Posted by Don Martin on Fri, Apr 29, 2011 @ 03:22 PM
SP index reached new highs this week since 2008 crash. This week the most prominent bearish advisor, David Rosenberg, said that the market may go higher (on a short-term technical basis). Inflation continues to go higher. Precious metals set new records. Oil is very high. So it looks like the bearish case is dead, right? Wrong!
Bubbles can last for years. The great mortgage and real estate bubble began in 1997 and continued until mid-2007 and took a year to die when Lehman went bankrupt in 2008.
The stock market is a very unreliable, emotional, unprofessional indicator. The market is very inefficient most of the time. Ben Graham said the market is at times a weighing machine and other times a voting machine. The economy has been manipulated by QEI and QEII, by a law banning “mark to market” accounting for poor quality loans held by banks, by artificially low interest rates, by huge fiscal stimulus.
The hard cold facts are that 16% of the population is unemployed or underemployed, a record number of actual or potential foreclosed homes have not been sold, and about half of all home sales are foreclosures or short payoff sales. To cure unemployment requires 300,000 new jobs every month for several years non-stop and this has not been done since the late 1990’s and is actually rarely occurred in history. To cure the economy more private sector lending needs to be done but can’t be done because potential borrowers don’t qualify under new, tighter rules.
Further, the facts are that, per Robert Shiller, the market’s 10 year P.E. is about 22 versus a norm of about 15-16, implying a substantially overpriced market. My observation is that the Crash of 10-19-1987 was due to the U.S. dollar rapidly declining which caused foreigners to withdraw from the market. Now the dollar is declining and reaching close to a new low, which if breached could provoke foreigners to sell U.S. stocks. Further the market has been propped up by a very low margin rates and very low VIX that allows hedge funds to buy Put options that allow them work with the extreme risk of being levered up 4 to 1 or even 10 to 1. Hedge funds have only been prominent participants in the last 20 years, so today the market could experience more volatility than was experienced before 1990. So a currency devaluation now could pose more risk today than it did during 1987 crash. During 1987 the U.S. dollar was artificially high due to artificially high interest rates, so it needed to come down; its decline was orderly and was not a sign of economic weakness. Today the declining dollar is not orderly and is a symptom of a weak economy with significant structural problems.
I have written “has the economy recovered enough to justify the stock market prices?” and "the effects of QEII will be negated by a market crash”.
This is not the time for bears to capitulate. The risk of a foreign currency crisis, a VIX crisis, a Flash Crash, a margin call on over-leveraged hedge funds (any one of which can lead to a mega Flash Crash) and no resolution of the economy's structural problems make this a good time to get prepared for a crash, not a time to abandon a bearish position.
This is an example of independent financial advice.
Posted by Don Martin on Thu, Apr 28, 2011 @ 03:18 PM
Investors worry: will the dollar collapse, what are investments for a Dollar devaluation, when will the dollar collapse? This is a risk I have written about in “
Emerging market currency investing” and “
Asset allocation with a crashing dollar”.
There was a good article in the Wall Street Journal today about a dollar rout.
The principles of investing are to avoid trying to get rich and instead focus on investing in quality investments that are diversified. So in regards to the risk of a Dollar rout perhaps a solution is to invest in a diversified portfolio of foreign currency denominated bonds with the attitude of seeking safety rather than seeking a windfall profit. One must be careful to avoid poor credit quality bonds and to try to stay close to short term maturities because rising inflation in Emerging Markets is hurting bonds in those countries.
The old paradigm of the dollar going up in value whenever a recession or a panic occurs may have been broken and a new paradigm may be that Emerging Markets are the new safe haven from the insolvent behavior of the developed countries.
This is an example of independent financial advice.
Posted by Don Martin on Wed, Apr 27, 2011 @ 11:00 AM
Today there was an excellent article in the Financial Times about hidden copper bullion stockpiled in China which implied that the price of copper was too high because speculation. Previously I have warned that covert shadow bank margin lending bubbles in China may have aided this speculation. This is important because economists worldwide assume that copper’s price and demand can forecast economic growth. But what if copper has become scarce and expensive only because of covert speculation? Then the world’s economy would not be as robust as it seems. And what if a margin call on these stockpiles of copper caused them to be suddenly sold? Then the shock of the unexpected supply of copper would send the price down, destroying economic models that forecast growth and inflation, thus making equities go down and bonds go up.
The article said 4 million metric tons are “missing”. The world production of copper is about 5.7 million metric tons a year, so that is a huge amount of phony demand. If this demand had never occurred then the price would be a lot lower and a lot of economic indicators would be less bullish.
I have seen this pattern before in America, where people overbuilt the housing market, making GDP bigger because of building an unneeded asset that was falsely labeled as an investment but which was really a losing speculation. The same happened in Ireland.
These commodity bubbles are labeled as proof of inflation and proof that a full employment economy is about to occur, when in fact they are simply bubbles.
I have written “China’s hidden loan bubble” and "Contrarian view of inflation”. These are examples of independent financial advice.
Posted by Don Martin on Tue, Apr 26, 2011 @ 12:42 PM
The public wants to know about investments for a falling dollar, emerging market funds, hedging against a falling dollar, preparing for the crash of the dollar. More evidence continues to build about risks of a disinflationary crash. Jeremy Grantham writes at gmo.com yesterday that while he sees commodities becoming more valuable over the long run there may be, in the near term, a bad commodities crash, as bad as the stock market crash of 2008-2009, especially if China crashes and the weather improves.
More news stories mention that the Fed’s policies differ from the other nation’s Central banks, with the Fed being the softest one. This softness means that the dollar will go down. If the dollar goes down then from a foreigner’s viewpoint the U.S. stock market is also going down, so the foreigner will sell his stocks. This is what caused the October, 1987 22% crash in the stock market. As I mentioned before U.S. stocks are propped up by hedge funds that get cheap Put option insurance from naïve writers of naked Put options who try to make 20% profit from writing options. When these Put option writers suffer a brutal crash then the cost of insurance will go up and hedge fund leverage will go down – it could go down involuntarily with margin calls and increased margin requirements. When someone is desperate to meet a margin call they sell the good assets at fire sale prices because the bad ones can’t be sold. This creates a sudden, surprising drop in the market. So conditions are developing for another flash crash. Remember it is all ultimately based on fundamentals: if a stock’s P.E. is too high and there is too much leverage then fundamentally a crash needs to happen. Add to that the risk of a crash in both China and in commodities.
The solution is to invest in quality investments: assets that are economically healthy, with lower than average risk, with minimal bubble tendencies.
I have written “Copper market looking weak” and "Contrarian view of inflation”. This is an example of independent financial advice.
Posted by Don Martin on Mon, Apr 25, 2011 @ 01:39 PM
Investors seek answers to the following: will the dollar be devalued, will the dollar collapse; if that happens what are investments for a dollar collapse, is oil a hedge against a dollar collapse, and what foreign investments are a hedge against a possible dollar collapse.
My view is that even though one should be aware of the risk of a dollar collapse, the most likely outcome is a slow gradual devaluation of the dollar. Further, investors are more likely to hurt themselves by panicking and overpaying for inflation sensitive investments then they are likely to be hurt by a surprise, massive dollar devaluation.
The solution is to wait patiently for the right time to buy investments (such as a foreign currency denominated bonds) that may protect from a dollar devaluation and then prepare to hold these for a long time and to assume the profit potential may be rather modest. If things go badly for the dollar then that will create a global depression, thus hurting most types of assets, so investors should not get too excited about profiting from a crash. Perhaps the best thing is to minimize risk rather than seek a way to make a windfall profit.
There was a great article by Jason Zweig in the Wall Street Journal on April 24, 2011 about the dangers of investing in silver. He cited examples of people overpaying 22% to buy a Closed-End mutual fund that invests in silver bullion.
I have written about "Investments for a dollar collapse" and "Will the dollar collapse". This is an example of independent financial advice.
Posted by Don Martin on Thu, Apr 21, 2011 @ 10:39 AM
To hedge against a falling dollar one investment technique is to use foreign currency denominated bond actively managed open end mutual funds. Be careful to verify that they are "unhedged". Some FX bond funds are hedged back into dollars so you get no protection from a falling dollar. Be aware the other major developed countries currencies (Euro and Yen) may perform worse than the dollar.
There are some developed countries with good currencies in resource exporting countries, Scandinavia, Switzerland. The EM countries are experiencing high inflation and to deal with that they will raise rates which will make bonds go down in value but make the currency go up, thus negating potential appreciation. If that occurs then being at the short end of the yield curve is best. Another problem is that EM bonds tend to be low credit quality around BB or B and I prefer to get A or better, but the highest are rated BBB. Also that asset class is poorly served by mutual funds with few funds being in business for over five years.
It is too hard to predict FX rates; instead one should diversify as a hedge against a dollar devaluation rather than attempt to seek a profit through short term trading. Many counterintuitive things happen in FX. Recently Turkey lowered rates to make its currency go down even though they needed to raise rates to fight inflation. There is the risk of future currency controls that would trap an investor's money inside of EM countries.
See my posts “Investments for a dollar collapse” and “Will the dollar be devalued?”
This is an example of independent financial advice.
Posted by Don Martin on Wed, Apr 20, 2011 @ 01:02 PM
People enquire about the risk of the dollar collapsing. The WSJ quoted Russia's Putin today: U.S. Monetary Policy Is ‘Hooliganism’. I have written in “Government shutdown and dollar collapse” and “Investments for a dollar collapse” explaining that there is no substitute for the dollar as the world’s reserve currency. Today’s WSJ article confirms that.
The talk about dollar collapse and the attempts by the Fed to reinflate the economy by weakening the value of the dollar remind me of the movie “Groundhog Day” where Bill Murray plays a character who tries to kill himself everyday but can’t. Every day it seems, metaphorically speaking, that the Fed tries to kill the dollar by increasing the money supply, or by “Quantitative Easing” (to devalue it), or by lending money to insolvent financial entities during the crash of 2008.
Yet no matter how hard they try they just can’t kill the dollar. Foreign governments have a need to prop up the dollar to fight competetive devaluations (currency wars) and they need to keep the value of the dollars that their Central Banks hold as reserves from declining.
However, the best analogy for the dollar maybe the British Pound that slowly depreciated after 1945. So the best solution to a weakening dollar is to diversify into other currencies, but do so with a cautious attitude and not with a hysterical attempt to flee from it. The risk is that despite a long standing paradigm that the dollar will continue to be propped up, there is the possibility that with enough attacks on its value that its value will eventually crack and fall through support levels and enter a new paradigm and trade at lower value.
This is an example of independent financial advice.
Posted by Don Martin on Tue, Apr 19, 2011 @ 10:05 PM
Apartment rents may weaken, thus reducing CPI. 40% of CPI is calculated from renting a residence. Since most rentals are apartment houses one should examine that as a source of inflation or deflation. I had thought that multifamily apartment houses were more stringently underwritten than single family loans and so I assumed that multifamily properties would be less likely to go into foreclosure. While that is still true, it is also true that failures are occurring in multifamily lending. In 2010 the amount of multifamily foreclosures doubled compared to 2009. See WSJ article “Apartment-Building Foreclosures Piling Up” on 4-20-2011.
I had written about this in “Will rents go down?”. Then WSJ had an article on 4-18-2011 titled “Project Comes Back to Life”, and subtitled “Former Condo Conversion on Broad Street Is Turned Back Into Apartments”. The story shows how more supply of rentals is occurring as a result of the housing market collapse. So with increased supply, from supposedly safe market segments, added to the obvious flood of single family foreclosures that will eventually become rental property will result in deflation in renting which will be disinflationary for the CPI. Today the media quoted the president of Chase complaining that foreclosure may take 500 days. So during that time excess inventory is held back from the market. I remember doing a loan on a foreclosed property that was from the crash of 1990. The buyer said the bank had kept it empty for two years after foreclosure!!! So the buyer stopped being a renter in order to buy that property and thus he was reducing the demand for rentals, which helped put downward pressure on rents.
Eventually in roughly five years the housing backlog will be cleared out and then rents will go up, but for at least two years there will be increased supply and a weak job market, resulting in a softening of rents, at least for above average quality property. Tenants could move to less attractive rentals to save rent causing rents to go up in that area.
The logical outome of the housing crash with the now ultra-tight mortgage underwriting is that only affluent landlords will step in to buy the huge inventory of foreclosed real estate. Some rookie landlords will be forced by excess supply to rent out their investments at competetively low rates.
This is an example of independent financial advice.
Posted by Don Martin on Mon, Apr 18, 2011 @ 12:56 PM
Today S&P rating agency announced it cut its U.S. ratings outlook to negative.
This is in regards to a possible downgrade of U.S. government debt. This is rather amusing. This risk has been known in the marketplace for a long, long time and has been fully discounted by the market, so it is not news.
The dollar is the world’s reserve currency and there is no credible alternative. The government’s debts will be repaid by simply having the Fed printing up more dollars if not enough taxes can be collected. Of course that would cause inflation, but then inflation helps debtors to pay off their loans.
An analogy to the dollar would be in physics there are strange counter-intuitive things that happen at the quark level of sub-atomic particles. The modern post-Bretton Woods fiat dollar is no ordinary currency. The Treasury debt is denominated in dollars and can be paid by the Fed monetizing the debt. Smaller, less developed countries make the mistake of denominating their debt in a hard foreign currency and then when they become insolvent their currency declines against hard currencies and this makes it utterly impossible to repay the debt. The U.S. has no such problem.
People inquire about the best investments for Fed tightening, and investment advice about the bond market. A possible scenario is that Fed tightening would affect the short end of the yield curve, causing the yield curve to flatten and cause long term rates to slightly decrease. Fed tightening implies less risk of inflation which increases the value of long term bonds, so LT bonds would go up in value and LT interest rates would drop. So short and intermediate term rates would go up if the Fed tightened but long term rates could go down, so that on the yield curve rates would be relatively the same (a flat yield curve). Since short term rates are the rate that hedge fund margin loan borrowers pay for leveraged trading then they would be less able to buy assets and would have an increased need to sell off assets. Hedge funds often are leveraged 10 to 1. So an increased cost of capital for them would result in hedge funds selling off equities and this would be deflationary, resulting in lower interest rates. Further, higher short term rates would dampen speculation by writers of naked Put options, causing the VIX to go up and making it harder for hedge funds to buy the Put options they need to survive.
I have written “Treasury bonds to be OK”. They are risky because there the possibility that an inflationary surprise could make LT bonds go down in value, so investors should not get greedy and maintain a large allocation in LT Treasuries in hopes of making a capital gain because there is too much risk that the probability of LT Bonds going down in value has a greater chance then the probability of it going up in value.
I doubt the Fed will tighten this year. It will not extend QE2 and Congress will enact spending cuts and by year end the stock market bubble caused by QE will have been discredited, and then capital will flee into Treasuries.
The consumer sentiment index of 69.6 is lower than at the bottom of the recession in 2009, the Fed can’t raise rates.
I have written in “Will the dollar collapse?” that there are many reasons that it won’t.
This is an example of independent financial advice.
Posted by Don Martin on Fri, Apr 15, 2011 @ 04:43 PM
Inflation can be created by three methods:
1. An increase in the money supply combined with tight labor markets and minimal excess capacity
2. Monetization of Treasury debt by the Federal Reserve
3. Quantitative easing, done to devalue the currency
None of these three can happen in the next few years. There is a huge amount of slack and excess labor capacity in the U.S. The only way to reduce unemployment is to increase jobs by 300,000 monthly for several years, a rate that has not happened consistently since the boom years of the 1990’s. This potential type of inflation is what happened in the 1970’s and is the most important type to be alert for.
Monetization of the Treasury debt will only happen if the Treasury can’t sell its debt to anyone. This would only happen if the Congress authorized a huge increase in spending. Huge deficits are forecasted in the distant future, but as we get closer in time to those years there will be more pressure on Congress to refuse to authorize huge deficits. Also there are very special reasons why foreign countries will continue to buy Treasuries.
Quantitative easing has failed. Its goal was to increase the money supply but the bank reserves it created were hoarded as cash by banks; instead bank lending actually shrunk. The velocity of money plummeted by 50% during the 2008 crisis and has remained at a low level. Its goal is also to devalue the currency but foreign countries will try to set an artificial rate for their currency so that they engage in competitive devaluations (currency wars) that prevent the Fed from devaluing the dollar.
I have written about this before “What is the potential source of inflation?”
Ask yourself what if the stock market and China’s economy are a bubble that crashes? What will happen to commodities? Will a “flash crash” cause a wave of selling that results in margin calls which trigger more selling? What about the small investors who write naked Puts to earn some extra money, will they lose their nest egg, and if so will the VIX be a prohibitively high level that would make hedge funds unable to invest with extreme leverage? The market is propped up by a low VIX and low margin rates that fuel asset bubbles. These bubbles are unsustainable and subject to a sudden crash. A risk asset (stocks, real estate, commodities) crash will make investors flee into Treasuries. This is an example of independent financial advice.
Posted by Don Martin on Thu, Apr 14, 2011 @ 04:12 PM
House Republicans may succeed in reducing deficit spending when the Treasury runs out of money in July and hits the debt ceiling. They are more determined than Newt Gingrich was in 1995 because the deficit is so huge. This would be bullish for Treasuries in July. It will be deflationary due to budget cuts; this is good for T-bond bulls. Service industries are not directly influenced by rising foreign labor costs (unlike manufactured goods) and are 67% of economy. If the economy slows down in the second half of 2011 and Congress contracts government spending when the economy is still fragile that could cause the economy to fall back into a double dip recession. The combination of better government solvency combined with a lesser degree of stimulus would make Long Term Treasuries more attractive, especially if option writers charge significantly more for Puts and the stock market declines by 40%. This could be the best contrarian investment surprise of 2011.
The hysterical talk about inflation is something I have written about in “Contrarian view of inflation hysteria”.
Bob Janjauh of Nomura predicts SP to go to 1000 during 4th Quarter 2011.
I think the stock market has been propped up by easy money from Fed QE2 stimulus and low interest rate margin loans. The hedge funds get to borrow at artificially low rates and lever up 10 to 1. They depend on cheap margin rates and cheap Put options. If more crashes occur then naked Put option writers will get burned and withdraw. Thus the cost of Puts will become too expensive for hedge funds and they won’t be allowed a highly leveraged margin loans by their banks. Then the absence of hedge funds as buyers and pressure from their selling to meet margin calls could be the tipping point that creates a new bear market cycle. This in turn would cause investors to panic sell out of commodities. Also capital would then move into Treasuries.
I have heard too many anecdotal stories about naive, unemployed small investors who live off income from the writings of Put & Call options. This may have created an imbalance of option writers thus lowering the VIX and creating a false sense of security for both sellers and buyers of options. If this cheap insurance dried up that would hurt the stock market because it would become prohibitively expensive for hedge funds to operate. Lack of Put options would move the market to a more reasonable long term P.E. ratio.
I discussed this in “US equities are 70% overpriced”.
NPR today said California cotton farmers dropped from 1 million harvest to 200,000 units this year and now that cotton prices are high they are now doing record plantings. This implies that cotton is following a cyclical price pattern that will come down, thus it is not going to cause long term inflation.
This is an example of independent financial advice.
Posted by Don Martin on Wed, Apr 13, 2011 @ 02:11 PM
Investors want to know about Black Swan investment planning and how to be a risk aware investor. They also inquire about using the “information ratio” for stock market investing.
One of the key principles of investing to have good risk management. It is important to remember that losses are more important than gains because if you have $100 in a stock that drops 50% and then rallies 50% it will be at $75 and so you have lost $25. Buffett said one of the most important rules is to avoid losing money.
Some risk management tools are:
* information ratio. An excellent tool. see “Sharpe ratio versus Information ratio”
* Risk aware investing. See “Investment standard deviation”
* Black Swan investment planning. See “Black Swans Now a Regular in Market”
Risk management means that you weight the rewards against the risks and only invest if the odds are in your favor. Paradoxically some investors are so eager to avoid the risk of inflation that they may have panicked and overpaid for alleged inflation hedges that may not even work if inflation returns. If you overpay for an insurance policy then you may end up losing money, especially if the policy never pays you adequately for a casualty.
Being risk aware means that you should spend a disproportionate amount of time studying an investment’s risks rather than its potential rewards. For example, try to understand its standard deviation, information ratio, Sharpe ratio, correlation with other assets, “worst case” behavior during the crash of 2008-2009. If examining a stock, if the company has issued bonds then look at the rating agency’s rating for its bonds. Use a database like Morningstar to evaluate the riskiness of the firm. Examine the securities trading to see how frequently do the shares trade and find is the spread between bid and ask. Read the prospectus and annual report to see if it is an opaque, hard to understand company or mutual fund. For example banks and companies that offer financial services that inside of a manufacturing company have a difficult time valuing loans on their books to market value during a crash, so it very hard to know what the value is of the constituent parts of their assets. So if it is opaque then simply boycott them and refuse to buy their stock. Perhaps a mutual fund can make a better estimate than individual investor about the credit quality of a bank’s portfolio. Be aware of a company’s corporate moat as rated by Morningstar. Be aware of a company’s debt as a percent of assets. Be aware of the error of using an investment’s high water mark and instead focus on its potential risk of dropping to the low water mark.
Learning how to reduce risk is a skill that is needed in order to carry out a plan to invest to protect from dollar devaluation. This is an example of independent financial advice.
Posted by Don Martin on Tue, Apr 12, 2011 @ 04:35 PM
People have inquired what will happen if the dollar collapses. They want to know will the FDIC be able to reimburse victims of bank failures? Will consumers be able to buy imported goods? Will the government be able to pay police and fire department members to maintain order? Will basic necessities be available in grocery stores? Will the government confiscate wealth as was done in the Great Depression when gold was outlawed?
These questions are topics that people are asking with increasing frequency. The very fact that people are getting anxious is good because it means that people are becoming aware of the shaky financial health of the government and that means people will be motivated to study, research and organize a plan of action.
Every family should have awareness of this matter and a contingency plan.
Key ideas:
- Reduce your debt
- Avoid high risk investments
- Invest in high quality investments
- Invest in liquid things that are easy to sell
- Avoid illiquid things like real estate, rare art
- Diversify internationally into countries with the best economic health
- Learn to think creatively and be adaptive about survival
- Develop portable career skills that will be marketable if living in different countries
- Develop foreign language and cultural skills to be able to live abroad
- Don’t worship your employer and assume they will never go out of business
- Be mentally prepared for career changes as the economy evolves
- Drive cars powered by natural gas or electricity made from natural gas or coal-avoid imported oil
If the government became bankrupt they could refuse to pay bondholders and would use income from taxes to pay modest salaries to public safety employees to keep order. There was a book by economist Anatole Kaletsky that said that governments that default manage to eventually return to normal.
If the dollar collapsed it is possible that many things would continue as before except that:
- People would not be able to afford a foreign vacation
- People could not afford imported goods
- Many people would sell their homes to foreign investors to get foreign currency and rent their house back.
- Many businesses would be acquired by foreigners and your ability to speak their language and dine with them and eat their native foods will help your career.
- Some areas in America could become special enterprise zones with special rules where foreigners might have a lot of “persuasion” over how the local government operates in return for increased creation of jobs by foreign companies. The constitution says that if the Senate approves a treaty then that overrides the constitution. So imagine a treaty with a foreign country creating a special enterprise zone for the foreign investors who protect their property rights with special courts and police that are not governed by the U.S. constitution.
- There would a huge amount of foreign tourism in the U.S. as they seek to benefit from a low cost dollar. Yosemite National Park and other popular places would cost $1,000 per day to visit for foreigners with subsidized rates for U.S. citizens. To encourage more visitors visa rules would be relaxed to the standard of “if you are rich come anytime”.
- Americans will gladly accept jobs from foreign employers who will pay them in foreign currency. They will rent an apartment from a foreign landlord and pay them in foreign currency through payroll withholding.
Of course, this does not need to happen because now that people are aware of it they can take steps to prevent a dollar collapse by urging the government to support a sound dollar, a government budget that leads to solvency, and a healthy economy.
i remember as a child in the 1960's doing "drop drills" at school where we hid under our flimsy desks when a siren sounded so that we could prepare for nuclear war. It was important to cover our head with our arms, we were told, in case we got hit with an atomic bomb. Fortunately the Cold War ended peacefully. Let's hope that our government's leaders can arrange for a peaceful end to the fiscal irresponsibility that has made the topic of a dollar collapse worth worrying about.
Regarding your own personal finances, you should seek independent financial advice. I have written about "investments for a dollar collapse".
Posted by Don Martin on Tue, Apr 12, 2011 @ 03:26 PM
Today the San Francisco Chronicle had two articles that were bearish about real estate. One article mentioned that when condo projects become disapproved by lenders then no one can get a loan in that project, so the only buyers are cash only buyers, which is rare.
I know this firsthand from years of working in real estate finance. During the real estate bubble I had predicted this would happen. During a real estate boom people buy condos because they can’t afford a house and then during a crash when there is a shortage of buyers then buyers can pick whatever property they want, so they will buy a house and avoid condos. To further complicate things some surveys lump houses and condos together as a single family residence so a collapse in condo prices can hurt housing prices.
I have written about the housing crisis in “Bearish housing market”.
The Chronicle had another article today about houses selling for less than cars. Amazing that you can buy a house for $35,000 in Arizona. I saw one for sale only a few miles from the ocean in Santa Maria, CA (north of the very wealthy Santa Barbara area) for $124,000. During the bubble the commonly held mythology was that there is a finite amount of land and since no more land can be made then this would allegedly result in ever rising real estate prices. However, there is a huge amount of land in rural communities and in suburban areas there are plenty of opportunities for in-fill, tear downs, demolishing old houses and replacing them with densely packed condos, building on landfill in the Bay, or going vertical that don’t require increasing the supply of land. Further, people may react to high urban land prices by moving jobs to distant exurbs, telecommuting, etc.
I remember reading an article in a business magazine that showed some collapsed 19th century U.S. real estate bubbles have never recovered.
Interesting how prominent banks did not become aware of this and plan ahead during the bubble. Instead they assumed that rising real estate prices meant that it would be safe to lend recklessly against home values.
This is an example of independent financial advice.
Posted by Don Martin on Tue, Apr 12, 2011 @ 12:28 PM
I continue to believe that the main driving forces of the economy are disinflationary. These are excessive unemployment which has continued for a very long time, continuing contraction in bank lending, 50% reduction in velocity of money, no end in sight to the huge overhang of foreclosed housing and shadow inventory of housing. Further the Euro is overvalued and continues to have growing problems with default risk in its PIIGS members. Rising commodities prices used to be symptom of rising economic activity but in the past decade commodities markets have been dominated by speculators who may have panicked about inflation and created a misleading feedback loop of rising prices. The fundamental justification for rising commodity prices is either because of China’s growth or because developed countries monetary policy will allegedly create inflation. If those reasons for being bullish about commodities are wrong then the price will crash. See “
Contrarian view of inflation hysteria”.
John Mauldin said on Financialsense.com that we have not had 300,000 monthly new jobs growth consistently since the 1990’s and that is the rate needed to reduce unemployment to normal levels. My opinion is to ask what reason is there to think that job creation will increase to that rate while we are going through a continued gradual collapse of the shadow banking system? And since the jobless rate is the key to low inflation and low interest rates then it seems that the intractable problem of unemployment strongly hints at interest rates staying low, Japanese style for a long time, far longer than most people intuitively imagine.
The history of interest rate cycles is that rates go into a long term trend lasting decades. Since these large secular cycles are rare then it is hard to use data from them for statistical purposes because each cycle is unique and there have been only a few major ones. So it is not possible to assume that the cycle of downward rates has run its course and is due for a reversal.
The driver of increasing consumption was easy credit from shadow banks, made easier by inflation from 1965 to 2008. But the shadow banking system collapsed in 2008 and is partially propped up by the government but is still in the process of collapsing. The shadow banking system competed with banks and forced them to match their terms before 2008. Now that this competitor has been crippled the banks can return to an era of reduced competition where they will not need to be as competitive in the terms and conditions of lending. So this means it will be harder for consumers and businesses to get loans, and harder for consumers to spend.
Stock prices went up in a bubble in the past two years because of QE1 and QE2 and because of artificially low rates. News articles say that the Fed needs to raise rates to more normal levels in order to maintain credibility. In theory that is true, but only if today’s low rates are justified due to fragile economic conditions then it would be a mistake to raise rates. What happens if rates are raised by the Fed? The first thing is that margin traders in hedge funds levered up 10 to 1 would find that they can’t justify some of their trades and would sell them. This would create a wave of selling and a sudden drop in the inflated stock market. Since the market is 70% overvalued, using PE 10 and Tobin’s Q, then a sudden debt induced, margin call induced equities sell off would create downward momentum until intrinsic value was reached and the SP would trade at 900 to 1000. See “U.S. Equities are 70% overpriced”. This would drive money into bonds.
If the Fed raises short term rates this would actually give credibility to long term bonds because it would show that the Fed is trying to fight inflation, so the rates used to calculate long term bonds might not change, if the market believes that the driving forces of the economy are disinflationary. Bonds are often owned by cash based investors like wealthy people, retired people and pension funds, so they don’t rely on a low cost margin loan to buy bonds. Of course there are financial companies that borrow short and lend long term and they would be hurt by rising short term rates. Stock prices are influenced by leveraged, rapidly trading hedge funds that rely on cheap margin loans. So rising short-term rates could hurt stocks more than long term bonds. The Fed’s QE programs bought mostly bonds in the middle of the curve (maturities between 5 to 10 years), so when the Fed stops manipulating the market that may not affect very long term Treasuries, especially if the Fed misjudges and raises rates too soon.
People inquire about the possibility of dollar devaluation and want to know what are good investments to protect from a dollar devaluation. The answer is that other countries are working hard to do competitive devaluations to keep their currency from rising against the dollar. So in preparing for the possibility of a dollar devaluation one should not get hysterical and rush into flaky overpriced investments. Rather, they should coldly view topics such as inflation or devaluation as simply another topic to carefully review, just as a stock investor should carefully review a company to see if the 10 year inflation adjusted P.E. ratio indicates the company is priced below intrinsic value. One strategy is to diversify globally with the assumption that it is very hard to predict foreign currency prices because they are influenced by sudden, dramatic asymmetric political actions rather than gradual events that occur as the business cycle changes. If the Fed raises rates that would prop up the value of the dollar. (Which implies they won't raise rates!).
This is an example of independent financial advice.
Posted by Don Martin on Fri, Apr 08, 2011 @ 10:54 AM
People have been enquiring about the following: will the dollar be devalued, when will the dollar be devalued, will the dollar collapse? They want to know what to invest in when the dollar collapses. They worry what will happen if the Congress and President can’t sign a debt increase and spending authorization tonight and the government is shut down.
If the U.S. government is shutdown tonight at 9:00 p.m. Pacific time nothing really serious will happen for a few weeks and then Congress and the President will eventually reach an agreement. A shut down that results in the Democrats agreeing to the Republican's demands would actually be bullish for Treasuries and the dollar because it would show the U.S. is trying to improve its finances. However, if a shutdown is blamed on the Republicans and they are seen as giving up and surrendering to the Democrats when a budget agreement is finally reached then the world’s capital markets will see the dollar and U.S. Treasuries as continuing to degrade in quality, which would lead to higher interest rates, low bond prices, lower stock market prices. All that is being negotiated are spending cuts of 2 to 4%. If the U.S. was a corporation or a family and they had a consultation with their banker while seeking to increase their debt they would be told to cut spending far deeper than 2 to 4%.
So if the worst happens and deficit spending continues unchecked then one should prepare for dollar devaluation but if it does happen it will happen gradually and slowly.
The world needs to keep any one large nation from devaluing too much because that steals business away from other countries and disrupts world trade. Further the world needs its reserve currency (the dollar) to be stable so the world has a vested interest in propping up the dollar. An analogy would be the giant U.S. banks that are deemed to be “too big to fail” are treated more leniently by bank regulators so that they are allowed to function even though should have been shut down by the FDIC. Another analogy would be when regulations were changed in 2009 allowing banks to stop marking non-performing loans to market value and instead report those loans at book value. In both cases the government is trying to cover up the weaknesses of the large, unhealthy banks in order to avoid the catastrophic cost of shutting them down. In the case of the world’s capital markets and governments they have a vested interest in pretending that U.S. government Treasuries and the dollar are as good as they have been in the past.
There is no realistic alternative to the dollar as a reserve currency. The Euro is not up to the task, because its debt market is a lot smaller than the dollar, has a lot of hidden risk and may break apart. The ECB may break its mandate to have sound money and engage in a desperate act of money printing should a chain reaction of sovereign defaults occur in Europe. The Renminbi will gradually become an international currency over many decades but may not be ready to be a reserve currency for another 30 years. Gold can’t be used in lieu of the dollar because there is not enough gold to act as a substitute for the dollar’s role as a reserve currency. Using SDR's from the IMF is a fantasy because SDR's are fiat money based on contributions of fiat money from the very governments that caused this imbalance, so why would an SDR be better than a basket of shaky Euros, Yen, and the dollar? SDR's are analogous to mortgage backed securities that were a blend of poor quality mortgages that somehow were repackaged as AAA quality debt. How can a blend of various shaky, deteriorating currencies inside of an SDR be any better than simply buying the ingredients of an SDR on your own?
The dollar's unique position is like what Winston Churchill said about democracy: it is the worst system in the world, with the exception of all others.
So the U.S. dollar and Treasuries are in a unique situation where the world has a vested interest in propping them up above fair value.
However, the invisible hand of the free market wants to make Emerging Market countries currencies go up against the dollar, even though the world’s governments don’t. Ultimately the markets are stronger than governments so the EM currencies will increase against the dollar. So go long on Emerging Market foreign currency, but don’t panic. Avoid the Euro and Yen.
I have written about this in “Treasury bonds to be OK” and “Will the dollar be devalued”?
This is my independent financial advice.
Posted by Don Martin on Thu, Apr 07, 2011 @ 07:31 PM
Investment choices: passive ETF’s versus actively managed open-end mutual funds
Reasons for ETF’s:
* Lower annual fee
* Lower broker fee than mutual fund
* Trades during the trading day
* Smaller minimum purchases than mutual funds
* No distribution pass-through tax trap
Reasons for mutual funds:
* Actively managed funds seek to become aware of risks and try avoid mistakes made by blind, passive investing
* Some screens of best performing active mutual funds showed mutual funds beating passive ETF’s, however past performance should not be relied on for future performance.
* Annual fees for “I” class mutual funds are not that much higher than ETF’s
* No concern about illiquid, hard to trade shares
* No need to be concerned with spread between bid and ask that may occur in ETF’s
* Buy at NAV (if no load), by contrast ETF’s may not track NAV
* Suffered less problems during May 6, 2010 flash crash than ETF’s. 90% of the problems that day were in ETF’s.
* Mutual funds do not lend out shares of the stocks they own to short sellers; some ETF’s do.
Conclusion: Because of investor's need for guidance I believe that actively managed mutual funds are better than passive ETF's. For example see "Stock ownership lasts 22 seconds" to see how program trading can interfere with investments made by ordinary investors.
This is an example of independent financial advice.
Posted by Don Martin on Wed, Apr 06, 2011 @ 04:15 PM
Despite all the inflation hysteria I still believe that it is transitory and the trend is toward no inflation or slight deflation. Labor costs per unit of productivity have not increased, real wages are stagnant, loan growth is depressed, the velocity of money fell off a cliff in 2008 and has not recovered. The combination of reduced lending, shockingly low velocity of money and high unemployment and stagnant wages, and unresolved housing crisis means that inflation can’t occur. The rise in oil and food is transitory and will be paid for (offset by) with a drop in demand and thus a cut in price for other goods. A list of inflation by consumer items shows that only oil, oil related industries, tuition, tobacco exceeded 3%. So if the oil price repeats the crash of 2008 then there will not be any inflation. The Dallas Fed trimmed mean 12 month PCE is currently negative 0.3%.
Regarding inflation, it should be analyzed just like an investment by removing the emotions and looking at it objectively. Long range statistics show it is under control. We can’t judge it by this month’s food bill but rather we need to use comprehensive statistics like the chart in the Economist magazine a few months ago showing a steady downturn in the inflation adjusted cost of food over 30 years. I have written "what is the potential source of inflation" and "independent investment advice about inflation".
Investment success comes from screening emotional hysterical noise and finding a contrarian idea. So a contrarian idea is that deflation, not inflation will occur and that people are overpaying for inflation protection. There is a moderate slowly building bubble in inflation protection investments such as TIP’s, stocks, etc. The key to investing in addition to being contrarian is to avoid overpaying for investments and preferably to only buy at discount below intrinsic value. Today on Yahoo a silver closed-end fund manager was interviewed and he talked about the fact his fund has a 19% premium over Net Asset Value. He warned that if you buy silver coins it will cost you 10% in various costs. So either way silver costs too much to buy. Silver was around $5 to 7 an ounce for many years in the 1980’s after inflation was defeated in 1982. Adjusting silver for inflation would mean the 1980’s long term price of about $6 was like paying $15 an ounce in today's dollars (Assuming the CPI increased prices by 2.5 times in 29 years). So any excess over $15 for silver may be a bubble price where the buyer is overpaying for insurance.
Yes, I too am hurting when I buy groceries and gasoline. But I must use logic and statistics in judging inflation and not simply look at the pain without looking at the gain from price cuts in other items. For anecdotal news items see the recent Economist magazine article that cited Las Vegas homes rented out as low as $150 a month. The rent cut will offset a lot of higher food & oil costs.
This is an example of independent financial advice.
Posted by Don Martin on Tue, Apr 05, 2011 @ 03:47 PM
Today’s Wall Street Journal has an article titled "How Many Borrowers Qualify for New ‘Safe’ Mortgage Rules?"
The article said “About one in five mortgages purchased by Fannie Mae or Freddie Mac over the 1997-2009 period would meet the proposed standard of “safe” mortgages that would be exempted from costly new lending rules, according to a federal report published last week.”
My opinion is that the great real estate, mortgage, and stock bubble occurred during 1997-2007, so if 80% of the lending done then was not safe then that explains why the bubble got so big and why it is so hard for the government to re-inflate the housing market. Since the government is not going to allow the banks to return to the reckless lending standards of that era then the only way the housing depression can be resolved is by prices of homes coming down until they are low enough for new investors (landlords) to buy them and rent them out at a profit. Further, since there is a lot of speculative talk that Congress will take away the mortgage interest deduction, then, if that happens, home prices would have another reason to continue declining.
I have written about “housing not comparable to the past” and “bearish housing market”.
This is an example of independent financial advice.
Posted by Don Martin on Mon, Apr 04, 2011 @ 12:49 PM
The FT today in Alphaville section quoted Michael Pettis “If that is the case, then since the banking system can no longer easily identify economically viable projects and is in fact wasting money, the usefulness of the bank-as-fiscal-agent model is much reduced.”
I would interpret this as supportive of my opinion that the boom in China is unreliable may lead to a slowdown. This in turn would cause Emerging Markets in adjacent countries and commodity exporting countries such as Brazil and Australia to have a decline in economic growth and a decline in equity prices in those countries. See my article "China is it a bubble?"
Bloomberg.com today had an article saying that New York City real estate prices declined 9.9% in the past 12 months as people switched from condos to cheaper co-ops. This is interesting because Wall Street executives have been making a lot of increased income in the past year due to the stock market’s recuperation from the crash of 2009. There have been anecdotal stories that New York City real estate prices were increasing, but those stories are wrong. Imagine how much worse the price declines would have been if the stock market and banks had not bounced back from the lows of 2009.
These stories show that the most attractive areas of economic growth are actually not doing that well or will be getting worse. With rising oil process and a slowdown caused by lack of factory supplied components in Japan it seems credible that the world economy will slow down and cool off by the fourth quarter.
This is an example of independent financial advice.
Posted by Don Martin on Fri, Apr 01, 2011 @ 11:13 AM
Today the monthly non-farm payroll unemployment report was released. It is the most important report for bond investors. In the past 11 years the U.S. population has increased 1% a year by 30 million, yet number of people on payrolls are lower, so adjusting for population we have a long way to go to recover the lost jobs. Further the jobs that are coming back are predominantly low wage jobs. The employment to population ratio went from 58.2 at the bottom in 2009 to 58.4, which is virtually no gain at all two years after the economy reached the bottom. Compare this to the peak of 64.7 in 2000.
For inflation to return both the jobless rate and the wage rate must improve and the jobless rate as a percentage of the population must improve. As I posted yesterday in "Hidden economic weakness" the best way to judge unemployment is by the employment to population ratio which has stayed almost unchanged. Baby boomers in their 50’s are finding they need to work longer to save for retirement and yet they may encounter age discrimination or age related disabilities hindering their job search.
The WSJ today had two interesting articles headlined: “More Jobs Doesn’t Necessarily Mean More Good Jobs” and “Eight Years to Get Back to Full Employment?” The second article said “…we’d need eight years of consistent monthly gains just like (today’s unemployment report) — taking us to the year 2019 — to bring the economy back to full employment.” So that means from 2000 to 2019 we had substandard employment, just like Japan's 20 year soft depression. The reason it will take so long for to reach full employment is that the labor force population increase of 1% a year means we need 100,000 new jobs a month for population increase plus 200,000 new jobs a month for recovery. So until a total of 300,000 new jobs a month have been consistently created then we have not recovered from the recession.
Employment is the key to interest rates and bond prices. When there is high unemployment or high underemployment, including a disproportionate amount of new jobs that are low wage jobs then the economy will be weak and the total amount of borrowing will be less than what people are accustomed to, and thus inflation will be reduced.
Regarding other deflationary signs: Gavekal’s Simon Ogis sees deflation despite input (commodity) price rises due to the shadow banking system that was a credit Ponzi scheme that collapsed in 2008 and still is collapsing, ex-Asia capital is being reduced, and loan growth is merely from shadow bank loans transferred to banks. When QE2 ends growth will stop. China has a history of being hurt by inflation so they will fight inflation.
This is an example of independent financial advice.