Wednesday, October 14, 2009

Its still debt

The inflationists are missing the boat. In fact, those in mortgage lending mess are right on the money, not making loans. The only outfits making loans are the ones controlled by the government. That won't last for long as debt is going to continue to pile up as trash on the curve. The inflation worm turned a long time ago and the money machine was destroyed with the housing bubble. Inflation to maximum potential has occurred.

Right now the Fed is buying mortgages and to some extent treasuries. The act is being called printing money, but at this time I see it as changing who holds the debt. The money was already printed by the banking system, spent bullets. The problem we face is debt not inflation. Now the Fed owes for what someone else owes, to someone who isn't even involved. The link is debt and liquidity,not printing money. The liabilities have to be solved. There isn't any running off the roll of toilet paper, only another note for another note.

We have had a bad stock market for 10 years now. IN fact, if you go back to 1968 when the SPX first crossed 100, the dividend yield was right on 3%. If the SPX was priced to yield 3% right now, it would be priced at 732, according to SPX data. The Shiller data from June 68 showed a price of 100.5 and the CPI divisor to August 2009 was 6.22, meaning to keep up with inflation the SPX would need a price of 625. This means that if you were constantly invested in the SPX for the past 41 years, you would have beaten inflation by 17% total, less than 1/2% per year. BBB bonds did better than that. In deflation, the market is going to fare even worse, as the relative volume of business is going to fall. Back to the 1929 peak, the SPX would adjust out to 395, still less than a double over 80 years, evidence the real return on stocks over an entire cycle is less than 1% over risk free.

Knowing the SPX has the potential to fall 80% or more, I can see that people are about to get tight. Those that don't eat at home are going to be looked at as spendthrifts. Debt is going to get tighter and tigher. There is almost no way we don't deflate and this depression will be longer and harder to exit than the last one.

Sunday, October 11, 2009

New loans will never come back

There are a lot of green shoots, but they don't make a meal for a small horse. It will never get out to people why this depression is happening because those in charge don't want a nation of people to catch on as those in bondage in Egypt did 3000 plus years ago. There will be all kinds of explanations like Black Swans and the last administration or subprime lending, but there will never be allowed to slip the deadly nature of credit and debt in general.

We are in a mess. The entire survival of modern civilization may rest on the solution to the current financial/debt system. It would be easy enough to get rid of the debt, but few understand the power that amassed debt considered money gives an economy when it is nearing peak. The massive amounts of performing debt represents capital, retirement, savings and money all at the same time. Problem is, it is also a cancer to the economic well being once it becomes excessive.

One of the paradoxes in this economy is that savings is debt. Debt is savings, debt is money and it is the basis of rasing more debt, more money and creating more savings. But, as more is generally better, more against something relatively fixed like the size of the economy eventually becomes overwhelming. To say that they can pile debt to the moon is only true to the extent that the expectations of it being serviced or repaid.

There is more to the debt than meets the eye. The dollar is debt. It is the debt that the Euro is largely based on. It is the backbone of the Chinese financial system. If another currency was to step forward and take the place of the dollar, it would imply that the country of origin had created enough debt to sustain that much debt outside the country. Most countries don't have private property rights or enough property to float enough currency to support the credit systems of the world. It would be nice to have something like the Swiss franc as a reserve, but it would only be a few weeks that Switzerland would be drained of money and a few years of borrowing it that it would be broke. The Euro would work, but the internal and external debt of Europe is massive. The yen might work, but the asset base of Japan has been eroded by deflation and to utilize the yen would drain what was left.

What is about to transpire is the no mathematical solution problem. This past week the former risk evaluator of FNMA from the 1980's came out with a loss projection for the FHA. With it were studies that raised the question of why defaults and foreclosures on mortgages were going up during the 1990's despite a good economy. It is pretty clear with some lookback that the general level of debt in the economy was making it more and more difficult to service existing debt. Once asset inflation stopped, the game was up.

Now governments around the world are trying to stimulate borrowing and lending to get the economies going and I don't believe it is going to work. Instead, we are going to find that all new debt is going bad in with the pile of the other bad debt. The maximum debt capacity of the economy has been reached and all new debt is merely adding to the losses.

Stock market bulls think the Fed has solved this and all we need is for banks to start lending money again. Of course, the nature of the stock market is all involved have stock for sale, meaning they are really only promoting what they have,like Kroger promotes groceries. The difference being that you have to come in and buy groceries from somewhere. You don't have to buy anything financial with your money if you don't want to.

The implications of what I write are dire for stocks, which are priced at levels where only more leverage can ever make the prices go up. Corporations may have a lot of cash, but they also have record levels of debt and any that get more debt are raising their odds of going broke. I am convinced that US corporations drew their credit lines last year as the crisis approached so they would be certain to have money. Though this action may have helped many avoid bankruptcy, it may have also ensured others they were going broke. GE could very well be one of them, with the government getting the bill for the insolvency.

The level of debt has to decrease and it cannot decrease without also decreasing the pool of savings and the money supply. The Fed is attempting to keep cash in accounts by buying debt, but I suspect they are going to run in place at best. Savings has increased, but I believe this is more a matter of consolidating ownership of cash balances in the hands of fewer people and the paying down of existing debt. We will see if I am correct soon.

Going forward I sense that bankers are going to realize as well that any new debt they issue is merely going bad with the rest. As the system deflates worldwide, which it will, prices of everything will collapse as those selling literally everything will need cash to attempt to service debt. That is how liquidations occur.

At this time, the banking system is choosing to speculate rather than make loans. This is in part providing liquidity for assets, but it has it dangers. Putting out cash for assets is just as deadly as lending cash. Once it becomes clear that the bigger fools are already in the game, banks and brokers who have been throwing stock between themselves to inflate prices are going to find they are the bigger fools. We are headed for a liquidation as we saw between spring 1930 and summer 1932. I am betting the SPX goes to under 400 for certain and the Dow under 4000, taking out the entire post 1995 bubble. Tens of millions are going bankrupt and the financial bubble in Asia is going to implode along with ours. The housing market decline is going to resume, as all in the making of mortgages are going broke and the government is going to have to adapt to survive itself.

Saturday, October 10, 2009

Why the Smart Money Missed the rally

There are plenty of falling knife catchers who pretend to be Einsteins now that the market has rallied to where it was after it had declined for a year straight. What those that missed this rally may forget, if they are now anointing these gurus as geniuses is that these same knife catchers were buying at the peak, buying in January 2008, buying in May 2008 and buying in August and September 2008, buying on October 14, 2008 and buying on election day 2008. I might also add that the first trading day of 2009, the Dow traded in excess of 9000 and the bulls were piling in and repeating the same mantra to the poor idiots that had listened to the Jim Cramers all the way down, stay the course.

For one thing, for many to have gotten into the market on the bottom, the volume of the trade would have had to have been well in excess of the clearing capacity of the exchanges. Instead, we have seen repeated massive volume in issues like FRE, FNM, AIG, C and GM, mostly defunct or near defunct on government life support entities. So the trading hasn't even been in these near healthy side of the market. Instead what we have seen is bears being forced out by nonsense moves more likely induced by Goldman Sachs trading computers, designed to unload acquired stock on the way up. In the meantime, Ben Bernanke created a new hallucination, green shoots for the bulls to munch on while they were being fattened for slaughter. Green shoots are things like statistical bounces in indexes. Reductions of unemployment claims to levels higher than any prior to December 2008. The suspension of mark to market allowed zombie banks to pretend they were solvent. Nonsense being sold as improvement?

The reason the smart money missed this rally is there isn't going to be a picking the bottom in this market. A point where dividends on the SPX are around 3% will never be a bottom in a deep bear market,nor a reason to hold stocks for the long run. At 2%, they are a game for fools to buy into. Where is the bottom supposed to be? Logically where there might be a chance for a 6% real rate of return. A 5% dividend would have been near SPX 400, not 666. In any case, the buy if someone was bottom fishing was in the bonds of these companies, not the stocks. This was the real claims on the assets of the companies in event of bankruptcy and the guaranteed returns were very much higher than the stocks.

So now we are sitting on the edge as the bulls proclaim victory while nothing in the private side of the economy is even operational. Trade wars and devaluations are in process around the world and several countries are on the edge of default. Foreclosure rates continue to go up, commercial properties are collapsing in value and many are headed for default and nothing in the banking system has been addressed. Bulls are now trying to entice others to come in and push up the value of their portfolios while the Wall Streeters are selling out with massive gains.

In late 2003 I put together the basis of a book I was going to call "So you think it is safe to get back in the water"? The SPX was roughly 1000 at the time and the Dow was about 10K. Just about 6 years later we are about the same price, meaning dividends have been the net result of holding the general market. Risk free treasuries would have paid the same return and 10 year treasuries about double the return of the market. Not a lot of people accumulated stock under the 900 level in 2002 or 2003, most having held on, the profit going to Goldman and others on Wall Street.

So we are getting the same bubble mania story we got last time. This time though we are looking at a zero Fed funds rate, clear evidence the world has reached an unsustainable level of debt, that even if growth returned the supplies of resources are insufficient for a long growth spurt and that the balance sheet of governments around the world have been irrepairably impaired. Add to that a series of job losses that haven't found a bottom or even showing signs a bottom is in the works and the real prospects for growth in equities is near zero.

Anyone paying attention to history knows there isn't a safe place to buy and hold stocks in this climate. Nor has there ever been a long term gain situation in holding the indexes at these prices. The limits of a bubble is how big it can get before it pops. Also, the real money generator of the economy, housing and real estate is not in a position to generate additional credit that drove the markets and consumer spending in the past. Holding equities is for people who don't know better.