Saturday, March 31, 2012

Tuna Heads For Open Waters

Drove down to beautiful Kiawah Island beach for the weekend so posts will be limited.

Jim Grant On The Markets:

Chris Martensen Interviews Charles Biderman:

Thursday, March 29, 2012

Checking In With Spain

In America we come home from work today and open the window to take in some beautiful fresh spring air. We turn on the news to hear that "stocks are up, unemployment claims are down, and the global economy is running back on track." Thank goodness that silly European sovereign situation that everyone was worried about back in October when the markets were crashing is now completely behind us. Greece has been bailed out, and we can now go back to our regular broadcasting.

But, wait a minute. The clip below shows what is taking place in the country of Spain this afternoon, which appears to be different than "back on track" and "full recovery." With over 23% unemployment in their country and over 50% unemployment for their youth they are not going home to open their windows and eat warm pie. They have decided instead to spend the afternoon smashing windows and setting buildings on fire.  Yes, I know, their news broadcasters must not have told them the European debt crisis is over.

Unfortunately, the people of Spain have recently found out that their government also cannot pay their bills.  They have found out that the price of the home they purchased for a retirement investment is in free fall as the Spanish real estate bubble continues to plunge downward.  

They have also been told that instead of government "stimulus" programs like America currently runs for its people, they will be getting government "austerity" programs for their citizens.  It turns out "austerity" means pay cuts and job losses. Here is how they have taken the news:

What is the worldwide exposure to losses in Spanish debt?

Just $1 Trillion. Or 6 times the size of the bailout needed for AIG.

This does not include payouts on credit default swaps, which we now know will paid out based on the process we just followed with the Greek default. See here.

But that is not anything for those outside Spain to be concerned about. "The stock market is up, unemployment claims are down, and the global economy is back on track."

For a complete analysis on sovereign debt see Global Market Forecast: Sovereign Debt Review.

401K Options: A Look Into The Future

I have spent the past few months discussing the bearish outlook for stocks which is mostly based around the extremely high sentiment of institutional investors and traders as well as the high valuations that have been placed on companies and their future earnings.

There is one positive development for stocks that is rarely discussed, and that is the "retail" investors (the average person in America investing through a 401k or IRA) have been exiting stocks essentially non-stop over the past three years.  Why is this bullish?

This means that investors have capital that can move back into stocks if they begin to become more appealing.

The following chart shows the relentless selling (when the red areas move downward) vs. the minor buying of stock funds since January of 2010 (the data is very similar going back to early 2009).

Every month investors in America have to decide how they are going to allocate their 401k's.  For some, picking these funds is the only investment decision they make in their lifetime (other than buying a home).  Most Americans spend about 173 hours a month (based on a 40 hour work week) focused on working and making money. They usually spend about 10 minutes or less deciding how to invest the money they are working for.

In general these decisions are made based on the sum total of the information they take in around them. This can be through the media, the price of stocks, or a friend that manages money for a living.

After the 2008-2009 crash the sum total of these thoughts for the average American = fear.  We don't have to guess this or take a poll.  We can just look at the chart above.

The vast majority of the 401k money is owned by baby boomers that are either in or very close to their retirement years.  They know they could not recover from another downturn in stocks so when they took that 10 minutes to review their 401k options every month, they moved money out of stock funds (sold) and into bond funds (bought).

The average investor loves to look at the "past performance" charts on their mutual fund options.  These charts show bonds have been rising in value for 30 years and (for those in longer dated treasuries) last year they were the best performers in any asset class (30 year treasury bonds returned close to 30% last year).

Bonds rise in value when their interest rates fall and fall in value when their interest rates rise.  As investors continued to push into bonds last year, it pushed rates lower, creating the massive returns on the underlying asset.

The "retail" investor was not alone in this buying.  They were joined by the Federal Reserve, which was engaged in QE2 to start 2011 (where they printed hundreds of billions of dollars and purchased treasury bonds) and Operation Twist to end 2011 (where they sold shorter term bonds and purchased longer term bonds). In addition to the Fed there was a tremendous amount of money exiting the Eurozone looking for safety. If you kept your money at a checking account in Greece, Portugal, or Italy last year, you were reading in the paper that there was a chance your bank could be closing.  This created a massive outflow of deposits into safer countries in Europe as well as bond funds in the United States.

Most of these 401k investors have no idea that the bond funds they are now sitting in could fall in value just as quickly as the stock funds.

But what if another scenario occurred? What if bond yields rise (bond funds lose value) and stocks fall in 2012. Now a baby boomer is looking at his 401k options which only include three choices:

1. Stock Funds
2. Bond Funds
3. Stock & Bond Funds

Some of the baby boomers may ask themselves the following question: If stock funds are paying out an average 2% per year in dividends and bond funds are paying out an average 2% per year in interest, but both  have the ability to lose 30% in a year if the market turns, why would I risk my retirement principle over a guaranteed 2% return?

Maybe some will take the next step and ask the following question:  If stocks and bonds are providing a guaranteed return of 2% (with massive downside potential) and the cost of living is rising by 3% or more (which it currently is) then why would I take a guaranteed annual loss of purchasing power coupled with massive downside potential?

This thought process is about 3 to 4 steps away from where we are today, but it is the kind of thought discussion you want to have now.  As an investor you don't want to be sitting at your kitchen table having these thoughts when everyone else across the country is at their table, you want to have this discussion today.

So what is 5 or 6 steps down the line in this thought experiment?  It is the next logical question: Where will these investors move their capital if they no longer trust stocks or bonds?  

Before I answer that let me review the argument that "stocks and bonds cannot move down together," which will be a common rebuttal from anyone you discuss this concept with.  You do not have to look far to find a scenario where this took place.  Last year in Europe money was fleeing out of government bonds on worries there would be government defaults.  Did it move into stocks?  No, European stocks were destroyed last year, falling almost equally in line with the massive bond losses.  The trifecta to this downturn was that the European currency, the euro, was falling as well.

A second argument, which is perhaps more consequential, is that some investors will face a 10% penalty if they choose to sell out of the 401k "trap."  This will stop some, but not all.  There are now ways you can move 401k funds into a regular IRA even if you have not changed jobs (I have helped investors do this). By moving money into a regular IRA it becomes similar to a cash trading account, meaning investors can now invest in almost any stock, bond, ETF, commodity, or currency around the world.

So where will the money go? Analysts on television today (who sell stocks) have been touting that the money will rotate back into stocks which will provide the market the momentum it needs to push to new all time highs and beyond. They could be right. That is, after all, how the market has behaved in the recent past.

I disagree.  I believe that a large percentage of the money is going to move into assets that resemble liquid cash (treasury bills, cash deposits, or "under the mattress" type money).  This liquid cash does not have the benefit of the 2% (or less) yield that bonds provide, but it faces no risk of downside collapse.

Investors will also be looking to protect themselves from the potential loss of purchasing power. This can be accomplished through investments in commodities. Energy, agriculture, base metals, rare earth metals, and precious metals will begin to see investments from the "mainstream" investor for the first time in this secular bull market. If just a small portion of the 100% of 401k money invested in stocks and bonds were diverted into commodities it would rocket launch these investments higher.

Remember, I'm not saying this process is going to happen tomorrow. This is a thought experiment that projects out possibilities over the next 24 to 36 months. Maybe stocks will move back to extremely high valuations that we experienced in 2000. Maybe treasury bonds for our government (which is bankrupt and cannot pay back the money) will move from bubble levels to extreme bubble levels and stay there forever. Maybe commodities will move from undervalued to extremely undervalued and stay there forever.

I heard an interview recently with Bill Fleckenstein discussing the grossly under priced levels of precious metal mining shares today, and he said that it does not matter that prices are undervalued unless others understand the valuations and take the shares higher.  This is an important concept to understand as an investor putting your money into the correct (undervalued) assets while you watch bubbles blooming all around you. You are always at the mercy of the market, which is why shorts got destroyed back in 1997 when they watched the NASDAQ bubble rise another 100% before collapsing.

There is only one assurance in investing and that is the herd always gets slaughtered.  Right now the herd has placed themselves 100% in bond funds right at the peak of the greatest bubble in history. It will not end well, and I hope that you not only get yourself out of the way but you take advantage of the profits that will occur on the downside collapse.

Chart courtesy of Zero Hedge

Wednesday, March 28, 2012

Funding The Government By The Minute

Another excellent video from Professor Antony Davies discussing what would have to be removed from government spending in order to fund our government for one year using our current tax receipts. The video provides a startling look at just how obscene our spending problem has grown, yet understates the problem in that cutting spending from the areas described would actually shrink the economy (and subsequently shrink tax receipts) meaning the government would have to cut spending even further.  Something to think about when you hear our politicians discuss their harsh budget "sacrifices" in the coming years (which will never actually come close to materializing until our country reaches the Greece moment and enters into a sovereign debt crisis). Of course, at that point it will far too late.

Peter Schiff CNBC Interview

Peter Schiff is always fun to watch during CNBC interviews, and he makes an excellent point in that the Fed's stress tests did not include the option that interest rates could rise anywhere which would create massive losses everywhere. 

Tuesday, March 27, 2012

The Health Of Real Estate: Case Shiller - FHA & Beyond

The Case-Shiller home price data was released this morning for the month of January. It showed an annual decline of 3.9% and a monthly decline of .8%.

The following chart shows the city by city look at price movement. Atlanta continues to lead the pack downward, falling a staggering 15% year over year.

Earlier in the month we received more data on the health of housing. The following graph shows a composite of new and existing home sales, permits and starts.  It helps provide a broader look at all the indicators together.

Breaking away from the existing home sales we can just focus in on the new home sales. The steps of the process (in logical order) are: sales, permits, starts (these three were part of graph above) and completions.  While sales, permits, and starts got a bump upward from their extreme lows last month, it has still not had any positive impact on the completions. Part of the reason is that many real estate projects do not reach completion (for multiple reasons) as well as that the positive data has not had a chance to work its way through the python.

From the new home sales portion of the data, we can separate it out even further into multi-family and single family.  After that, you see that all the recent positive data is coming exclusively from the multi-family side, while the single family data remains flat-lined.

Overall, the (non-multifamily) market remains a disaster.  The following graph shows the mountain of shadow inventory waiting to enter the market - which Corelogic reported at 1.6 million units this month.  This number only includes those that are seriously delinquent (90 days and beyond), meaning it understates the true size of the shadow inventory.  Estimates show that there are over two million homes 30 - 89 days delinquent (a number rising fast) that have not entered this data.  It also does not include the massive number of underwater homes that still continue to make their payments.

Foreclosure sales were up 29% in January (the most recent data) meaning that some of this shadow inventory is finally beginning to enter the supply stream following the long lull due to the robo-signing scandal.  The lull period as well as the most recent pick up can be seen in the graph below.

The recent burst of optimism in the stock market has had an unintended consequence on the real estate market - as money has left the bond market and moved into stocks, interest rates have been rising on the ten year treasury bond.  Why is this important?  The ten year treasury bond is the benchmark used to determine mortgage rates which have been rising steadily over the past two weeks from under 4% to close to 4.20% as of the most recent reading.

If this trend continues, it will hurt the ability of homeowners to both refinance and qualify for loans.  Remember, this when commentators discuss the benefits of a rising stock market.

How about the artificial force that is currently holding housing up today: the government backed mortgages that have dominated the market since 2008?

The main driver of growth in this market has been the Federal Housing Administration (FHA), which has seen its balance sheet balloon to over $1.1 trillion (up 300% since 2007) in home financing guarantees.

The FHA lends up to 97% on home purchases meaning any downturn in prices is catastrophic for their balance sheet.  By law the fund is required to hold 2% of its portfolio in cash reserves (meaning if loan values fell by more than 2% they are insolvent), which is a ridiculously low number.

How much did the FHA hold in loan reserves as of the most recent data report (September 30th)?


Yes, that is a decimal. One quarter of one percent in reserves. Why is that?

Their models do not account for the possibility of home prices falling.  Have you heard that before? It is exactly what we heard when Lehman Brothers was leveraged 35 to 1 on their mortgage portfolio, only this time the 1.1 trillion dollar (and rising fast) program is 100% tax payer funded.

Their projections called for 1.2% home appreciation in 2012 and 3.8% appreciation in 2013.

As home prices fall these "3% down" loans immediately move under water making it far more likely home owners will stop making payments.  These loans will be added to the current massive shadow inventory and the losses to tax payers will be enormous.

Why does this matter?

If the FHA is forced to tighten lending restrictions in order to try and stem losses (which are coming in force), then it will push home buyers out of the market that only qualify for the FHA's loose lending restrictions.

If buyers are forced to put 10% down instead of 3%, imagine the number of buyers this will remove from the market as some buyers will be forced to save for a few more years before buying.

This is all a healthy part of the re-balancing of home prices to sustainable levels, but it must be monitored closely for anyone thinking about making a home purchase in the near future.

For an in depth discussion on the Outlook for both the residential and commercial real estate markets see 2012: Real Estate Outlook.

h/t Calculated Risk, The Big Picture, Zero Hedge, Street Talk

Daniel Hannon On Iceland: "Who Is Laughing Now?"

There are many that argue that back in 2008, if we allowed the insolvent banks to fail and allowed the inefficient businesses to fail, then the world would have come to and end.

We do not know the outcome of this scenario because not only did the US nationalize its insolvent banks as well as a large portion of American business (auto, auto loans, and mortgage), but just about all of the remaining developed world did so as well.

Except a country called Iceland.  Iceland decided to let their banks fail and allowed the toxic debt to cleanse from their economy.  They allowed unprofitable businesses to fail.  What happened?

The country experienced a massive recession.  Many people involved in inefficient businesses had to find different jobs.  The country devalued its currency (part of the natural re-balancing of an economy).

Now, after making the difficult decisions and taking the pain in the short term, Iceland is booming.  They have a real economy that is not dependent on the drug of government spending, mortgage financing, auto-loan financing, or transfer payments.

We already know the outcome of the developed world's decision following the financial crisis because we have seen it with Japan.  They nationalized their banking system, massively increased government spending, and embarked on endless quantitative easing programs after their bubble burst in 1990.  After 22 years of slow and steady declines, their economy is ready to disintegrate.

Which option sounds more appealing?

Want more data on the "devastation" following countries that choose to default on their debt and cleanse their financial system?  The following chart provides a list of countries that defaulted on their debt and shows that almost all had equal or higher GDP measures just three years after default/devaluation.

More from MEP Daniel Hannon on Iceland:

Monday, March 26, 2012

The Fed Hints At QE3?

The market feels that the Fed hinted at Quantitative Easing part 3 (QE3) this morning in Ben Bernanke's speech.  QE means that the Fed prints money to purchase assets.  Up until now it has been only treasury and mortgage bonds, but the Fed has the power to purchase any asset (such as stocks) and probably will before this financial crisis has run its course.

After the hint, stocks and precious metals took off to the upside.  he following chart shows the market reaction after each QE announcement over the past few years.  It also shows the market impact when the artificial stimulus was removed.

The Fed must now walk a tight rope with oil prices hovering at record highs and other central banks around the world flooding their markets with currency to deal with their own sovereign debt crisis. 

The markets are being held up by Bernanke's artificial QE fire power.  Will he push hard now and send commodities (the cost of living) surging or will he let a temporary correction occur?

Speaking of gasoline, it is always interesting to look at the cost by cost comparison of different states in the US.  I live in North Carolina, and I'm always surprised at how much cheaper it is just a few miles away after crossing into South Carolina.

For those in America that anguish when thinking about $4 per gallon, remember that over in Europe prices are close to crossing $10 per gallon.  It appears some of the LTRO (recent "QE like" program from the European Central Bank) has made its way into oil as well.

h/t Bloomberg, Zero Hedge

Sunday, March 25, 2012

Bernanke "The Hero" Creates A New Mirage

Back in 1999, as the NASDAQ bubble was roaring higher, Robert Rubin, Larry Summers, and the Federal Reserve chairman at the time (Alan Greenspan) graced the cover of Time magazine with the headline "The Committee To Save The World.

After "rescuing" the American economy back in 2001 by lowering interest rates to 1% and flooding the country with cheap credit for consumers to purchase cars, trips, and homes, Greenspan received the name "The Maestro."

Just a few years later in 2008, after choking on the easy money debt Greenspan created, America entered into an economic depression and the financial system collapsed.

Since then we have followed the same prescription only this time the debt has been taken on by the federal government and it has been financed by Ben Bernanke with low interest rates and trillions in quantitative easing programs.  The sugar high of the debt and easy money stimulation has once again entered the economic bloodstream, and we have a feeling of euphoria last felt during the 2002 - 2007 consumer debt fueled boom. The Atlantic this week trotted out a cover with a smiling Ben Bernanke calling him "The Hero."

Bernanke has promised us low unemployment, economic growth, and inflation at 2% per year.  This can be done, he tells us, without suffering any pain from the debts incurred by both consumers and governments over the past 40 years. Greenspan, the Maestro, promised Americans the same thing after the stock market crash in 2000. Americans, politicians, and businesses believed him back then and shockingly most of them believe Bernanke today.

Even a young child can understand that this concept is ridiculous, but let's just say for a moment that this economic "miracle" can become reality. What does this desired 2% inflation that Bernanke wants so desperately to achieve look like?

2% inflation per year cuts the value of the dollar by 75% over a typical lifetime. That means if an American works hard, saves their money, and accumulates 1 million dollars for retirement they will find out that inflation has taken away 75% of their purchasing power.

Over a 35 year period, 2% inflation cuts the value of the dollar in half. Over another 35 year period it cuts the value of the dollar in half again. This is due to the magic of "compounding interest" that you may have heard about when the bank tells you to put money away at a young age.  This magic can be seen in the following chart.

What if Bernanke misses his target by just a small amount while he is working on getting unemployment lower with endless QE programs? What if inflation ends up running at 4% per year (it is already running close to that amount today based on government measures such as the CPI)?

At 4% inflation the value of the dollar will be cut in half in just 18 years. That means when your child is born and you begin saving for their education, when they reach high school graduation half of the purchasing power of that savings will have disappeared.

Bernanke tells us not to worry about this because all boats will rise together. If prices rise it must mean that wages will rise as well, right? Up until late 2007 (when America entered its current depression) wages tracked prices beautifully as can be seen in the chart below. Since then wages have fallen and stagnated sideways while the cost of living continues to rise.

The trillions pumped into the economy worked beautifully on making the price of gasoline, food, rent, and insurance rise, but wages have been falling (for anyone lucky enough to have a job).

The recovery, just as it was during the artificial credit fueled boom of 2002 - 2007, is a mirage. In 2008 the economy hit a wall when consumers as well as state and local governments could no longer borrow and spend.  Their debt still sits on the balance sheets, suffocating them more every day.

On top of that we now have a credit fueled explosion in federal debt and student loan debt, which have now crossed $15 trillion (federal debt) and $1 trillion (student loan debt). How will this be paid back?

It won't.  When the markets understand this Bernanke "The Hero" will become as vilified as Greenspan "The Maestro" was after his bubble burst. It takes no courage to keep interest rates at 0% and run endless QE programs promising no pain for anyone.

Back in the early 1980's, Federal Reserve chairman Paul Volker raised interest rates close to 20% to crush inflation and cleanse the economy of the toxic debt it had incurred. The country entered a deep recession during the period. He was hated by politicians, business owners, and Americans who were addicted to the easy credit. There were no covers of magazines proclaiming his courage, but he did what was best for the country and created the foundation for the greatest economic boom in history from 1980 to  2000.

As Bernanke tells us today that there is no danger in his funding of our deficits with printed money, it is important to remember what he was telling us back in 2005 to 2007, just months before the financial system collapsed.