians will use the opportunity to prop up the mortgage markets with taxpayer guarantees and create much larger losses, which could quickly mount into the hundreds of billions if not properly dealt with. A new populist-oriented administration could find this problem on their desk as they take office. I would not want to own any stock in the financial sector. There is going to be a continual stream of write-offs over the coming year, at a minimum. Yes, some banks are better managed and will avoid the real life-threatening problems. Some will be like JP Morgan and end up with solid assets backed by government guarantees.

But which ones? Do you want to trust the analysts that have been telling you there is value in the financials at each step, all the way down? The management who insists they are in good shape, then raises capital at dilutive prices? The very people who did not see the problems to begin with, telling you that they are now solved?

The "value" that analysts optimistically see in various financial stocks is evaporating with each quarter, as they slowly write down ever more losses. With another potential $1 trillion to be written off or absorbed through earnings from profitable parts of the business, there is more pain to come. Investing in financials today is like trying to catch a falling safe.

The Ugly Muddle Through

Goldman Sachs published a report Thursday in which they suggest the most probable scenario for the next 12 months is GDP growth between -0.25% and 0.25%, or basically zero. Wayne Angell, mentioned above, expects the second half of '08 to be no better than the first half and for GDP growth to be 1%. In the Bridgewater report mentioned above, they estimate that the net worth of US-based assets is down about 13% since January 2007, a total loss of almost $8 trillion. This is hitting pension plans, corporations, and consumers, making them think twice about planned investments and expenditures.

Earnings estimates are being cut with each passing month. The P/E ratio for the S&P 500 is currently at a sporty 23. Historically, in times of rising inflation, the stock market goes through "multiple compression." That means P/E ratios fall more than earnings. If multiples fell just 20%, back to 18, which is still above long-term trends, the market would see another 20% drop from here. Even with earnings growth, the market is going to have a challenge rising in the current environment.

Sidebar: A number of you have written questioning my source for the P/E ratio, as you read or hear different numbers from what I write. You can indeed find estimates of forward P/E ratios as low as 12 a year from now. That is a lot different than the 23 I cited above.

There are two basic types of earnings that are reported. [[And, moreover, one can use forward or trailing earnings— forward earnings, being largely imaginary, are invariably higher, but see The Real P/E Ratio?.: normxxx]] One is "operating earnings," or what I call EBTBS, or Earnings Before The Bad Stuff. Then there is "reported earnings," which is what the corporations report on their tax forms. Not all that long ago, in the mid-'90s, operating earnings and reported earnings were generally in line with each other. Companies would deduct genuine one-time, unusual losses from their reported earnings to give us operating earnings. And such a system has a valid basis for existence. If something is truly one-time, maybe an investor should overlook it when evaluating the company's potential.

But then the media and analysts started using the operating earnings as the primary number [[virtually ignoring the reported, aka GAAP, earnings: normxxx]], and companies began to game the system. More and more items were considered 'one-time' [[even though regularly repeated each year, or almost each year: normxxx]]. One of the more egregious examples was when Waste Management Systems declared that painting its garbage trucks was a 'one-time extraordinary expenditure' and should be accounted as such! Today the difference between as-reported and operating earnings can be 20-40% or more. It seems there are many losses that management assures us are just 'one-time' items.

Standard and Poor's has a web page where you can see a spreadsheet of historical data and projections for both types of earnings. That is the source of my data. Analysts' estimates do tend to get brighter the further out one looks into the future [[—no one likes a wet blanket, even if correct; and an overly negative analyst may be long gone by the time his/her predictions pan out: normxxx]]. But if the growth scenarios mentioned above come about, and banks have to curtail all sorts of lending, the earnings projections are going to be way too high, as they have been for the last 12 months. That is going to mean yet more pain for the stock market.

I think it is quite likely we will see the Dow slip below 11,000. (Ok, I wrote that Thursday!) As I said on Kudlow the other night, another 10% drop in the market would take us only to the average bear market. A "9 handle" on the Dow seems quite possible, if not likely. (Note: when someone says "a 9 handle," they mean that the first number in the index or stock price is a 9. The first number is the handle.) The risk is to the downside, given the tepid potential growth of the economy.

Once Again, The BLS Numbers Paint A False Picture

I almost get tired of writing this each month, but it is important, and I will do it quickly. The unemployment number from the BLS last week showed a loss of 62,000 jobs. Private sector jobs were off by 91,000, with the government showing growth of 29,000.

But once again, the birth/death model's estimate of 'imputed' new jobs added was 177,000. As The Liscio Report noted:

"... without the b/d's contribution, private employment would have been down by something like 268,000. It added 29,000 [new jobs] to construction, 22,000 to professional and business services, and 86,000 to leisure and hospitality. Given the weakness of the economy and the crunchiness of credit, we doubt that there are enough startups around to match these imputations."

Revisions to the prior two months were a negative 52,000. When they do the final numbers a few years from now, we will find that the revisions will be in the hundreds of thousands for the first half of this year. We have now had five consecutive months of downward revisions, which is typical of recessions.

Unemployment held steady at 5.5%, but that masks an underlying and growing problem. There has been a huge increase in the number of people working "part-time for economic reasons" and a large number of people who are discouraged and not looking for a job but would like one. These two categories are not counted as unemployed. If you add them into the equation, the unemployment or underemployment number goes to 10.3%! (per Greg Weldon)

As I warned above, this has not made for pleasant reading. But it is reality, and we need to deal with it.

And let me say that even given the above, I am a long-term (and even mid-term) optimist. We have to work through some serious problems, but we will [[—we always have, and sometime in the future, like stories of the Great Depression, it will make for some exciting reading: normxxx]]. Valuations are going to be low once again, and it will be time to become bullish. And researching and writing my book on how the world will change in 20 years makes me very optimistic. No one in 20 years will think of today as the "good old days." The changes that are in front of us will be amazing. So, simply take a deep breath, be conservative today, and get ready for a really wild and fun[!?!] ride.



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.