The Barnard Observer
▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀
Home Vault Misc Contact c2003-09 Thomas Barnard
The Next Big Bubble: Government Debt
The Case for a Rally, part deux
About six months ago, I thought we were due for a rally. Mostly, I was wrong, though the present rally may be the one I was looking for back then, and it may persist for a while. Typically, such a retracement rally might recover half the amount we have lost. So, if we have lost something like 7500 points, we might see this thing go back to around 10,000. But it may only make to its previous recovery high of 9000.
I'm not at all clear that 6440 is the final low. The problem is that PE ratios are still quite high. And you have to remember, when things go in the other direction, they can stay there for a while. To get an average PE of 16, that means it spends a good deal of the time above 16, and then it also spends a good deal of the time below 16.
For those who have read me before, bear with me as I reiterate. It took the Dow 23 years to get back to its high point of September 1929. And the Dow hit 1,000 in 1966, but it took 16 years to see any new high ground. I doubt we'll see 14,000 on the Dow for rest of this decade and the next.
Stolen Demand
Again, I have written about this before, but on the economic front Alan Greenspan did us all a disservice. He lowered rates to the point that any kid out of college could buy a condo, and any idiot could buy a car and get a no-interest loan. In short, and I'm stealing this idea from nonagenarian Seth Glickenhaus, who has a wonderful track record, Greenspan stole demand from future years. And now we are there. There is no demand for cars, and the car companies are nearly gone. And the last time demand for houses was this low you have to go back to the 1940s.
It wasn't enough to produce all manner of mortgage products. The ARM (Adjustable Rate Mortgage), for example. Was I the only one who got worried when people were only able to qualify for a loan at the teaser rates? What did those people think was going to happen when the loans re-set at higher rates? For that matter, what did the banks think was going to happen? Well, it is pretty clear by now that the banks didn't give a damn as long as the executive team got its bonuses. And for that matter, the consumer didn't think he was going to hang on to a house beyond five years. He was going to watch Flip This House, and learn how to get rid of it, take a huge profit, and move on to the next teaser rate ARM.
If we take the 20% down, 30 year fixed loan as the norm, then everyone who qualified only for a lesser quality loan (an ARM) was eating into future demand because, remember, this is not the norm. For the past 100 years, everyone needed to put 20% down. And when all the low quality ARM loans weren't enough, then the bankers took their scrapers and headed for the bottom of the barrel. The sludge and gunk that normal bankers avoid. But they went for it, gave it a gentle, up-tempo name, "subprime" (instead of say, god-awful) and cleaned out any demand for future homes.
The truth is that Greenspeak was just what you thought it was: doublespeak. On the one hand, he decried a savings rate that went to zero and then negative, but on the other, he lowered interest rates to ridiculously low levels, and people took him up on it. They borrowed money and spent it, which helped to prop up GDP, but reduced the savings rate even more.
Of course, Greenspan had help. The Chinese and Japanese were buying our bonds, keeping rates down. Mortgage brokers, and real estate brokers, and the investment bankers, and, well, everyone who bought a house expecting to make a fortune on his home. I think that's about everyone, isn't it?
I'm wishing the President and his team all the luck in the world, but if banks have gone back to the old standard of 20% down, 30 year fixed, who is going to qualify for these loans? Not the subprime borrowers, that's for sure. Do I think there will be people who will qualify for those loans? Yes, just not very many. What is important is that the banking system not do further damage. By this I mean, during bad times like this not even people who have their 20% down payment will get their loans. This needs to be avoided at all costs.
I see more unemployment: Indiana reports 10%, California 11.2%, South Carolina 11.4%, yet the U.S. government says unemployment is only at 8.5%. Shadow Stats (http://www.shadowstats.com/alternate_data), which figures unemployment on the old basis, has us up to near 20% unemployment. I think we can expect periods of negative GDP, and slow, slow growth as we absorb all of these bad loans, and bad bets (I speak of the crazy Credit Default Swaps). There seems little question in my mind that this recession will be labeled in history as a depression.
The problem for investors is that by bunching up demand with the squeeze of an accordion, we now have to let it out for a while. For ideas about what might be done: Increasing Employment.
More Demand Problems
The University of Michigan Consumer Confidence Index is as low as it as been since 1982. Consumer credit fell by $7.48 billion, or 3.5 percent at an annual rate, to $2.56 trillion, the Federal Reserve said today in Washington. Credit increased by $8.14 billion in January, more than previously estimated. The Fed’s report doesn’t cover borrowing secured by real estate [Bloomberg].
The consumer does not want to borrow, he's pulling in his horns, he's paying down his credit cards. That's what the fall in consumer credit means. The idea that easy money or tax cuts will make any difference seems to me easily overestimated. Better that the tax cut money went to increasing job rolls, but okay I don't want to wear you out with this.
Create Demand with New and Interesting Products
One of the things that creates demand is new and interesting products. I do not think the great stock market boom from 1982-2007 was an accident. Let's remember, in that time we got: the personal computer, the cell phone, and the internet. But now we are at the point where we have reached 90% saturation point of households with these products.
The automobile was only in 10% of households in 1914, but by 1929 it was in 90% of households. And then demand went into the lurch. Nearly everyone had a car. So, a depression was in the cards. Figure it out: what's going to drive a new bull market? Solar? Maybe. New battery operated cars? Not yet, they haven't reached the correct price point - the batteries cost $10,000 apiece.
This demand cycle scenario has played out time and again. When the railroads all got built out, there was a recession.
But without new great important products, any recovery will be lukewarm at best. I liked the idea of putting a colony on Mars. It would drive the imagination of the kids, and they (and the Mars program) will give us new products.
There will be new great products even if this depression lags on. Biotech will give us some. Obama has freed up stem cell research, and that alone might generate some interesting new products and procedures. Although this may take some years. Someday we'll have robots to do chores for us. Soon enough we'll be talking to our computers, and our computers (or agents or whatever they end up calling them) will be doing stuff for us. Already you can see the other party on the telephone. Skype has done this for free (I'll not get into how a free service can't work indefinitely, which is why Ebay wants to shed it). Televisions will become connected to the internet, and your cable provider may end up being only your internet provider, and one of many possible content providers.
Homes
Home prices have fallen quite a bit, but Harry S. Dent thinks they will fall further. He says they would have to fall 40%-50% to synchronize with long term trends. His work and that of Robert Schiller suggests that adjusted for inflation, home prices typically don't do much at all. He thinks because trends tend to exaggerate price moves, home prices may fall 40%-60%.
Putting things into perspective, Japan has seen falling home prices since 1991 pretty much up to the present time. That's 18 years. Their bubble was somewhat worse, but ours has been a lulu.
Demographic trends will not help housing much. Immigration seems to be slowing down, and couples are having fewer children.
The New Bubble
Well, the obvious new bubble is the bubble in government obligations, which are growing faster than tulips in the spring.
I am not necessarily alarmed by the size of the debt, which I think is necessary to get the economy going, but I'm worried that we will not be getting enough for our money. Martin Feldstein is concerned that we won't even get $1 of GDP increase for each $1 borrowed. Richard Russell said in his letter it takes six bucks of debt for a dollar of GDP. I don't see how paying state deficits and Medicaid deficits counts as stimulus, and although I would usually be for tax cuts, I don't really see how tax cuts will get people who are worried about their jobs to spend any money. As I said, they'll be paying off their credit cards. This does mean that at some point in the future, consumers' balance sheets will be better off, and then they will feel like spending again. But that moment is not now. Confirming this is the fact that that savings rate has gone positive again.
If it were me, I would pay attention to jobs. When people are secure in their jobs, they spend money. I would be building more roads, I'd be decorating the countryside in wind turbines and solar panels. I hear you saying that it's not economic to do that now with the low price of oil. But I say, look forward a year or two or three. My pal in the oil industry says they're shutting down a lot of oil well projects now, which means that supply will be short when demand picks up, and all these alternative projects will look brilliant when that happens. Moreover, as a part of our national security strategy, we should be less dependent upon unreliable sources for our oil.
There's a bit of trick in all this debt. It may help to get things going, but unless Bernanke takes out a lot of this money when things start up, there will be a hell of a lot of money covering a shrunken GDP, and that spells inflation. Let me just make this abundantly clear, if inflation raises its ugly head, it is not good news for the stock market. When inflation was last at its worst, 1978-82, the PE ratios of stocks dropped to single digits. Very hard to make any money in the stock market in that scenario.
Gold and the Debt Bubble
Gold. Even though I hate it, even though I think it is a step backward in the march of civilization, it is probably going to do okay in an environment where the government is so relaxed about getting its money's worth and so relaxed about the money supply. It is very important for paper currencies to correspond to the total nation's goods and services (GDP). Milton Friedman liked a bias of a 2% constant increase. Okay. But if money supply increases greatly and GDP is shrinking. Well, you do the math.
Bernanke has the best of intentions, but here it is: Andrew Mellon in the early 1930s said that many businesses were going to fail, and there wasn't much you could do about it. Roosevelt said you could do something about it. Well, in the end, Roosevelt himself said it was the war that ended the Depression, not the New Deal. Even though Mellon was basically right, Hoover had done nothing for the morale of the nation. And Roosevelt cheered people up with his fireside chats and his efforts to end the depression.
On the other hand, the problem for gold is that deflation may overwhelm efforts to reflate the economy. Using the Shadow Stats data, it looks like the money supply growth is dropping in spite of Bernanke's efforts. Which is why he is trying so hard to prevent it from collapsing.
Here's my point in a nutshell. Bernanke cannot with his magic wand create demand. People still have to want to borrow at the lower rates to get the whole thing to work. And how much can they borrow?
The Good News Is That We Can Trust Wall Street Again (Yeah, sure)
The good news is that Wells Fargo had a good earnings report. Goldman Sachs beat street estimates. Citicorp said its first two months were good. And if you can borrow for next to nothing and put it out at 4% and 5%, then you have great chances to make money. Monday, Bank of America reported higher earnings.
Back to Goldman Sachs for a moment. A blow out quarter, but interestingly they changed horses in midstream, changing their monthly reporting from Dec - Feb to the normal Jan - Mar. Their last report was from September to November. Their most recent report was from January through March. So, what happened to December? December got orphaned, and didn't figure into any comparisons. It featured a pre-tax loss of $1.3 billion. Some fancy soft shoe there.
Goldman has been the beneficiary of a lot of shenanigans. How is it that its former chief became Secretary of the Treasury? And how is it that Secretary Paulson decided to bail out AIG, which owed Goldman $5 billion?
Now all of sudden Goldman is in a rush to pay back the TARP money, so the bonuses can roll as usual. But from my view it's all fakey-phoney-baloney. And Goldman's future quarters may not be so rosy.
"It's different this time."
"We are in a new bull market."
My whole point being that this is a time to be skeptical. I don't know if we can ever trust Wall Street. The system has problems. Companies pay the rating agencies that rate their debt. Companies pay the auditors that give them their okay. There is nothing like arms length dealing in any of this.
It's a Bear Market Rally
The Dow may get back to 9,000 (the old previous rebound high) or 10,000, which would be a typical recovery rally (half of the amount lost since 14,000). Harry S. Dent thinks it might even get as high as 11,800. Wherever you feel comfort, I would think of raising some cash. Sell whatever you don't want to hold when stocks test their lows again. The obvious thing is even if 6400 were the low, this market is going to roil for a while to come, and it will test the bottom again, and again, but you would be correct if you interpreted bear market rally to mean the final lows have probably not come in yet.
If I had to guess, I would think that perhaps the Dow might go above 9,000, thus giving a signal that might reinforce the idea that this is a new bull market, but fail somewhere around 10,000. We'll probably know within a month or two. Good earnings from the financial sector may help. But it's going to be a grinder. Maybe we won't hit bottom for another year, though I think it could come later this year. I would use the true and tested: sell in May and go away.
We keep needing to put things into perspective. Yes, in previous bad economies, Chrysler was near to belly-up, Chrysler is in similar bad shape this time around, but this time GM (the auto company formerly known as General Motors, the biggest auto company in the world) is all but kaput. Official unemployment is at 8.5%, but we're not showing any signs of stopping or leveling out. Home building is a disaster. But most importantly, demand is completely in the tank. So, I think chances of devastating new lows in the averages is quite high.
It always seems to be a bit of a challenge to get the PE's (Stock Price/Earnings ratio) for the major averages, but it looks like the Dow is at about 15, and the S&P is at around 13. So, if we end up in the single digits, which I surely expect for a depression, stock prices will fall below the old lows, with the PE's likely staying in the single digits for a year. Let's review the data Robert Schiller of Yale has collected going back to 1881 to see when the S&P's PE was in single digits:
1917-25, World War I and on into the twenties (8 years)
1932, the bottom of the Great Depression
1942, U.S. enters World War II
1949, U.S. enters Korean War
1974, the great recession
1977-84, the great inflation (7 years)
By the way, before 1929, the Great Depression referred to the depression of 1893.
So, there was a 25 year gap when stock PE's stayed in the double digits, from 1949 until 1974. And now we are at another 25 year gap, 1984 up until 2009, and we haven't fallen to single digits yet.
It is very hard to be a long term investor in such an environment. It looks like all asset classes will suffer. Here comes the revenge of the Poles. Mattress stuffers are going to do better than anyone when all asset classes go down. Perhaps the thing to do is grab some of the bargains when stocks are very low, and peddle them off when there are periods of recovery.
The Dow peaked in September of 1929 at 381. It took until June of 1932 to hit its bottom of 41, a loss of 91%.
If we do not fall into single digits on the PE's now, then it will come later.
I know long term buyers. You have missed your moment. If you want to buy, wait until the market starts testing the lows again. The reason is simple. You long-termers have no idea when to sell. And if you buy now, you'll watch your stocks fall below your buy price well into negative territory. Wait.
GE in the 6's was awfully cheap. Whole Foods in the single digits was cheap. I'm not necessarily saying any of these things is so cheap now. There could still be some more recovery, after all, I'm saying stocks may go from 8,000 here to possibly as high as 11,800 before the market swoons again.
I don't really have any longs I would recommend right now. For the courageous and possibly fool-hardy, you might consider short selling via the ETF's if the market gets up to 9,500 or so. I did a little of this on the way down, and brunted my losses a bit. I didn't do enough, and because of my basic optimism, I closed my position too soon. DXD is the symbol for the UltraShort Dow 30 DJIA, SDS for the UltraShort S&P 500. You buy shares just like you would a stock. It was a happy thing to see some green spots when my stocks were cratering. And in a sense, it might be the patriotic thing to do; otherwise, sinking stocks are a complete loss of wealth. This way you would be saving some wealth to restore stock prices later.
Why We Like to Predict the Market
The theory of Jeff Hawkins, who wrote the book On Intelligence, is that the brain is principally a forward-thinking, predictive instrument. It has certain expectations. It expects when you wake up, that the furniture will be where it was when you fell asleep, and you shouldn't stumble on the way to the bathroom. But if there is a toy in your usual path, you run into trouble because your brain didn't predict it. (And with your eyes closed, you didn't see it). Similarly, in just about every situation, the brain has certain expectations, makes certain predictions.
So, it is natural if the brain likes to think ahead, then stock selection would be one such avenue to test one's mental junk. So it is that one of the most forward thinkers, Ray Kurzweil, has his own investment fund, and so on.
Recently, I have not done well at all at this, and as a consequence, I've been pretty quiet. But I'm also a writer, and writers like to write. And hopefully, even if I'm wrong I can be the whetstone that you use to make up your mind. This is a long piece, but I'm not sure when I'll get to the next one.
April 20, 2009