Friday, July 31, 2009

Cheapest Plays In Emerging Markets

The Four Cheapest Plays In Emerging Markets
An Interview With Arjun Divecha: Choosing The Right Emerging Market.

By Lawrence C. Strauss, Barron's | 27 July 2009

After going through a horrible stretch in 2008, emerging stock markets have snapped back. The MSCI Emerging Markets Index is up about 36% this year, powered by equities in China and India, among others. So what's a good way for equity investors to play these markets, which can be tricky and volatile?

"The main thing in emerging markets is that getting the country right matters more than anything else".— Arjun Divecha

For some perspective, Barron's last week spoke with Arjun Divecha, portfolio manager of the Berkeley, Calif.-based GMO emerging-markets equities group. He has worked for the institutional asset manager since 1993, overseeing
$13 billion in assets. Divecha, 53, estimates that his value-investing approach is roughly 80% quantitative and 20% fundamental. One of the funds he oversees is GMO Emerging Markets III (ticker:GMOEX), whose minimum investment is $50 million. Its 10-year annual return of 11.43% bests nearly 90% of its Morningstar peers. Among the countries sporting the cheapest valuations are Turkey and Russia, Divecha says— but he is underweight China. To find out why, read on.

Barron's: Let's start with your macro view of the emerging markets.

Divecha: I look at countries around the world as a spectrum. At one end are the countries for whom this is a secular crisis, such as the U.S., the U.K. and Spain, where there are going to be massive changes in the financial sector, and maybe in other parts of the economy, due to the current crisis. On the other end of the spectrum are a lot of emerging markets for whom this is really a very bad cyclical crisis, as opposed to a structural crisis. So the emerging markets got hit badly last year for two reasons, one being their dependence on exports. No. 2, a lot of them had become reliant on cheap foreign capital, which came out of the credit boom.

Just how much have emerging markets decoupled from developed markets?

I think of each of these emerging-market countries as being like a boat with two engines, one for exports and the other for domestic consumption. So when people talk about decoupling, they need to think about each of these separately. Clearly, the export engine cannot decouple. But the second part, the domestic-consumption engine, has been stimulated, and the stimulus in a lot of these countries has worked exactly as you would expect it to work. Consumers, because they were not overleveraged, can in fact borrow. So in places like Brazil, where interest rates have come down from 15% to around 9½%, car sales hit an all-time record.

What's driving these changes in Brazil and other markets?

There is a massive amount of latent demand in Brazil from people who love to buy cars. What has kept them from doing it has been, effectively, the cost of ownership. So the stimulus, a combination of an increase in government spending and lower interest rates, is actually working the way that you would expect it to.

The other thing that has changed in the past 10 or 15 years has been the demographics; there are a lot more younger people in the workforce now. And as a result, the savings rates in most of these countries have gone up quite a lot. So in India, for example, the savings rate 10 or 15 years ago was 8% or 10% of gross domestic product; today, it is over 30%.

…Which contrasts markedly with the U.S. and Europe, where the populations are aging?

That's correct. But it is more important for these countries, because they need to invest. In order to develop, India needs investment. So 10 years ago, it would have had to rely on foreign capital. Today, with a 30%-plus savings rate, India is not as reliant on foreign capital as it was.

What are some of the major changes you've seen in emerging-markets investing over your career?

The main thing in emerging markets is that getting the country right matters more than anything else. If you can pick sectors and stocks in the developed markets, that is what really matters. But in emerging markets, if you don't get the country right, it becomes much, much harder to add value.

In what countries do you see the best opportunities?

The countries that we are most positive on are actually ones we think will have the biggest recovery from the bottom. Our favorite four are Turkey, Russia, South Korea and Thailand. Some of our less favorite countries where we are underweight are China, South Africa and India. China and India have recovered a lot. Their stock markets have gone up a lot this year, and are much more expensive than other markets. And given that we are primarily value investors, we look for cheapest above everything else. Countries like Turkey and Russia are very cheap in terms of stock valuations.

When we spoke earlier this month, you mentioned that you were bullish on China short term, but much less so over the long term. Is that still the case?

I've changed my mind since we last spoke. We are negative on China short term as well. The reason is that the stimulus package there has been absolutely massive. As a percentage of GDP, it is three or four times the size of the U.S. stimulus. In this year alone, they've had new loans worth over $1 trillion, of which more than $250 billion was issued in June. It is massive.

What's your biggest concern about that?

I believe that a lot of this money is not going into productive investment. What we are hearing anecdotally is that a lot is being lent by the banks, which, remember, are government-owned. Who are they lending to? For the most part, this money is going to state-owned enterprises, which are not particularly efficient companies.

We know that they are buying real estate, and they are doing all kinds of things that we don't think in the long run is particularly productive investment. Now, in the short run, the stimulus works, because it puts money in the hands of people who are buying and consuming stuff. So therefore, car sales in China hit an all-time record last month.

What will be the consequences in China?

Two things are likely to happen. First, longer term, if the banks don't have a problem with bad loans now, they will almost certainly have a lot more bad loans two or three years from now. Second, from a short-term point of view, at some point the government is going to get really worried about having too much credit-creation; that leads to a credit bubble, just like you had in this country and everywhere else. As a result, they will start to withdraw liquidity by tightening the gates on money. I don't know when that will be. But I worry that it is coming.

A fair amount of the stimulus money has found its way into the real-estate and stock markets because China has a closed economy. So there is no way for money to leave the country. The stock market and real estate have had huge spikes. So when that liquidity is withdrawn, it seems inevitable that the stock market will take it badly.

What gives you pause about Brazil, which isn't at the top of your list?

It doesn't give us a lot of pause, and we are not negative on Brazil. It is just that other countries have become much cheaper. We still like the story there. We still think that the government has a lot of room to stimulate in Brazil, because interest rates at 9½% are still very, very high relative to inflation, which is about 2½%. So the ability to stimulate, if they need to, is absolutely massive.

Which emerging markets are you avoiding?

We are very wary about Eastern Europe, which, in many ways, resembles Asia during the crisis of '97. A lot of the Eastern European countries have too much debt denominated in foreign currencies. So if you have a problem with the currency, which they have, your debt suddenly balloons— because you have to pay it off in the foreign currency. [He's neutral on South Africa in part because of worries about its current-account deficit.]

Why is Turkey one of your top countries? Does it's not being in the European Union hinder its prospects at all?

I don't think anybody expects that is going to happen any time soon, although it may happen in 20 years. But quite frankly, they already have what I consider to be the most important part of access to the EU. They have a customs union, which basically allows them to ship exports with a zero tax rate.

What specifically do you like about the country's prospects?

Primarily, the Turkish stock market is as cheap as we have ever seen it, trading at seven or eight times forward earnings. We have increased our exposure to the banks there, because they tend to be the most highly leveraged part of the economy. So if the economy is going to recover, the banks tend to do the best in that kind of a scenario. And in most emerging markets, you don't have banks that lent too much money— whereas in the U.S. and the developed markets, one should be wary about the banks.

Is there anything else in particular that recommends Turkey as an investment opportunity?

At the end of the day, cheapness is what matters more. What you pay for something is the most important thing of all. If you can buy something really, really cheap, you are going to make more money on that than buying something that is really good. So Turkey is pretty well-positioned, because No. 1, unlike a lot of other countries, they are used to having crises. They have crises with great regularity. So they know how to get out of crises very well. And they definitely have done a pretty good job of being very competitive in various sectors like textiles, machinery, and auto parts.

Turning to Russia, one of the biggest concerns about investing there is corruption. What's your read on that country?

Everything that everybody says about Russia is true— that the corruption problems are really terrible. But at the end of the day, when you really get down to it, Russia is an oil play. It is really an energy play. And then really, it's about: What are you paying for that energy?

To give you a comparison, ExxonMobil (XOM) has a market value of about $345 billion, versus about $40 billion for Lukoil (LKOH.Russia). One of my favorite sayings is that you make more money when things go from truly awful to merely bad than when they go from good to great. Russia is [a place] where the situation is not particularly good. The economy is actually in pretty bad shape right now. But it is a question of being able to buy at a very, very low valuation, in this case six or seven times forward earnings.

Why do you think South Korea is a good investment opportunity?

Again, valuation is very cheap, under 10 times earnings. The most interesting thing about Korea is that the won has fallen 43% from its peak against the yen, and it has fallen 36% against the Chinese yuan. So relative to the two biggest competitors they have for exports, their currency has fallen massively, improving their competitiveness dramatically. As soon as you get any kind of a recovery in global exports, the Koreans are very well placed.

What about Thailand?

It's very, very cheap, trading at less than 10 times earnings. Part of the reason why Thailand is so cheap is because the politics there have been really quite awful for the last couple of years. You had the coup, among other turmoil. Our reading is that the politics is getting better, although I don't think it is reflected in the stock market.

How do the prospects for emerging markets look?

Longer term, we are quite bullish. The only issue is that we've had such a huge rally in the last four or five months. And one has to worry about a pullback, although I'm not predicting one. Still, I'm pretty sure that you are going to get good growth out of a lot of these countries. It is hard to make that case for a lot of the developed markets. It may happen, but the case is easier to make for emerging markets.

What are your biggest concerns about the emerging markets?

Things like protectionism coming out of the West. If the crisis was to get worse in the U.S. and in the developed markets, and that brought about a legislative or governmental response for greater protectionism and you start some kind of a trade war, that would clearly be very bad for emerging markets. And it certainly would be worse for the emerging markets than the developed markets.

Thanks, Arjun.

China's Hidden Debt Problem

China's Hidden Debt Problem
Despite Robust Growth, The World's Third Largest Economy Is Potentially Deeper In Debt Than Originally Thought.

by CNNMoney

BEIJING (Reuters)— On the surface, China presents a fiscal study in contrast with the United States, keeping a remarkably low ceiling on debt even as it spends its way out of the financial crisis. But when Chinese leaders meet their U.S. counterparts this week, they should pause for reflection before venting any criticism, because hidden liabilities mean China's books are uglier— potentially much uglier— than at first sight. Thanks to successive years of fast economic growth and even faster government revenue growth, the official debt-to-GDP ratio was 17.7% at the end of last year, far lower than almost any other major economy.

The trouble is that that excludes local government borrowing, the current surge in loans backstopped by Beijing, and bad assets cleared from the banking system but still floating about. When all are thrown into the pot, analysts estimate that China's debt may be closer to 60% of GDP, putting it in virtually the same league as the United States, which was at 70% at the end of 2008 before it launched its massive economic stimulus program.

To be sure, Washington is now set on a path of exploding debt that Beijing will largely avoid. The United States budgeted for a federal deficit of 12.9% of GDP this year, whereas China is aiming for just 2.9%. But China's finances are deteriorating more quickly than the government expected, fueling a rise in the stock of both explicit and disguised debt that will constrict its wriggle room. "It is serious because, one, much of it is hidden and, two, local governments are currently doubling down on their bets," said Stephen Green, economist at Standard Chartered Bank in Shanghai. "As with all fiscal deficits, it limits space for further stimulus."

This is probably a moot point, for now. With China's economy back on track and private-sector investment kicking in, few think Beijing will need to ramp up spending beyond its existing 4 trillion yuan ($585 billion), two-year stimulus plan. But the narrowing of options still discomfits Chinese leaders. "Our fiscal work is very grim," Chinese Premier Wen Jiabao told officials last week.

Eroding Finances

Government revenues declined 2.4% in the first half compared to a year earlier, well shy of the official goal of an 8% rise. Expenditures were ahead of target and set to surge in the second half on the back of infrastructure projects. Tax intakes are, of course, closely tied to economic activity, so China's upturn should deliver cash to government coffers. But improvement in June came mainly from land sales, a one-off revenue source that masks the difficult road ahead.

"Even when we are already factoring in relatively optimistic revenue growth due to the economic recovery, the deficit is quite sticky at around 5% per year for the next three years," said Isaac Meng, economist at BNP Paribas in Beijing. But the real worry is the thickening morass of indirect debt. Officials at the Ministry of Finance estimated earlier this year that local government debt already topped 4 trillion yuan, or 16.5% of GDP, much more than previously assumed.

Above and beyond that are 400 billion yuan in bad loans in banks' hands and at least 1 trillion yuan in non-performing debt hived off their books and assigned to 'asset management' companies. The buck stops with Beijing on all of these. The record surge in bank lending this year means that its sum of liabilities is about to swell in size.

Banks have showered money on infrastructure projects that are seen as having iron-clad government guarantees. Green said he "conservatively" estimates that Beijing's bill for covering loans issued this year alone will be 1.75 trillion yuan, enough to push its 2009 deficit to 10% of GDP.

"Debt bomb"

Most troublesome of all is the potential for a "debt bomb", in the words of China's Economic Observer newspaper, at lower levels of government as those officials engage in 'financial engineering' that is both opaque and highly leveraged. Rules prevent Chinese banks from lending to governments the equity capital which they need in order to obtain further loans for investment. But local officials and banks are now exploiting a vast loophole thanks to intermediaries known as 'trust' companies.

The process is simple enough. Trusts create specially designed "wealth products", which banks sell to their clients. Banks then give the funds to the trusts and they, in turn, funnel them to governments as equity capital.

Local authorities, in short, are piling debt on top of debt. The Chinese banking regulator has started to warn trusts and banks of the growing risks, state media recently reported. It was not long ago that bad loans in China's banking system seemed to pose a massive debt threat to the wider economy. The core solution over the past decade was sustained double-digit growth, vastly expanding the denominator in debt-to-GDP ratios and generating the taxes to pay down the numerator.

Beijing is already looking to raise taxes where it can— increasing the levy on cigarettes, for example— but a return to super-charged growth is again its principal debt reduction plan. In the meantime, China needs to fund its rising deficit. On that front, at least, the government can be supremely confident, even if it has to issue more than the planned 950 billion yuan in bonds this year and yet more to cover shortfalls in coming years.

"There is so much saving and so much liquidity, so there is definitely not a problem that China will not be able to finance its deficit," said Tao Wang, UBS economist in Beijing.

Thursday, July 30, 2009

Iceland's Krona Proves A Magic Wand

Iceland's Krona Proves A Magic Wand As Europe Ails

By Ambrose Evans-Pritchard | 31 July 2009

Iceland's krona is working its magic cure. Well-heeled Japanese tourists— once a rarity— can be seen these days sampling halibut at Reykjavik's Siggi Hall, or buying Gymur jackets at the 66°North store on Bankastraeti. The krona has fallen by half against the euro since the `New Viking' trio of Landsbanki, Glitnir, and Kaupthing strayed out of their depth and brought down Iceland's financial system. Nothing is cheap, but prices have come within reach. Reykjavik's caf├ęs are packed with euro-youth, at last able to afford a taste of all-night dancing at this Arctic Ibiza.

Out in Iceland's Eastern fjords meanwhile, Alcoa has raised aluminium production to record levels— and metal matters as much as fish for exports. "The smelters are running full speed," said the new-broom finance minister, Steingrimur Sigfusson. So is Mr Sigfusson himself. Last week he launched three new banks on the ruins of the old. Normality is returning. "We are going to get through this better than feared. We're feeling real activity in the economy, and much of this comes from a favourable exchange rate," said Mr Sigfusson.

Iceland's great lurch towards casino capitalism over the last decade has a cultural logic. "We are a fishing culture: when the herring is there, we take it," said Andri Snaer Magnason, author of `Dreamland: A Self-Help Manual for a Frightened Nation'. There was no easier catch on offer than the Greenspan bubble (2000-2007) and the global "carry trade". How could fishermen resist?

In one sense it was a terrifying shock for the 310,000 inhabitants of this Norse-Celtic outpost of lava rock to see their currency, banks, and global image crash in a single week last autumn. Yet nothing has really changed. "Everything still feels normal. The services of the state are intact. The swimming pool is open. You can still have a decent heart attack in Iceland," said Mr Magnason.

"Friends who lost jobs in banking have already found new work, and you could say the [fall of the] krona has worked as a buffer for us. We all went down together, and that has led to healthier recession without mass unemployment." The jobless rate has risen to 9.1%. This is below the eurozone average of 9.5%, and is stabilising much earlier.

Those who point to Iceland as a scarecrow exhibit of what happens to a small country caught in a financial storm without the shield of euro membership have the matter backwards, as will become ever clearer over the next two years. The OECD expects Iceland's economy to shrink 7% this year. This is much better than Ireland at minus 9.8%, and recovery will come sooner. So next time you hear the Sacra Congregatio of the euro faith incant yet again that 'EMU saved Ireland' from a terrible fate, know that they deceive only themselves.

You take your punishment early with devaluation, as Britain did on leaving Gold in 1931, or ending the D-mark torture in 1992, or now. You look a sorry sight at first, but sweet vindication comes later. It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34% in Spain, 28% in Latvia, 25% in Italy, 24% in Greece, and rising.

At Iceland's central bank— mercifully, no longer listed beside al Qaeda as a terrorist body by UK authorities— Governor Svein Harald Oygard says currency therapy is working as it should. "If you lean back and look you can see that fall of the krona accentuated the shock at first, but it is also now working as a turbocharger for recovery. We've seen a strong hit on wealth and asset values, but the story for real economy is very different."

Devaluation is always double-edged. Some 13% of households in Iceland hold mortgages in euros, Swiss francs, or God forbid, yen. Their debt levels doubled overnight. Some 70% of corporate loans are in foreign currencies. Exporters are hedged. Those that earn in krona are not, and a "large number" are now in dire straits.

The Governor is a Norwegian who cut his teeth in the Oslo banking crisis of the early 1990s. He was brought in as a troubleshooter after the last crew was literally banged out of the Sedlabanki by the 'Saucepan Revolution' in February. With justifiable pride, he showed me the latest trade figures. Iceland has defied the global shipping crash to eke out an 11% rise in exports over the last year. Even China has seen a fall of 21%. [[Wonder if he would consider replacing BB at the Fed!?!: normxxx]]

Iceland will be back in surplus by next year, from a peak deficit of 25% of GDP. You could say the same about Latvia, which has stuck to its euro peg under orders from Brussels. But there is a big difference. Latvia is balancing its books by crushing demand. Exports are down 28%, but imports are down even more. The result of this Stone Age policy is economic contraction of 18% this year, and 4% in 2010 (state data).

Icelanders have taken a hit, of course. Unions have accepted 'real' wage cuts of 10%. [[Which I believe at current rates of inflation, still amounts to a decent 'nominal' raise.: normxxx]] Health care and welfare are being cut 5%, education 7%, and the rest 10%. This is comparable to what is happening in Ireland, but again there is a difference. Dublin faces a Sysphean task as collapsing tax revenues force ever deeper austerity: Reykjavik is over the worst.

It baffles me why rating agencies still talk of downgrading Iceland's debt to junk. The country should emerge with public debt of 80% to 100% of GDP— much like Britain. Yet Iceland also has the world's best-funded pension system at 120% of GDP. It is the two together that counts. In their angst, Icelanders look wistfully at the apparent safe port of EU membership. The Althingi has voted to start entry talks. But the storm will have blown over well before an EU referendum is held in two or three years. By then the delayed cluster bomb of Europe's unemployment will have detonated. Try selling EU protection then.

Wednesday, July 29, 2009

Foreclosures Are Often In Lenders' Best Interest

Foreclosures Are Often In Lenders' Best Interest
Numbers Work Against Government Efforts To Help Homeowners

By Renae Merle, WP | 29 July 2009

Government initiatives to stem the country's mounting foreclosures are hampered because banks and other lenders in many cases have more financial incentive to let borrowers lose their homes than to work out settlements, some economists have concluded.

Policymakers often say it's a good deal for lenders to cut borrowers a break on mortgage payments to keep them in their homes. But, according to researchers and industry experts, foreclosing can often be more profitable.

The problem is that modifying mortgages is profitable to banks for only one set of distressed borrowers, while lenders are actually dealing with three very different types. Modification makes economic sense for a bank or other lender only if the borrower can't sustain payments without it yet will be able to keep up with new, more modest terms.

A second set are those who are likely to fall behind on their payments again even after receiving a modified loan and are likely to lose their homes one way or another. Lenders don't want to help these borrowers because waiting to foreclose can be costly. Finally, there are those delinquent borrowers who can somehow, at great sacrifice, catch up without a modification. Lenders have little financial incentive to help them.

Special Report: Foreclosure Prevention Program— Homeowners' Calculus

'Triage' Tool: The Lenders Calculus

These financial calculations on the part of lenders pose a difficult challenge for President Obama's ambitious efforts to address the mortgage crisis, which remains at the heart of the country's economic troubles and continues to upend millions of lives. Senior officials at the Treasury Department and the Department of Housing and Urban Development have summoned industry executives to a meeting Tuesday to discuss how to step up the pace of loan relief. The administration is seeking to influence lenders' calculus in part by offering them billions of dollars in incentives to modify home loans.

Still, foreclosed homes continue to flood the market, forcing down home prices. That contributed to the unexpectedly large jump in new-home sales in June, reported yesterday by the Commerce Department.

"There has been this policy push to use modifications as the tool of choice," said Michael Fratantoni, vice president of single-family-home research at the Mortgage Bankers Association. But "there is going to be this narrow slice of borrowers for which modifications is the right answer". The size of that slice is tough to discern, he said. "The industry and policymakers have been grappling with that."

The effort to understand the dynamics of the mortgage business comes as the administration is prodding lenders to do more to help borrowers under its Making Home Affordable plan, which gives lenders subsidies to lower the payments for distressed borrowers. About 200,000 homeowners have received modified loans since the program launched in March, while more than 1.5 million borrowers were subject during the first half of the year to some form of foreclosure filings, from default notices to completed foreclosure sales, according to RealtyTrac. No doubt part of the explanation is that lenders are overwhelmed by the volume of borrowers seeking to modify their mortgages. Rising unemployment and falling home prices have added to the problem.

But a study released last month by the Federal Reserve Bank of Boston was downbeat on the prospects for widespread modifications. The analysis, which looked at the performance of loans in 2007 and 2008, found that lenders lowered the monthly payments of only 3 percent of delinquent borrowers, those who had missed at least two payments. Lenders tried to avoid modifying the loans of borrowers who could "self-cure," or catch up on their payments without help, and those who would fall behind again even after receiving help, the study found.

"If the presence of self-cure risk and redefault risk do make renegotiation less appealing to investors, the number of easily 'preventable' foreclosures may be far smaller than many commentators believe," the report said. Nearly a third of the borrowers who miss two payments are able to self-cure without help from their lender, according to the Boston Fed study. Separately, Moody's, a research firm, estimated that about a fifth of those who miss three payments will self-cure.

When Adrian Jones fell behind on the mortgage payments for her Dallas home earlier this year, her lender asked her to cut other expenses. Jones said she eliminated movies and coffee breaks. She turned to family members for loans. When that failed to raise enough, she sold her second car. "It hurt, but it also made sense. The debt was my responsibility," Jones said.

But six months later, after catching up on the mortgage, Jones is again feeling pinched after her hours as an office assistant at an architecture firm were cut. This time, she's not sure she can fix the problem herself. "I am going to try, obviously," she said. "But it is getting harder and harder". Like Jones, those who are most determined to meet their obligations are often unlikely candidates for loan modifications.

"These are the people who will get a second job, borrow from their family to keep up," explained Paul S. Willen, a senior economist at the Federal Reserve Bank of Boston and an author of its report. "… From a cold-blooded profit-maximizing standpoint, these are the people the banks will help the least". Lenders also worry that borrowers may re-default even after receiving a loan modification.

This only delays foreclosure, which can be costly to the lender because housing prices are falling throughout the country and the home's condition may deteriorate if the owner isn't maintaining it. In some cases, lenders lose twice as much foreclosing on a home as they did two years ago, said Laurie Goodman, senior managing director at Amherst Securities. American Home Mortgage Services, based in Texas, was willing to modify Edward Partain's mortgage on his Tennessee home last April after business at his beauty salon slowed and a divorce stretched his budget.

But after months of negotiating with his lender, Partain said he was surprised to learn that it would only lower his payments by $90 a month, instead of the $250 decrease he expected. "At $250, I would have had a chance, but after they added in late fees and payments, I couldn't do it," he said. Partain soon fell behind on his payments again and went back to American Home Mortgage Services seeking a more affordable payment. Partain said he was told that he was ineligible for another modification because it had been less than a year since his last. A foreclosure sale was scheduled for late July.

After American Home Mortgage Services was contacted by The Washington Post about the case, the company said Partain would be considered for the federal foreclosure-prevention program and it delayed the sale by three months. Partain is relieved but anxious about the details. "You want to wait and see what figures they come up with," he said.

Administration officials have not said publicly how many borrowers they expect to re-default under Obama's program. But the experience of a separate program run by the Federal Deposit Insurance Corp. could be instructive. After taking over the failed bank IndyMac last year, the FDIC began modifying troubled mortgages held or serviced by the company. Richard Brown, the FDIC's chief economist, said the agency expects up to 40 percent of those borrowers to re-default.

Even at that rate, he said, the modification program is more profitable than doing nothing. "The idea that a 30 to 40 percent re-default rate represents a program failure, is false," Brown said. The administration has estimated that its foreclosure-prevention program would help 3 million to 4 million borrowers by 2012. But lenders' reluctance could limit the impact to less than half that, said Mark Zandi, chief economist for Moody's Coupled with re-defaults, this would mean that the number of people losing their homes to foreclosure could reach nearly 5 million by 2011, he said.

Mark A. Calabria, director of financial-regulation studies at the Cato Institute, warned that political rhetoric is driving the policy discussion. "What we really need to do is have an honest debate about what are the magnitudes of people we really can help," he said. But administration officials defended their program's progress, reporting that it has surpassed an initial goal of offering 20,000 modifications a week. These officials said they have taken into account the re-default risk and possibility for self-cure in designing the effort.

Michael S. Barr, assistant Treasury secretary for financial institutions, noted that the report by the Boston Fed does not cover the period since the administration launched its initiative. "We will continue to refine the program as new data becomes available," he said. "We are committed to studying the effectiveness and efficiency of the program, and we welcome outside analysis."

Willen, of the Boston Fed, said the government program could boost several-fold the number of seriously delinquent borrowers receiving modifications. But so few people had been getting their loans modified that even a dramatic increase in the percentage would still touch only a small fraction of troubled borrowers, he said. "We're still not talking about a program that will stop a large number of foreclosures," he said. "We're talking about a program that, at the margins, will assist more people. It is unlikely we will see a sea change."

Tuesday, July 28, 2009

It's Already Worse Than The Depression

It's Already Worse Than The Depression

By Robert Brokamp, Motley Fool Stock Advisor | 23 June 2009

Remember all that talk about whether we were entering another Great Depression? Much of it has subsided since the 30% rally in the S&P 500 and the sprouting of the economy's supposed "green shoots" (or, as skeptics call them, "yellow weeds," "Venus flytraps," or "poison ivy accidentally used as toilet paper"). But you'll still find doomsayers who think the worst is yet to come. (And I mean "doomsayers" in a good way— there should be a little part of all of us that expects the worst and plans accordingly.)

Whether or not our current 'less-bad' economy— when most economic metrics are still ugly, just not as ugly as they used to be— sort of like me in college— is really an indication of "green shoots" or more like the worm-like tongue of the alligator snapping turtle remains to be seen. But I can tell you this: By at least one metric, it's already worse than the Depression at this point in relative time: the Dow then was down only 12% at the apex of the post-1929 crash rally; we're now still down 32%.

It Didn't Have To Be That Bad

But wait. Some investors did see their portfolios grow over the past decade. How did they do it? By owning asset classes other than U.S. large-cap stocks. While those returns won't turn a pauper into Prince (or whatever his name is these days), they're still better than losing money. And investors who had these more-diversified portfolios ended up with almost twice as much money as someone in an S&P 500 index fund.

In my Rule Your Retirement service, I have created model portfolios that contain 10 to 12 asset classes. Let's take a look at how a few fared over the past 10 years using mutual funds (mostly of the index variety) to measure their performance, compared with an investment in the Vanguard 500 (FUND: VFINX), our proxy for U.S. large-cap stocks.

Portfolio Investment(s) Total 10-Year Return $100,000 Turned Into …
100% U.S. large-cap stocks           One fund           (22.8%)           $77,160
100% stocks, of all sizes and countries           10 funds           31.4%           $131,414
70% stocks, 30% bonds           11 funds           47.3%           $147,325

Source: Morningstar Principia software, May 1, 1999, to April 30, 2009. Portfolios are rebalanced annually.

What makes these portfolios different? They're built with funds that invest all over the world, in stocks of all types and sizes. They still have the big-name American companies— such as Microsoft (Nasdaq: MSFT) and IBM (NYSE: IBM)— but also small stocks, such as Seagate Technology (Nasdaq: STX) and ImmunoGen (Nasdaq: IMGN). And they're not limited to America, either, including funds that invest in stocks like Nokia (NYSE: NOK) and China Mobile (NYSE: CHL).

And then there's boring old bonds, which made up 30% of the third portfolio. You should own them— especially if you're within a decade of retirement, or just can't stand the volatility (or, perhaps most important) uncertainty of an all-stock portfolio. [[Not to mention that bonds have outperformed stocks over the past 5, 10, 15, 20 and 25 years!: normxxx]] Of the portfolios above, the one with bonds did best.

Hope For The Future

Just as in the 2000s, holding bonds beat an all-stock portfolio in the 1930s. However, it wasn't until the 1970s that bonds once again reduced risk and boosted return over decade-long time frames. In each case, one bad decade for stocks was followed by a multidecade run of good returns. Put another way, since 1926, U.S. large-cap stocks have never posted two consecutive decades of losses. That gives us some hope for the coming decade.

Of course, there's a first time for everything. In 2005, Ben Bernanke, then an advisor to President Bush, said on CNBC, "We've never had a decline in housing prices on a nationwide basis. What I think is more likely is that house prices will slow, maybe stabilize … I don't think it's going to drive the economy too far from its full-employment path, though". Well, we've since had our nationwide decline in housing prices. (That gnawing sound you hear is Mr. Bernanke eating his words.) Given that history is a useful yet imperfect guide, it's likely— though not guaranteed— that stocks will post decent[!?!] returns over the next decade.

So for those near or in retirement, or for conservative investors of any age, using bonds to balance the risk of stocks makes sense. And every investor should hold stocks of all shapes, styles, sizes, and nationality. It would be grand to know which type of investment will do best over the next decade. But until you've fixed your crystal ball or perfected time travel, a smartly created, well-diversified portfolio should be the foundation of your retirement savings.

See also Paul Merriman's "The Ultimate Buy-and-Hold Strategy" for actual alternative portfolios.

Monday, July 20, 2009

Fiscal Ruin Of The Western World Beckons

Welcome To The Eye Of The Storm
Second Half, 2003… or 1987!?!

Fiscal Ruin Of The Western World Beckons
9 Reasons Jobs Won't Recover Soon;
7 Reasons Why Housing Isn’t Bottoming Yet

By John Galt | 23 July 2009

The Dow has rallied nicely since March of this year.

[ Normxxx Here:  Even as the dollar has cratered (be careful; note the different starting points)…

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

Expect this relationship to hold… and who knows where the dollar will end…

Colin Twiggs: "…The euro broke out above the recent triangle against the greenback, signaling a primary advance with a target of
$1.50. Follow-through above $1.43 would confirm the signal. Reversal below $1.38 is unlikely, but would warn of reversal to a primary down-trend".

Bill Cara: "I am on the record as saying I think the $USD will hold at this level for the short-term although— and this is quite connected— $GOLD would make a run to close to
$1,000. Here’s what I now think. President Obama’s healthcare legislation efforts lie in the balance; therefore, the Fed must keep rates down a while longer, but also continue to support the Dollar. The odds of a replay of Black Monday October 19, 1987 are rising…

"So, bottom line (Cara): there will be some false break-downs in the US Dollar in the near-term, causing $GOLD to lift— one final time in this short- and intermediate-term cycle. The stock promoters will be active this summer. Their well-paid newsletter writers will come through with wonderful stories. The people will buy. $GOLD maybe hits
$1,000, possibly a bit higher before the cycle ends abruptly."

normxxx: The S&P will top 1000 this summer together with gold… But, then comes the fall…  ]

Washington, D.C. appears to be returning to the 'good' status of "stalemate" which satifies the world. The "War against Terror" is now 'the police action against misguided radicals'. All must be well with the world because U.S. bankster profits are [once again] off the scale [[thanks to some very funny accounting: normxxx]] and I swear 'Maria the Money Honey' had an actual Bubblegasm reporting Apple’s earnings this afternoon.

Welcome to the eye of the storm. And that storm, as displayed above, is Hurricane Wilma, the most intense storm in recorded history. That storm is getting ready to move again and the most powerful part of the eyewall is about to slam into our economic fantasy land at full force.

Without going into great detail, let me try to outline in brief the series of events which will be swirling like the eye wall, with 200 mph gusts and record low pressure. Duck if you see one of those buildings coming at you, it’s probably a foreclosed home being 'wiped off' the books.

1. Iran— Israel will not sit by idly waiting on the Messiah to ‘talk’ to them, they will act. Fall would be the perfect time as the Iranian defenses should be exhausted from all the probing. [[Not to mention riots in the street.: normxxx]]

2. The banking system is still extremely unstable. Despite saving those deemed "too large to fail"— now there are too many [little ones] to 'save'. The rumors about a bank holiday are swirling— but what would be logical (good luck with this one) is if they did execute such an action, consolidate or close the 2000 or so bad banks, put the assets into a RTC style liquidation firm, then re-open in less than 14 days, it might work. But the panic it would create would be astonishing at every level. [[Forget it; it would take a veritable army of CPAs, attorneys, etc.— none of whom are in sufficient quantity for even the current operations of the Fed.: normxxx]]

3. The U.S. Dollar is losing steam and the threats made by the BRIC nations to create separate trading blocs that do not use the USD is becoming reality. Without its reserve currency status— which will not be at risk this year, but just the threat of that action— the U.S. dollar is little more than an Argentine peso, albeit from a country with a big navy, air force and ['repurposeable'] ICBMs.

4. Unemployment is deteriorating at a faster and deeper level than any projections. According to numbers produced from various sources, unemployment really ranges from 18.2% to over 20.6% which matches some of the estimated 1893 and 1930’s depression levels.

5. Derivatives: From Martin Weiss July 10th— The Giant Accumulation of High-Risk Debts and Bets Called "Derivatives"

A must read and I really do not have much more to add to this subject as the risk is now on full display with the still ongoing three 'circus rings' of the monoline insurers, AIG, and CIT.

6. Swine Flu— As of this entry there just may be a vaccine, but the virus is rapidly mutating making it difficult to create an effective vaccine. This challenge could create another flu panic this autumn and winter that further impacrts our financial system. [[But I'm looking out for the 'double dip' as more likely in Fall, 2010.: normxxx]]

7. Bankruptcies— Personal and Corporate bankruptcies are accelerating and as we head into the fiscal year end for many corporations, Chapter 11 could be a viable option. As individuals lose hope and can not escape the debt spiral they are filing at a pace unseen since the modification to the bankruptcy laws in 2005.

8. The P/E ratio for the S&P 500 is an absurd 15.74 on forward earnings and the NASDAQ an even more absurd 19.22. Traditional recession level ratios are between 5 and 8 (Source WSJ, 7/21). Considering the spin being put on earnings this week, the potential for a major corrective move to the downside is wide open. [[But much more likely to strike in the 3Q, since 2Q earnings estimates were (often absurdly) low-balled, but 3Q earnings estimates are now hastily being revised upwards: normxxx]]

9. Manufacturing is not recovering— just slowing its descent— with little evidence that the automotive sector will 'spring' quickly back to life. New single family home construction trailing levels have been unseen since before 1958, and there is no logical reason to think the 'housing recovery' has begun (see item 12).

10. The retail disaster is still ongoing with further bankruptcies likely, including some historic and major names which will add further pressure to an already devastated Commercial Real Estate market.

11. Import/Export data via rail car bookings, TEU container counts, etc. indicates that our export markets are still declining at about 14-29% per month depending on the port and our imports are still declining at a 20-28% decline year over year. Thus validating a continuing manufacturing disaster.

12. Real Estate Reality— Despite a mass move of foreclosed homes, the banksters are still sitting on numerous months of inventory which have not been put up for bid or worse, have often postponed final foreclosure action to prevent further market price deterioration [[an estimated 8-10 months delay between first non-payment and final auction, if any— and, despite all, new foreclosures are accelerating faster then the banks can get rid of the old ones. See also "What Can a Half Century of Housing Inventory Data and Past Recessions Tell Us?"; "Lenders Abandoning Foreclosed Properties"; and "In 'Foreclosure Limbo'".: normxxx]].

Add in the CRE disaster which is starting to pile up and the projected delinquency rates in the 8K’s for the real commercial banks (not Goldman) and you can see that any improvement is [very likely] seasonal only and will resume a steep deterioration in the fall.

That's why I am keeping up the 'hurricane warning' signs for everyone. For those of you who have never experienced a storm like this, the eye is the deceiving part. You can either keep the storm shutters on and get ready for the worst part of the storm or you can be like the idiots on Bubblevision [[and at the Fed?: normxxx]] and begin taking the storm protection down. For what it is worth, I think Dennis Kneale (CNBC) is that fool you see in every storm with a beer can in one hand trying to lean into the 150 mph winds right before a tin awning cuts him in half. In other words, as every other economic storm in our history, there is always some fool proclaiming "this is nothing, come on out, enjoy the rain"; famous last words, like these, don’t you think? :

"…there are indications that the severest phase of the recession is over…"
— Harvard Economic Society (HES) Jan 18, 1930


Fiscal Ruin Of The Western World Beckons

By Ambrose Evans-Pritchard | 22 July 2009

For a glimpse of what awaits Britain, Europe, and America as budget deficits spiral to war-time levels, look at what is happening to the Irish welfare state. Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15% of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous compounding debt trap.

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12% and heading for 16% next year. Education must be cut 8%. Scores of rural schools must close, and 6,900 teachers must go. "The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb", said the Teachers Union of Ireland. Nobody is spared. Social welfare payments must be cut 5%, child benefit by 20%. The Garda (police), already smarting from a 7% pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc.

"Something has to give," said Professor Colm McCarthy, the report's author. "We're borrowing €400m (£345m) a week at a penalty interest."

No doubt Ireland has been the victim of a savagely tight monetary policy— given its specific needs. But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base.

As the International Monetary Fund made clear last week, Britain is lucky that markets have not yet imposed a "penalty interest" on British Gilts, given the trajectory of UK national debt— now vaulting towards 100% of GDP— and the scandalous refusal of this Government to map out any path back to solvency.

"The UK has been getting the benefit of the doubt, both in the Government bond market and also the foreign exchange market. This benefit of the doubt is not going to last forever," said the Fund.

France and Italy have been less abject, but they began with higher borrowing needs. Italy's debt is expected to reach the danger level of 120% next year, according to leaked Treasury documents. France's debt will near 90% next year if President Nicolas Sarkozy goes ahead with his "Grand Emprunt", a fiscal blitz masquerading as investment.

There was a case for an emergency boost last winter to cushion the blow as global industry crashed. That moment has passed. While I agree with Nomura's Richard Koo that the US, Britain, and Europe risk a deflationary slump along the lines of Japan's 'Lost Decade' (two decades really), I am ever more wary of his calls for Keynesian spending a l'outrance.

Such policies have crippled Japan. A string of make-work stimulus plans— famously building 'bridges to nowhere' in Hokkaido— has ensured that the day of reckoning will be worse, when it comes. The IMF says Japan's gross public debt will reach 240% of GDP by 2014— beyond the point of recovery for a nation with a contracting workforce. Sooner or later, Japan's bond market will blow up.

Error One was to permit the bubble in the 1980s. Error Two was to wait a full decade before opting for monetary "shock and awe" through quantitative easing. The US Federal Reserve has moved far faster, but already seems to think the job is done. "Quantitative tightening" has begun. Its balance sheet has contracted by almost $200bn (£122bn) from the peak. The M2 money supply has stagnated since January. The Fed is talking of "exit strategies".

Is this a replay of mid-2008 [[or 1936: normxxx]] when the Fed lost its nerve, bristling over criticism that it had cut rates too low (then 2% in 2008)? Remember what happened. Fed hawks in Dallas, St Louis, and Atlanta talked of rate rises. That had consequences. Markets tightened in anticipation, and arguably triggered the collapse of Lehman Brothers, AIG, Fannie and Freddie that Autumn.

The Fed's doctrine— "New Keynesian Synthesis"— has let it down time and again in this long saga, and there is scant evidence that Fed officials recognise the fact. As for the European Central Bank, it has let private loan growth contract this summer. The imperative for debt-bloated Western [governments] is to cut spending systematically for year after year, off-setting the deflationary effect with monetary stimulus. This is the only mix that can save us.

My awful fear is that we will do exactly the opposite, incubating yet another crisis this autumn, to which we will respond with yet further spending. This is the road to ruin.


9 Reasons Jobs Won't Recover Soon

By Mortimer Zuckerman, U.S. News & World Report | 20 July 2009

Job losses over the past 6 months have exceeded anything we've experienced since World War II, and the number (and percentage) of long-term unemployed is at an all-time high. There are signs the recession may end in coming months, but recovery is likely to be so listless that many won't feel the difference, says The Wall Street Journal's David Wessel.

Recent unemployment numbers have undermined confidence that we might be nearing the bottom of the recession. The appropriate metaphor is not the green shoots of new growth. It's better to view the total of jobless people as a prudent navigator perceives an iceberg. What we see on the surface is disconcerting enough. The Bureau of Labor Statistics estimate of 467,000 jobs lost in June increases to 7.2 million the number of unemployed since the start of the recession.

The cumulative job losses over the past six months have been greater than for any other half-year period since World War II, including demobilization. What's more, the job losses are now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all employment growth from the previous business cycle. That's bad enough. But here are nine reasons we are in even more trouble than the 9.5% unemployment rate indicates:

1. June's total included 185,000 people assumed to be at work but many of whom probably were not. The government could not identify them; it made an assumption about trends. But many of these mythical 'estimated' jobs were 'imputed' in industries such as finance that, in fact, have absolutely no job creation. As official numbers are adjusted over the next several months, some of those 185,000 will likely be added back to the unemployment totals.

2. More companies are asking employees to take 'unpaid leave'. These people don't count on the unemployment rolls.

3. At least 1.4 million people weren't counted among the unemployed, even though they wanted work or were available in the past 12 months. Why? Because they hadn't searched for work in the four weeks preceding the survey. The assumption is that they had found work or don't want it, but there are other explanations: school attendance, family responsibilities, sheer exhaustion.

4. The number of workers taking part-time jobs because of the slack economy, a kind of stealth underemployment, has doubled in this recession to about 9 million, or 5.8% of the work force. Add those whose hours have been cut and the total of unemployed and underemployed rises to 16.5%, putting the number of involuntarily idled workers in the range of an overwhelming 25 million.

5. The inside numbers are just as bad. The average workweek for production and nonsupervisory private-sector employees, around 80% of the work force, dropped to 33 hours. That's 48 minutes a week less than before the recession began, the lowest level of (weekly) activity since the government began tracking such data 45 years ago.

Full-time workers are being downgraded to part-time as businesses slash labor costs to remain above water. Factories are operating at only 65% of capacity. If American workers were still putting in those extra 48 minutes a week, 3.3 million fewer employees could perform the same aggregate amount of work. With the longer workweek, the unemployment rate would reach 11.7%, not the official 9.5% (which in turn dramatically exceeds the 8% rate projected by the Obama administration).

6. The average length of official unemployment increased to 24.5 weeks. This is the longest term since the government started to track these data in 1948. The number of long-term unemployed (those out of a job for 27 weeks or more) has now jumped to 4.4 million, an all-time high.

7. The average worker saw no wage gains in June, with average compensation running flat at an average of $18.53 an hour.

8. The jobs report is even uglier when you consider that the sector producing goods is losing the most jobs— 223,000 in the last report alone.

9. The prospects for job creation are equally distressing. The likelihood is that when economic activity picks up, employers will first choose to increase hours for existing workers and bring part-time workers to full-time status.

Many unemployed workers looking for jobs once the recovery begins will discover that jobs as good as the ones they lost are almost impossible to find because more layoffs in this recession have been permanent and not temporary. Instead of shrinking operations, companies have closed whole business units or made sweeping structural changes in the way they conduct their business. For example, General Motors and Chrysler shut down hundreds of dealerships and reduced brands; Citigroup (C) and Bank of America (BAC) cut tens of thousands of jobs and exited many parts of the world of finance.

In other words, we could face a very low upswing in terms of the creation of new jobs, and we may be facing a much higher level of joblessness on an ongoing basis. Job losses may last well into 2010, and unemployment may peak at close to 11%. Can we find comfort in knowing that employment has long been considered a lagging indicator? It is conventionally seen as having limited predictive power because employment reflects decisions taken earlier in the business cycle.

But today is different.

Unemployment doubled from 4.8% to 9.5% in just 16 months, a rate so rapid it may influence future economic behaviors and outlooks. Bear in mind that the lackluster increase in inventories suggests that there's little prospect of real growth in consumption, investment or exports. So the terrible state of the labor market is likely to be a strong headwind against consumer spending as wages and overall income growth are decelerating.

And households soon will have received their full portion of the stimulus package. How could this happen when Washington has thrown trillions of dollars into the pot, including the famous $787 billion in spending that was supposed to yield $1.50 in growth for every dollar spent? For a start, too much of the money went to transfer payments— Medicaid, jobless benefits and the like— that do nothing for jobs and growth. The spending that creates jobs is new spending, particularly on infrastructure. [[But, as Japan has aptly demonstrated over almost 20 years, such spending— necessary as it is— seems to be almost useless as a "kickstart" for the economy.: normxxx]] It amounts to less than 10% of the stimulus package today.

Second, while the stimulus package may have been well intentioned, it was too small and too badly constructed to get money into the economy fast enough to replace lost consumer and business spending and to slow unemployment. Workers' pessimism is justified: About 40% believe the recession will continue for another full year. And, as paychecks shrink or disappear, consumers are more hesitant to spend and won't lead the economy out of the doldrums quickly enough.

It may have made him unpopular in parts of the Obama administration, but Vice President Joe Biden told it as it is when he said the administration misread how bad the economy was. The administration inherited the problem but then failed to understand how ineffective its solutions would be. The program was supposed to be about jobs, jobs and jobs. It wasn't. The recovery act included thousands of funding schemes for tens of thousands of projects, but those programs are stuck in the bureaucracy as the government releases funds with typical inefficiency.

An additional $150 billion, allocated to state coffers to continue existing programs like Medicaid, did not add jobs. Hundreds of billions of dollars were set aside for tax cuts and for benefits for the poor and the unemployed, and that did not add jobs. Now, state budgets are drowning in red ink as jobless claims and Medicaid bills climb.

Next year, states will have depleted their initial rescue dollars. Absent another rescue plan, they will have no choice but to slash spending or raise taxes, or both. The state and local government sector, comprising about 15% of the economy, is beginning the worst contraction in post-World War II history in the face of a deficit gap of $166 billion for fiscal 2010, according to the Center on Budget and Policy Priorities, and a cumulative gap of $350 billion in fiscal 2011.

Similarly, households overburdened with historic levels of debt will be [[mostly involuntarily: normxxx]] saving more. The savings rate has already jumped from zero in 2007 to almost 7% of after-tax income and is rising. Every dollar of saving comes out of consumption. Because consumer spending is the economy's main driver, we are going to have a weak consumer sector, and many businesses simply won't have the means or the need to hire employees.

In the aftermath of the 1990-1991 recession, Americans bought houses, cars and other expensive goods. This time, the combination of a weak job picture and the (continuing) severe credit crunch means that people won't be able to get the financing for big expenditures, and those who can borrow will be reluctant to do so. In recent times, Americans found myriad ways to fuel spending, even as incomes stagnated, by borrowing against once-rising home values, by tapping credit cards… No longer. The paycheck has returned as the primary source of spending, and pay is eroding even for those who have jobs. [[Welcome to deflation, stage I: normxxx]]

This process is nowhere near complete, and, until it is, the economy will barely grow, if at all, and may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of over 30 years of an accumulated excessive debt has been completed. Until then, the private economy will be starved of adequate credit, profits and cash flow, and businesses will not hire for expansion. Nor will they race to make capital expenditures when they have vast idle capacity.

In other words, there are many more reasons today to expect the downturn to continue than to expect a turnaround. Consumer spending and residential investment could be even weaker than most estimates, and, as the level of fiscal stimulus starts to decline in the second half of 2010, we may be facing an even more difficult future. No wonder poll after poll shows a steady erosion of confidence in the stimulus measures. One survey showed 45% believe the limited results suggest they should simply be abandoned midway. The disappointment is understandable, but that would only make things worse.

So what kind of second-act stimulus program should we look for? This time, it should not be an excuse to pass a lot of programs that don't really have a multiplier effect on job creation and economic growth. And it should not be a handout for the fat-cats. Given the trends, it is critical that the Obama administration not play politics but begin to prepare a second stimulus program to sidestep a major downturn. It will be possible this time to provide much more rapid government support to infrastructure spending that will maximize the creation of jobs.

The time to get ready is now.


7 Reasons Why Housing Isn’t Bottoming Yet
Click here for a link to complete ORIGINAL article:

By Barry Ritholtz | 20 July 2009

On Saturday, I posted the chart above and wondered why "Some people were calling for a housing bottom". That generated a ton of emails asking about further clarification. The people I referred to [in the quote] were mostly the usual happy talk TV suspects (i.e., Cramer) who have been perpetually wrong about Housing for nigh on 3 years. I not only disagree with them, but don’t respect their opinion— essentially headline reading, gut instinct, big-money-losers. No thanks.

Then there were the slew of MSM who insist each month on reporting that 3% (±11%) is a positive integer. We disposed of that silliness on Friday.

But the crux of the email was over this post. There are a handful of people whom I disagree with, but nonetheless have a great deal of respect for [because of] their [sound] methodology and process. Over the past year, these have included Doug Kass and Lakshman Achuthan and Bill of Calculated Risk. We may reach different conclusions about a given issue, or disagree on timing, but these are the folks whose opinions force me to sharpen my own.

When I tossed up that chart yesterday, I had not yet seen Bill’s comments on the subject (McCartney!) but he is one of those people I can respectfully disagree with. We simply have reached different conclusions about the timing and shape of the eventual Housing lows. There are a plethora of reasons why I believe we are nowhere near a bottom in Housing prices or activity.

Here are a few:

    • Prices: By just about every measure, Home prices on a national basis remain elevated. They are now far off their highs, but are still remain about ~15% above their historic metrics. I expect prices will continue lower for the next 2-4 quarters, if not longer, and won’t see widespread Real increases for many years after that; Indeed, I don’t expect to see nominal increases anytime soon;

    • Mean Reversion: As prices revert back towards historical means, there is the very high probability that they will careen past the median. This is the pattern we see after extended periods of mispricing. Nearly all overpriced asset classes revert not merely to their historic trend line, but typically collapse far below them. I have no reason to believe Housing will be any different;

    • Employment & Wages: The rate of Unemployment is very likely to continue to rise for the next 4-8 quarters, if not longer. This removes an increasing number of people from the total pool of potential home buyers. There is another issue— Wages have been flat for the past decade (negative in Real terms), crimping the potential for families to trade up to larger houses— a big source of Real Estate activity. Plus, more unemployment means more . . .

    • Foreclosures: We likely have not seen the peak in defaults, delinquencies and foreclosures. Many more foreclosures— which are healthy in the long run but wrenching during the process of dislocation— are very likely. These will pressure prices yet lower. And Loan Mods are not working— they are being redefaulted on in less than a year at between 50-80%, depending upon the mod conditions themselves.

    • Inventory: There is a substantial supply of "Shadow Inventory" out there which will postpone a recovery in Home prices for a significant period of time. These are the flippers, speculators, builders and financers that are sitting with properties that they do not want to bring back to market yet. Given the extent of the speculative activity during the boom years (2002-06), and the number of foreclosures so far, my back of the envelope estimates are there are anywhere from 1.5 million to as many as 3 million additional homes that could come to market if prices were more advantageous.

    • Psychology: The investing and home owning public are shell shocked following the twin market crashes and the Housing collapse. First the dot com collapse (2000-03) saw the Nasdaq drop about 80%, then the Credit Crisis of 2008 saw the unprecedented near halving of the market in about a year. Last, Homes nationally have lost about a third of their value since the 2005-06 peak. Total losses to the family balance sheet of these three events are about $25 trillion dollars. These losses not only crimp the ability to make bigger purchases, it dramatically curtails the willingness to take on more debt and leverage. Speaking of which . ..

    • Debt Service/Down Payment: Far too many Americans do not have 20% to put down on a home, have poor credit scores, and way too much debt. All of these things act as an impediment to buying a home. At the same time, to get approved for a mortgage, banks are tightening standards, including 1) requiring higher Loan to Values for purchases; 2) better credit scores to get approved for a mortgages; 3) Lower levels of overall debt servicing relative to income for applicants. Yes, the NAR Home Affordability Index shows houses as "more affordable," but it conveniently ignores these [other] real world factors.

    • Deleveraging: For the first time in decades, the American consumer is in the process of saving money and deleveraging their balance sheets. After a 40 year credit binge, it's long overdue. The process is likely to go on for years, as a new generation is losing confidence in the stock market, Corporate America and their government. Think back to the post-Depression generation that were big savers, modest consumers, who eschewed credit and borrowing. The damage is going to take a while to repair.

    • Zero % Interest Rates: As many have written, when rates are this low, they only have one direction to go: Up.

There are more reasons I expect the Real Estate market to remain punk for many years, but these are a good place to start when considering the question. The Housing Boom & Bust, and the 2002-07 credit bubble created massive excesses. More than anything, it is going to take time to resolve them. [[Probably at least as long as it took to create them in the first place! : normxxx]]

More Doom and Gloom

Modeling the Market: Dow Jones Industrial Average (DJIA) Model
Click here for a link to ORIGINAL article:

"In fact, there are several other possible outcomes from here [than a 'repeat' of the last 40 years, which would give us Dow 40,000 by 2020]. One is the market will move in a range like it did during the 1960s and 1970s. Another scenario has the DJIA following the Japanese experience and going into a very long decline.

"In the late 1980s, Japan had explosive growth in sharemarket prices, similar to the DJIA in the late 1990s. The euphoria in Japan was driven by healthy export growth, but especially by a housing and construction boom. The real estate bubble burst in the early 1990s and the Japan market started to plunge. Japan has been in and out of recession ever since, and the latest stock meltdown from late 2007 has seen the value of the Nikkei 225 (an index of the top 225 companies in Japan, something like the DJIA in the USA) return to values last seen in early 2003, and before that, in 1983.

"Investors who were in the market during the 1980s did very well, but since then, many people have lost a lot of money. The graph of the Nikkei 225 since 1975 is as follows:

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

"The early part of this chart is quite similar to the exponential rise of the DJIA and it is interesting that both stock bubbles were in part fuelled by real estate bubbles. If the DJIA unwinds over the next 20 years in a similar fashion to the Nikkei, we might see a return to values last seen in the 1980s.

"In this next graph, I have superimposed the DJIA (in dark red) and the Nikkei (in dark blue). The period from 2003 to 2007 for the DJIA has a remarkably similar shape to the runup for the Nikkei from Dec 86 to Dec 1989. The wipeout that followed is also very similar. The Dow's low of near 7500 in Oct 08 corresponds to the Nikkei's low of around 20000 in late 1990.

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

"So will the Dow follow the Nikkei's pattern over the next 20 years? We hope not, but if so, we can expect the DJIA to be somewhere around 2000 to 3000 at that time (2029), or less than one third of its current value (as at July 2009). That will make a lot of retirees seriously unhappy."


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.