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The anecdotal evidence of a deceleration in the US economy is, unfortunately, evident everywhere as outlined below. On May 18, 2010, CMV issued a 50% sell recommendation on all US equities and suggested that investors switch from being short bonds (TBT - higher interest rates) to going long (TLT - lower interest rates) to reflect the reversal in the direction of the economy.
On May 29, 2010 CMV issued a SELL on all US equities with the exception of FAIRX. The US equity market has become volatile with dissemination of bullish and bearish news on a hourly basis. Second quarter earnings remain positive which has buoyed the market but unfortunately driving your car while looking in the rear-view mirror doesn’t give you a proper perspective of what is ahead. And, it is dangerous. Despite the market rally in mid-July, CMV believes the indices will decline going into fall.
The Economic Cycle Research Institute is a reliable source of information to determine the direction of the economy. In March, 2009 the Institute reported that the economy was improving and based on their outlook CMV became fully invested in US equities on April 1, 2009 and the results were most favorable. They recently reversed their position indicating that there was a “sharp deceleration” in the economy. They were right at the bottom and CMV now buys into their current outlook.
The Baltic Dry Index (BDI) is an index that measures the daily rate for a ship that carries dry bulk goods such as grain, coal and iron ore. Through July 16, the index has declined for 30 consecutive days and nearly 55% from its May 26th peak of 4209. The index is now under 2000 and the chart looks like a path of a sinking ship. The index is lower than at the bottom of the recession in mid-2009. The BDI is thought to more accurately reflect the usage of raw materials as opposed to the trading and speculation in commodities. Some experts say that the BDI doesn’t reflect the fact that there are more ships and increased capacity rather than declining demand. Conversely, Chinese exports of finished goods are booming again. Will their goods go untouched on the shelves of US retailers? A picture that CMV will continue to follow but take the BDI as an indicator of decelerating demand — worldwide.
The US bond market remains a reliable indicator of the future economy. The two year Treasury Note reached an all-time low yield of .56% this month. The 10 year Note reached a 2.89% low. Bond traders acknowledge that these notes are priced for a recession. “Business Insider” reported on July 22nd, that the US 10 year bond rate is substantially correlated to the fall of the Euro and if the European crisis abates, the 10 year could shoot up to 4%.
Another major barometer is the housing market (see page 6 for additional information). Across the nation, home sales are deteriorating, inventories of unsold homes are piling up and builders are scaling back construction. June new starts dropped to a seasonally adjusted annual rate of 454,000 homes — down from a high 1.47 million in 2006. Ironically, it was housing that dragged down the economy at that time and now it’s the economy that is negatively impacting housing. New starts had been increasing each month for the past 12 months until this reversal in June. There is a pyramid food chain that derives its sustenance from housing. This reversal will impact manufacturing, the trades, retail and other sectors of the economy.
In November, 2002 prior to his appointment as Fed head, Ben Bernanke made his most remembered speech when he said that there would never be a depression in this country because: 1. We could drop $100 bills from helicopters and 2. The Fed has at its disposal a new technology called the printing press. True to his pronouncement eight years ago, that’s exactly what “Helicopter Ben” is doing. He said July 21, 2009, in his testimony to Congress, “We remain prepared to take further policy actions as needed to foster a return to full utilization of our nation’s productive potential in a context of price stability.”
Since 2002, the Fed has promoted anything but a stable growth economy.
Perhaps his most candid comment came when he said, “If the debt continues to accumulate and becomes unsustainable...then the only way that can end is through a crisis or some other very bad outcome.” The stock market sold off sharply in response to these words but miraculously recovered the next day. The Fed head knows what’s ahead and he’s now on record so that he can refer back to that day and say, I told you so. As CMV has reiterated over and over, this massive amount of debt is unsustainable. Any trend that is unsustainable must come to an end and it will end badly. This inevitable outcome is cast in stone because there are those in power whose goal is to destroy capitalism — unless these collectivist architects of change can be constitutionally removed from power.
Financial Reform ?
The Financial Reform Act, otherwise known as the Dodd-Frank bill, is now law and comprises 2300 pages which will unleash the most massive wave of financial rule-making since The Great Depression. Lawyers estimate that the law will require no fewer than 234 new formal rule-makings by 11 different federal agencies. The SEC (Securities Exchange Commission) whose regulatory failures did so much to contribute to the meltdown on Wall St. and allowed Bernie Madoff to craft his ponzi scheme, will write 95 new rules. Maybe the new bill should more appropriately be named the “Doddle-Frankenstein Bill!”
One thing this growing bureaucracy will most certainly not do is reduce the uncertainty that now plagues American Businessmen and Women. Of 1600 CEOs surveyed according to the WSJ, 87% said the “federal government doesn’t understand the challenges confronting American companies.” And, these are companies that are sitting on almost $2 trillion of cash that are unwilling to invest in people, equipment and expansion faced with this uncertainty.
The WSJ editorial of July 14, sums up the bill introspectively:
“...the biggest financial players aren’t being punished or reined in. The only certain result is that they’re summoned to a closer relationship to Washington in which the best lobbyists win, and smaller, younger firms almost always lose.”
D-F couldn’t have been passed without the vote of Scott Brown of Massachusetts. A nice vote of thanks to Tea Parties who were responsible for Mr. Brown’s upset victory last fall. How soon money corrupts principle.
Onerous provisions of the bill will be discovered daily. Starting in 2012, businesses will be required to file hundreds of millions of new 1099 forms with the IRS for every purchase of goods that exceeds $600 a year for any vendor even when that vendor is a major supplier. Think of the massive burden this will put on sole proprietors and small businesses and the expansion of the IRS bureaucracy to handle the filings. And, as the Daily Bell reports, gold and silver purchases which are not now reported, could ostensibly have to comply with the new rules. The Federal Government is desperately seeking revenues and this is just the first act.
It has just recently surfaced that effectively hidden in Obamacare is a Real Estate Transfer Tax of 3.8%. Starting in 2013 those with incomes over $200,000 will be subject to this tax on profits on the sale of their primary residence or investment properties. This new tax will also apply to investment income and dividends. Call it what you want — a medicare tax, an excess profits tax or whatever. It is part of the scheme to redistribute wealth. Maybe, just maybe, there won’t be any profits to tax.
The Ghosts of 1938
Most stock market watchers recall the crash of 1929 and its aftermath but perhaps few would recognize the similarities (and anomalies) to the current crash that began in June 2007 and intensified in September 2008.
From October, 1929 to June 1, 1932, the S&P 500 had lost 86.2% from its top. From those 1932 lows, the S&P rallied 177.31% by 1937 but was still down 61.7% from the 1929 peak. What most investors probably don’t recall from history is that in 1937 a “recession within a depression” occurred and by 1938 a second crash took the S&P down to a loss of 90% from its 1929 high.
Donald Luskin, the chief investment officer of Trend Macrolytics, Ltd. who provided this bit of market history ,then traced the rally that began in March, 2009 to the current date. From the 2007 highs the S&P plunged 56.8% and the index rallied 79.9% in the next 14 months leaving us 24.7% from the 2007 high before the May 2010 reversal. The worrisome aspect of this analogy should be quite apparent to the observer. Both markets had precipitous declines followed by a sharp rally of a similar pace and magnitude. The question is — will the US market duplicate its past of 80 plus years ago? And, what happened in 1937 that caused the second downtown?
Luskin says that the Roosevelt Administration made a number of critical policy mistakes. The Fed raised the banks reserve requirements tightening credit and increasing interest rates. New taxes were initiated to pay for the then new Social Security program. In addition, the government, concerned with deficits cut spending. The big mistake however, was that FDR mounted a “anti-business” campaign and, though not mentioned by Luskin, income tax rates for the wealthy exceeded 70%. Sound eerily familiar?
Another historical analogy. Henry Morgenthau Jr., FDR’s Secretary of the US Treasury, said in 1939:
“We have tried spending money. We are spending more than we ever spent before and it does not work...After eight years of this administration we have just as much unemployment as when we started...and an enormous debt to boot!” — Henry Morgenthau, Jr. testifying before Congressional committee, May 9, 1939.
That is where the USA will be in 2012. Our Hope is Not in “audacity” — It’s in “frugality.”
Robert Prechter, President of Elliot Wave International, predicts that the Dow will fall to 1000 from its present 10,000 level. Richard Russell, (Dow Theory Letters), who has substantially more credibility with CMV than Prechter, is calling for a monstrous decline ahead and he was a teenager in the thirties.
On the other end of the spectrum there was Harry Dent, who, in 2000, wrote a best seller “Dow 36,000" and has authored a number of books since then attempting to ameliorate his absurd forecast. (You can buy a used copy of “Dow 36,000" on Amazon for $0.01 but it is hardly worth the price.)
Where between these extremes does CMV stand? At present, the economy is sharply decelerating. The Keynesians in control in Washington will put on a full court press again to stimulate the economy and consumer spending while at the same time plotting to destroy capitalism. What could possibly result from this bi-polar strategy? CMV’s best guess, at this point in time, is an INFLATIONARY RECESSION.
The Re-Emergence of High Risk Lending
(The Last Rodeo)
It had to happen. Consumer spending is almost 70% of the nations’ Gross Domestic Product (GDP) and with consumer sentiment as measured by the University of Michigan plummeting from 76 at the end of June to 66.5 in early July, the handwriting was on the wall. Consumers were into withdrawal. Those that had jobs and income were saving money (4% in June) and paying down debt. Those with minimum wages or unemployment benefits or lousy credit couldn’t contribute to the great credit-driven US economy. It was as if an urgent command came down from above to the banks:
Shirley Davis is a 66 year old retired phone company administrator who lives in Brooklyn, New York, owes $33,000, earns only $2,414 per month and filed for bankruptcy in June, 2010. Just prior to filing, however, she received a letter from Capitol One Financial Corp. offering her a credit card despite the fact that the company had sued her in 2006 to collect a $4,470 debt on a card from the same bank! The letter said, “At some point we lost you as a customer and we’d like to have you back.”
In another case researched and authored by Ruth Simon and Jessica Silver-Greenberg, that appeared in the Arizona Republic on July 15, 2010, Melissa Peloguin of Bolingbrook, Illinois, reports that she has received no less than six credit card offers since she and her husband have emerged from bankruptcy in June — a month ago.
Sub-prime lending is alive and well and expanding exponentially. Ameri-Credit Corp, (AMC) who is exclusively a sub-prime auto lender, has indicated that new car loan originations could reach $900 million in the quarter ending June 30th, as opposed to $175 million a year ago. You could surmise that a large percentage of these loans were to borrowers who turned in the keys to their previous auto within the past couple of years. Most readers will not recall that it was sub-prime auto lending in the early 1990s that was the precursor of the surge in sub-prime mortgages 10 years later.
On July 22, 2010 General Motors announced that they were acquiring AMC for $3.5 billion to bolster their lagging sales. Readers should recall that their former financing arm, GMAC, failed and cost taxpayers $17 billion. Now that GM is controlled by the US Treasury and the UAW, the goal is jobs and benefits and not repossessions. That will be the concern of taxpayers (listen to my streaming radio podcast on Gabcast of July 23, 2010).
Kathleen Day, a spokeswoman for the Center for Responsible Lending, said her group is “seeing banks re-enter the sum-prime market at a steady clip and make loans to borrowers who don’t have the ability to repay. This is the “last rodeo” folks. In CMV’s opinion this is the beginning of the last credit and spending binge before a massive global debt contraction unfolds.
There are also signs of positive and creative lending. Sam’s Club has just announced that they will offer up to $25,000 in loans to small business owners who are members. A smart way to attract new customers. Check this out if you qualify. Chase bank has a radio ad going now that offers a .5% discount on (per new employee hire) loans to businesses tied directly to new hires up to 3 new employees and bonus discounts for additional criteria for a total 2.0% discounted rate.
The principal sector for new lending is, of course, real estate. Fannie Mae, now under control of those same government financial wizards who bankrupted the largest home lender in the US, and now bankrolled by taxpayers, announced a new program for first time home buyers that requires a down payment of only $1,000 or 1% of the loan amount. Morgan Stanley and Citigroup are back in the HELOC business — home equity loans. They’re offering home equity credit loans up to $2.5 million.
Unfortunately, according to a close friend and client who has been in the mortgage business for over 30 years, residential financing today resembles 1981 (except for the interest rates). Lenders other than the government are determined to find reasons not to make new loans. 30 year fixed rates are at 4.37% and 15 year at 3.875% but very few applicants qualify. Institutional sources who normally provide the capital for jumbo loans don’t take their orders from Washington — yet. A change in their underwriting will be market driven, not by executive order.
There has been a sign of a change in loan modifications, however. A client of CMV has been negotiating with their home lender for a year. They had worked out a “trial period” for a new loan and made seven payments versus the required three. A few weeks ago they were informed by the lender (a bank) that they had no record of receiving any of the seven payments! Frustrated and at the boiling point, they didn’t know what to do. Unexpectedly in the week of July 12th, the bank called and said, “I think we can do your loan now,” What changed? Was some agreement or compromise reached between the banks and the authors of Financial Reform to expedite all loan mods? Are the lenders being financially incentivized (additionally) to modify these loans? Only the Shadow (Government) knows! Since March 2009 there have been 1.3 million applications for loan modifications but 530,000 have been canceled making the program to date, a failure.
CMV has a sense (but no anecdotal evidence) that something big is about to happen in the residential market to address the massive foreclosures and shadow inventory problem, further aggravated now by a decelerating economy. Will Fannie, Freddie and FHA be restructured to make direct loans to those that are underwater with taxpayer money? Will a new Federal agency be established to purchase vacant homes? Could we see cash payments made to homeowners to pay down their loans? Sounds absurd, doesn’t it? During The Great Depression almost 50% (by 1934) of all residential mortgages were at risk of foreclosure in the US. Most of the states passed laws to provide permanent or temporary moratoriums on foreclosures. In this era of “Big Brother” government with the intent on the redistribution of wealth, there is no limit of programs that could be proposed to address what is one of the most critical issues of our time. CMV believes that it’s a crisis that won’t go to waste.
Here’s the bottom line. In order to head off DEFLATION and to inflate the value of fixed assets, there has to be a financial medium — LENDING. The combination of increased consumer demand, quantitative easing and devaluation of the US dollar will, you guessed it, create a temporary, but devastating INFLATIONARY BOOM and BUST. CMV rejects the strategy but recognizes the opportunity to profit from it.
Note: If CMV can be of assistance to you in addressing any of these issues call (602) 840-4117 or e-mail email@example.com
-- H. L. Quist