Saturday, June 26, 2010

The Stage Is Now Set

I feel as though the financial markets are carefully and systematically setting the stage for the next leg down in this current depression.

Churning through the financial data released all last week paints a frightening picture.  I would like to take a moment and discuss each domino carefully being set.


The first and most important is the ECRI weekly leading economic indicator.  This is an indicator that is used to forecast the direction in the economy.  It is released every week and composed of the six categories outlined below:

1. Money Supply
2. Material Prices
3. Housing Activity
4. Bond Market Pressures
5. Stock Prices
6. Job Market

When Phil Jackson entered the NBA Finals as coach of the Lakers he had won 100% of the playoff series he coached after winning game 1; he was 47-0.  This was disturbing to me when the Celtics lost game 1 of the series.  True to history, the Lakers ended up winning and his streak remained perfect.

The ECRI weekly leading indicators are measured by a single number placed on a graph.  When the number crosses above 0 and goes positive it usually means we have entered a period of economic growth and is positive for the stock market.

When the number crosses below -10 on the chart it means the economy is heading for recession and contracting, which is very negative for the stock market.  How often has this occurred after crossing below -10?  100% of the time.  The same record as Phil Jackson.

The chart below shows that was have just hit -6.9 on the ECRI.  The fall has been breathtaking and at the current rate we will be at -10 in less than 3 weeks.  ( I will update this information as we progress forward)


The second important domino piece to watch is the credit market around the world.  The CDS (cost to insure) debt in Greece has just hit an all time high.  This is in the face of the $1 trillion European bail out.  The market does not believe at this point that they will be able to stop the contagion.  The chart below shows the CDS for Greece exploding upward:


The contagion continues to spread around Europe as Portuguese banks borrowed more money from the ECB last month than ever before. (ECB is Europe's Federal Reserve)  The chart below shows this massive increase in money borrowed representing the strain on the banking system.  The same problem is taking place in Spain, only at a much faster pace as the banking system is freezing up across the board.


Over here in America the same event is taking place only it is at our state level.  Bloomberg reported on Friday that 46 States are massively underfunded and now face Greece-like fiscal emergencies.

This week Illinois passed California as the most dangerous debt in the country in regards to cost to insure. (CDS)  The chart below shows their rapid rise.  Look for more and more states to accompany California and Illinois on the troubled list as we move forward.


GDP (the size and strength of our economy and what creditors use to estimate our ability to pay debt) was revised down this week to 2.7%, a sharp revision lower.  The housing market continues to roll over in every category as I discussed in detail this past week.  Unemployment continues to remain elevated, and the largest component of the money supply, M3, is falling rapidly as can be seen in the chart below. (Blue Line)  These are some of the components of the ECRI weekly economic indicator discussed above.


For the seventh week in a row American equity (stocks) mutual funds have seen massive withdrawals.  Americans continue to pull money from the stock market and put it into bond funds.  The market has been held up thus far by the commercial banks and high frequency traders.  If they decide they do not want to push this market higher, look out below, as they also have the ability to turn on a dime and short the market if it moves lower.

Outside of the brief period during the credit crisis in the fall of 2008, the 10 year treasury bond is now at the lowest point since 1962.  It crossed under 3.11% this week, which signals to the markets the fear and distrust in the system, similar to what we saw leading into the last credit crisis.

As I stated above this paints a very dangerous picture for the economy and credit markets moving forward.  The dominoes are now set and we wait to see what will represent the small push the markets need to topple.

Friday, June 25, 2010

Obama's Approval Before The Real Collapse

The following chart provides an update on Obama's approval rating since taking office. 

This comes at a time when he is borrowing and printing trillions to keep our economy on artificial life support and pushing back the real correction that the economy desperately needs.

Just imagine the approval rating when the bill comes due for this borrowing and printing and we finally begin the real crisis.

The only hope is that our foreign creditors cut off our credit card before Obama's first term ends and the public can truly see what a house of cards our economy has become.

Wednesday, June 23, 2010

New Home Sales Bloodbath

New home sales for May were released this morning.  They began tracking this number back in 1963, this was the lowest recorded number in history coming in at 300,000 annualized, a 33% monthly drop.


This spells tremendous trouble for the home builders in the coming quarters, however, this is excellent news for the housing market.  Why?

The last thing we need is an increase in the supply of homes.

We currently have 8 million homes in some stage of default. (This is currently 15% of all mortgages in the country and grows every month)  Estimates show that 80% of this shadow inventory will eventually be foreclosed on and put onto the market for sale.  That is 6 million new inventory homes coming to the market.

In addition, the government's loan modification program shows that 70% of home owners entering the program will re-default.  This is additional shadow inventory that is not currently being calculated in the 8 million discussed above.

Finally you have short sales.  These are homes that are not on the market for sale, current on their mortgages, but are so far underwater that they work out a deal with an investor and the bank before the property hits the MLS.  This is another hidden portion of the total shadow inventory.

The coming supply of new inventory will be staggering.  I wonder what the analysts project this will do to home prices?  Have that factored this into their economic outlooks?   Let's take a look.....

Consensus View: Housing Bottomed Today

The Case-Shiller research team has composed a wide ranging and in depth consensus on where analysts see home prices heading in the future.

The consensus view is that home prices have bottomed this month and will rise at a steady rate for the next 4 years.  The following chart shows their conclusions:


This will be a good one to come back to in a year from now.

Jim Rogers CNN Money

The great Jim Rogers takes some time to speak with Poppy (great name) on CNN Money.  Some highlights of his thoughts:

-Holding gold but not buying at all time highs
-Accumulating silver and agriculture at depressed prices
-Does not understand BP disaster costs so waits to buy
-More currency troubles coming

Couldn't agree more.

Tuesday, June 22, 2010

Japanese Threat Lurking

As the sovereign debt crisis moves around the world, consuming the fiscally irresponsible, it has become investor's main focus to move themselves out of the way before the next sovereign time bomb explodes.

Bombs are currently exploding all throughout the European Union as Greece has gone bankrupt and it appears Spain is close behind. Many estimate that Portugal and Italy will follow soon after.

Where the crisis moves next is a little tougher to tell. My estimate is that it moves first to the UK, then heads to Japan, and finishes off in the United States; the largest debt bubble of all time.

The following short video discusses the crisis growing under the surface in Japan. It is interesting that citizens there can feel it coming while most of America is oblivious to the coming Armageddon.

Existing Homes Sales Plummet

We received the existing home sales this morning for the month of May.  Analysts were expecting an increase of 6% on the month, the number came in at -2.2%.  The second worst monthly drop in history.

As Meredith Whitney pointed out on Monday, most economists are factoring the possibility of a double dip in housing, not the certainty, which has already arrived.

Look for talks of a new housing "stimulus" program from Obama's team of mass financial destruction.  Since mortgage rates are already at record lows (30 year Freddie Mac loan fell to 4.89) due to 95% of all loans being purchased by the government (taxpayer), maybe the next housing credit will be a $50,000 check in the mail or even $100,000.

If I received a $100,000 check in the mail, even I would buy a home. (As long as it was less than $100,000 purchase price)

Niall Ferguson

Niall spends some time with Erin Burnett discussing the Yuan revaluation, the G20, the European Union, and the coming United States fiscal crisis.

His view is that the fiscal crisis will arrive within 2 years, best case scenario 4 years.

Monday, June 21, 2010

The Queen

In the fall of 2007 I met a girl.

I woke one morning in my uptown apartment to her sweet voice.  She was in the middle of a conversation with a gentleman named Charlie Gasparino.  She was explaining to him how the investment banks, the darlings of the universe, were on the verge of massive losses.

She downgraded a company that week named Citigroup, which was the largest of these Wall Street darlings.  The stock at the time was trading just under $50.  Today it trades around $4, and is only above $0 because it has been nationalized by the government.

Her name is Meredith Whitney, and this morning I heard her sweet voice again.

Sunday, June 20, 2010

A Sunday Morning With Tuna

This morning I got up at about 6:30 and it was off to Dunkin Donuts for a large coffee.

I then got back to the house and read through the Charlotte Observer, the Charlotte Business Journal, the Weekend Wall Street Journal, and Financial Times.

After the physical papers are finished I move on to the Google Reader online, which organizes about 40 different websites and their articles so I can review them in an easy and efficient manner. (Highly recommend it for those who read a lot online)


Then it's off to the park for a run.  It's a beautiful day today and most of the babies the ducks had a few weeks ago have grown significantly.  Very wholesome.

When I get back home and shower it's time to go to work.  This is where it gets fun.

During the week, commercial real estate agents send me information on properties when they come available for sale.  If a property looks interesting I sign a confidentiality document and they send me the financial details on the property.

This morning I did a full analysis on an apartment complex in South Carolina.  (I cannot give out name and address due to confidentiality.)  However, the following information is a brief summary of what I used to review the property:

Total Units: 80
Year Built: 1999
Asking Price: $3,600,000

Total Income (Rents): $428,890 (Yearly)  This number includes the current vacancy rate (empty apartments) and any additional income a property may have such as a laundry room, vending machines, or car wash.

Total Expenses: $281, 146 (Yearly)  This includes property taxes, insurance, management salaries, maintenance salaries, advertising, utilities, legal, accounting, and any additional costs associated with running the property.

Net Operating Income: $147,744 (Yearly)  The Net Operating Income (NOI) is the most important financial piece of information in real estate.  It is simply total income - total expenses.  (**This number does not include the monthly mortgage costs**)

When I finish running the financial numbers (I use a detailed excel program), I determine how much I would be willing to pay to receive the net operating income.  The rate of return I am willing to accept to recieve the net operating income is called the cap rate.  This is the second most important piece of information in real estate.

The owner is asking for $3,600,000.  This means that he is asking me to agree to a 4% return on my money.

$147,744 (NOI) / .04 (Cap Rate) = $3,600,000 (Purchase Price)

What would I realistically pay for this income?  I would ask for an 11% return.  An 11 cap.  So now I just figure out the purchase price I need to receive this return.  You essentially work backwards:

$147,744 (NOI) / .11 (Cap Rate) = $1,343,127 (Purchase Price)

The current cap rate for a similar property in this area is 8-9%.  As our economy continues to implode, rates begin to rise, and real estate financing become more difficult, market cap rates will continue to rise.

Summary:  This seller is most likely in serious trouble.  They may have to refinance in the near future, as I discussed in the article below and they may be trying to get out of the ticking time bomb before it explodes.  In the example of this property I would rather wait till the property is bank owned and purchase it from them.

Just for fun though, what if they property was bank owned and I could purchase it at a realistic cap rate of 11%.  The property is currently 32% vacant.  If I could decrease the vacancy to 15% by finding renters, which is very realistic in the market the property is located, what would the investment look like?

Let's assume I finance the property 100%. (Nothing down)  I would borrow 80% from the bank at a 7% interest rate.  The remaining 20% down would come from private capital/partners who I would pay 15% plus possibly a percentage of the profits when the building was sold.

1,074,400 at 7% (80%)
268,600 at 15% (20%)
Total annual cost to borrow this money: $126,060

New NOI with vacancy at 15% would be $254,996.
Now I subtract the cost to borrow          ($126,060)
Total Annual Cash Flow:                           $128,936

This means I would make $128,936 in passive income with a full staff onsite managing the property.  I used none of my own money to purchase the building.

Hold on, it gets better.

With the NOI now at $254,996, at an 11 cap, the building is now worth $2,317,873.  The building has increased in value by $1 million with no rental increases and no change in what the market would pay for the return.

This will be only a mediocre opportunity compared to the incredible deals that will present themselves during the latter stages of this depression.

It's about 1:00 now, so some of my friends are probably waking up from their long nights drinking.  Time to go pick them up and head to the bar to watch some soccer and golf.

Have a great Sunday and Happy Father's Day!