Thursday, November 18, 2010

The SeeSaw

The markets have begun to move in a seesaw like fashion that essentially hinges on the current direction of the US dollar and the Euro.  Or it can be classified as:

US dollar weakness and Euro strength = Risk On

US dollar strength and Euro weakness = Risk Off

Since the Jackson Hole speech Bernanke gave at the end of August when he signaled to the market his intentions for Quantitative Easing II, it has been continuous dollar weakness and risk on.  In this environment essentially every asset rose across the board, and some exploded to the upside. (commodities)

Since the day QE II was announced and leading into the early part of this week with the Ireland default concerns, we have seen the opposite side of the seesaw move;  The euro weakened, risk came off, and assets fell across the board.

This morning we received word that the "bailout crew" (The IMF and ECB: the banks that can print money) had arrived in Ireland, and the market became hopeful that an agreement would take place.  This eased rates on Irish bonds, the Euro rose, risk came off, and every asset rose while some exploded to the upside. (commodities)  I wrote in detail about the Ireland bail out earlier this week.

So what does this all mean? 

It means you have to pay close attention to events taking place now around the world and events that will take place that are unseen under the surface.

The unseen events are:

The next Euro defaults: Portugal and Spain

The next American defaults: California and Illinois

The strategy to employ as an investor is to understand what investments will perform well in the final endgame and plan on purchasing them when the seesaw moves in the right direction.  For example, if and when the euro weakens again because of problems with the Ireland bail out or concerns over the next default then these assets will most likely fall AND will perform well in the final endgame.  This should be regarded as an opportunity to add to current positions:

Gold, Silver, Oil, Agriculture, Canadian dollar, Australian dollar, Asian currencies and stocks

Then there are assets that will most likely fall, but should not be purchased:

American stocks, American muni bonds, corporate bonds, long term treasury bonds, junk bonds

Then there are assets that will continue to fall in either seesaw movement, and should not be purchased:

American residential real estate, American commercial real estate

I will discuss how the final endgame will play out in the future, but this should provide a view of how and why the markets will perform over the next few months.

Uh Oh

It is fairly obvious the direction home prices will soon be taking with 40 months of shadow inventory ready to enter the supply stream, unemployment continuing to surge, and our depression moving into the next leg down.

But what if the artificially government suppressed mortgage rates were to actually start rising?

The chart below shows this past week's move in rates.

Uh oh.....

Wednesday, November 17, 2010

Euro Zone Big Picture

The following pie graph provides an excellent visual on the size of the PIGS (Portugal, Ireland, Greece, Spain) debt in relation to the entire Eurozone.

Ireland (1.7%), Portugal (1.8%), and Greece (4%) are small potatoes and can easily be contained.  However, if interest rates begin to rise in Spain (9%) and then move to Italy (23%), the contagion will be uncontrollable at that point.

This is the reason the European leaders are trying to put out the Irish fire as soon as possible.  While they could care less about Ireland, they need to keep the flames away from these other countries.

The pie graph is on the left and the interest rate spreads are the right.  The higher the rate, the more the market is pricing in default. (And the more it costs these countries to purchase additional debt)

Clock Ticking On Ireland

If you'd turned on the news or scanned through some financial headlines over the past few days you have seen that Ireland has now become the new problem in the European Union.

While all the PIGS (Portugal, Ireland, Greece, Spain) are moving toward insolvency/crisis, they have come in stages up till now.

The breaking point is determined by the market when there is a run on the debt.  This causes the interest rates on their bonds to rise significantly and causes the cost to insure the debt (CDS) to rise along with it.

This happened to Greece last spring, and it has finally reached the next chapter in the form of Ireland when last week their bond market began to implode.

The Irish story is far different than the Greek one told last spring.  The Greek crisis was focused on their government debt, meaning they were closing in on the moment when they would be unable to make current payments, and their ability to borrow new money had dried up.

It is the equivalent of living on credit cards and continuing to open up new cards every year to pay for last year's spending.  It is also known as a ponzi scheme.

If the Greeks defaulted on their debt, they would have had to work out a deal with the people who lent them the money.  For example, they may only pay 10% of their "credit card" bill, and they would start over fresh.

This is the way free market capitalism works, and it is the way it should have happened.  The problem with this situation is that the other banks throughout the European Union in other countries that lent Greece money would take major losses on their balance sheet if they were to default.  This would create what they call "contagion" as these losses would lead to bank failures and additional losses.

So instead of allowing that to happen they created their form of the TARP program, which they called the ESFS.  Greece received a $120 billion loan and a formal program for bailing out countries was now in place.

Six months later: enter Ireland.  Only this story has a slightly different twist.

The Irish crisis is not in their government debt, they have enough cash to fund themselves to July 2011 and possibly longer, it is within their banking system.

Back in September 2008 during the height of the financial crisis, Ireland decided to fully backstop their entire banking system moving forward.  That move then has led to this crisis today as their banks are closing in on the "Lehman" moment.

The markets have been shaken over the past few days because Ireland has not been fully open and excited about receiving the EFSF bailout.  (The bailout comes with strict restrictions on how your country is run moving forward)

You probably remember the Greek riots last spring, but on the news today there are no riots in the streets of Ireland.  This is because the problems are all with the banks.

What is fascinating is that if Ireland takes the bailout, they will be forced to enter into a massive austerity (spending cut) program which will then bring the Greek lifestyle to the Irish people.  Then you will see the rioting.

The bail out is not for Ireland, it is for the $650 billion in bank exposure in other countries around the world.  However, the Irish people would be the ones paying for this bail out.

Stay tuned, this story is changing every hour.  The implications of how this is handled will be massive for the currency markets, which now have a major impact on stocks, bonds, and commodity prices.

I will comment much more on that topic as the final bailout decision and outcome become clear.

Monday, November 15, 2010

Keeping The Party Going

As our country moves every day toward its own Greek/Irish insolvency crisis, it is always helpful to look at the drastic steps our leaders are taking toward keeping costs in line.

This week USA Today took a look at one budget component: federal employee pay.  They found out that:

"The number of federal workers earning $150,000 or more a year has soared tenfold in the past five years and doubled since President Obama took office"

The numbers are stunning: those earning over $150,000 in the past five years have grown from 7,420 to 82,034, a 1,006% increase. More shockingly, those earning over $180,000 has surged from just 805 in 2005, to 16,912 in 2010: a 2,001% increase.

In response to this runaway reckless spending, Congress has decided to clamp down and only give the 2.1 million Federal workers a 1.4% raise this year across the board.

That was not a typo.  The salaries are increasing.

I have friends who work for the federal government or work for a company that does work for the federal government. They make an exorbitant amount of money.

And you know what?  They are doing the right thing.  Why not continue to cash out while the money is good?

As long as they continue to funnel their massive paychecks into non-dollar based investments (which many of them are), and they keep their passport ready to exit America once this party is over, then god bless them.

We will leave the baby boomers here with their $100 trillion credit card tab.  And please don't worry, I am positive you'll find someone else who is more than willing to pick up the bill.

h/t Tyler Durden