Vindicated?

A dear friend who is responsible for me starting this blog a little over a year and a half ago asked me today if I feel vindicated by the market downturn the past several weeks. Two years ago I was simply emailing friends in my office about the approaching calamity and this friend referred to me as Chicken Little. As the sky began to fall in keeping with my predictions, he suggested I start blogging. He follows what I write - and undoubtedly is the first one reading these words - and knows that I am among the few that maintained a bearish stance over the past year as the markets rebounded. I told him no, I do not feel vindicated. But I have to admit, perhaps a bit. But I am not enjoying it. So why did I tell him no?

First of all, it is a bit early to get cocky here. A few weeks of downturn does not a bear market make. I certainly see no near term reason for things to reverse themselves from a bearish direction in any great way, but I have given up on predicting market direction. I am simply sticking to fundamentals and the belief that in the long term the market has to reflect them. I view the markets as possibly beginning to reflect reality at the moment, though would not be too surprised to see some major stimulus packages being announced in the U.S., EU or elsewhere soon to bring the markets back from the brink. I will comment on this possibility more below.

Second, I do not want to be right in my doom-and-gloom. I see no alternative given debt, unemployment and everything else on a world scale, but I would still love to be wrong. I have a three year old, a six year old, parents on Social Security, in-laws on Social Security and a host of other reasons I would love to see the economy rebound. Nonetheless, I have been planning my finances according to the fundamentals and reality - as I see it- and I do not see fundamentals as good for a very long time. If you see things the same way you may want to do the same.

Governments Between a Rock and a Hard Place.

I noted above that I would not be surprised if the U.S., EU or other governments came out with stimulus soon to bring the markets back to life. Okay, I may have fibbed a bit. The EU just did its nuclear option to address the Greece situation and probably is not anxious to do much more to address the Hungarian situation today. They would probably like to do something but have nothing left in the arsenal that they think would work, so they are stuck. After using it once, the nuclear option is no longer an option, and I suspect before doing it that was a topic of discussion, i.e. "If it does not work, we cannot do it again. We are screwed." From my perspective, it did not work and they are screwed.

The same is close to happening for the U.S. The U.S. still has a few bullets left but Obama and company have to be wondering how well their bullets will work and, at least for now, they probably want to keep their powder dry. The real devil in the details is debt. Greece, Hungary, Spain, Italy . . . etc. are largely in the mess they are in because the governments there are too far in debt. They spent their bullets - and then some - and have few alternatives left. They do not have the tax revenues to pay the debts. More stimulus will only add to the public debt problem. And the austerity measures currently being imposed on them will merely lead to economic stagnation/depression, which will further deplete GDP and tax receipts, only enhancing their problems. It is a vicious cycle that will undoubtedly lead to restructuring of debt or default. The elephant in the room that everyone needs to address is that it makes sense to restructure or default sooner, not later. We only add to the problems by waiting and throwing more money at it.

The U.S. will hopefully learn this lesson. Rather than spending trillions propping up too big to fail financial institutions and transferring massive amounts of money from taxpayers to the perpetrators who brought the pain, we would have been better served by biting the bullet, dismantling these companies and paying the price up front. Instead, we spent the bank saving them and promoting them merging with each other to build even bigger too big to fail institutions. The question now becomes, is the U.S. too big to fail. If it keeps up with idiotic moves, I am abstaining from the vote on this question.

PIMCO - The Voice of Reason

I admit a lot of my retirement is with PIMCO. Nonetheless, tooting their horn will not lead to any gain for me personally - that I am aware of - so here goes. Bill Gross and others at PIMCO seem to have their act together better than any other place you can put your money. They see a world of hurt ahead in the EU, a very slow recovery with a lot of unemployment issues (and a new normal) in the U.S. and they are warning investors that for the foreseeable future they need to learn to live with annual returns in the low single digits. They also caution that the alternative to low single digits - for those chasing more -could easily be losses. These, folks, are sound words. It is not a time now to be chasing gains. It is a time to hunker down and be happy with less.

Now Bill Gross and Mohamad El-Erain of PIMCO are both referring to our current economy as the "new normal," as in expect less spending and economic growth for now.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aBfNsejozGCc

We have spent most the past couple of decades in one bubble or another - tech, real estate and such - so the "new normal" may actually simply be normal, i.e., without bubbles. I posted several times last year on what I was then calling the "new reality," which is the same concept, slightly different name.

http://financialspiltmilk.blogspot.com/2009/08/new-reality.html

Indeed, my first post on this, as I just found, was January 31, 2009. I attach the entire post here and will let you decide whether I was right or wrong.

http://financialspiltmilk.blogspot.com/2009/01/new-reality.html

As I described the new reality then, I simply noted we had for years, perhaps decades, lived beyond our means, accumulating debt to pay for it, and we were simply reverting to mean - perhaps below mean to pay off debt.

Worse Than the New Normal

My real concern at the moment has nothing to do with reversion to mean; nothing to do with the new normal or new reality; my concern right now is some level of meltdown. We averted for now a financial meltdown but in doing so may have set up sovereign meltdowns, which could have signifiantly worse percussions, including leading to new financial meltdowns as the financial institutions hold the sovereign debt. Now some of the sovereign problems -probably many - were due to countries not properly managing their spending or their economies/taxes not supporting government needs. Be it that or massive government deficit spending to deal with the recent recession, governments are in a world of hurt. I see defaults and restructuring coming and the real question is how the world governments deal with it.

On one front they can do as they have by throwing money at it and imposing austerity measures, which is wortheless. On the other, they can start affirmatively dealing with restructuring to avoid defaults and put a plan in place to deal with the ramifications of restructuring. The sooner the better.

Disclosures: I am heavily invested in PIMCO. Otherwise, none.

Signs are Mixed - To Say the Least

Let's begin with the markets and a man named Fink. The markets in the U.S. were up roughly 2.5% today based - according to Bloomberg - on good housing numbers. Meanwhile, Fink - the name says it all - head of BlackRock, says stocks in the U.S. are ready to "rock." Do you get it . . . Black"Rock" ready to "rock." He is not so positive on the EU, but who is. By the way, BlackRock manages over $3 trillion in investments (yes, that is with a T) so he arguably has good street cred. So it is with great difficulty that I have to build a case to disagree. (My six year old daughter would say to me that I am being sarcastic at this point).

http://www.bloomberg.com/apps/news?pid=20601110&sid=aRyKXyGE.xUY

Let's start with the housing numbers. At least Bloomberg acknowledged that the pick up in sales was due to the end of an $8000 tax credit promotion at the end of April. Nonetheless, I saw numerous headlines, analysts and commentators today touting the good housing numbers, which according to most of what I read is responsible for the good market numbers today and good numbers so far in the market in Japan. Don't believe me, listen to Bloomberg in this attached link.

http://www.bloomberg.com/apps/news?pid=20601087&sid=ahdrnfUqZWbU&pos=1

So where, might you ask, lies the problem? Let's start with the prospect that on housing we have paid it forward big time and are in for a world of hurt the next few months. And I mean a serious world of hurt. Let me just say new mortgage applications, since the lapse of the home buyer tax break, have gone down just a tad - AS IN THE LOWEST LEVELS SINCE 1997!! Did I say a world of hurt?!

http://www.calculatedriskblog.com/2010/06/mba-mortgage-purchase-applications.html

How on Earth can the markets react so positively on this artificial housing number? I think because market wise we are down 10-11% in a matter of weeks and money is itching for an excuse to come back in. Money just chose today a poor excuse to come in.

Now it is not like housing is showing a great resurgence because foreclosures or defaults are down. Yes, for those companies now owning most of the mortgages in this country -Fannie, Freddie and FHA - delinquencies are down, but perhaps only because they are being more aggressive in pursuing foreclosures. The REO numbers for this trio continue to set new records each and every month, and we are talking about a staggering increase of REO inventory among them, increasing roughly 50% between second quarter 2009 and fourth quarter 2009. With all these foreclosed properties coming on the market I do not see much in terms of a RE bounce this year.

http://www.calculatedriskblog.com/2010/06/fannie-mae-serious-delinquencies.html

Now I would be remiss not to note that auto sales are posting some strong gains YOY and there are other signs of recovery, but a lot of this seems to be companies finally filling in historic low levels of inventory. Exports are up in the U.S. but how long can this last as the dollar continues to strengthen - especially against the Euro. Bottom line, with overburdened individuals and governments in terms of debt levels there is just so far this run can go.

I could be wrong on my expectations but the fundamentals still do not lead me to trust a Fink.

Disclosures: None.

Not So Silly After All

A few weeks back I wrote a post on the situation in the EU and how, for once in my life, I nailed it in terms of predictions. That is not why I am linking that post.

http://financialspiltmilk.blogspot.com/2010/04/tootin-my-own-horn.html

At the very end of the post I posited what I called a "silly" proposition of a worldwide declaration that all debt - both public and private - is cancelled. It is still obviously a silly idea, but perhaps not as silly as I thought at the time. Some folks are noting that the best way out of our debt doldrums may well be default. Wipe the slate clean and start over instead of years or decades of digging out. In the linked post the author notes, as many have of late, that jingle mail, bankruptcy and they like may not be the worst alternative. Now as an attorney I am certainly not advising anyone to do anything. You need some serious counsel before doing any of this as there are financial, credit and TAX consequences to some of them you may not expect. Nonetheless, the prospect of a few years of credit rating pain versus many years of suffering under massive debt is something that many folks I am sure are considering.

http://www.nakedcapitalism.com/2010/06/guest-post-default-please.html

And little did I know but Christian societies many centuries back had a debt Jubilee every 30 years, apparently doing what I suggested, erasing all debt. Now I still think the idea is a bit silly but I can guarantee you folks in the EU are starting to consider some silly alternatives.

Wait - All is Well on the Western Front

Before you run off and consider bankruptcy or jingle mail, think again. Analysts - 2000 of them in the aggregate - think we have some good times ahead. Indeed, they think the S&P will gain 27% over the next year. That is incredible!!! Now I define incredible as being something that is not credible, but you can reach your own conclusion.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aD8QSy9AdOtc&pos=10

And all this gain must be in part due to the financial institutions being more sound. Banks are, after all, more sound in terms capital, profit, reserves and everything else - right? Well, think again. It seems some of this may be accounting slight of hand, all signed off on by government powers that be.

http://www.nakedcapitalism.com/2010/05/economist-declares-mission-accomplished-on-repairing-bank-balance-sheets.html

If you do not believe accounting is hiding some weakness, consider the fact that we are up to 78 banks failing this year and being taken over by the FDIC, five last Friday alone.

http://www.calculatedriskblog.com/2010/05/bank-failure-78-sun-west-bank-las-vegas.html

And the FDIC list of problem banks is getting much worse rather quickly. It went from 737 to 762 in the past week. Go figure.

http://www.calculatedriskblog.com/2010/05/unofficial-problem-bank-list-increases.html

Disclosures: None.

Thank Goodness - Now I Can Sell My Bridge

With the market turmoil and people actually selling-off last week, I feared reality and rationality had set in and I would be stuck with this bridge forever. But today on minmal good news the markets are back to the races - up 3% - and I think I have a lock on getting this sucker sold. If I look around I might even have two or three other bridges laying around to off-laod. Let me know if you are interested.

There is a reason no one is lending to builders - shhh, don't tell the government no one is buying other than those taking advantage of the tax credit

If you have a "viable" building project as a home builder, the government has a loan for you. I am not certain what they define as "viable" but I am pretty sure they have set the bar pretty damn low. I am thinking viable simply means the houses will stand once they are built. The point being, of course, that in the housing arena "build it and they will come" is not a good motto to live buy, even if the government is willing to lend you the money. It is a loan, after all. Yet I am sure some builders in desperation will take it thinking that by the time they finish construction there will be someone around to buy what they are building. As the author of Calculated Risk points out, however, they would be ignoring the existing inventory - not to mention the shadow inventory, as in all those people who wanted to sell, or banks with REO who wanted to sell, but who have been holding off waiting for the market to stabilize or improve. I have seen a lot of new houses hitting the market this year in my area, undoubtedly due to the economy (reportedly) doing better. We will see how much better housing is now the housing tax credit is gone and most other stimulus wanes in the third and fourth quarter of this year. Personally, my house just appraised for 5% less than 9 months ago. Go figure.

http://www.calculatedriskblog.com/2010/05/housing-production-credit-crisis.html

Disclosures: None.

DOW 13,000

I read a couple of months ago that some fund manager at a fund overseeing billions of dollars predicted the DOW at 13,000 by year end. (By the way, the book "DOW 30,000 by 2008" is still in stock at Amazon if you rush.) Today I read one who said the "U.S. economy is on solid footing" and another who said he was "scratching his head" on why the market is doing so poorly the past couple of weeks. Both of these individuals also work for companies managing billions of dollars, one tens of billions. And so . . . I am scratching my own head, and a few other things.

Either these fund managers are idiots who cannot be trusted with balancing their own check books or they are (perhaps) puffing a lot to keep their clients investing and the commissions coming. Either way they are serving no purpose to society in general as they are truly ignoring reality. There are plenty of reasons the market is down of late - most of which have been around for years and are getting worse, not better. Just ask those in Greece and Spain. Austerity is our future.

http://www.bloomberg.com/apps/news?pid=20601010&sid=a10kjBAhN1q4

Disclosures: None

You Ask Me - Things Ain't Lookin' So Good

I will not spend a lot of time repeating what I am linking here from Bloomberg, but the bottom line is that corporate bonds are selling at spreads last seen when Lehman went under. Lots of jitters in Europe.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aU1fAD2hZxd4&pos=4

I tend to think the austerity measures will not work and the EU 3% cap on public debt versus GDP is toast. Governments need to spend some money in financial crisis so caps on spending should go by the way side - though I am the first to note that government support needs to be coupled with taking down and dismantling some companies, debt restructuring and such. We need to spend the money wisely. In any event, the PIIGS are on the spit.

Not the least of the problems in the EU is the new inability of companies there to raise capital. Seems no one is buying. Everyone is hunkered down.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aOMbAJVBGXhU&pos=7

Now this is a case where fear feeds on fear because no one wants to be left holding the bag, so folks will exit the markets before logic dictates simply because they expect others to exit before logic dictates. They want to be the first to the door, not the last. And so this spiral builds upon itself.

Generations Lost

I will have more to say about this in time, but I just want to note that I am totally ashamed that I have lived the generation where we undoubtedly will, for the first time in centuries, leave the next generation worse off. There has been increasing talk in the press lately how for the first time in hundreds of years we may leave the next generation worse off than us. This takes many forms. First, due to fast food, prepared food and our inability to cook food at home, kids today are expected to live shorter lives than us. Now medical science at great cost could avoid this, but the point is that our kids will grow up less healthy than us, largely due to diet and exercise. It is no secret that kids are more obese than ever and this is in no small part due to diets. And I have to wonder to what extent our population growth may be to blame. What are now increasingly large corporate farms are growing our food - vegetables, fruit and meat - on a massive scale using new chemicals and technologies. Call me crazy but I suspect from a nutritional perspective this is not ideal. Time will tell.

Second, on the financial front, we have royally screwed our children and grandchildren and for that I am ashamed. Our debt load in the U.S. and most industrialized countries is incredible, both on a corporate and individual level. In the U.S., when you hear stats, pay attention on whether they include unfunded Social Security and Medicare obligations. If they do not, ignore them. If they do, you will realize there is no way we can fund these obligations - especially with the current economic conditions. No question but that Social Security and Medicare will either disappear or be wholly revamped lower in the next 10-20 years. Two words to the wise: (1) don't bank on Social Security or Medicare being there when you retire and (2) plan for your kids and grand kids to have to endure what we have built.

Disclosures: None.

A Few Observations

What That Guy Said . . .

There is a reason PIMCO is the largest bond fund the world - they have some smart folks in charge. And so I must agree with El-Erian, their CEO. His words are not shocking news or original to him. It is, however, always refreshing to hear someone who knows what they are saying to tell it like it is. I almost throw-up daily reading from those managing money about how the market is about to launch or the DOW will hit 13,000 by year end (I have not heard this for a couple of weeks, by the way), so hearing reality is a nice change. El-Erian's comments on how this time is different and how we are now finally addressing structural headwinds are dead on in my opinion.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aPcF.fPJgadU&pos=5

Here is a Surprise . . .

LBO junk bonds are falling like a duck covered from oil in the Gulf of Mexico. Seems greed never dies and people wanting to make money are willing to invest in junk even in dangerous times. Sometimes you get what you deserve.

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

Did I mention . . .

we are back to S&P levels we were at in 1998.

http://www.calculatedriskblog.com/2010/05/market-update_20.html

Yep, a dozen years with no growth. Thank goodness interest rates and inflation were really low during that period, so investors lost a smaller chunk of their money than might have otherwise occurred. I suspect we will be going into the way back machine soon, as in the market will drop to levels last seen many years before 1998. With the S&P breaking some key technical barriers today at close, some folks are saying watch out below. Personally, I am not a big fan of technical barriers, moving averages, head and shoulders and such. Short term they may provide some guidance I prefer to focus on fundamentals and the market has been defying them for some time. Now this defiance was built on fiscal stimulus and I fully expect Obama and team to come out with some new stimulus package to arrest the current drop, so again we will kick this can down the road, but we will in time catch up to that can and be unable to kick it. Just ask Greece.

And the beat goes on . . .

I noted yesterday the dismal real estate picture, in terms of foreclosures, delinquencies, applications, CRE and the like. Not at all pretty. And unemployment showed a turn for the worse today. No surprise then that a lot of local and regional banks are getting more into distressful situations. A lot of them had heavy CRE exposure and that area is in dire straights at the moment, so no mistake that the FDIC list of Problem Banks has grown to the highest level since 1993 and we have had 69 bank failures this year in less than five months. By comparison, before the recent turmoil we had a couple of years with no failures.

http://www.calculatedriskblog.com/2010/05/fdic-q1-banking-profile-775-problem.html


Tomorrow should be interesting.

Disclosures: None.