Friday, June 27, 2014

When The Herd Turns & Investors Leave U.S. Assets

We're in a period right now, and have been for some time, where almost all asset prices around the world are expensive. Other than a few brief glimpses of value, which I tend to document hear as I nibble with purchases, the market environment today is set up for an investor to essentially sit and wait. My argument over the past few months has been this sitting should be done with a portfolio composed of a higher than normal weighting of cash to allow an investor to have capital for when the "sitting" becomes "buying."

Sitting drives people crazy. The financial market casino knows this and it's how it makes its money. If someone is just holding and not trading, the market machine is not skimming the top of trades with commission charges as investors come and go. Selling also involves paying taxes which is why Warren Buffet suggests that the best length of time to hold a stock is forever.

Instead of getting frustrated by the lack of activity, I try to use the sitting time as an opportunity to develop my general skill set within the markets. I have often discussed my study of commercial real estate study through management and finance, but I have also begun studying some of the best books on equity investing.

I believe the next major downturn in the U.S. stock market is going to be the last decline of the current secular bear market. A secular bull or bear market tends to last 17.6 years on average and we are fast approaching that mark (the current secular bear market for stocks began in March of 2000). Actually talking about the secular bull coming to end makes me feel old.

During the next decline, I believe the most likely scenario will be U.S. stocks, bonds and real estate falling together (bonds rallied during the 2008 decline while stocks and real estate fell). 99.99% of market participants and analysts believe this is the least likely scenario.

The world began moving in an enormous herd toward all U.S. financial assets beginning in mid 2011. This has continued for three straight years. This herd now believes U.S. stocks, bonds and real estate falling together would be a physical impossibility.

What I believe this group underestimates is the extent to which we now live in a global marketplace. All it would take to shift the herd would be a portion of the capital seeking investments outside the borders of the United States. Or potentially shift into cash or commodities.

Herd behavior is one of the most fascinating psychological pieces of the financial marketplace. The following brief video looks at this phenomenon, and the opening elevator scene sums up the global markets perfectly:

Thursday, June 26, 2014

GDP & Profits Fall In The United States: The Stock Market No Longer Cares

We learned yesterday that the U.S. economy contracted by 2.9% in the first quarter. Corporate profits also experienced a cyclical peak in the first quarter of 2014 as seen below:

Analysts have shrugged this off as a simple anomaly due exclusively to cold weather. However, there has been continued weakness in many sectors of the economy (including housing) into the warm spring months.

Meanwhile, the stock market has not only ignored the weakening data, but continues to surge higher every week. It is now pricing in perfection moving forward the next 12 months and beyond. The green bars show the return of equity inflows from 401k funds which tends to occur at a cyclical peak when the public rushes in to capture the easy stock market fortunes that await.

Perhaps the economy resumes its cyclical growth, housing begins to turn up again and corporate profits once again accelerate higher. The problem is the market has already priced in this utopia. It is only confidence and euphoric speculation now pushing it higher.

Sunday, June 22, 2014

The New Credit Mania Is Now Complete & Its Resolution Will Be Catastrophic

There was a brief deleveraging period in the United States following the 2008 financial crisis where Americans felt they should cut back on additional borrowing and even pay down some of their debts. This period did not last long as Americans almost immediately returned to the debt markets to borrow money on mortgages, auto loans and student loans.

Loans for those three categories have been sponsored by the U.S. Federal Government (tax payers) through Fannie & Freddie (mortgages), Ally Bank (auto loans) and Sallie Mae (student loans). Hold on, Ally bank is a private company, right? That is true. It is the recreation of GMAC, which provided auto loans up until 2008 when it went bankrupt and was bailed out by the government. Ally is the worst kind of government monster where the share holders keep the profits during cyclical growth periods and tax payers pay for the losses during cyclical declines. This is how the U.S. banking system works today with Bank of America, Citigroup, etc., leveraging up and collecting profits and massive bonuses on the way up and tax payers standing ready to bail them out following the next collapse.

The total U.S. debt mountain, after taking a moment to catch its breath in 2008, has now surged to $60 trillion in size.

Any remembrance of what got the world into trouble leading into the last financial crisis has been completely swept from the collective conscious. The leveraged mania goes beyond the mountain in the chart above, even returning to the stock market. You can see in the chart below that we have now experienced the third "mountain of margin" (stock purchased with borrowed money) during the last 20 years. The third peak of the mountain came this past February with the climax of the biotech stock mania.

One area within the credit markets where many thought Americans had finally learned their lesson following the 2008 crisis was credit cards. While mortgages, auto loans and student loans have surged higher during the last five years, Americans have continually paid down their credit cards and refused to open/use new accounts. This changed in early 2014. Americans stopped paying down their credit card debt and have opened their wallet to go out and spend future earnings/savings. After all, they are now certain their 401k balances and home prices will only move higher next month and the month after. These higher levels of appreciation will take care of any money needed down the road to pay off additional debts taken on today.

But what if 401k balances and home prices began to move sideways or even decline? All that would be left under the surface to pay down these debts would be real wages. Beneath the $60 trillion mountain of debt, it is real wages of the American people that must ultimately grow in order to pay off these existing and future liabilities. Ultimately, Americans are responsible for paying off the debts borrowed by federal, state and local governments through taxes. They are responsible for paying off their mortgages, student loans, auto and credit cards. They are even responsible indirectly for paying off commercial and business loans because they must purchase the products these businesses create with the money left over every month after taxes and loan obligations have been paid.

Here, unfortunately, is where we see the magical economic circle of printed money and credit growth does not complete. Data released this past week shows that real average hourly earnings are now at the same level they were the month after Lehman failed back in 2008, almost six years.

While the illusion created through massive borrowing and printed money has been truly epic, the resolution will be equally legendary. As asset prices begin to decline and the debt mountain begins to implode, the world will find out the god-like powers central bankers are believed to possess are nothing more than a parlor trick. Then you will see fear spread across the collective conscious in unprecedented fashion. As the world rushes toward the precious liquidity available, there will be a once in a generation fire sale buying opportunity for the once beloved paper asset prices around the world. Stay patient.

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