The Barnard Observer
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Home Vault Misc Contact c2003-00 Thomas Barnard
The Recession of 2008
The Narrative
Well, I was wrong last time. There was no simultaneous new low for both the Industrial Average and the Transports, although there was a non-simultaneous sell signal from last year. The good news is that although we are still seeing 300 point down days, the number of new lows is decreasing, though I am not getting much comfort from this.
We have two huge industries in consolidation: housing and auto. It remains to be seen if we can continue high employment with these two central industries in free fall. You want signs of consolidation? Ford is selling Jaguar to Indian company, Tata Motors. The other day, UBS announced $12 billion in write downs and the market goes up. I don't think this can be believed.
And there isn't any particular good news from the drug companies, Merck and Schering Plough fell down go boom-boom with the news on Zetia and Vytorin.
One question we have to ask ourselves, is if the Asian countries, which have been feeding off the over-consumption of America, have internal growth sufficient to avoid a crushing recession if the U.S. falls into one. I suspect the answer will be: not yet.
Bernanke, a student of the Great Depression, is doing everything in his power to avoid the psychology that came with the massive stock market sell-off in 1929. With that sell-off came severe consequences. The consumer stopped spending. When the consumer stops spending, they don't buy autos or houses or gifts for Christmas. And nothing could be done for 10 years to get the consumer to spend, and the economy went into the crapper.
Bernanke would like to avoid this crushing sequence of events. In his Senate testimony, he said that Secretary of Treasury, Andrew Mellon, felt that the government should do nothing, and allow businesses to fail. And fail they did, by the thousands. He intends to act to avoid this. Certainly, in his camp is the successful investor, George Soros, who recently said, ``The belief that markets tend towards equilibrium is directly responsible for the current turmoil,'' the billionaire philanthropist writes. ``It encouraged the regulators to abandon their responsibility and rely on the market mechanism to correct its own excesses.''
Certainly, if spending has to drop off, he would like it to be gradual and not precipitous, so that it won't take as much for spending to start up again.
Unfortunately, his hands may soon be tied because the Fed's main job is to protect the currency, and inflation has already kicked in, Starbucks tall cup of coffee is now $1.80 in Oak Park. So, if another crisis arises among the banks, there may be nothing to do but let the business fail. Moreover, why should the Fed protect the greedy employees of Bear Stearns?
George Soros predicted, "It is not going to be like the 1930s – we are not going to allow financial institutions to fail – but this is a historic event like the Great Depression was."
He was in England when he made his remarks, here is some more, "To say that it won't affect the real economy is untenable, because it affected it on the upside, so it will affect it on the downside. Recession in the US is inevitable. There will be implications for the globalised economy and the UK happens to be as vulnerable as the US, but in different ways. The finance industry is much more important to the UK because London is a financial centre and the industry is going through a painful process of deleveraging. The housing market in the UK has at least not seen the building boom that we have seen in the US and the supply of new homes has not gone up, but on the other hand, the indebtedness of UK households is actually even greater relative to income than in the US."
There is a flip side to allowing markets to correct themselves as Mellon recommended, and that is to over-intervene, to muck up the works with intervention after intervention.
The Mortgage Problem
Well, there is a tendency at least on my part, to blame a lot of the mortgage crisis on Alan Greenspan. He kept the rediscount rate too low for too long. He did nothing in the way of oversight of bank lending practices, or other regulation. When he saw the housing industry go too far he didn't suggest Congress give up the mortgage interest deduction, to slow down new home sales. And so far, he is not owning up to his end of the problem.
But all of the blame is not his. Long term rates were kept down by the Chinese, who used their dollars to buy more treasuries, and buying treasuries kept the long term interest rates down. Just an idle thought, but maybe the Chinese can get ownership of Taiwan by threatening to sell its horde of U.S. treasuries, which would create untold havoc and chaos in our financial markets. Just threatening not to buy more treasuries was scary enough six months ago that it required a denial for the press. And maybe Bush, when he started to scare the hell out of us with national security, should have thought about the consequences of borrowing so much money to run a "discretionary" war. There are national security consequences that come with enormous borrowing.
Also, the oversight agency for Fannie Mae and Freddie Mac could have insisted on higher standards on the mortgages they were buying. This would have been another way to stop the freight train.
And there is the philosophical question: Just how much influence does the Fed have? Markets are free to adjust rates on their own.
You cannot rule out the evil geniuses. The people who dreamed upped ARMs (Adjustable Rate Mortgages), no-doc loans (loans not requiring documentation, sub-prime borrowers), or lending 100% of the house cost (thus assuming the market risk). I just saw a Frontline on credit cards. There was an evil genius who dreamed up the idea of lower minimum payments (and higher balances for banks to charge interest against). He also developed the idea of low introductory interest rates. The consultant's name was Andrew Kahr.
Maybe years of stable prices and jobs have set up the consumers for the coming crisis. Some have never experienced an economy in serious retreat, so borrowing 100% of the cost of a house or condo, seemed reasonable enough. They had never seen house prices go down. People were quoting Mark Twain on land, "God quit making it." Job loss was not such a big threat. And perhaps this is the problem that comes with fine tuning the economy to avoid some of these potholes in the economy. Consumers lost a sense of the possible adverse things that can happen. Should the government bail out such dumb consumers? Well, that lies outside of the scope of this newsletter, which is to protect your capital. But there is another question, can the government bail out consumers? It may turn out that such bailout will be too expensive. More borrowed money, et cetera.
There are a lot of parties to share the blame, including the useless rating agencies, but I'm not letting Greenspan off the hook, nor, do I think will anyone else. This is from our second newsletter August 4, 2004:
I think that housing is also going to suffer some kind of slow down. Goldman Sachs recently said that houses in the U.S. are high by 10%, but in Britain they are high by 15%, and 29% in Australia. We recently read that a Harvard study puts normal demand at 1.4 million houses per year. Once again demand may have been stolen from future years because we have been running above 1.4 million houses, which suggests there could well be a lull in demand at some point. Further, it appears to me that banks have been reducing their standards to book loans, so there could be trouble down the road for them. And foreclosures, already high, could add to the supply of homes on the market, and damping demand for new homes.
Washington Mutual recently announced its 2004 earnings would be 11% below expectations, perhaps an early warning that the housing bubble is about to pop. One wonders how strong the balance sheets are of financial institutions when you receive unsolicited faxes like the one I recently received advertising the following:
· Bad Credit – OK
· Bankruptcy – OK
· Foreclosure – OK
· No Documentation Required
Yes, I wrote this in 2004, but I am not claiming any prescience. This was just obvious stuff.
Another Problem for Banks
Just as it will seem the banks are finishing up with home mortgage crisis, there is still another possible crisis looming out there. Martin Weiss of the Safe Money Report, says that savior of Bear Stearns, J.P. Morgan Chase, has more derivative exposure than any other bank. Although he engages in the practice himself, Buffett has warned these derivatives may end up being financial weapons of mass destruction.
And Soros also recently warned that the "scariest unregulated market" now is the credit default swap market, with outstanding contracts amounting to $45 trillion today. (Credit default swaps are a form of contract insurance that has been widely sold by hedge funds.)
40 Years
In Business Week, March 31, 2008, Maria Bartiromo interviewed the CFO of Lehman Brothers, Erin Callan, she asked just how tough the credit environment is now, Erin Callan answered: "I think the market is worse than anybody who has been in the industry has seen for the better part of 40 years - including my CEO, Dick Fuld. What started in one or two asset classes in credit and fixed-income assets migrated over the course of the last six months into really virtually every asset class regardless of fundamentals and regardless of basic quality."
The General Problem for Stocks
The real problem for stocks is that the PE ratios have been high for years (16-22). The PE for the S&P 500 is 17. We can expect a regression to the mean, but if the mean is 12-14, you could expect that there could be years of sub-mean or sub-average PEs, such as in the 1970s and 1980s when the PE of stocks was routinely in the single digits. That's the ugly truth. And this means there could still be striking new lows to be endured.
Moreover, I don't think high PE's can be sustained at this time. I do not believe there is the out-sized growth to support such valuations, so no matter what we will see PE's drop. And they already have. Microsoft which sported a PE ten years ago of 40, now sells at 20 times earnings. Same for Cisco. Same for Intel. It is happening right before our eyes. If Microsoft's earnings keep increasing and the stock price remains the same, this would be a gentle means of lowering PE's, but just because we have seen flat prices for years, does not mean we will now see higher prices. They could stay flat, and sudden, horrible dips, as we saw in January, are still possible.
The basic problem with Microsoft, Cisco and Intel is that they are now mature companies, they will never grow as they did in the 1990s. And we don't have these huge new industries to power us ahead, and replacements don't appear on the horizon.
The Problem for the Economy
The most serious problem for the economy is that the consumer may begin to pull in his horns. Consumer Confidence - Expectations stands at 47.9, the graph I was looking at only went back to 1999. In 2000 it stood at 115. This is at a level much lower than we have seen in the past 10 years. The Consumer Confidence Index stands at 64.5, down from, say, 145 back in 2000. Also the lowest level in years.
Even worse is the University of Michigan Consumer Sentiment index, which stands at 62.3. This is the lowest level since 1982. In 1999-2000, it was around 110.
Consequences are already out there, Business Week reports that 100 businesses have shut down in the Guangdong province because of lower demand from the states. Americans are buying less stuff to fix up their homes. There will be less spending because there will be less borrowing by consumers to do kitchens, bathrooms, and decks.
This results in the multiplier effect in reverse. The multiplier effect in the usual sense means that business improving means that companies by more stock to replenish inventories to meet improving demand, the hire more people, who buy more products, and so on. But what happens if this moves in reverse. Businesses don't have enough revenue to meet expenses, so they reduce their employee staff, or shut down. Employees are no longer working, and they no longer buy goods and services.
I am not saying consumers will quit spending, but it sure looks like they will start to pinch pennies, and this is not good for the economy in the short run.
The Good News
From a technical point of view, I think there is room for stocks to rise. Bearish sentiment among investment advisors stood at 44.7% on March 18, and bullish sentiment among investment advisors stood at 30.9%. Its most bearish reading in years. Since this is a contrary indicator, the high bearish sentiment should signal higher stock prices. As of April 1st, bearish sentiment was still higher than bearish sentiment, with 38.5% for the bears and 37.4% for the bulls.
Also, it is not usual for stocks to decline when the monetary policy is easy, which it is. They usually go up, though stagflation seems like a real possibility for now since the Fed is so conflicted about its role. Its role is to keep prices stable, but the Fed is trying to save the world, so all bets are off.
Gold
There may be an intermediate role for gold. We may very well experience more inflation. With a tall Starbucks coffee at $1.80 (including tax in Oak Park), can there be any doubt about inflation? We may also get a secular inflation from the foodstuff sector as we continue to encourage that foodstuffs be used as energy. As farmers roll out more corn, then the acreage devoted to soybeans drops, so soybeans go up. Corn goes up. This is a disaster.
But the plain fact is that there is too much money covering too few goods and services, and that means inflation. Also, central banks, not just the U.S., have been inflating their currencies. Good for gold. The Fed has stopped publishing M3, why do you suppose that is?
But here is the problem for gold: we may end up with serious deflation. House prices are in deflation. Perhaps lumber will end up in deflation. If the economy tanks, even oil may start down. And if we have serious deflation, gold could also lose its value in a serious way. In this case, cash may be your best bet.
Oil and Gas
The question is whether demand from Asia will offset a possible decline in demand in the U.S. Also, higher prices has spurred some exploration. This might be the formula for much lower oil prices. I'm not predicting anything here.
Investment Advice
I am not willing to subject more money to this meat grinder. Here's the scenario I envision: the market will show signs of overcoming the crisis only to have new crises to deal with, and we drop to lower lows. I have no idea when the bottom will be achieved, or what that bottom may be. Best to steer clear. If you have extra cash, now is a good time to own your home. John Templeton thought owning your home was the starting place, so does Richard Russell.
This may seem counterintuitive. House prices are declining. Yes, I agree. They are. Okay, selling now and renting is a possibility, if you are willing to endure the change encountered by such an action. Moreover, selling may not be so easy. I just think it is a good idea to own the home you living in. If things turn south, this is one expense that will be more manageable.
Sure, there are still tech stocks that I like, but now it is going to take some development in earnings to generate recommendations, so I am shying away from any recommendations at this time. In the general sense, I feel the Fed is losing its way. It cannot be all things to all people. It needs to protect the currency from inflation. The government needs to adopt trade and tax policies which will promote employment and earnings.
It's just a feeling, but I think higher stock prices will lead people to think the worst is over, and then stocks will nose dive again. As they used to say on Hill Street Blues, be careful out there. If I thought we'd seen the last of the bad news, I'd be the first to tell you back up the truck. Just doesn't feel that way. Keep your powder dry.
Editorial - Ownership, In Trouble Again
For those of you who own land, you know what I'm talking about. How can you say you own your home, when, if you don't pay your land taxes, aka property taxes, the house goes up for sale. So, really, all you can say when you own land is that you rent the land from the government.
When faced with a monthly health premium of $812, all I can say is that I'm leasing my body from the doctors and hospitals. I can't even say I own my own body.
And Now a Message from Our Sponsor
Mi Cosa
My P10B (potential 10 bagger) is asleep. But management is not. The new billionaire leader is following his plan. He has acquired two new companies in rapid succession. So, where there was one company a year ago, there are now four companies. He has taken steps to get listings on bigger exchanges, and this is happening. This may be one of those stocks that will move ahead even if the economy tanks because it is a new technology that can save consumers, individuals and businesses alike, a lot of money. Though in the environment that I see developing, hopes and dreams are not enough, so I now require substantial earnings to recommend a stock, and they are still ringing up losses.
April 9, 2008