Friday, December 28, 2012

When Will Chicken Little Finally Buy Stocks?

I want to review a couple excellent charts from Bianco Research that provide another excellent glimpse into the sentiment toward the stock market today.

The first chart shows the percentage of financial newsletter writers that are bullish (believe stock market is going higher - green line) and those that are bullish but believe we will have a brief 10% correction before rising to new highs (blue line). They currently represent 47% and 27% of all writers.

The next chart shows the other category, the bearish newsletter writers (they believe market is going lower). This is the chart that is very interesting. You can see that the number of bearish writers surged during the summer of 2011 when the market fell significantly during the debt ceiling discussions. Since then the number of bearish newsletter writers has plunged and not budged since.

The market has had a few significant sell offs since the debt ceiling fiasco. Normally during these times you see the number of bearish letters rise and then fall again after the market resumes its climb. This had not taken place over the last 18 months.

Bianco notes that the bearish letters are in the tightest range in the 50 year history of the survey. The normal "temporary/reactionary" bears have left the building, and it appears they are not returning.


The market now has full faith and credit standing behind the Federal Reserve. The market believes that QE will always push stocks higher, and it believes that any correction will only lead to a larger QE program that will artificially push it higher.

This new paradigm has created one of the most dangerous market environments in history. Printing money has no fundamental increase on the value of stocks, in fact it is the exact opposite. For an in depth discussion on why this is the case please see The Dark Side Of QE: The Next Chapter In Our Story.

Let's look even further into the second bearish chart above. There are a select percentage of bearish writers that have not budged during the most recent artificial push upward. This group is normally called "perma-bears, chicken littles, or broken clocks" during market moves higher.

I am currently part of this group. I have been bearish on American stocks since I penned the first article on this site in August 2008. For the first six months of writing people assumed I was "correct" as stocks plunged 50%. Since then people have assumed I have "wrong" because stocks have rallied for years off that low.

Will I be bearish on stocks forever? Of course not. I can't wait for the day when I can sell precious metals and select foreign stocks to invest in American business. I wish it was tomorrow.

I believe that American stocks are overvalued today based on the price of the stocks weighed against the backdrop of both the American and global economy. I will go into this subject in great depth during the coming 2013 outlook, but for now I will try to sum it up in just a few sentences.

The total credit/debt of the United States has grown from $1 trillion in 1971 to over $54 trillion today. During that time the size of the economy has grown to about $16 trillion. The fundamental, underlying, debt servicing method to pay off debt is the income of the workers within that country. The median income has stagnated for decades and has fallen significantly since the current depression began back in 2007.

Total credit - top line. GDP (size of the economy) - bottom line. Click for larger image.

A visual look at income and net worth: Click for larger image.

So what would it take for me to become bullish on US stocks?

The total debt would have to be written down significantly. This would allow the country, which is currently drowning in debt at every level, to have a solid foundation for growth. The second option would be to have real unemployment move back to a healthy level (under 5%) and income levels to increase by about 200% to allow the ability to service the current debt load.

Or.....stock prices would need to collapse to reflect the current reality the country faces. If stocks moved down to 4000 to 6000 on the DOW it would mean that the current economic environment would be priced in. P/E ratios would have moved back down to single digit levels creating undervaluation in the stock market.

Low stock prices would make me extremely bullish. At that point you would probably see the number of bearish letter surge up to the 75% plus level (where the bullish letters are today) and the number of bullish letters would now be in the 25% or below level. These would be the new "perma-bulls, the broken clocks."

I can't wait to be a part of the future perma-bull club. The "crazy" people.

How long will this take to resolve? When will gravity finally hit? I have no idea. I will be bearish on stocks for as long as they are fundamentally overvalued. If stocks are overvalued for the next 20 years then I will stay bearish for 20 years. I assure you I will never "give in" to the euphoria of the market of media around us. It does not matter if stocks rise by another 10%, or we have a fiscal cliff resolution, or the Fed announces QE4. All three of these headlines fundamentally lower the value of stocks further. The country actually going (and staying) over the fiscal cliff is the best thing for America in the long term.

There will be a day (I consider myself fairly young so I hope I see the day) when this site is focused on investing in stocks and real estate.  It will be a lot more fun at that point, but investing in those assets will take a new set of tools (especially real estate). I look forward to the day when we can sell precious metals (at an overvalued price) and invest in a country (or world) worth investing in (at a discount).

Be patient. Gravity always wins and bubbles will always eventually pop.

Tuesday, December 25, 2012

Part Two: Should I Buy Stocks Or Gold Today?

The goal of this site is not to provide readers with short term day to day "trades." The goal is to study the global macro-economic landscape and look for secular market trends that last years if not decades.

Once we can determine what those are and where we are in the current secular cycle you can then look for shorter term moves within those secular cycles. The main tool to use during these shorter term cycles is sentiment.

That may sound like a mouthful, and it is, so let me provide a real life example to help show you how this process works. Just over a month ago I posted an article titled Should I Buy Stocks Or Gold Today? In that post I discussed this very topic as I like to do when sentiment moves toward extremes.

I believe that we are currently in a secular bear market in stocks. This does not mean that stocks will always trend downward during this cycle, in reality the last two major secular bear markets looked like side ways moving markets when looking at a chart over a century long period. However, during this sideways type market (which is the best case scenario) the danger always exists to the downside.

The chart below shows the bear markets over the last hundred years (including the current one) in pink and the last secular bull markets in green. These cycles tend to last 17.6 years - for much more on secular cycles see Historical Guide: Stock Market Cycles & Public Ownership.

The next chart zooms in on the far right pink portion of the chart above to our current secular bear market in stocks. You can see the "side ways" movement.

I spent the latter part of the summer leading into the fall discussing the optimism growing in the stock market (and the simultaneous danger that optimism creates) as prices moved higher. Then the week following the election stocks plunged every day for a week straight. Following that plunge I posted the article linked above saying that pessimism in the market was back. This did not mean that it was time to buy stocks (we are still in a secular bear market) but that the short opportunity that existed before was gone and it was time to remove those shorts.

The opposite existed in the gold market. As stocks fell, gold surged higher and optimism entered the market. That optimism did not exist in the early stages of the summer at the previous buying opportunity. The same concept exists in the gold market today as with stocks only in reverse because gold is in a secular bull market. You don't sell when the market surges and optimism enters the markets, you just hold positions and wait for the next decline and pessimism to return.

Fast forward to this week.

The following chart illustrates this process of sentiment tracking beautifully. You can see that during the most recent sell off into and following the election that the sentiment indicator (the bottom line) turned green. This is called the dumb money indicator and it calculates a composite of four different sentiment indicators:

1. Investor's Intelligence
2. MarketVane
3. American Association Individual Investors
4. Put/Call Ratio

When the line turns greens it means that investors are pessimistic about the future (they think that stocks are going to fall further). This was the moment that I said that you can remove your short positions. Click on chart for a larger image:

Now the indicator (bottom line) has taken a sharp reversal. As stocks have once again moved higher the optimism toward the market is back. The indicator has risen drastically and is now back in the danger zone. This provides a much safer entry point for those looking to add to stock short positions.

Gold has seen the same flip flop. Gold prices have fallen drastically over the past two weeks and investors are fearfully selling metals (or sitting on the sideline) as pessimism has returned. As I discussed in detail last week in Deja Vu: Gold & Silver Plunge Into Year End - this is the best time to buy.

Merry Christmas

Merry Christmas to all. Christmas time means that I am at home with my immediate family for the few days I get to see them all year, which makes it extra special.

Here's my favorite Christmas song and a good way to get your morning started.

Friday, December 21, 2012

The Real Problem Ahead

The picture below describes the situation better than any words I can provide. The problem will be pushed back with a "compromise" on the cliff. Then the debt ceiling will be raised. No real solutions will be reached. No tough decisions will be made. As Kyle Bass so eloquently described in his most recent speech posted yesterday, Japan and the US live in a world today where the over half the debt is financed by interest rates at 0%. When that changes, and it will change, the world will be completely different from what you know and see today.

Thursday, December 20, 2012

Deja Vu - Gold & Silver Plunge Into The Year End

I am not a financial advisor. Please speak with one before making any investment decisions.

As precious metal investors once again prepare to dump their assets and throw themselves from very tall buildings, I can only hope that they once again come here first before deciding to so.

Can we look back in history and find a time when precious metals went into free fall and everyone went into complete panic heading into the end of the year? Yes, this same exact thing happened exactly one year ago.

Rather than essentially re-printing the entire thought process of buying low and selling high I would just re-read last year's article written on December 29, 2011: Precious Metals Fear & Panic. Good chart from Jesse's Cafe Americain showing the silver take down in December 2011.

I bought silver today for the first time since early summer as it moved back under $30. If it goes lower, I will buy more.

The Sprott Physical Silver Trust (PSLV) now has a NAV at just 1%. This means that the price you pay for all the physical silver the fund holds is now just 1% over the total value of that silver based on the share price of the fund today. You would be hard pressed to find a better premium buying price for physical silver anywhere.

I was fortunate to put the sell order on the site here (and for myself personally) when the NAV on the PSLV fund reached close to 32%. I recommended at the time that investors look at the Central Fund of Canada (CEF) as another option to buy metals when the NAV was less than 1% (the NAV for the CEF is now over 4%). For the discussion see Purchasing Precious Metals: NAV Considerations

For those interested in purchasing physical silver, the NAV on the Sprott Physical Silver Trust plus the recent price plunge makes it a doubly attractive holiday gift for your portfolio.

Rick Santelli & Peter Schiff Discuss The Fed's Exit Strategy

In a normal business cycle the Fed lowers interest rates when the economy slows to stimulate spending. When the economy begins to pick up speed they raise interest rates to slow down the over heated growth. It's been so long since we lived in a world like that people forget that it even existed.

In today's world there is no longer even discussion of an exit strategy for the Fed's recent actions, never mind actually raising interest rates. An exit strategy would be the Fed shrinking the size of its enormous balance sheet. The balance sheet grows when the Fed prints money to purchases assets (mostly mortgage and treasury bonds) and those assets then move onto the balance sheet. In exchange, the sellers of those assets (banks) receive fresh cash in return.

The plan is to "someday" reverse this process by selling all these mortgages and treasury bonds back into the economy in exchange for cash (to remove all the printed cash from the system). Peter Schiff asks the question that no one dares to even think about:

"Who would be the buyer?"

If the Fed even slowed down their purchases, never mind stopping and then reversing course by selling into the market, these artificially low bubble interest rates would launch higher and all the financial models that have priced them in to eternity would suddenly no longer be relevant. This would destroy stock, bond, real estate, and most cash portfolios.

For a longer discussion on this topic see Why Most Investors Will Lose In Every Asset Allocation.

More with Schiff and Santelli:

Kyle Bass AmeriCatalyst Presentation

The YouTube clip has its embedding disabled so I cannot put the full video directly on this page. The following is an 8 minute portion of the segment focused on Japan:

You can view the full presentation by following the link here:

Kyle Bass AmericCatalyst Presentation

For those unfamiliar with Mr. Bass, you can get a quick refresher below with his most recent newsletter and two most recent interviews:

Kyle Bass: The Global Economy, Japan, & Why He's Buying Mortgages

Kyle Bass Interview: Darden School Of Business

Sunday, December 16, 2012

Stream Of Consciousness: Stock Euphoria, Fiscal Cliff, Gold, & Japan

No piece of financial news on the week could possible take center stage over the tragedy that happened in the Newton Elementary school shooting. Events like that always make you step back and appreciate what is way more important than finance in life; health and family.

That said, let's take a quick run through some of the best charts and data points on the week in no particular order.

The first chart shows the percentage of those now bullish on stocks surging up to 77%. NBC News recently reported that "even the bears are bullish for 2013, a year in which every Wall Street expert believes the market will post a positive year." The average gain for 2013 called for by a group of 15 brokerages polled was 14%. Readers here know that the more bullish people become on an asset class the more I am ready to run for the exits or go short. When everyone is on one side of the boat, it is time for (at a least a temporary) reversal.

Next up is a longer term perspective showing the history of world GDP. It is lost on most of the current market participants, but today's "developing" nations such as China (red) and India (pink) dominated the world economy for centuries in the past. They are not an up and coming force, they are just re-taking what was previously theirs.

The following shows median household income in the 21st century. While nominal growth has risen (red), the real rate of income growth in comparison to the rise in the cost of living (Consumer Price Index - CPI) has flat lined and recently plunged, now down 9% in the new century. I will provide an entire article devoted to this chart's impact on the price of real estate in the future.

The following shows the real estate price decline (blue) vs. stock price decline (red) in America since the depression began in late 2007. The impact of the real estate decline is felt far more on the average American since close to 70% of the nation was a homeowner at the recent peak. Far more capital was bet on real estate (since most homes were bought with debt) vs. stocks. Therefore a 30% decline in real estate, assuming an average home price of $250,000 at the peak, cost a family $75,000 in paper wealth. Assuming they owned $30,000 in stocks saved through their 401k, the 10% decline from the peak has only cost them $3,000 in paper wealth. This illustrates the urgency of both the Federal Reserve and the government in blowing real estate prices back up to artificial bubble levels.

Another great look at the taxing vs. spending problem and which one is more important. The left chart shows the current unfunded spending liabilities on the left and the proposed tax hike "solution" to these problems on the right. Without using a calculator and eyeballing the situation, I hope you can quickly determine how much the increase in taxes will help. Give this to a 6th grader and see how quickly they can solve the problem. (Hint: reduce the size of the bar on the left).

If you need some help with the graph, I can provide the cliff notes version:

Far more important than the ridiculous fiscal cliff discussions is the coming debt ceiling hike. Not because any meaningful spending cuts will ever be implemented, but because the size of the next debt ceiling raise will help us determine the near term outlook for the price of gold. The following shows the two tracking each other perfectly all the way up:

Earlier this weekend I discussed how the new Evans Rule will impact future monetary policy in How Those Giving Up Looking For Work Will Impact The Gold Price. A headwind to the recent decline in the unemployment rate may come from small business hiring. The NFIB small business optimism index experienced a cliff diving plunge in the most recent survey.

In addition, small business earnings have fallen through almost all of 2012. The Obamacare tax changes, which I have discussed in the past and will focus on more moving forward, will only add another reason not to hire additional workers or cut the hours of the ones already in place.

As promised, I want to keep you abreast of the steady decline of Japan as they lurch toward their coming debt crisis, the real black swan (not the fiscal cliff) flying down the train tracks toward the global economy. Japan's GDP growth was revised down to -.1% in the second quarter and their third quarter GDP saw a decline of -.9%. These two consecutive negative quarters officially puts Japan back in recession. Buckle up, because when this baby blows it is going to make Greece look like a walk in the park. For much more on Japan see Kyle Bass: The Global Economy, Japan, & Why He's Buying Mortgages.

h/t Sober Look, JS Mineset, Dr Housing Bubble, Economist, Zero Hedge

Bill Ackman: Everything You Need To Know On Finance In 40 Minutes

I recently posted this video segment on the "Today's Video & Media" tab at the top of the page, but I thought it was a piece that deserves a space down here on the main page.

Bill Ackman has become one of my favorite people to listen to over the past few years. He has had both monumental successes (the acquisition of General Growth) and monumental failures (purchasing a major stake in Target).

He has one of the best financial minds in the industry and the ability to look forward and explain his vision of why an event should/will occur with clarity. He is also a real estate expert, something that always has a special place in my heart.

I am not an expert on determining value in stock through a company balance sheet, but it is something I study on occasion  My personal expertise, due to many years of study, is in the ability to review and analyze the balance sheet of a commercial real estate property.

Therefore, when purchasing stocks I rely on the expertise of someone who reviews balance sheets for a living in the specific sector I want to make a purchase. For example, if I want to buy shares of a gold mine I seek out the best people in the world at reviewing a gold miner's balance sheets to find value. I then pay money for their expertise before making a purchase. It is not worth my time to visit with the management of a company and learn to study their balance sheets when the cost to obtain that information from a professional who does it full time can be obtained at a reasonable price. For an example, see John Doody's Gold Stock Analyst newsletter.

That being said, having a baseline understanding of finance will help you no matter what you do for a living. The following is an excellent primer and can open the doors to additional study for subjects you'd like more information on.

Everything You Need To Know About Finance In 40 Minutes:

Saturday, December 15, 2012

The Value Of Time & Losing Money Playing Poker

I was playing poker the other night and as happens often in No Limit Texas Holdem my entire stack was taken in a single hand. There was close to $1,200 in the post with just about half of the chips coming from me. I was holding a pair of 10's and my opponents had Ace-King and King-2. The final card to be turned was a King, and I lost the hand along with my stack.

Many people would look at this as a terrible situation (and it certainly felt like it at the time). However, I had all my money into the pot with 5 cards to go as a statistical favorite to win the hand. There were only 5 cards, the 3 remaining Aces and the 2 remaining Kings, in the deck that could have beaten me.

If I was offered to make this bet 100 times in a row, I would take it every single time. This thinking is common sense for someone who regularly plays poker but may seem strange to someone unfamiliar with the game or general statistical theory.

I find myself applying the logic used in poker to other aspects of my life. While I was driving home tonight I purposefully made a slightly illegal turn onto a one way street (the wrong way) and then immediately continued straight down another street. It is tough to explain this scenario in writing but there is no possible way someone can get hurt by me making this action, there is only the chance that a police officer catches me in the act.

That is exactly what happened. As I made the move a police officer was coming down the side street and caught me red handed. He pulled me over and proceeded to give me a ticket.

Here is why I tell this second sad story. The first thing I thought of was whether or not I will choose to make that same exact move the next time I am in the same situation. Most people would certainly never make the same move the next time they approached that turn due to the law of recency - when an event occurs recently it tends to have a greater impact on decision making in the near future.

However, my initial thoughts were a calculation on the time I save driving making the move vs. the likelihood that I will get caught making it and the cost I will incur when I get caught.

I've probably made this move close to 30 times and this was my first time getting caught. So right now we'll use 1 out of 30 as our number. Additional data would obviously help this (and any) extrapolation on odds.

What if the ticket cost me $75 (including the impact to my insurance). That means that making that move costs me $2.50 every time I do it. Is that worth it? Probably not.

What if the ticket cost me $30. It would cost me $1 every time I do it. Is that worth it? Maybe. It depends how much value I put on my time. I don't know the cost of the ticket price yet (it will come in the mail), so I only have the ability to speculate before it arrives.

Here's another example that's easier to understand. I have a friend that works for a big name tech company out in San Francisco. The owner of the company, one of the original Google employees who has already created another company and is worth millions, puts an emphasis on the value of time for his employees.

He forces his staff to run every possible minor task through a website called task rabbit. People at the site bid on your service (like a reverse eBay where the price to complete the task is bid down). For example, the cost to take your clothes to the dry cleaners could be bid down to $10.

Imagine my friend makes $250,000 per year. With 2,080 working hours per year (if he takes no vacations), his working hours are worth $120.

Let's say that he takes 4 hours per week to wash his car, clean his house, get his clothes dry cleaned, and take care of his yard. He puts a $480 price tag per week on these services by taking his own time to do them. What if he task rabbited these 4 tasks instead and spent those 4 hours working and adding value to the company? My guess is that he could task rabbit those items for close to $200 per week.

Ah you say, but this is only calculating his working hours, not his free time. Okay, let's say that he sleeps 8 hours per day. That means every hour he is awake, 7 days a week, is worth $43. How many tasks that take him an hour during the week can he task rabbit for less? I bet a lot.

This scenario shows that the more he uses task rabbit (pays other people) the more money he makes total at the end of the year while providing him more time to focus on other things like friends and family.

I spend a tremendous amount of time studying behavior psychology and statistical outcomes (through poker and the financial markets), so it has a way of blending into my "real" world. I wanted to provide my thoughts on some of these basic ideas to show you how they can be viewed through a different lens.

How Those Giving Up Looking For Work Impact The Gold Price

One of the more interesting parts of the Fed's recent addition to the QE-ternity program, initially discussed here, is that it is now tied to the unemployment rate. This has been dubbed the "Evans Rule."

The Fed has promised to keep pumping at least $1 trillion ($85 billion per month x 12) of freshly printed currency into the system every year until the unemployment rate reaches 6.5%. It currently stands at 7.7% today.

The second part of the equation, which they announced over the summer, is that the Fed will continue to keep pumping money into the system until the inflation rates reaches and stays above the 2% annual mark.

The notion of both of these two goals, to somehow tie them to printed money in the system, is pure lunacy for reasons I hope long term readers of this site understand. We'll look beyond how this obviously will hurt the health of the economy in the long run and focus on how it will impact the financial markets; specifically gold.

Gold has initially sold off on the addition of the QE-ternity program which has left many perplexed. There are countless reasons for short term moves in the gold market but one of them can be tied directly to the announcement of the Evans Rule. Market participants feel that the unemployment rate can reach 6.5% a lot sooner than the point they initially thought the Fed would slow down their printing.

Readers here understand that the unemployment rate, based on the way it is calculated, is only a piece of the true health of the actual employment market. This is due to the simple fact that when workers are unemployed for so long they give up looking for work. At this point they are no longer counted as unemployed and the unemployment rate falls.

The following graph shows the labor force participation rate, the percentage of Americans that are actively looking for jobs, since the 1950's. You can see that the participation rate was very low during the 1950's and 1960's. Did this mean that an enormous amount of people had "given up" back then and the economy was very unhealthy? No, it was the exact opposite. The 1950's and 1960's period was the peak point of America's economic greatness. It only took one income to support an entire household, meaning that a mother could stay at home and take care of the children. They were not part of the participation in the job market - for good reason, they didn't need to be.

The steady rise in the participation rate was the slow and steady rise of women into the work force. While women are proud of the fact that they are part of the working population today, I assure you that many would prefer to have the choice in going to the office every day. Many would rather have the option of staying home with their young children. That option is gone today.

People consider the fall in the participation rate since the peak in 2000 contributed mainly to baby boomers retiring. We know that the largest number of boomers hitting retirement age did not begin until 2010. We also know that a tremendous amount of boomers that planned on retiring have now extended their working years due to the financial crisis.

The following chart shows the employment demographic by age since 1970. Pay particular attention to the portion of the graph since our "recovery" began. You can see that those aged 55 plus (red line rising) have been the major addition to the jobs market taking over 4 million new jobs during this period. The major losses in jobs have come from those aged 25 - 54 (dark blue line that peaked and then fell once the crisis hit - they have lost their job).

Here's an easier one to visualize. The labor participation rate of those 65 and older (green arrow) vs. those 25 - 35 (red line). The youth have given up, while the older generation is looking for jobs instead of retiring.

So how does this all impact the unemployment rate, the Fed's policy, and gold? If the economic depression continues lurching forward it could create an environment where more and more workers give up looking for work, "helping" the unemployment rate. There is also the lack of hiring, so far, in the residential real estate construction portion of the economy even though the government and Fed have blown up another mini housing bubble that has led to new homes being built. The blue line below shows the recent pick up in housing starts for residential building. The red line shows that the number of people employed in this sector continues to flat line and fall. If the builders ever begin to grow their staff again it would also help the unemployment rate (or perhaps they understand that this is all artificial and temporary? we'll see).

The economy could enter an environment where it is in a worse fundamental position and the Fed slows their printing because they "promised" the 6.5% rate was their target. We would have an economy of people that have given up looking for work to collect welfare (see Welfare Vs. Working: Retiring Young In America) and those that are once again employed adding to the housing supply with more homes that we don't need (the banks could just unleash the shadow inventory into the market and we would have enough housing for the next few years).

If we were to hit 6.5% unemployment tomorrow (everyone gives up) and the Fed stops printing, where would the fair value of gold be based on the money that has been printed so far? The following chart provides the update. The blue line shows the base money in the system vs. the US gold holdings, essentially what it would take to back the current money supply with gold - simple accounting. That number has now risen to $10,039 for an ounce of gold.

The following shows the base money trajectory projected out through 2015 under the new QE-ternity program. You want to sell your gold when the yellow line crosses above the blue line, which has happened twice in the last century (1932 and 1980 - both charts show the 1980 cross over). That is the point when gold moves to "overvalued" based on fundamentals. We'll get there again this decade.

Friday, December 14, 2012

Friday Fun: Another Look At Lord Of The Rings

For the nerds out there like me who spent hours of their youth reading The Hobbit and Lord Of The Rings trilogy (and who will be in the theater this weekend watching The Hobbit), and ALSO for those out there that look and make fun of the people like us as the very strange group we are.

Thursday, December 13, 2012

UK Credit Rating Outlook Cut To Negative

One of the remaining pillars who still has an AAA rating and should be rated much closer to junk is the UK. They are just another one of the major developed economies which has no possible way of ever paying off its government debt (without massively devalued British pounds - their currency).

This slow and steady deterioration of credit quality is exactly what happened with subprime during the 2006 - 2008 process. Everyone remembers the day Lehman Brothers failed, which was the climax of the subprime multi-year event, but they forget that there were small episodes for years that led up to that moment.

Mortgage backed securities laced with toxic subprime loans were rated AAA and valued at 100% all the way up to the end. Then they were downgraded, the veil was pierced, and the value of the debt went into free fall.

The same is occurring today with France (recently downgraded), the United States (recently downgraded), Japan (recently downgraded), and the UK (outlook just cut). The price being paid at this moment for the debt of these countries is the highest it has ever been in history (lowest bond yields) at a time when the credit quality of the debt is the lowest it has ever been in history (most likely to default). It is beyond a bubble, it is blind hysteria even worse than the episode in subprime, and it will not end well.

When will the "Lehman" moment occur? I have no idea. I'm selling all my developed world government paper and currency now. I would rather sit back and wait for the madness of crowds to run its natural course. I'll buy back in after the collapse, just as some investors, like Kyle Bass, are today with subprime mortgage debt.

See Kyle Bass: The Global Economy, Japan, & Why He's Buying Mortgages

Welfare Vs. Working: Retiring Young In America

Staggering piece of data below based on recent research from the Congressional Research Service. They find that an average family living today is better off accumulating the average of all welfare payouts vs. working and collecting the median family income in 2011.

The number represents the total payout of welfare programs that pay food assistance, cash assistance, housing costs, and medical costs (essentially all living expenses). The federal money on these programs in 2011 was close to $1 trillion.

A family that takes the time to research how much they can make by not working and maximizing their welfare payouts often finds that the monthly payout greatly exceeds the income at a job.

With American now entering this new form of retirement, I find it fascinating that people are still confused with last month's election results in America. This past week's Newsweek cover sums it up perfect.

Wednesday, December 12, 2012

Fed Announces Larger Monthly QE-ternity Program

As expected and discussed last week, the Fed increased the size of its QE-ternity program today from $40 billion per month to $85 billion per month. This means that they will now print money to purchase $40 billion in mortgage bonds and $45 billion in treasury bonds.

The Currency Wars continue and they are now picking up speed. Look for Japan, the European Union, and the UK to respond as the former powers of the global economy all try to devalue their paper currency against each other to provide an artificial short term stimulus to the economy. The biggest losers of this war will be almost everyone. The biggest winners will be the few that understood what was happening and began accumulating precious metals early.

Why Most Investors Will Lose Money In Every Asset Allocation

A main argument for higher stock prices moving forward in the US is that the average American household has not participated in the rally. The following excellent chart from the Wall Street Journal shows the price of the S&P 500 since 1987 (orange) vs. the percentage of household assets in the stock market (blue).

I want to discuss this concept for a moment because it is both often discussed and important to understand. To begin, this chart does not go back to the beginning of the most recent secular bull market in the early 1980's. Stock ownership was even further below the 20.2% bottom shown on the graph in 1987. The bull market was already 5 years in at that point so investors were already beginning to tip toe in.

A major reason for the move into equities in the early 1980's was the creation of the 401k program. This made investing in stocks a new way to "save" for retirement that had tax advantages. It opened the door to a much larger portion of the country which did not participate in the market in the past.

It is also important to briefly point out that the 1987 "bottom" in ownership on the chart was just after the 1987 crash. You can see that as the market rises more average investors enter, and as the market falls/crashes, more sell.  This is known as herd behavior, a topic discussed here often. The public is always positioned for the most possible damage at the worst possible time and is usually not in the market at bottoms (at this moment in time this is occurring in the bond market as the average American household has put the majority of their retirement income into the "safety" of bonds at the absolute peak of the market - they will soon once again be slaughtered).

Many discussions you hear that takes place on the relative value of stocks concerns the percentage of money moving back and forth between bonds, stocks, and real estate. For example, in the first quarter of 2000 we will assume that Americans had:

50% of their funds in stocks (chart above)
25% in real estate
25% in bonds

As real estate prices moved higher and stocks fell leading into 2002 it created the next transition. We'll say that in 2006 Americans had:

40% of their funds in stocks
40% of their funds in real estate
20% of their funds in bonds

Now in 2012 we'll say that Americans have:

40% of their funds in stocks
20% of their funds in real estate
40% of their funds in bonds

These are estimates used to provide an example of what I'm talking about - not actual data (although I'm using the stock data from the WSJ above as reference).

So now a financial advisor looks at the above numbers and says that it is a good time to purchase X because he believes that money will be moving toward that asset market from one of the other asset markets and it will push that asset price higher. For example, he'll say that "money will move out of bonds and go back into stocks."

This analysis misses a critical piece of information and it is why most investors will be hurt bad in the years ahead.

Imagine that you lived in Greece in 2009. You sit down with your financial advisor and have this same conversation using the same percentages above. What happened to the markets in Greece?

They were all destroyed. Point out which graph below you would like to have been invested in.

Greece stock market - disintegrated

Greece home prices - free fall (losses with leverage)

Those that moved into the "safety" of the bond market were hurt the most. Greece 2 year government bond prices - higher yields (rising chart) means lower prices:

Why did this happen?

Because money did not move back and forth between the three categories - it left the country completely. Capital fled Greece at every asset location when their government debt crisis hit.

This is the new normal for investing in the global economy. If your country is bankrupt and has not yet entered its sovereign debt crisis - France, Japan, the UK, United States, your money is not safe in any of the "big 3" investment options.

Money will move to where it is treated best. Over the next decade I believe that will be in commodities and emerging markets with strong balance sheets (simultaneously creating stronger currencies). The current bizarre landscape where more government spending and money printing leads to more capital entering the country (see the United States) will reverse.

This is the exact opposite of almost every financial forecast for the future, and it has been the blue print for the future here on this site since governments around the world nationalized the financial system and backstopped these paper government promises with a printing press back in 2008.

Look for Japan to be the first major tremor to hit. Pay close attention to how capital will leave the country at every asset (stocks, bonds, real estate). Greece has provided the blue print - make sure you are paying attention.

Why Health Care Costs Are High: Another Piece Of The Puzzle

The more the government gets involved with a sector of the economy, the more inefficient and expensive that sector becomes. This can be seen most recently by looking at charts of the cost of tuition at colleges in America at the point when the government entered the student loan market in force.

60 Minutes reviews another major portion of the inefficiency in the cost of health care in America. Costs will continue to skyrocket higher as Obamacare moves into place. Just as with student loans, these costs will continue to be spread out equally across the country on the backs of the American tax payer. Until the system breaks and the Greece moment arrive.

Tuesday, December 11, 2012

Which Government Bond Markets Are Heading Toward Cliff Fastest?

Excellent graph below showing the worst government debt to GDP offenders around the world since 2008.

What this means is that since the crisis broke out in 2008, which countries have added the most debt relative to the size of the economy in order to boost/juice/stimulate growth.

You see Ireland, Greece, and Spain in the top 4, and the US, Japan, and the UK rounding out the top 6. Why have Ireland, Greece, and Spain had such trouble with their funding of this stimulus vs. the other three? Because the bond market decided not to let them play.

Soon the bond market will do the same for the US, Japan, and the UK. It is only a matter of which one happens first. My money is on Japan, but those holding precious metals care little about the order of collapse.

Friday, December 7, 2012

A Simple Walk Through: Why Home Prices Have Not Reached Bottom

Most people I know and interact with on a day to day basis do not not that I am a finance nerd. If you met me or even if you are someone that has known me for years it would difficult to discern. I spend a tremendous amount of time with friends, watching sports, playing basketball, and doing "normal" people things. Its only during alone time when everyone is tucked away in their normal lives that I open the laptop or current book I'm reading to delve back into the exciting world of global finance.

I was visiting my cousin last night who was nice enough to welcome me in to his home in Raleigh, NC. We began talking about normal stuff, which somehow led to a financial topic. I began to briefly give me thoughts and he asked me a question, and another, and another, which I went on to explain. Somehow it led to derivatives, which is a place you do not want to go while watching Thursday night football. Anyway, he found out last night that I am a finance nerd.

I bring this up because the discussion finished with, "is this a good time to buy a house" as it so often does. This is always a very difficult question to answer in just a few sentences, which is why I have tried to dedicate a large portion of this website to answering it including this year's massive real estate outlook.

I came across a chart this week that provides a tremendous visual tool to explain a piece of the real estate puzzle: the concept of interest rates.

Imagine that you are an average working American family and you decide it is time to purchase a home. The first thing you most likely do is figure out how much you can afford. That begins with a calculation of your monthly income to determine after taxes, other expenses, and what may be put away in the 401k, how much you have left for a mortgage payment every month.

We'll say that this family, the Thompsons, determine that number to be $1,100 per month. I would guess this is very, very, close to the average number for middle class families in America (based on average income data). 

Now with this number they head down to the bank. They tell the bank they want to buy the maximum amount that $1,100 per month will allow. The bank representative opens up their calculator and writes down a number on a piece of paper. The Thompsons then call their real estate agent with this number in hand and start looking at homes.

Let's pause for a moment to take a look at the most important and misunderstood piece of this entire process: the impact of mortgage rates on the number the bank representative writes down.

The following graph from Iacono Research shows on a sliding scale how much they can pay for a home with an $1,100 mortgage payment. If mortgage rates were at 10.5% today the Thompsons could afford to pay $130,000 total for a home (all these estimate a 10% down payment). If mortgage rates are down at 3.3% (they are at 3.31% this week), the amount they could afford to pay for a home rises to $280,000.

Let's now extrapolate this further because many people (including me) believe that mortgage rates have the ability to fall even further in the short term. If 30 year mortgage rates fell to 2.5% the home price would rise up to $310,000. If mortgage rates fell to 1.5% the home price would rise up to $350,000.


Now let's move forward and see how this plays out. If the Federal Reserve and the government, which have nationalized the mortgage market, can artificially push rates down to 1.5%, imagine that the Thompsons had the opportunity to lock in at that rate.

The Thompsons rush out to purchase their $350,000 per month home with only $1,100 per month in payments. They are feeling real good about themselves. Then they hear on the news that interest rates begin rising. "Who cares?" they say, they have already locked in at the low rates making them the smartest buyers on the block.

Interest rates are now rising quickly, beginning to move back toward the normal historical rate between 7 - 10%. Rates stop at 4.5% (still historically very low) when the Fed announces they will purchase another round of mortgages. Two of Thompson's neighbors put their home on the market to cash in on their new $350,000 home price. Buyers show up to look at the home but they have some bad news.

With interest rates now at 4.5% new buyers only have the ability to pay a maximum of $240,000. They like the home, they tell the sellers, but the only way they can afford the monthly payments would be if they dropped the price by $110,000.

After talking to their neighbors the Thompsons have a sick feeling in their stomach. They realize that by locking in at the all time record lowest rates in history they have moved into a coffin. Every tick upward in interest rates means less buyers that can afford their home and a lower price. 

Does this help explain why buying at low interest rates is the worst possible time to purchase real estate? Especially when they are created artificially by the Federal Reserve.The Fed is doing everything in their power to create another artificial bubble. As soon as interest rates either stop going down, or (gasp) begin to rise, home prices will plunge.

h/t Iacono Research

Wednesday, December 5, 2012

The Future Of America: Socialism

Merriam-Webster reported this week that "socialism" and "capitalism" were the most looked up words of the year. This statistic reminded me of another Pew survey I recently came across. The results were terrifying.

According to Pew, 49% of the youth survey responded positive to socialism, while only 43% responded negative (18 - 29 years old).

When asked about capitalism, 47% responded negative, with 46% responding positive.

This staggering statistic shows the deeply embedded culture in America today that it is the responsibility of the government to take care of the people. If this is already embedded into the minds of the younger generation it paints a horrifying picture for the future of America.

Tuesday, December 4, 2012

ECRI's Achuthan Defends His Call For Recession

I have posted every one of his media appearances since September 2011 when he first announced the coming recession so I will continue to do so here until he is proven correct or incorrect. Achuthan claims that we entered recession right around the mid year point (his late 2011 call) and discusses what a recession means for the ECRI group, which is essentially a slowdown in four coincident indicators: industrial production, personal income, sales, and employment. The first three peaked right at mid year but employment has continued growing (which he discusses in the video below).

The most recent discussion (attack) toward Achuthan.

Sunday, December 2, 2012

Stream Of Consciousness: Visual Thoughts

I was down in Atlanta working for most of the week and I have also been pretty sick the last few days so I apologize for the limited posts. While I made sure to keep up with the markets, I have not had the time to put my reading into words and pictures. Let's do that now with a stream of thoughts on some of the best graphs I came across during the week.

The first is a simple look at the result of the Fed's Operation Twist program. This fancy name essentially means that the Fed sells short term bonds on their balance sheet and buys long term bonds. The result is not an increase in the money supply, and its goal is to reduce longer term rates for market participants (this has worked).

The problem now, seen below, is that the Fed is running out of short term bonds (0 - 3.5 year terms) to sell. Many (including me) anticipate that the Fed will announce a larger QE program in January to keep the purchase of longer term bonds going. This means that instead of selling short term bonds to buy long term bonds, they will print money to purchase long term bonds. It will result in the current QE program (printing $40 billion per month to purchase mortgage bonds) to rise to $85 billion per month (an additional $45 billion will be printed per month to purchase longer term treasuries.

The following graph providing data from the US mint shows that US mint sales in gold went parabolic in the most recent month. Whether this trend continues is something to watch very closely. Dealers are reporting low inventory levels due to China's activity in the gold market. Good article on that topic here.

Does this mean that the average American has now become manic in the gold market? Let's put this recent buying into context. The following shows gold and jewelry demand in 2011 for countries around the world relative to their GDP (total size of their economy). You can see that India certainly leads the group running at 16%. China has recently risen to 4%. The US? A fraction of 1%. Does this chart represent a mania in the US for metals? I will let you decide. As the world continues the currency wars, look for these percentages to rise everywhere as the citizens see the paper levels of currency explode and the amount of physical gold available around the world stay level.

The following chart sums up the transition of the American economy over the last decade. Since 2001, food stamp enrollment is up 158%, medicaid enrollment is up 52%, and government employment has risen by 6%. The category of the country that pays for these luxuries, private employment, has fallen by 2%.

An easier way to sum up this transition is that there is now 1.25 people employed in the private sector for every 1 person that receives welfare assistance or works for the government.

The increase in debt, the only source of growth during the current depression, was 45% over the past 4 years. This 45% increase has led to only a 7.1% increase in real growth.

The source of income that will be used to pay back this debt is household income. How much has income grown during this recent debt accumulation period? Since 2000 real median household income has fallen 8.1%. While we have seen temporary bubbles in stocks and real estate (plus the current bubble in bonds) that create temporary flashes of artificial wealth, the real measure of wealth is seen in employment income which continues to disappear.

Freddie Mac reported new record low mortgage rates this week with the 30 year mortgage at 3.32% and the 15 year mortgage at 2.64%. The 10 year treasury (considered the risk free rate) is at 1.64%. Treasury bonds and mortgage bonds are considered the same today by the market (the government is the mortgage market) so the spread between the two will most likely continue to contract (mortgage rates will continue to fall). Ultimately, both rates will skyrocket as the government debt bubble in America implodes. The debt bubble implosion will provide an excellent opportunity to purchase American real estate, stocks, and bonds (if you like to buy low and sell high).

The restaurant performance index broke back into contraction territory this week. This is a good measure of the strength of the American consumer because restaurant meal purchases are discretionary expenditures.

I'll leave you with the following image, which I think perfectly sums up the most recent election for a large part of those that belong to the older generation.

h/t Sober Look, Zero Hedge, Calculated Risk, Street Talk Live, JS Mineset, Casey Research, DShort