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Below is a preview of the CMV (Contrarian Market View) Newsletter for September, 2011. See the end of this post for a free book offer with the purchase of a subscription to the full monthly newsletter. (Note: due to the limitations of a blog post the appearance of this preview is not as it will appear in the actual subscriber copy.)
This past month was, perhaps, the most volatile August in global stock market history. And, few were at the office to deal with it!
August is the well-established month for vacations in Europe when the Greek crisis worsened. The cost to insure against a Greek sovereign debt default (credit default swap - CDS) soared to a rate higher than 2008 and interest rates on two-year Greek notes skyrocketed to 44%. Depositors are withdrawing funds from the Greek banks in droves and 50% of the money is going out of the country exacerbating a liquidity crisis. Converting euros to Swiss francs has prompted the Swiss to attach a surcharge on new accounts as the franc has soared in value against the euro. In short, Greece is heading towards default, a restructuring of their sovereign debt and possible expulsion from the EU. The Swiss franc is so overvalued a Big Mac in Zurich now costs $17.19 and the Swiss National Bank has spent $36 billion in its attempt to hold down the appreciation of the franc. Imbalances such as this foretells a crisis of huge magnitude is waiting in the wings.
Here in the US, Congress passed the Deficit Reduction Act, which was a farce, and proceeded to adjourn for the month of August. We were told that the Act would reduce spending by $2.4 trillion over 10 years but it won’t. What it did do was allow the US Treasury and the President to exceed the current limit and immediately borrow $900 billion in two quick tranches (which most has already been allocated) and another $1.2 trillion after some trade-offs. The “Super Committee” reports on Thanksgiving which seems inappropriate for us pilgrims.
What soon followed was the greatest case of motion sickness the US stock market has ever experienced. The Dow Jones Industrial Average’s week “that was” ended:
Tuesday August 4 -265.87
Wednesday August 5 +29.82
Thursday August 6 -512.76
Friday August 7 +60.93
Monday August 10 -634.76
Tuesday August 1 +529.92
Wednesday August 12 -519.83
And, it continued in varying degrees for the remainder of August.
Who benefited from this game of yo-yo? Professional and day traders, of course. And, the exchanges who gain the most from volume regardless of profits or losses. The principal cause is the “robo” High Frequency Trading (HFT) that senses the direction and momentum of the market and piles on. HFT cares less whether the move is north or south. Long-term investing now has come to mean more than one day. It’s devastating because it destroys confidence. The small investor feels that they don’t have a chance. And, they don’t.
CMV sees this phenomenon as a forecast of things to come. It’s as if the traders also sense that we’re in the last stages to exploit the equity market before the pall of deflationary doom wipes away all the momentum and the profit opportunities. Here are a few signs that the last quarter may be a real downer:
● Consumer confidence has taken a significant drop in August.
● The August Chicago Purchasing Manager’s Index has fallen from 58.8 to 53.8.
● Nomura Securities reports that there has been a major decline in payroll tax receipts which could forecast an increase in unemployment for August and validate their opinion that a “new recession” began this past month.
Note: Normura and Rick Santelli were correct. The August job growth was Zero! This hasn’t happened since 1945. Layoffs are the highest in the financial industry and state and local government. It’s official, the “Double Dip” is here whether we like it or not.
● Inflation adjusted GDP for the second quarter was -3.4%.
Assuming for the moment that a slowdown is indeed ahead, what about the Fed and the Fed Head? Traders eagerly awaiting GODOT (Ben Bernanke) speaking from atop the Grand Tetons, were disappointed that he did not reveal another easy QE stimulus plan that would move the markets north. No commands were etched in stone as GODOT descended from the mount. His silence was deafening but perhaps he was reserving his pronouncement until after the Fed’s meeting on September 20-21. (That now appears inevitable given recent data.)
Both Nouriel Roubini (Dr. Doom) and CMV’s favorite asset manager, Felix Zulauf, both agree that the Fed (though dissidents exist on the Board) will be compelled to inject massive liquidity into the economy this fall to prevent the slowdown becoming a slide into the abyss of a depression. In event that these two experts are correct we can expect a stock market and commodity rally that could propel these markets to all-time highs. Gold would knock out the inflation adjusted high of $2200/oz faster than Usain Bolt could run the 100 meters! The “Last Rodeo” would begin. Pick the bucking bronco of your choice and jump aboard. It will be a wild ride and the key will be to jump off before you’re thrown off. The “crack-up boom” will end the party. It’s CMV’s time to shine!
Late News Flash
A highly regarded strategist at Goldman Sachs (GS) (whom CMV affectionately refers to as Goldman Sucks), has issued a 54 page report sent to its’ institutional clients that forecasts that Europe, US and China are in deep doo doo. Goldman’s Alan Brazil has designed a complicated option play that is intended to hedge all these markets that he believes will decline substantially. This report could have triggered the sell-off on September 1, 2011
The Rating Game
The Standard & Poor’s (S&P) downgrade of the US’s credit rating triggered a sell-off in the US equity market pushing the Dow Jones Industrial Average to its sharpest one-day decline since the financial crisis in October 2008. The Dow ended the day down 634 points (5.5%) to 10,810. Trading volume reached the fourth highest level in history. A volatile “Week That Was” followed.
The question CMV raises is, why did S&P wait so long when the burgeoning US debt was rising exponentially for several years. One answer is that S&P has a proven track record of failing to do their due diligence when there would have been time for affected parties to react prior to a credit event or default. Cases in point:
New York City in the sixties or early seventies was an example of political mismanagement and phoney accounting according to an editorial by Thomas G. Donlan in the August 15th edition of Barron’s. While rumors persisted that the Big Apple might be rotten at its’ core, City officials effectively lobbied the two major rating agencies S&P and Moody’s, and their top credit ratings were affixed in 1972 and 1973 by both agencies. By 1975, however, the City finally faced up to its’ inability to meet its bond obligations and a tense period followed when NYC defaulted.
The recent housing fiasco can be directly tied to the AAA ratings by both agencies which enabled Wall St. to market those mortgaged-backed securities all over the world by virtue of their ratings. A critical component of these fallacious ratings were the extension of AAA to Fannie and Freddie and their paper. Both were still rated triple A until the downgrade in August!
S&P has done a horrendous job of forecasting the potential for sovereign debt default in advance when investors need guidance. Of 15 government defaults S&P has tracked since 1975 , the firm rated 12 of the countries single B or higher one year prior to default. To S&P, a single B rating had just a 2% average chance of default within a year. In short, S&P drastically underestimated a one-year default risk in 80% of those cases. They missed the Russian default in 1998 when Long Term Capital Management lost $5 billion in one day and set off a major US financial crisis. They missed the Argentina default in 2001 when the country stiffed the US banks and settled years later at about $.30 on the dollar. There was also Orange County, California in 1995. And, Enron and World Com in 2001 which were massive frauds. S&P just recently announced that it was opening an Investigation into the sub-prime fiasco. Hello!!!
Now, the ratings are playing out in the political arena. As the President’s approval rating dropped below 40%, he reminded all Americans that “despite the ratings the US will always be Triple A.” Tim Geithner, US Secretary of The Treasury, had stated prior to S&P’s decision, “The US will never be downgraded.” There are those who speculate that Republicans conspired with officials of the ratings companies to encourage a downgrade to make those in power look bad. To that CMV responds, they did not need any assistance.
“Un” Real Estate
There are a couple of initiatives that have recently surfaced that could materially impact the real estate market.
J. P. Morgan Chase has notified a number of delinquent homeowners who are fighting foreclosure that the bank will forgive $100,000 in debt on a “short sale” with a kicker for the homeowner: $10,000 to $35,000 to stay on the property and facilitate it’s sale. The reasoning is that the bank recovers more than in a foreclosure and avoids attorney fees and the cost of maintaining the property. It’s also possible that the bank can’t locate the original note and these number of cases may be limited. JPMC, like other major banks, faces a fine for the “robo signings.”
The Obama Administration has floated another of its trial balloons regarding the government’s inventory of unsold real estate in a formal Request for Information (RFI) – turning foreclosures into rental homes. Fannie and Freddie together with the FHA own approximately 250,000 homes at the end of June, 2011 and other 830,000 homes are in some stage of foreclosure. A couple of the proposals are:
1. Sell packages of hundreds or thousands to investors in bulk who agree to rent them out, or
2. Have investors enter into joint ventures with Fannie and Freddie to invest in a pool of converted rental homes. There would also be national property management business to handle the landlord responsibilities.
This administration, keeping a keen eye on the 2012 elections, recognizes that all of the residential real estate initiatives to date have failed and represent a major obstacle to re-election if the problem is not resolved. A market-based solution would be a good idea but CMV’s concern is that the bureaucrats at Fannie and Freddie, whose number one objective is to preserve their jobs, will prevail and the “evil twins” will dodge their programmed extinction and live again to bleed the US taxpayer. What 99.9% of all Americans don’t know is that these two zombies continue to pay huge dividends (despite horrendous losses) to the US Treasury (and others) from taxpayer funds. That’s why, then Secretary of the US Treasury John Paulson, placed Fannie and Freddie into CONSERVATORSHIP rather than Chapter 11 – use taxpayer money to create and service debt with income accruing to the benefit of the government.
It was announced in late August that Freddie Mac plans to accelerate its program to buy loans secured by apartment buildings – up to $16 billion this year. Fannie has already bought $10.5 billion in the first 6 months. It probably hasn’t occurred to these bureaucrats that they are exacerbating the single family home rental market in the process.
Bloomberg reported on August 12, 20011 that Barclays Capital has projected that Phoenix and Atlanta have the best potential for the sale of new homes. Phoenix has the potential for 46,485 new home sales but no time period was given.
The Debt Bubble
Both the Democratic Truman Administration (1945-1951) and the Republican Eisenhower Administration (1952-1960) were faced with the unenviable task of growing the economy, providing jobs and paying down the massive mountain of debt accumulated during World War II. They were both successful and the 1950s came to be regarded as the “Golden Era” in America. Sound fiscal government ended in the mid-60s when Lyndon Baines Johnson convinced Congress that America could afford an entitled “Great Society” and an expensive war in Viet Nam (“Guns & Butter”) at the same time. Thus began a borrowing binge and a raid on the Social Security Trust Fund that has brought the United States to the point that it can’t possibly meet its public obligations amassed over the past 45 years.
Richard M. Nixon, a Republican (in name only), drove a stake into the heart of America’s fiscal sanity when, exactly 40 years ago (August 15, 1971), he declared himself a Keynesian and effectively took the US off the gold standard when bullion was $35/oz. Nixon also instituted wage and price controls which ultimately created severe imbalances in the economy and contributed to the ruinous inflation in the late 70s. The US Dollar has lost 82% of its’ value since that fateful day. And you thought Watergate was Tricky Dickie’s place in infamy.
Your writer remembers that day as if it happened yesterday. It was a Sunday and the Quist family was returning from a weekend at the lake when the news flash was announced on the radio. Somehow your writer knew that this event was a watershed moment. Several years later it became legal for US citizens to own gold again and by 1974 bullion rose to $195/oz. By 1979 it reached $850/oz. The relationship between the federal and public debt and the price of gold over this 40 year period should have been apparent to even a casual observer but it hasn’t registered until now.
Despite all the evidence to the contrary, there are those in Congress who insist that the federal government must borrow and spend more to stimulate the economy. We’ve been there and done that and it’s resulted in a dramatic decline in the nation’s GDP. Worse, these Keynesians have unleashed a vitriolic attack on fiscal conservatives that projects an irreconcilable stalemate that lies ahead.
E. J. Dionne, Washington Post columnist said that Tea Party representatives were content with “blowing up the country.”
Joe Nocera, New York Times columnist said, “Tea Party Republicans have waged a jihad on the American People.”
Maureen Dowd, New York Times columnist, referred to Tea Party members acting like “a maniacal gang with knives held high.”
And, the epitome of criminal aspersions was cast by Vice President Joe Biden who said that Congressional Republicans “have acted like terrorists.”
It isn’t an accident that all these statements characterize conservatives as an evil, destructive force, whose policies will destroy America. The irony, of course, is that there are those, who while cloaking themselves with the intellectual cover of Keynes, are in fact, Marxists whose goal is to destroy Capitalism and America as we knew it. The 1960s Cloward-Piven strategy was to so burden the US Government with entitlements that the economy and by proxy, Capitalism, would collapse. The hope is that fiscally conservative Democrats and Independents who are committed to America’s future have already seen through this charade and this Administration will suffer a humiliating rebuke in 14 months.
A wise philosopher once said, “Civilization hangs by a thread.” That frayed rope is close to breaking.
● We witnessed the riots in Egypt as the 30-year rule of Hosni Mubarak came to an end. The revolt reportedly was for freedom.
● We witnessed the riots in Syria to depose the autocratic rule of the Assad dynasty. The revolt reportedly is for freedom which may be quashed.
● We witnessed the riots in Greece where free democracy was born. There the long abuse of freedom has led to the nation’s bankruptcy and ultimately a full circle return to bondage.
● We witnessed the riots in a democratic England where the opinion pools cite criminality as the root cause .
CMV sees the onset of a new movement - egalitarian envy - a rebellious flash-mob outburst from the hooligan have-nots to take from the haves enabled by English law which protects the criminal and imprisons those who defend themselves. All Euroland is faced with a common seed of discontent fostered by high unemployment amongst those under the age of 25. Spain has an unemployment rate of 21% but it is 45% under age 25! Greece 15% and 39%, Italy 8% and 28% and the rest of the Eurozone has similar numbers. The only major exception is Germany at 6% and 9% but given their recent economic data, it appears that those numbers could change for the worse.
The European Union is bound together with one currency and one constitution and has shackled itself. It doesn’t have the flexibility to solve this growing problem. They can’t adjust wages based on productivity and local living costs since wages in many countries are set “centrally.” Most have costly indulgent entitlement programs that decrease the incentive to work and provides the youth the time and motive to create havoc. In the past, these government would improve labor costs and opportunities by devaluing their currencies. That option is no longer available.
Why is this important to you?
1. The European Union is the largest economy in the world. GDP is plunging there at a dramatic rate. The contagion will have a severe negative impact on the US economy which is already slowing. The EU may not survive.
2. The present administration in the US has embarked upon a European-styled central planning strategy that is also doomed to fail.
3. The concept of egalitarianism (equal legal rights, economic benefits and political status for all citizens) is migrating to the US. As the economy worsens social unrest will quicken. As a small business owner, what will you do when they come to take what you have? Will our police, already stretched to the limit in manpower and resources, stand by or be overwhelmed by the masses? Develop a strategy now!
The global social, political and economic infrastructure is crumbling. The rule of law is being circumvented. Fraud and corruption are running rampant. People are becoming more polarized. There is little sense of community. The change we were promised three years ago, was an illusion. And, there are those in power today that see the coming chaos as a means to an end – destroy Capitalism and make the masses more dependent on government.
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-- H. L. Quist