Tuesday, October 7, 2008


We are in a bear market, yet no one wants to recognize that. We are in a recession, yet we keep hearing about how we might avoid a recession. We have reached the level of maximum credit, yet the Fed pushes on a string, refusing to allow the markets to correct. Every bounce in the market brings in the debate between the talking heads that a bottom is in.

2006 was the year home prices peaked and trouble appeared on the horizon. The top wasn't in for 3 months before speculation started as to if the bottom had been hit or not. The year 2007 had more bottoms, despite the research and history being provided by Robert Shiller, whose name is now on the index he created, that housing was way out of the bounds of American pricing history. The appreciation was real, the subprime buyers were real buyers and the stall was nothing but a hiccup.

2007 saw the top of the stock market. A top in the early part of 2007 was followed by a break that many bears thought was the top. The bulls piled in and the market went higher. CDO's were still selling and hedge funds were still leveraging up on everything, providing massive cash. We had a mild panic in July 2007, followed by another bottom and bulls piled in and created a new high in October. The bulls had been buying for 2 years based on the idea that the Fed would cut rates and everything would be okay, even while the Fed was raising rates. Speculation was rampant and thinking was wishful.

What has 2008 provided us? In housing we have witnessed lower and lower prices and sales of existing homes has fallen to 4.9 million units. How many truly qualified new home buyers are out there? My guess is maybe enough to absorb 1.5 million to 2.5 million units annually, putting speculative purchases in the range of at least 50% of the market. They call these guys investors. I call them speculators and I think over the history of investing, these buyers would be called speculators and not investors.

Why would a housing market, where existing sales had fallen about 30% be speculative? I say it is speculative because there is a long history of statistics in housing sales and existing home sales had never exceeded 4 million units prior to 1997. That was the long term top. We are 125% of the long term top in home purchases. Some of this could be related to excessive inventories, but what we are looking at is excessive inventories being even more excessive if sales actually reflected the bust that prices are reflecting. What we are seeing is price declines in the midst of historically high home sales in a period where the claim is that credit is being restrictive. Normal busts would have home sales at or below 3 million units, not 5 million. http://calculatedrisk.blogspot.com/2008/07/graphs-existing-home-sales.html If you look at this link, you will see where downturns have taken home sales and under any definition, housing is still in a speculative bubble. It is one that if it actually succeeds in turning a profit over the next couple of years will actually lead to an even larger bubble, more speculative lending and an even bigger bust. The NAR has carefully hidden long term statistics to hide the fact that home sales are still at boom levels on a nationwide basis and not in a bust, hoping of course to get more government aid and more speculative interest.

The stock market may be even more speculative. I can hear over and over again these guys talking about the bottom being in, how stocks are cheap and how earnings are going higher and higher. The 20 somethings and 30 somethings have never seen a market that wiped out a decade of gains, as the 1966 to 1976 market did, taking the Dow down to mid 1950's levels on a non-inflation adjusted basis in 1975. A return to prices last seen 20 years ago would take us down 80% from current levels, which is in the territory of where most bursted bubbles end up. The last trip down has created the idea that anything under the 2000 top is a bargain and anything under Dow 10,000 or Nasdaq 2000 has to be a steal, throwing out economics and financial principals that have prevailed up until this bubble.

It takes buyers to make the market go down because the market ceases to exist without buyers. The insiders have to become buyers or face ruin quite often as their inventories of stock have to be marked to market and thus they have to stop declines. But, they also get to sell out in general terms once the rallies happen. This time it might different as so much of the capacity to short stocks has been forbidden, thus denying the market of one of its key braking and rallying mechanisms, forced short covering.

I believe that there are literally millions of speculators out there on the long side that recent years have convinced that making money in stocks is simple business, just buy dips. The bigger the dip, the bigger the bargain. This time is different is what they say, and this time is different. I believe that the collapse after the House vote on the $700 billion fund to buy mortgages and other paper was due to the fact that the entire world had already front ran the news. What the bailout did was give the smart money time to sell out. Give the illiquid time to raise liquidity. Once the vote happened, the reason to buy was gone and the selling took over. The speculators were all in before, but they were there none the less. When the whole world is afraid of missing a rally on a vote, speculation is excessive.

There are prime indicators this is a speculative market. For one, there is the idea that prices are cheap. The Shiller index shows that prices are high, not cheap. Dividends are lower on the SPX now than they were at the peak in 1929, 1966 and 1987, yet stocks are being called cheap. The PE is based on the peak of a credit bubble, thus on inflated earnings and at the same point, historically high, not low, but being considered at bargain levels. There is buying on anticipation of the end of an economic downturn that hasn't even been admitted to exist. Supreme faith is being put in the Fed recreating the mess that got us in this mess in the first place.

This market is going to ruin about all that play it. Bears will get ripped to shreds and once bears gain faith to stay on their shorts, the bottom will be in, as there will be a rally that totally wipes out short margin. But, in the meantime, bulls will continue to relate to the highs on stocks and the shortness of prior recessions. The 2001 recession literally didn't happen if you believe statistics, though the market didn't finish declining for a year after the recession supposedly ended. The bulls say the market will see the end of the recession 6 months early, while it took a year last time for the market to see the end of the recession. Such are bubbles, as opposed to normal markets.

I lived through a housing bust in DFW back in the 1980's. The bust started in 1983 to the best of my estimate and wasn't over until about 1992 or 1993. DFW was a rapidly growing metro area during that time, not a ghost town. One problem DFW had and I believe a problem California and Florida are going to have is that housing and commercial real estate were such huge parts of the local economies, long term growth having been established much earlier that the industry itself put a hole in demand.

There were some amazing deals on the DFW real estate market in 1992. Guys with deep pockets picked up deals that broke guys with deep pockets several years earlier. Trammel Crow, who was one of the biggest developers in the world was on the ropes by 1992 and couldn't buy anything. My guess is Buffett will be on the ropes by the end of this one and won't be buying much. There won't be much dry powder by the time this bear is done.

This is why I am a deflationist. I will cover in another writing what I think is going on, why the Fed, despite its current wrecklessness, won't be able to produce the expected inflation until we don't need it. I think the basic problem is the bulk of debt that can be covered is in the financial, business and corporate management areas and stocks will be sold to cover debt. Instead of the cash changing accounts as it has over the past several decades, this cash is going to pay credit. Irving Fisher, in his deflation thesis (Bernanke is clearly a follower of Fisher, who was a Wall Street delusional socialist), said the more debt was paid down, the greater the actual value of what was owed. What the bulls think is the solution is nothing more than keeping the door open for this process to occur. Until everyone that wants to buy to make a quick buck is broke, this market will keep going down.

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