Friday, November 14, 2008

Market Cycles

As discussed repeatedly in the past, investment classes follow a general twenty year pattern. The previous bull market from 1980-2000 was in American stocks and it was a 20 year bear market for commodities. We are now in a bear market for American stocks and a long term secular bull market for commodities which began in the year 2000. The following chart helps visualize asset performance since the beginning of this decade:

Click on the chart below:



Any rally in the stock market provides a strong selling opportunity and any pull back in the commodities market provides a strong buying opportunity. The same goes for bonds as their recent strength will subside and their values will fall off a cliff. The real estate market is plummeting and has a long, long way to go before reaching a bottom nationally.

It's interesting because many homeowners still have an opportunity to sell their homes and receive some of the artificial paper wealth created during the bubble years that will soon be erased. The reason for this is because it is still a "stigma" in this country to be a renter. People would rather own a home that is falling in value that costs them significantly more money every month because if you are a renter you are considered lower class in our country.

That will change over the next few years. As prices continue to collapse, people will begin to look at homeowners the same way they now look at renters. This moment will likely mark the time to look at real estate as an investment because the increase in sellers who become renters will have the impact of driving home prices down and driving rents higher. The will generate cash flow opportunities for investors entering the market.

Wednesday, November 12, 2008

What TARP Program?

Our treasury secretary announced mid summer, when things were very calm relative to where we are now, that he would be guaranteeing the debt on Fannie Mae and Freddie Mac. He told the country that this is not a cause for concern because just by guaranteeing the debt it would mean that no money would be necessary.

Two weeks later he announces that the companies have been nationalized. Hundreds of billions have been poured into the companies to cover losses and hundreds of billions more will be needed.

About a month ago he lined up in front of Congress to ask for the TARP program. He told our leaders that he would need a blank check for $700 billion but far less than that would be needed. The goal of the TARP program was to buy mortgage securities from banks at attractive prices to make a market for these securities. Once the government started buying them, then everyone else would, and banks would start lending again. The government could then sell those assets back into the market and make a profit for the taxpayers.

A week after getting his blank check, Paulson says he must first send the investment banks $125 billion in direct cash, momentarily pushing aside the original plan. The next day he announces that he will send another $125 billion directly to smaller banks once again pushing back the original goal of the taxpayers money.

This morning it was announced that the government may now buy zero mortgage securities with the money. None. This means they have done nothing to help the credit markets other than send hundreds of billions of dollars to banks who are now just sitting on the cash to cover losses.

With the wiff of what is going on, lobbyist have lined up in front of Washington to take a piece of the bailout pie. Companies in all shapes and sizes are now standing in line to get some free money.

Originally called the TARP, we can now call it the IBFE. (Inflation Bill For Everyone)

To counter that ongoing insanity, they have also redirected focus toward modifying additional home loans. Any outcome from this is going to be a disaster. Any home owners that are still making payments that can qualify for the new program will immediately stop. Many will come up with ways of rearranging their finances to qualify for modification. This will have a horrific effect on our economy as a whole.

In order to pay for the ongoing bail out support, I would keep your eyes open for new government programs to raise additional money. One such program may be to have 3-5% deducted from workers pay checks that would be placed into an "investment fund." The government would tell the country that they will be helping them invest for their future and the money will be returned with a strong return.

The money, however, will immediately be spent and replaced with treasury bonds. (IOU's) This is the way that medicare and social security work when it is deducted from your pay every month. The government spends that money instantly and replaces it with IOU's.

It is important to remember the final outcome of all this, which will be the collapse of our currency and our country declaring bankruptcy. We move closer to that point every day, and the majority of Americans will have their entire life savings wiped out in the blink of an eye. Not in the amount of money they have, but with what that money will purchase, their true wealth.

Tuesday, November 11, 2008

The Fall of 98'

10 short years ago the markets were gripped with the panic known as Long Term Capital Management. LTCM was a hedge fund that was the darling of the industry throughout the 90's. They were the brightest minds in the world in risk management and every major bank in the country was sending them billions of dollars to invest.

They were betting on risk spreads between bonds of different nations and after growing confident over the years they were leveraging their bets up to ridiculous levels. They would collect massive checks year after year as long as there was not some "event" that would shake the markets. Of course, that event came as it always does, in the form of Russia defaulting on its debt in the summer of 1998.

Long Term Capital Management was leveraged up so high that they turned to the Federal Reserve to bail them out because they represented systemic risk to the financial system. The Fed did just that, but the unwinding of their trades caused enormous shock waves through the credit markets, stock markets, and commodity markets.

Oil fell from $20 all the way down to $10 a barrel. The media cheered of the bursting of the oil bubble. To start the new year in 1999 the Economist magazine ran on it's cover that the price of oil was going to $5 and staying there for the foreseeable future. What was the reason? Demand Destruction.

Does any of this sound familiar?

Soon after the price of oil was announced to stay cheap forever, auto manufacturers created the wave of the future in SUV products that rolled off the assembly lines. Gas guzzlers if you will.

When the entire world was buying tech stocks in 1999, a small percentage of investors began buying oil companies due to the forced selling in the trading pits. They have done pretty well over the past ten years with those companies. The tech stocks? Well, we know that story.

I believe the next 5 years will have a similar story to the last ten. Oil touched $59 today. Unbelievable. Everyone is cheering for $20 oil, and cheap oil forever. The Demand Destruction has arrived. Or has it?

Worldwide demand is on pace to grow this year, and recent depletion studies are showing a 9.1% annual decline. SUV sales have risen sharply as buyers are picking them up at discounts hoping that oil will stay low. I'd rather buy oil stocks on discount, but time will tell who is making the right choice.

As Goes GM.....

It is pretty much a consensus at this point that General Motors "must" be saved. Letting them fail would cost hundreds of thousands of jobs in countless industries across the country. Of course we can't have that right? Wrong.

GM is failing right now because it is a bad business. It has overpaid employees and terrible management. What would correct that? Bankruptcy.

The government sending them money every year is just propping up a terrible business model. If they were allowed to fail, it would initially cost hundreds of thousands of jobs, yes. I agree. But what would happen then?

GM would still have assets that would be bought by a new investor. That new investor then would come in and design a better business model for the company with better management without ridiculous pensions, labor costs, ect. The people would then have work again, it would just be at a much lower pay. If they don't like the pay, they can go work for someone else. Why should we pay for their salaries? We already pay everyone in Washington's ridiculous salaries.

Here is the most important part: The money that would be wasted on keeping GM artificially propped up could then be used for real productive good. (Think China below)

No one ever thinks about that though, they only think about the immediate impact they see in the jobs losses. You have to be able to see two steps down the road from a decision. If our government cannot do that then we will continue to fail as a nation.

Monday, November 10, 2008

Going Numb

It's interesting how people hear the news now and just calmly churn through the daily headlines. For example, crossing the wires today (Monday) we saw:

-Circuit City declares bankruptcy
-AIG now needs $150 billion to stay solvent
-Fannie Mae says will need more than $100 Billion to stay solvent
-GM needs $25 Billion to stay solvent
-American Express becomes commercial bank so Fed can just give it free money

The Federal Reserve grew its balance sheet by $185 billion LAST WEEK, and has now crossed over $2 Trillion. The head of the Dallas Federal Reserve said last week that they will cross over $3 Trillion by the end of the year. Here's a look at what that growth looks like:



This weekend China decided to join the party in stimulating their economy. They are preparing a $550 billion stimulus program. I guess they are in a similar situation as us, right?

No, it's almost exactly opposite. China has $550 billion SAVED. They run a massive trade surplus every year that mostly comes from the USA. Our $4 Trillion stimulus comes from printing money and borrowing from foreigners. We take that money and throw it away on banks, auto manufacturers, credit card companies and Fannie Mae to stay solvent.

China is using the money to invest more in their countries infrastructure. They will invest in new factories and tax cuts for business growth. Can you see the difference between the two? It is very important that you can. Do not let the daily headlines numb you. The trillions of dollars that are being printed will be accounted for. The trillions of dollars that are being borrowed will be accounted for.

Who will do this accounting? Gold will. And more specifically the dollar will. Probably not tomorrow, and maybe not this year. Every day that passes means the correction will be bigger when it comes.

Looking at a major news website yesterday, I saw 20 to 30 articles discussing the topics above, mostly focusing on the news that GM will be downgraded and may file for bankruptcy. In a small side bar, completely ignored, I saw the headline:

"US debt grows exponentially and the country may file for bankruptcy."

I thought that was funny.

Warren Buffet, the richest man in the world and the greatest investor of all time, has recently moved 100% out of his wealth out of US treasury bonds. 100%. He understands what is coming.

Bill Gross, who manages the largest bond fund in the world and is considered the greatest bond trader of all time, has recently announced he is moving substantial holdings away from US treasury bonds. He understands what is coming.

Commercial banks are taking massive short positions right now on the US dollar. They know what's coming.

The super rich around the world are making massive purchases of physical gold and silver. They understand what is coming.

The Federal Reserve stands ready to print money with NO LIMIT, and while everyone is talking about bailing out GM, no one talks about who is going to bail out the US.