Saturday, June 2, 2012

2012 Second Half Outlook: Introduction: Psychology & Sentiment

2012 Second Half Outlook: Introduction: Psychology & Sentiment
2012 Second Half Outlook: Policy Response & How To Invest

I spent the first six months of this year, after posting the complete 2012 Outlook, discussing the triggers for the slowdown for the global economy that were out in the distance. I have focused a tremendous amount of writing on the European debt crisis and its impact on the markets. I discussed overvaluations in stock market prices (specifically America), as well as the danger of the sky high sentiment toward the future price direction of stocks.

While my readership continues to grow weekly (a sincere thank you to everyone who reads/contributes to this site), I notice that there are surges in viewership during days the markets sell off significantly. It is natural human psychology for people to see the market make a large move in a particular direction and immediately seek out a “reason” for that move.

The mainstream media understands this dynamic and they feed on it.  If you pull up the headlines on a website such as CNBC (I always pick on them because it is so easy), they will have articles such as “market is up today because home builder sentiment rises” or “market moves lower this morning due to fears in Europe.”

Trying to make investment decisions by watching what the market did on a particular day and then reading the media headlines is like driving down the highway looking through the rear view mirror.

While I spent the first half of this year tracking every tic higher in Spanish bond yields, tracking the deposit flows out of European banks, and tracking the global economic indicators rolling over every step of the way, most financial analysts, traders, and every day citizens (specifically in America) did not see any problems ahead. Why is that?

The American stock market was rising.

People seek out a reason to “justify” the move higher and mentally screen out the bad information around them. This is not a recent development - studies of both markets and psychology (one of my favorite topics to read about) going back over a hundred years shows this occurring over and over again.

The DOW fell close to 300 points in a single session this past Friday and is now down over 1,000 points since the beginning of May. The mainstream media headlines are now filled with same headlines found on this site four and five months ago (European worries, global economic data rolling over, etc). The media is now providing the "justification" for the stock market’s recent decline.

Back in mid March, I released an article titled Global Market Forecast specifically discussing the frothy sentiment in the stock market with a specific focus on Apple. At the time, Apple stock was being discussed relentlessly by analysts on television as it moved higher almost every single day.

A week later as the stock crossed over 600 for the first time, I wrote an article titled Apple Goes Parabolic, showing the chart of Apple moving in a straight vertical line upward. One week later, USA Today ran an article with the following headline: “Apple, Priceline, & Google race to hit $1,000-a-share mark.” In it they gush about the future direction of America’s new darling stock:

“It’s the new ego boost, to get a stock to $1,000,” says Jon Johnson of A stock’s price, by itself, doesn’t indicate how expensively or cheaply valued a company’s shares are.”

“As Priceline and Apple blow past existing price targets, analysts are making adjustments. Topeka Capital Research this week put a $1,000 price target on Apple.”

“Shares of gadget maker Apple, for instance, are up 54% this year. If that pace continues – something that many analysts say would be a tough accomplishment – the stock would easily top $1,000 by year’s end.”

Shares of Apple touched a high of $639 a week later and have collapsed down to $560 over the past 60 days.

While Apple topped out in April, many stocks in the overall market continued to move higher through the month. On May 1, after a massive and relentless four month run higher in prices, Alan Greenspan (the Federal Reserve chairman before Ben Bernanke) announced through the media that he felt “stocks were cheap.” Wall Street applauded Greenspan's approval and upped their huge end-of-year price targets, short interest fell significantly, and the sentiment indicators surged higher (all discussed along the way here on this site).

The stock market would top the day of Greenspan’s comments, and it has since become much “cheaper.”

People have watched the relentless flow of mutual fund money out of stock funds and into bond funds citing it as the number one reason why the markets should move higher in the near future. They look at this as “money on the sidelines,” but how does this stack up when you look at a longer timeline?

From 1974 through 1994, the percentage of households that owned stocks ranged between 23-36%. In 1980, shortly after the famous “Death Of Equities” cover, almost no American wanted to invest in the stock market. Today, after four years of steady withdrawals from the market, 53% percent of households are still invested in the market. The number topped out at 65% in 2007 (as the market was touching all time highs). This shows that the “average investor” still has a long way to go before sentiment reaches a normal or even pessimistic level. In the back of American minds, while currently afraid, they still have memories of the great 1980 to 2000 run as well as the recent market highs in 2007. It will take another "cleansing" move downward in order to truly bring back “The Death Of Equities.”

In the following sections we will review how the global economy and financial markets have changed over the past six months since my initial 2012 Outlook was released and discuss where markets are likely to move from here.

2012 Second Half Outlook: European Debt Crisis Catalyst

2012 Second Half Outlook: Introduction: Psychology & Sentiment
2012 Second Half Outlook: Policy Response & How To Invest

The global financial system is now more interconnected than ever. What happens in a trading room in London now impacts the workers in a factory in China. This is known as the butterfly effect - a concept I discussed in detail in 2012 Outlook: Global Butterfly Effect.

Entering the year, the yields for government bonds in European economies were falling due to the impact of the European Central Bank’s LTRO program. (For a detailed explanation of the LTRO program see Behind The Curtain: The European Bank Bailout & LTRO Part 2: Central Banks Are Making Their Last Stand)

Fast forward to today and Spanish government bonds are once again approaching the 7% mark, considered by many the “point of no return”, where they will have massive difficulty funding both their current and future payments. Italy has tracked higher along with Spain, quietly moving into the danger territory.

Greece continues to be an ongoing disaster. Before Greece’s bailout in March (discussed in detail here) the country had 368 billion in government debt outstanding. The bailout forgave 100 billion of this debt and simultaneously provided a 130 billion euro rescue package (additional debt). This gives Greece a current debt total of close to 400 billion as their GDP continues to shrink in size month after month.

They lurch forward as a zombie country today based solely on life support with no access to the debt markets outside the current bailout system. Based on the information in the paragraph above, a 5th grader can understand that their current situation is now worse than before the bailout and they will need continuous help moving forward.

As part of the bailout package, the Greeks were forced to agree to “austerity programs” which means spending cuts. These cuts come at a time when the economy is already in deep recession/depression based on the unemployment numbers and negative GDP growth.

The people of the country are obviously upset. Polls show that Greeks do not want austerity cuts, but they do want to stay in the euro. Both of these cannot happen simultaneously and which direction they choose to move in the months ahead will have an enormous impact on their political polls and the global economy.

In the meantime, while their general public decides on whether they would like to remove themselves from the euro currency or not, depositors have decided not to wait. Money has been fleeing the Greek banking system over the past six months at a relentless pace, moving into the safety of German and Swiss banks. The following chart shows this silent bank run taking place:

While the Spanish bond market has not quite reached the dire levels of Greece, the Spanish citizens, corporations, pensions, and financial institutions have connected the dots and have already begun moving their money as well.  The month of April saw a 31 billion euro outflow from the Spanish banks.

The deposit outflow only compounds the problems the battered Spanish banks face with their mountain of toxic real estate loans resting on the balance sheets.  Bankia, one of the largest banks in Spain (after already merging with other toxic balance sheets), announced over the past few weeks that they will need a bailout of 19 billion euros ($24 billion) in order to survive. The current bank bailout fund in Spain has only 5.3 billion euros available. Where will the government find the remaining 14 billion euros when they are having trouble financing their current deficits? This is an excellent question.

Estimates have already begun to emerge on what type of bailout package/firewall would be needed to keep both Spain and their banking system alive. An EU/IMF bailout package to cover their funding needs through the end of 2014 (enough time to temporarily calm the markets) would need to be 350 billion euros in size, 75 billion of which would be used to recapitalize the banks.

The European banking system as a whole is $46 trillion in size. In comparison, the US banking system is now only $12 trillion in size. This is due mainly to the excessive leverage the European banking system has in place (26 to 1) vs. the United States which has deleveraged significantly following the financial crisis (12 to 1).

Standing behind their banking system is the balance sheet of the European Central Bank (ECB), which is currently leveraged at 36 to 1 and has mushroomed to over $4 trillion in size.

Up to this point the ECB has not begun to monetize assets directly as the Federal Reserve has over the past few years through various QE programs. The ECB has created programs that exchange assets in return for cash. The problem is that European banks are running out of assets. Europe will soon reach the point where either the ECB must monetize debt directly or their entire massively leveraged banking system with both real estate and government toxic debt will collapse on itself.  The following chart shows the continuous decline in European banking stocks, now down 50% from July 2011.

What lies next for Europe? Forecasts for unemployment continue to rise across the board.

Deposit outflows appear to be picking up speed and the bond yields of Portugal, Spain, and Italy continue to move slowly toward the abyss. Political battle lines have been drawn between “Austerity vs. Growth” on how to deal with the future.

My belief is that in the short term, the people of Europe will continue to vote for anyone who tells them they are against austerity and for both increasing government spending and “stimulating” the economy through this rough period.

As recently as a few months ago, both France and Germany were vocal supporters over the need for austerity across Europe. As the French economy begins to slow down and their banking system (which holds a massive amount of Italian government bonds) continues to deteriorate, they have slowly changed their tone and moved toward “growth through spending.”

In the meantime, while the politicians argue back and forth, the rest of the global economy is feeling the pain of the European slowdown. The butterfly effect is now once again front and center.

Up Next: The Butterfly Effect Returns

h/t Wall Street Journal, Eric Sprott, Phoenix Capital Research, Zero Hedge

2012 Second Half Outlook: The Butterfly Effect Returns

2012 Second Half Outlook: Introduction: Psychology & Sentiment
2012 Second Half Outlook: Policy Response & How To Invest

The following picture provides a great visual of just how interconnected our global economy is today. It shows that over 50 percent of the global trade now runs through Europe.

This means that austerity cuts in the PIIGS (Portugal, Ireland, Italy, Greece, Spain) have an impact on factory workers in India and China. The impact on those factory workers has an impact on investment demand in the United States and Brazil, and so on it goes. The PIIGS economies make up over 5% of global GDP seen in the following chart.

As Europe moves into recession, the butterfly effect has washed onto the shores of two of the largest economies in the world: India and China. The following graph shows India’s GDP collapsing downward to only 5.3%, below the 2008 financial crisis lows and the lowest level in 9 years.

The problems in China are even greater. Beginning in 1990, China built their economic model around export led growth. They did this by providing goods at a low price (through extremely low wages of Chinese workers) and artificially manipulating their currency to stay competitive. This model worked beautifully until the main purchaser of these goods, US consumers, hit a brick wall in terms of their ability to take on additional debt and spend (we will cover this topic in detail in just a moment).

As exports began to collapse in late 2008, China faced a serious problem. International newspapers reported that 20 million Chinese factory workers lost their jobs and were forced to return to the countryside to look for work as agricultural laborers. China needed a way to keep the economy growing until exports picked back up and they responded with the growth of credit through the banking system.

China allowed the total number of bank loans to grow by 60% over a two year period beginning in 2009. This number is staggering. Money flowed or was channeled into massive real estate projects. Visitors in China’s largest cities over past few years always reported seeing hundreds of cranes filling the skylines. China began to build empty cities and enormous empty malls. The factory worker jobs were replaced with construction based jobs.

Over 25% of China’s GDP is now related to the construction industry. Over the past 8 months there have been problems emerging for this “economic miracle." Real estate prices, which had been surging in price due to the massive credit expansion, have now reversed and are falling. Developer loans for massive projects built for future growth now sit empty and the loans are delinquent. The cranes that once flooded the skyline are now slowly disappearing as the massive effect of overbuilding takes hold.

China is now in serious trouble. They have have an oncoming banking crisis and an economy that is searching for its next form of growth. They are looking for the next “economic miracle” just as Japan was after their real estate bubble burst in 1990. Recent manufacturing data (their PMI) show a continuous and worrisome decline.

China’s goal was to buy some time until their global export model moved back into high gear allowing real estate workers to shift back into factory workers. In order for that to happen, the consumers of the largest economies have to once again be both willing and able to borrow and spend. We have already discussed the outlook for that prospect in Europe. We will now look at the United States .

Up Next: US Consumer Credit Growth Potential

h/t Sober Look, Richard Duncan

2012 Second Half Outlook: US Consumer Credit Growth Potential

2012 Second Half Outlook: Introduction: Psychology & Sentiment

Richard Duncan’s most recent book The New Depression (the best book of this year) did an incredible job  explaining how both the United States and global economy have become dependent on credit growth for economic growth. The inflection point came in 1971 when the world moved off the gold standard and all currencies began to float against each other, backed by nothing, allowing an unlimited amount of credit to be created.

And grow it did. Between 1971 and 2008, the United States economy saw a credit expansion from $1 trillion to over $50 trillion. The impact this had on global economic growth cannot be overstated. It allowed a massive global stock market boom (1980 – 2000) followed by an even larger global real estate boom (1997 – 2008). In some countries, such as Canada, this real estate boom even continues today.

The American consumer took on an unprecedented amount of debt in order to finance an enormous consumption binge. Home equity lines were withdrawn to purchase new kitchens, vacations, clothes, and electronics. An unlimited amount of credit was provided at 0% interest to finance new car purchases. Anything remaining to be desired could be financed through credit cards. And it was.

Then in 2008, the ability to finance this debt, in many cases through borrowing additional debt, reached the breaking point. Since the 2008 financial crisis, the US consumer has entered a massive deleveraging period where they have paid down (or defaulted on) credit cards, auto loans, and mortgages. Taking on more debt or opening a credit card, once the trendy thing to do, has now become uncool. 

The following shows total household debt through the first quarter of 2012. All categories of debt continue to fall month after month, except one (which we will get to in a moment).

The main reason why debt can no longer expand is that income growth did not rise with the borrowing binge of the past few decades. We will discuss both income and employment in the next section. 

You may have read in the headlines recently that total consumer debt has been rising and it has. It rose by $21.4 billion from February to March - the largest month over month rise since November of 2001.

The problem is that almost all of these gains have come from only one sector: student loans. While the American consumer has continued to pay down mortgages, credit cards, and auto loans, they have opened the floodgates with student loans.

Since the peak of household debt in the third quarter of 2008, student loan debt has increased by $293 billion while other forms of debt have fell a combined $1.53 trillion. The following graph helps paint the picture of the exponential growth in this market.

This massive surge in debt (along with federal government spending which we will get to) has provided a form of the “economic miracle” in the business of education. The unlimited amount of money has allowed tuition prices to soar to unimaginable levels and real estate construction and local businesses to boom in college towns.

The problem, just as the Chinese have recently found out, is that someone needs to actually pay back the money that has been borrowed. Student loans that are 90+ days delinquent have surged to 8.7% in the first quarter, a number that is higher than the peak in mortgage delinquencies. The government essentially took over 100% of this market back in 2010 through its Sallie Mae vehicle (think Fannie Mae for student loans). As these loans continue to sour, Sallie Mae will need a massive injection of tax payer support.

Why are these loans beginning to go bad? The income is not there to support the payments. How do you create income? Employment and wage growth. We will now look at both.

Up Next: US Employment & Income

h/t Calculated Risk, Wall Street Journal

2012 Second Half Outlook: US Employment & Income

2012 SecondHalf Outlook: Introduction: Psychology & Sentiment

This past Friday we received the US employment numbers for the month of May and they were catastrophic. Analysts had a consensus estimate of 150,000 new jobs created. The number came in at only 69,000 new jobs created. The April number was revised down to 77,000 from the originally reported 115,000. Almost all of the job growth came from part-time jobs. From the Wall Street Journal:

The number of Americans working full-time fell by 266,000 in May, erasing all the gains of the past three months. The total employment figure only rose because 618,000 more people got part-time jobs. Many of the people would rather be working full time: the number of people classified as “part time for economic reasons” – meaning they’re working part time because they can’t find a full time job rose by 250,000 to 8.1 million people.

For the first time in history, a majority of jobless workers over 25 have attended some college (see student loan discussion above). In addition, more companies continue to higher from overseas.

So with the number of people unemployed, taking part time jobs, and taking pay reductions surging, how is the American consumer continuing to go shopping every month? Government stimulus programs.

The following graph shows the number of Americans that have flooded into both the food stamp and disabled workers programs for government income:

This has been combined with the two years of unemployment benefits. The percentage of Americans receiving government benefits had risen to 49.1% at the end of quarter one 2011. The number is certainly higher today.

In addition to direct government support, there is the current economic stimulus of those not making mortgage payments. While foreclosures continue to be held off the market (see Home Prices Reach New Lows), it allows an enormous number of Americans to live payment free month after month. 

In a moment, we will discuss how this federal spending has been financed as well as the outlook for employment, but first let's take a look at current asset prices around the world. You must know where you are today before you can determine where you will be moving in the future.

Up Next: Asset Prices Today

h/t Wall Street Journal, David Rosenberg

2012 Second Half Outlook: Asset Prices Today

On Friday, after the jobs report, stocks fell 2.5% on the day to close the DOW at 12118. Gold was up 4% on the afternoon - the highest one day gain since January 2009 - and finished at $1,622.

Looking beyond the US stock market at the global stock markets shows that the MSCI global market index peaked in April and has been falling steadily for the past 30 days. Stocks are now falling in unison around the world.

Commodities peaked on April 22 and they have been falling line with stocks. The index was crushed further this week as oil prices continue to take as massive beating - falling to $83 on Friday. The CRB Index below shows this longer term decline:

Up until Friday morning precious metals were part of the commodity decline. For an update on where we are in the real estate cycle see Home Prices Reach New Lows.

With money moving out of stocks, commodities, and real estate around the world where is money moving right now? Bonds. And it is moving there with massive force.

The 30 year US treasury bond finished the trading day at 2.5%. The following graph provides a long term view of US treasury long term rates going back to 1790. We are now moving down toward the 2.09% record seen in the 1940’s when the Federal Reserve held interest rates artificially lower for almost a full decade.

The 10 year US treasury bond reached 1.43% on Friday: the lowest return in over 220 years of data, meaning they are now priced higher than any time in history.

This dynamic is playing out around the world as investors move back into “risk off” mode. Money is crowding into the short term debt of what is perceived as the safest government balance sheets and currencies. The following shows the return on a two year German government bond moving into the negative in Friday’s trading. This means investors now pay the German government to hold their money for the next two years.

The following is a table of the ten lowest 10 year government bonds in the world. Investors now only require .48% for the Swiss government to hold their money for ten years and .81% for the Japanese government to hold their money for 10 years. Yes, that is one half of one percent.

This dynamic can be seen even more clearly through a longer term view of the two year yield in the US, UK, Japan, France, Canada, and Australia in the graph below. Investors charged these governments close to 8.5% per year to use their capital back in 1990. Today they lend governments their money at no charge.

For the past four years, the average investor has removed money from the “danger” of the stock market into the “safety” of bond funds. In addition to pension funds and insurance funds increasing their bond holdings, regulations are being put into place to force banks to hold more government bonds - this is part of a process known as financial repression (for a complete discussion see What Is Financial Repression?

Now that we know how we got here and have a benchmark of where the markets are today, let's look at possible policy responses to the global downturn and what is means for asset prices in the months ahead:

Up Next: Policy Response & How To Invest

h/t The Big Picture, Sober Look

2012 Second Half Outlook: Policy Response & How To Invest

2012 Second Half Outlook: Introduction: Psychology & Sentiment

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

As discussed throughout this outlook, the global economy is now exclusively dependent on the ability for credit to grow in the financial system. If credit begins to contract, as it is in many parts of the world today, it tends to infect other parts of the global economy through the interconnected nature of our financial system, a concept I like to call the butterfly effect.

Our discussion has also reviewed that the former driver of credit growth around the world, the American consumer, has hit a wall in their ability to borrow. Since this dynamic began in 2008 we have seen governments around the world unleash massive stimulus programs (growing credit) and this has occurred simultaneously with central banks purchasing an enormous amount of debt to keep interest rates artificially low. These lower rates have allowed many troubled borrowers to refinance and new projects to come online  that otherwise would not (known as mal-investments).

These investments will face their judgement day at some point in the future when interest rates eventually rise off their artificially low (close to 0%) levels. Many commercial real estate, residential real estate, mergers, acquisitions, financial trades, and business projects have taken on a tremendous amount of debt over the past few years using models that show interest rates staying low forever. They will not, and these investors and investments will be slaughtered in the years ahead.

But we are getting ahead of ourselves. That is a much longer conversation for another day. You want to know what is coming next.

With the former engine of credit growth unable to grow, a projection toward the future should be based on the policy response from both governments and central banks around the world. These are the last remaining entities capable of additional leverage and credit (for now). It seems strange to look at the world this way, but I assure you that the stock price of a company over the next six months is going to be determined far more by how the central banks of the world take action vs. how that company's management team takes action. We live in an economy that is floating on hundreds of trillions of dollars in credit that is floating on over a quadrillion in derivatives contracts.

So let's begin with the United States. The US is currently in an election year meaning that the ability of the leaders to come to a compromise that would bring a large scale stimulus program is very unlikely. This means that through the remainder of this year the burden rests exclusively on the Federal Reserve.

The Fed needs to have a large asset price sell off before they can make their move and based on how the markets have moved since May 1 it looks as if they will get it. The most important asset class for the Fed when looking at their ability to take action is oil. The cost of gasoline at the pump is something that stays in front of Americans every day. It not only makes a major impact on discretionary spending, it has a major impact on inflationary expectations.

People do not talk about inflation running high at dinner parties when the price of copper or sugar goes up, but gasoline is something that they can constantly measure and quantify. Oil has collapsed over the past 5 weeks with the slow down in the global economy. Touching over $110 a barrel just a few months ago, it is now moving close to the $80 mark.

In addition the Fed will be watching the stock market. Bernanke has discussed the "wealth effect" many times in the past (describing consumers likelihood to spend when stock prices are higher) and has even used rising stock prices to justify his actions as a success.  The key question is; how big of a sell off in the market is needed for the Fed to make their move? The following shows the Fed's intervention in the market during each sell off during the past four years and its effect on the stock market. You can argue that they have "bought" a total of 1,150 points on the S&P 500.

The Federal Reserve has monetized (printed money to purchase) 60% of the increase in treasury and GSE (Fannie/Freddie) paper since 2008. The following graph shows this amazing level of activity in the market with the Fed's purchased highlighted in red.

I believe that the Federal Reserve will announce QE3 at some point this year. The program will be focused on both treasury and mortgage bonds. They have very little tools remaining in their box beyond purchasing these bonds. During Bernanke's helicopter speech in 2002 he discussed the Federal Reserve entering the stock market to purchase equities, but I don't think we are quite at that point (yet).

Europe is now waiting on the next major bailout program to prolong the collapse just a little bit further. The truth is, once you have looked at the situation from every possible angle either the European Central Bank (ECB) will step in with major force (even greater than their massive LTRO program) or the ship is going to go down. At the end of the day when their backs are against the wall I believe they will print. Remember that entering the weekend before Lehman's bankruptcy American politicians (and the central bank) were in agreement that no more bailouts would occur under any circumstance.

When Lehman failed it opened the door to hell and the world was able to gaze in. Will they need a "Lehman like" bank or country to fail before they have to political will to unleash the ECB on the markets? Maybe. This is the problem with trying to forecast a market not based on economic analysis, but the whims of political decision making.

How about the rest of the global economy?

China, as we discussed in detail, is in serious trouble. While a complete discussion on how I expect China's government to react is beyond the scope of this outlook due to the length of time it would take to explain the China-US currency/trade relationship, let me try to explain it in quick and easy terms. In order to keep their currency pegged to the United States the Chinese central bank must mirror the actions of the Federal Reserve. If the Federal Reserve unleashes QE on the markets this year, China must do the same, a concept that few market participants understand.

Australia and Canada are two countries in similar circumstances. Both have experienced an ongoing boom in their real estate market that allowed them to recover from the collapse of 2008 at a much faster rate than the rest of the world. Australia's housing bubble has just begun to burst (a topic I will cover in great detail in the months ahead) while Canada's has not yet rolled over (making it even more dangerous). Other than their coming problems in their real estate markets they have strong government balance sheets and export driven economies. Australia is heavily dependent on both Japan and China for exports meaning that while all emerging markets will suffer they will be hit extremely hard in the coming global downturn. Brazil, while having slightly different characteristics than these two markets, is also in a very similar situation.

How will their policy makers respond? Currency devaluations and stimulus programs.

Japan, just like America, is currently receiving the benefit of money moving rapidly out of the Eurozone and looking for a home. Their currency and their bonds have both appreciated significantly, something that is only partly welcomed due to their export led economy. What no one is discussing or looking at today is that Japan is the next sovereign debt crisis, and they will make Spain and Italy look like child's play when it begins. Until that point, however, their underlying rot will remain undiscovered by the markets. For much more see Japan Government Bond Disaster: The Storm Cloud Approaches.

Before they enter their coming crisis, Japan's central bank will continue to both intervene in the currency markets and the financial markets through QE programs as they have been over the last two decades. Japan is further along than the United States' QE programs in that they are already printing money to purchase stocks.

Now that we understand that the global slowdown has arrived and have an understanding of how policy makers are likely to respond we can look ahead at how a portfolio should be constructed.

Entering the year, I felt that a portfolio should be composed of safe cash and precious metals. Sentiment levels toward the future direction on stock prices were at extreme highs. Sentiment levels toward precious metals were at extreme lows as they were just coming off a massive sell off.

Entering the second half of the year we are now in a slightly different situation. The stock market has now sold off for a full month and the index has just crossed into negative territory for the year. With stock prices moving lower, as we discussed in depth in the introduction, people can "see" that there may be some trouble ahead for the economy. Sentiment levels have moved much lower.

Does this mean this is a strong entry point for the stock market? I don't believe we are there yet, although, I would not recommend taking a short position with sentiment levels this low. Only after major rallies with high sentiment during secular bear markets (something we saw in March and April of this year) do I recommend actually betting on prices falling.

I have said since the spring of 2010 that you want to hold on to current positions and raise new cash. Nothing has changed since that point (other than a brief green light to purchase additional precious metals back in December). You want to put together a shopping list of attractive assets you want to own for when they go on sale during a deflationary sell off. For example I personally like:

Gold, Silver
Precious Metals Mining Shares
Oil, Agriculture, Water, Rare Earths
Specific Stocks Purchased Through These Currencies:
Australian Dollar
Canadian Dollar
New Zealand Dollar
Brazilian Real
Asian Currencies

Are any of these assets cheap enough today for me to be purchasing them today? Yes, I have been purchasing the past few weeks silver and specific precious metals mining shares (although the mining shares have recently exploded upward in price over the past week making me more cautious to enter here). Other than making purchases in those two specific assets, I continue to raise "safe" cash while I wait for the others to go on sale.

Oil and agriculture are close to what I believe are good entry points for long term investors looking for businesses that generate dividends through these commodities. The DBA ETF in the 22-24 range, and oil in the mid to low $70's would give the green light to begin accumulation.

I have closed my short position on the stock market that I took on in April. If the market rallies and sentiment begins to get back to frothy levels then I will bring the shorts back on.

This list above is not for everyone. These are the assets that I believe are in long term secular bull markets. I believe that the stock market is currently in a cyclical bull market (which may have just peaked), part of an overall secular bear market (for much more on secular cycles see Secular Bull & Bear Stock Market Cycles Back To 1870).

I believe that the bond market is currently in the final stages of the greatest bubble ever. More money will be lost over the coming years in the bond market than in the stock market and real estate bubbles of the last decade combined. I will spend much more time discussing the dangers of bonds in the months ahead.

For an explanation on what I mean by "safe" cash as well as recommendations on both how to purchase precious metals and get recommendations on the best precious metals mining shares please see: 2012 Outlook: How To Invest.

If you are looking to add precious metals to your portfolio, I personally use and recommend Goldmoney. You can open an account in just a few minutes and begin storing metals electronically in safe vaults around the world by visiting the following link:

GoldMoney. The best way to buy gold & silver

Friday, June 1, 2012

Global Macro Investor: The End Game

Raoul Paul, founder of the Global Macro Investor, has put together the following excellent presentation discussing the future for the global markets and the financial system as a whole. His conclusion is that we are now in the final years of our current monetary structure and we are nearing the point of the big "reset." He sees the first domino being a European bank failure that will trigger a global financial collapse. The End Game

Thursday, May 31, 2012

One Thousand Years Of Europe

Interesting video below that takes you through how the look of Europe has changed over the last 1000 years. What I noticed in particular was how steady France stayed in terms of territory control from the very beginning through today.


Tuesday, May 29, 2012

Home Prices Reach New Lows

I have been reading more and more from those that were previously bearish on housing who have now become bullish and are putting in their "bottom calls." I will get that to that in a moment, but let's begin with the data.

This morning we received the Case-Shiller real estate prices for the month of March, which showed all three composites touching new post bubble lows (from the peak in 2006). The national composite was down 2% in the first quarter.

Earlier in the month we received housing permits, starts, and completions (the natural three step process real estate moves through in order to come out of the ground). While almost all the current activity is focused on the multifamily portion of residential real estate, you can see in each of the charts below that we are still in multi-decade troughs in terms of activity.

Housing Permits:

Housing Starts:

Housing Completions:

At the bottom of each of the graphs above, you'll notice that the data has turned up slightly from the lows. This has led to market observers "putting in the bottom" for real estate prices. Under a normal boom/bust cycle this would be correct, but as I have discussed many times in the past, this was no ordinary cycle.

Housing still faces enormous headwinds in the months ahead in the form of underwater mortgages, shadow inventory, rising interest rates, demographic trends, and a struggling jobs market.

We'll begin first with the underwater mortgages. The following graph shows the total percentage of underwater mortgages in the United States (far left blue line), which has crossed over 30%. It is incredible to think that almost 1 out of every 3 mortgages in America is drowning.

The shadow inventory is the category I believe is fooling some of the recent bottom callers. When the robo-signing scandal was completed at the start of this year it was assumed that the backlog in homes held off the market would begin to make their way into the inventory supply. This has not yet happened as seen in the graph below. This inventory, which continues to be held off the market, has created an artificial supply squeeze in many markets. This will change when the dam breaks.

To compound these issues, there is the larger and larger percentage of the youth in America that are moving in with their parents. These younger students that finish college with tens of thousands in student loan debts needing to be paid every month now have far less money to put toward either a monthly payment or a down payment (even with the government's ridiculous 3% down loans). It will take a "cleansing" of this debt (tax payer funded bailout) from a politician looking to get elected, perhaps as early as this fall, that will provide the boost needed to get these younger Americans into homes (or coffins - as they are referred to these days).

Speaking of homes underwater, there are currently over 12 million underwater homes, but there has been a recent change into what type of loans make up this toxic debt pool. In the graph below you see the new entrant to the party, government (tax payer) backed FHA loans which now make up close to 25% of the total and rising fast.

This has created a surge in FHA delinquencies, and they will soon either need a bailout or they will be forced to create much stricter lending standards - meaning less potential homeowners will qualify for a loan.

We are much closer to the bottom for real estate prices than we are to the top, however, I believe there will more pain ahead before we find that bottom. The speed at which we reach the bottom will depend on how soon the shadow inventory enters the market and how long the government can continue to fund subprime loans.

The following chart shows month over month and year over year changes city by city. The price declines in Atlanta are staggering (click for larger image).

For much more on the outlook for residential housing see 2012 Outlook: Residential Real Estate.

h/t Calculated Risk, The Big Picture, Dr Housing Bubble, Zero Hedge, The Chart Store

Jim Rickards: Currency Wars Presentation

Jim Rickards, author of one of the top two books released last year (along with John Mauldin's "Endgame"), provided this year's Casey Research Summitt with a presentation on the current currency wars. The following is a portion of that presentation:


Monday, May 28, 2012

Memorial Day Weekend - Taking Chance

I spent some time this weekend watching the movie "Taking Chance," which documents the true story of a marine lieutenant volunteering to escort home the body of a fallen marine from his home town. The movie was excellent and brings you through the entire process of a soldier coming home to his family from war in the worst way possible. It makes you appreciate those out there that continue to fight for your country, whether you believe in everything they are fighting for or not. For readers outside the United States, while our country has a laundry list of problems (usually discussed here on this site), remember it is our forces and our troops that keep the peace around the world. When our country reaches its debt crisis and funding for those forces will no longer be possible or significantly reduced, it is hard to argue that the world will be a safer place. Take some time to thank someone you pass wearing a military uniform, and if you are looking for a good film I highly recommend "Taking Chance" on Memorial Day.