Wait for Late August or September

A couple of months ago I made a rather generalized prediction that the markets would suffer a lot this fall. I based this largely on option ARM resets but there are a lot of other factors at play here. For one, the markets often do well in the summer only to collapse in the fall, especially in October. I personally do not think we will make it that far. I suspect by mid-to-late August and early September at the latest things will come to a head and we will see markets retesting their lows in March of 2009. So why, you ask.

I return to real estate first. Things seemed pretty good through the first quarter this year but folks were taking advantage of a rather significant tax credit (don't get me started on how much this benefit cost the rest of us). That credit is gone now and we front loaded a lot of sales. Don't take my word for it, purchase mortgage applications were at a 13 year low last month after the expiration of the credit and lumber prices this past month are down 30%. Not signs that real estate is on a sustained recovery.

Still on real estate, we have a lot of adjustable rate mortgages (ARMsO) resetting this fall. Now I know that a lot of people who could, refinanced to a fixed rate, that the resets for most will not be that bad as rates are low and many of those with ARMs have already defaulted, so the impact is muted, but there are still plenty out there and the defaults will likely peak in the last half of this year. Some option ARMs allowed buyers to only pay interest so even with low rates the resets will now require payments on principal, which will increase payments. Between that, homes under water, and high unemployment in a lot of states where the option ARMs were pushed, you have a toxic mix.

Let's go beyond real estate. In the U.S. the stimulus in many sectors is ending about now and the impacts of that will really start to hit home this fall. Now I suspect the administration may seek to prime the pump a bit more with more stimulus but the soveriegn debt problems in the EU will lead to a lot of second thoughts on that and, at a minimum, will lead to less drastic stimulus. Governments have a new focus on deficits after the problems in the EU and rightly so. The economy in the U.S. and a good part of the world for the past year or so has all been stimulus, so when it is gone we will have to face reality and reality is not real pleasant just yet. I suspect it will not be approaching pleasant for a generation or two, but what do I know.

Let's talk about banks. We bailed out the big players that delivered us to this mess and that in my book was a major mistake. I am of the Austrian school and believe we should have dismantled the culprits (I was tempted to use a less family friendly word). Nonetheless, despite all the government support and the big press about how the key players have repaid the government we nonetheless have some facts to face:

• First, the big banks are looking good financially because the government has sanctioned them hiding a lot of the debt on their balance sheets. If they truly had to reflect assets at value - even difficult to value assets like mortgage backed securities - they would be screwed;
• Second, local and regional banks that were not the recipients of government support are aching, in part because of government support of their corrupt competition. Some have significant commercial real estate loans, which are still peaking in terms of defaults, and virtually none have the government BS support the big boys received. Between 2000 and 20006 only 24 banks failed in the U.S., with none failing in 2005 or 2006. This year to date -as of today - we are up to 83. These are local and regional banks, but it shows the banks lending to small businesses and individuals are having problems. Indeed, the problem bank list continues to grow significantly, which cannot be a good sign. http://www.calculatedriskblog.com/2010/06/unofficial-problem-bank-list-increases.html What I have seen is that banks, big and small, are really not lending a lot of money. Credit continues to be frozen in many sectors. The big players who got all our support to start lending are locked shut for anyone less than stelllar wanting credit.. ;
• Third, is the EU. It is going to melt down late this year or next year. I am not expecting this to reach peak this fall but it well could in the fourth quarter or early next year. There are just too many issues there for them to continue as a union. I predicted the EU having these issues a year and a half ago and I still stand by my original prediction;
• Fourth, to the limited extent that China has been a safe harbor in this storm, it is certainly entering into its own storm. It's GDP has always been too small in this economic crisis to have much impact but what little impact it has had - largely emotionally for the markets - is soon going the disappear as it lacks the real, sustained, economic activity it needs to continue; and
• Fifth, debt! I keep going back to this. Debt in the U.S. on a personal level and government level is way too high, even before you factor in Social Security and Medicare. Debt on a personal level and sovereign level in the EU is obviously too high for the vast majority of countries there. The economy for a generation was built off debt and it will take a generation or two to get us off of our addition.

This list is a lot longer than I have posted but I am tired and these are enough to chew on for now. I am sticking by my prediction that the markets are in for a world of hurt this fall

Disclosures: None.

Real Estate Bubble - China?

You have heard it before, there is a real estate bubble in China. Now you would think that a country where the government calls the shots would be able to stop bubbles in their tracks. Well, apparently it cannot. This is not to say the government in China will not eventually be successful, but their initial measures have fallen short so far. And the fear is that enacting measures that might be needed will be overkill and lead to the very result China is trying to avoid, i.e. a popping of the bubble.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aHmZ.NWuCybc&pos=4

So let's step back. We have an economy that many have thought to be the saving grace for the world - our crutch, if you will, as the rest of the world labors to recover economically. Well, I read an article last week showing that the GDP of China is a relatively small percentage of the U.S. and EU GDP, showing even a hot economy in China has no real chance of leading to a global rebound. So let's not put our chips on that bet. And even for those making that bet, the inevitable popping of the China real estate bubble will lead to the opposite result, as other real estate bubbles around the world have proven well in the last few years.

Now we all know what happens when a real estate bubble pops as most the folks in the U.S. and Europe have seen it first hand. Thank goodness all that is past us here in the U.S. Well, then again, perhaps not. I posted a couple of weeks ago on how new mortgage applications fell to a 13 year low after the government tax incentive ended. Most builders were somewhat up beat in the past month or two. Now, at least one builder has changed its tune recently. Apparently things since May have been a tad worse than last year (a very bad year) for Toll Brothers. They seem to blame it in no small part on the oil spill situation in the Gulf, which they fail to note was in full swing when they were rather up beat toward the end of May.

http://www.calculatedriskblog.com/2010/06/toll-brothers-demand-choppy-sales-down.html

BP Coming to the Confessional

And talking about the oil spill situation in the Gulf, I have not read all the articles but it appears BP is maybe about to do something right. It is a long time past due for BP to come to Jesus and save what little is left of its image. It could be the stock price, folks avoiding their stations or other problems but they finally have decided to do what they should have done a long time ago and made their peace with Obama. They are suspending dividends and agreeing to a $20B fund for the cleanup. Dollar short and a day late, as they say.

Disclosures: None.