The past 2 weeks we have seen the markets do things that simply do not seem natural from freefall flash crashes to intraday 300 point turn around rallies. However, there is one thing that is pretty clear, I would not buy this pull back. As David Rosenberg points out and a few other non-perma bull market strategists, not that there are many left, point out is that these wild swings are not normal in a bull market.
Think back to the market of late 1999 to the early 2000 and you will remember such swings, but do you remember how it ended? If you bought on those dips you never made your money back, ever if you bought the NASDAQ and you would have barely broke even in the S&P 500 if you sold at the peak in 2007. I think it is safe to assume that this market action is a sign of a sick overbought market trying to lure you in to buy one more time before it robs you blind, don’t do it. To be clear, I believe the broad market will move lower, I think 900 to 950 is not an unreasonable target, but we could move much lower than that. Before you say it, no the fundamentals are not so strong that we could not see the lows of last March, more on that in a minute.
I am not saying do not buy great individual companies, not at all, I am bearish on the market, but I like some individual names. I am bullish in the biotech area as there are tons of patents expiring in the next few years and you will see big pharma buy many of these names, but I also like big pharma too. Look at the yields and the rock bottom P/E’s, they are dirt cheap and you should look at some of these names, but biotech is not a prisoner to the business cycle, as long as it is well funded and near approval for a drug. I also like consumer staples that pay dividends, boring names, but they pay you to hold them and no matter what the economy is doing you will always need toilet paper and a toothbrush, I hope at least. I also still like high quality bonds and can make a case for treasuries right now, but use your own discretion, I would stay away from high yield, I sold mine a couple months ago.
Why do I think boring and income is the best model right now? Well, the market is going to correct even more than it already has, kind of a simple explanation. Income strategies, which I have been on the record for supporting since last year, makes sense because we are living in disinflationary, possibly deflationary, times where real yields are much higher than what we think. I am a long-term inflationist, come on look at all the money being printed and Obama wants to double exports in 5 years, you cannot do that with a strong dollar, but right now deflation is the name of the game and income makes sense. Deflation also means stocks need to be trading at much lower multiples than most people think and that is why I think this correction will potentially be much deeper than most people believe. Time will tell who is right about that.
The Fundamentals!
What about the fundamentals? Are they better than a year ago? Sure. Do they support a 20 P/E multiple on the S&P 500? Nope. Do you really think the housing data since the homeowner tax credit implementation was actually real data? No way. How about unemployment, do you believe temporary jobs are going to lead America to the next level of prosperity? Well, all the amazing job growth has been only in the temporary job area, let’s not forget that the actual employment report numbers are tinkered with via the birth/death model which added 188K jobs to last month’s employment report. For those of you who don’t know, the birth/death model are estimates the BLS uses to predict how many new business are started based on how many business died and population growth, it is fantasyland stuff basically.
What about corporate earnings? They have been good, but I do not believe they are sustainable. First, the stimulus is running out, that is a very important thing to remember moving forward. Second, a cool 30% of the S&P 500’s earnings come from Europe and up until lately U.S. companies enjoyed, globally, a weaker dollar which is over since the new sovereign debt issues are driving the value of the dollar higher. In technology a large percentage of earnings came from Asia and I do not believe that will continue much longer because of what is happening in Europe, Greece was a big deal indeed.
You see, Europe represents 20% of the worlds GDP and, believe it or not, China’s top importer is not the U.S. it is the EU. So, if the EU is going to have lower growth because of austerity measures, which they will, it will automatically be a drag on world GDP, but it will specifically hurt China. If China begins to slow down that is very bad news since China is “the recovery story of the world” or some other tag line the media gave it. In other words, China will be buying less from the U.S., exporting less to the EU and the EU will be buying less from the U.S. Also, China will be running, more than likely, trade deficits not surpluses which means they do not need to buy our debt. Can you see the problem now?
Greece is/was a big deal not on its own, but because it was locked in with the other PIIGS which were locked into the EU as a whole. It is all very bad news and no matter what CNBC says we are all still coupled with each other. It is the interlocking of the global economy, especially in the debt markets, that is the problem and there is no escaping it. I am afraid that even when governments guarantee debts that may not be enough anymore because, as the price of gold is proving, people are losing faith in money. Our whole system is based on faith and when that faith is damaged that is when problems get out of control and I believe we are just about at that point. The rumor yesterday was a .50% rate cut, how is that good for the Euro? If anything that would have brought it closer to parity to the USD. Printing another trillion just won’t calm markets because it means nothing. At this point I cannot see much of anything from Europe that will calm the markets.
The only things they can do is let the PIIGS default on their debt and kick them out of the EU, not necessarily in that order. Anything else will just prolong the problem and the printing press is the cause of the problem, not the solution.
Apparently the markets, that wonderful forward looking discounting mechanism, did not see or have fear what is happening in Greece. It is safe to assume that this proves that the markets are not efficient and it fails to see potential problems. What is interesting is that Greece and Portugal were not or should not have been a surprise to the markets since we have all known about the issues with the PIIGS for months now. How anyone could have been surprised by this news today is beyond me. I guess the junk rating on Greece may have been a surprise, but come on, when the 2 year note was yielding 11% how in the world can it be anything other than junk?
The market has gone up for 8 weeks in a row and while the talking heads thought this perpetual “tortoise rally” was normal anyone who has even a little investment experience knew it was not. I still remember Dennis Kneale, last week, calling people who held cash “fraidy cats” because the market is back and it will be a bull market forever. The world does not work like that and the risk trade has been, frankly, out of whack. Money has been pouring in to everything from high yield to emerging markets in the expectation of a steady 1-2% a day. This was verified from mutual fund flow data reported last week which showed investors moved more money into equity funds, for the first time in a longtime, and, in my mind, confirmed we must be near a top, dumb money always moves in after fantastic rallies.
Whether or not this was a top remains to be seen, but it certainly looks like it from my lens. I have been wrong before and might be again, which I admit. However, even though I was wrong it doesn’t mean that the markets were right either. Earnings are better, I still see some misses in revenue though, but the underlying macroeconomic data has merely gone from very bad to just plain bad. When we cheer a 57% confidence reading that is a problem because that it is a horribly low number. The housing data is not verifiably strong when you have, like in October, a rush of people buying for the tax credit right before it expires. If the housing numbers stay “strong” for May then you may say housing is rebounding, but I highly doubt we will see such strong numbers at that time. Housing is a key indicator because it employs so many people and homes were the collateral that were the bad debt sitting on bank balance sheets.
Unemployment remains incredibly high, use the U-6 data not that foolish headline number, which is a severe problem. Given that weekly claims have stabilized at -450K is horrendous at best. That number shows that private employers are still shedding jobs and I am confident that the employment report next week will show “stellar” job creation in the government sector and in the temporary help area, those are not good areas to see growth in. I am a believer that the temporary help is just that, temporary and will not convert into fulltime employment, we would be seeing that conversion by now, but we are not. Housing problems plus high unemployment will keep the economy down for some time.
On top of the squishy soft economic data being heralded as a full blown recovery, don’t get me wrong less bad is a welcomed improvement, we have a sovereign debt crisis. People claim that Greece is only 2% of Europe’s GDP and dismiss their troubles. That is a bad idea because while they are right about Greece they conveniently forget that all the PIIGS account for some 13% of Europe’s GDP and they are all in trouble. Spanish and Italy’s bonds have been trading lower pushing their yields up over 4% and Portugal was officially downgraded, that is all really bad news. Each country, individually, is not a big deal, but combined we are talking about the potential to default on hundreds of billions of dollars worth of sovereign debt.
To put this into prospective, France owns some $781B of PIIGS debt, if they all default what will happen to France? They will be in trouble, of course. Then there is Germany, how much PIIGS and French debt do they have? I do not know, but I assume a lot. What will happen to Germany if they get stuck with declining value of all that paper? They will have to bailout their banks, I assume France would have to do the same for their banks as well. That, basically, puts the banking system in jeopardy again, in less than 2 years. What I am explaining, probably in a horrible way, is what contagion looks like and it doesn’t end there either. The U.K. has exposure to all these countries and they are already in horrible financial shape and the series discussed above makes the U.K. susceptible to the contagion.
U.S. banks have exposure to both European banks and sovereign debt which means out fragile banking system could face another challenge. Let us not forget that the U.S. is also heavily indebted, along with Japan, and people may start to question the safety of U.S. Treasury debt, as they should I might add. From my lens, in a worst case scenario, meaning this all happens, it would be a coin toss as to which country goes next, either Japan or the U.S. given their immense debt loads. This scenario is unlikely or has a low probability of happening, but it is possible and it could trigger a global currency crisis.
This explains why gold went up today in the face of a stronger dollar and a rush of selling from the market. Even silver held its own today in the face of dollar strength. This shows that gold is still a flight to quality, it is also in a bull market as well, and it is a trusted currency. In fact, gold’s rally today is why I think it is possible for a global currency crisis because if this was another credit crisis, like 2008, it would have sold off for liquidity, but it did not. I am not sure if I would be buying gold right now because I already own a position, but if I did not own any gold I would be a buyer.
All is not well in the global markets and people should stay nimble as to where to put their assets until things settle down. I would say this decline is extremely bearish and way overdue, the higher the market went the worse the selloff would be, which could make it worse. It was insane to think that volatility would not comeback and that people went from sheer panic a year ago to such utter complacency this year. The worst part about all of this is if this does trigger another crisis what can the Fed or the governments do to calm the markets or remedy the situation? Nothing, they already spent all their ammo and they even had to borrow some to boot. I am not saying this will trigger another crisis, but it certainly has all the ingredients for one, if you look at the big picture.
I have been delinquent in really looking at some of the technicals, mostly because the economic data has just been so bad that I really never thought we would get to this level. Honestly, with the economy still shedding, depending on which numbers you want to look at I prefer the real numbers, but, 263K jobs a month and credit contracting at a record pace and a whole host of other nasty things I could rattle off who would have thought we would be sitting at Dow 10,000?
I think it is safe to assume no one thought we would be at this point, even just a few months ago very, very, few people thought we could see the market at this level. However, now we are right back at the levels where we were right before Hell was unleashed last year and the S&P 500 is about to hit major resistance right in this range and the Dow will have reached its 50% Fibonacci retracement at 10,300, or so. Therefore, we are right at the peak of where the technical equity rebound can take us on its own and the weak dollar is horrible for the US for anything longer than a short-term basis.
I would have to say that after the weak dollar rally and the retracement has hit its peak we will need real substance to sustain this rally and it is simply not there. Without government stimulus and government transfers we have horrible GDP growth. Intel, as I have repeatedly said, was a story about Asia and a weak dollar, not about a US recovery. This is confirmed by Dell saying the US PC demand is still weak, but the pundit dismissed Dell and refused to look under Dell’s press release, so you are left in the dark unless you are doing your own homework.
Clearly multinational firms are going to do well, but how well are they really going to do? Johnson and Johnson missed on the top line and they are a well diversified consumer defensive company. It is my belief that we will see more weak top line revenue growth, except from firms doing business in Asia or have international sales, thanks to Helicopter Ben. I firmly believe that Banks are still bad bets because of the lack of mark-to-market accounting rules. I know, JP Morgan had markup’s today, please, when you can mark securities to fantasy land of course you’re going to have markup’s. What surprised me is they only took $400M in markup’s and not $4B.
With real estate still in the tank, which is reflected in every piece of data shown by the government and even industry shill’s, there is no way banks are making money on their real estate holdings. With commercial real estate defaults up 7 fold YoY to $22B, from $7B last year (the really “bad” year), how in the world are things better? Not to mention junk bond defaults which are projected to hit 14% in the near-term. I simply do not buy a V shaped recovery or even a robust recovery for that matter and this is most evident in the employment numbers, which is a leading indicator for credit recessions.
Retail sales are a joke considering some 8,400 stores were closed over the past 12 months, many of which were the worst performing stores I might add. So, if you dump your losers and keep your winners do you think your sales comps will go up? Hmm, I am pretty sure they will. Of course, was this advertised on any of the media outlets this morning? Nope. Do you really think another 530-550K initial claims report tomorrow is going to be bullish? Either do I, but I am sure this cost cutting method will be embraced by CNBC as gross margins will improve.
As much as I want this to be over, believe me I do since I suffer as much as the next guy, there is no way that it is. Declining income, declining credit, increasing defaults, rising unemployment, declining spending and then throw in shrinking corporate revenue that pretty much proves there is not much of a recovery. I admit the data is getting better, but nowhere near where the talking heads claim we are at for a recovery. Sometimes I sound like a broken record, but a rising stock market is not a reflection of a healthy economy. The other major misconception that needs to be never, ever, mentioned again is how great the market is at forecasting the economy, it is not and never has been, it’s a myth. Otherwise, in 2007 the Dow would have been at 7,000, not 14,000 and there are about 100 other examples.
It has been perhaps the longest year of our lives where we witnessed the absolute collapse of the banking system, to the largest bailouts in history, one of the largest market declines in history, historical political elections, the largest stimulus in the history of our country, and the list actually goes on. There are a lot of history making events that happened over the last year and with those history making events we were promised change and a brighter tomorrow. However, what has really changed? Absolutely nothing, for the most part.
We are expecting the political establishment to address us in the upcoming week to tell us what a great job they have done in ‘saving’ our system and way of life. While they are patting themselves on the back and congratulating each other they know that they have merely postponed the inevitable. No matter how hard they try to hide the facts we know all is not well and we know that there is no way the epic stimulus packaged saved any jobs or created new ones. What our leaders have done is nothing short of criminal as they allowed us to go deeper into debt bringing our long-term liabilities to upwards of $55 trillion dollars.
The Banking System
Next they will tell us how the bailouts, no matter how distasteful, were necessary to preserve the way we live, which is so fatally flawed that defending it is impossible. The sad reality is that the banking system is just as insolvent today as it was last year this time. How could I make such a statement with the market screaming and banks climbing to 52 week highs? Simple, look at the economic facts:
Defaults have increased substantially year-over-year. If defaults broke the bank last year then surely twice the level of defaults must have inflicted horrible damage to the balance sheets of banks. However, mark-to-market is gone and mark-to-fantasyland is here and if they don’t have to mark the assets down or include SIV’s and the other BS then everything is fine. They merely postponed the inevitable problems to a future date.
Unemployment was nowhere near where it is today last year. If you really think we are at 9.7% ‘real’ unemployment then I have a nice CDO to sell you. The reality is we are closer to 17% real, real, unemployment according to how the government used to calculate the unemployment rate. This will lead to more defaults in credit and is the nexus of our problems.
Defaults across the board are sky high and will likely get much worse. Of course, as long as you get to market things to fantasyland does it really matter? No, not until it ultimately blows up on us, which it will.
Everything they told us they were going to do, they did not do. Banks will hold those toxic assets forever because they are worthless. Why participate in the PPIP if you have to sell the assets at market value versus holding onto the assets at fantasyland value? It makes no sense which is why the PPIP was scaled way down because no one wants to participate, except for the FDIC and Federal Reserve which is surely holding a bunch of that garbage.
The Fed is encouraging risk by allowing Goldman and the remaining investment commercial banks to borrow at the discount window and speculate driving earnings through the roof. At the same time the Fed is simply trying to re-inflate the same credit bubble that got us here to begin with. One wonders why anyone would think more debt is the answer to our already overwhelming debt load is the answer.
As far as banks are concerned, I would not touch them, period. Yes, they have the backing of the US government, but the bottom line is you have no idea what their assets are really worth. From a personal point of view I also wonder about their ethics, or lack thereof. When they came to Washington, hat in hand, for their bailout which Congress was ‘pressured’ to give, more than likely to save their largest campaign contributors, they received it, no questions asked. Now that these same banks are ‘healthy’ and allowed to pay back their TARP funds, presumably so they can receive their annual bonuses, while at the same time hiking their banking and overdraft fees from the very people who bailed them out.
The Federal Reserve refuses to tell the American people which banks received any special loans and what was taken in for collateral for those loans, if anything. We already know the banking system is fragile and that banks were in jeopardy of failure so there is little reason to not tell us who got what and how much. Of course, let us not forget that we have had 89 bank failures this year which means that the bailout was, in my opinion, a failure. Not to mention that by the time these failures end, some predict 1,000 bank failures, it is clear that only the Citi, BoA, and Goldman Sachs will be the only survivors left which leads us to an oligarchy banking system with only a very few big players left, who just happen to be the most politically connected I might add.
Even politics have not changed at all, with the exception of grander spending projects. Washington is still polarized and, from my perspective, we went from an inept president, who was utterly clueless, to another inept president who is equally as clueless. Even more disturbing is the fact that Congress is, mostly, the same as it always has been. When looking at the list of Congressmen and Senators you see that very, very, few are new names and the names you recognize have been there for decades. How in the world do you get change when you elect the same people every election? That has always bothered me about politics; you want change so you vote in the 18th term congressmen? We get, at the end of the day, what we deserve.
I realize that speaking against our newly elected messiah is a one way ticket to being called a racist or, somehow, anti-American, but, frankly, nothing has changed. The Patriot Act is still alive and well, lobbyist are ever where, Iraq is still alive and well, Afghanistan is getting worse, spending is even more out of control and we are all still polarized between two parties who only care about campaign contributions. Nothing, and I mean NOTHING, has changed and to think otherwise is simply being delusional. If we now have a transparent government why are all the questions people want to ask always having to be pre-approved? Sorry folks, I am just pointing out the obvious here.
For all intents and purposes the country was blackmailed by the banks to bail them out so they can continue business as usual. It is perhaps the greatest heist in history and did nothing for the American people except tack on trillions of new debt. To make matters worse the industry is at it again coming up with a new securitized product for life settlements, perhaps the sleaziest way to make money. Life settlements basically buy life insurance policies from those who will die soon. They buy the policies for 40% or so of face value, pay the premiums and collect the difference when the person dies, only in America. Goldman Sachs, always ahead of the game, is even starting an index so you can bet on whether people, as a group, will live longer or shorter than expected, I always knew they were vampires, but this is taking it to a new level.
So as we come up on the 1 year anniversary of the Lehman Brothers collapse and we watch the politicians pat themselves on their backs, for doing nothing, we really need to ponder what has changed. As you think about where we were to where we are today you will see that nothing has really changed except for some accounting gimmicks that really never should have changed. Even though the industry and politicians threatened a complete collapse if they were not given money or unless the accounting rules were changed is complete hogwash. Elizabeth Warren who chairs the Congressional Oversight Committee over the EESA is not even convinced that a total collapse would have happened if we just said no to the bailouts.
To think anything has really changed is simply a matter of people not doing their homework or just buying what they are being told by the media. Based on the above, fairly quick, but accurate analysis, it is clear that things are still the same. We simply just postponed everything until a future date and that future could be tomorrow or 10 years from now, who really knows. What I do know is that we must vote out our leaders faster than every 10 or 20 years, when they die of old age in office that is simply just too long.
Diana Olick did another piece about foreclosures tonight and I find the data very interesting. I would like to reiterate my respect for Diana and her work Frankly, I believe she is one of the best CNBC has to offer and does not attempt to carry the water for anyone. The numbers just speak volumes to the problem at hand and the data is provided by Hope Now Alliance.
Apparently people were pretty tough on Diana claiming she was lying or shilling for the industry, which I find had to believe, but those were the claims being hurled at her. She was simply reporting on the information she had, just as most bloggers or people do when they repeat something, even though it was only from limited sources. I tend to think that she is probably getting only the best part of the data points from the banks, but no one really knows because there is no one source for data. Each state has different regulations and laws when it comes to foreclosures not to mention that the foreclosures are so high courts are simply backlogged and banks may not even know a home is foreclosed on.
Regardless, the new data she brought from the Hope Now Alliance will shed some pretty bright light on the subject, both good and bad. The good news is that there are more workouts, which means that the bank and homeowner are working out the problem, but workouts or modification plans rarely work in the long-term and people lose their homes anyhow. However, what really caught my eye was the prime and sub-prime foreclosure starts, this is a lot of data so bear with me.
From 3Q07 to July of 2009 there are a total of 5.03 million foreclosure starts, which means they bank begins proceedings, which is just astronomical for a 2 year period. Out of those 5 million starts the majority of them are prime loans, at 2.7 million, which are supposed to be the safe loans, and sub-prime came in at 2.2 million. Clearly this is not merely a sub-prime problem and goes into conforming 20% down conforming loans, which means banks have many more loans that they will have to take losses on in the future.
In July alone there were 283K foreclosure starts and when compared to a total of 744K for all of 2Q09 that is a significant number. Of those starts in July 211K were prime mortgages and only 71K were sub-prime. The problem is simply getting worse, not better.
Now, the foreclosure starts are the beginning of the proceedings which means nothing happens to the property until it is sorted out through the foreclosure process. The other side of that coin is foreclosure sales which means the property has been ‘sold’ back to the bank or the bank retook possession of the property. From 3Q07 to July of 2009 there were a total of 1.7 million foreclosure sales, bank repossessions, which has been widely reported, now are you seeing the difference between the 5 million foreclosure starts and 1.7 million repossessions? It’s pretty significant and shows that there will indeed be a massive second wave of foreclosures in the near future.
Not to mention that in 2Q09 there were a total of 235K repossessions and in July the total number was 89K of repossessions which is on track for a substantial increase in 3Q09 over 2Q09. Out of those repossessions we see that prime mortgages are still leading sub-prime in both 2Q09, with 153K prime repossessed and only 82K sub-prime repossessed, and in July we see 59K prime and 29 sub-prime repossessed. Clearly the supply of foreclosures is building and will hit the market in the future, whenever that might be, and sub-prime is not the problem.
One could argue that there were more prime loans made which would explain the discrepancy, but that is not correct. Simply put, there are just so few sub-prime properties to foreclose on now then 2 years ago which explains that problem. However, there were more problems with prime mortgages then sub-prime mortgages with the exception of a few quarters. At the end of the day it really doesn’t matter, but based on these numbers sub-prime was a smaller part of the problem than we may have thought previously. No matter how we cut the data the one thing we know for sure is that foreclosures are here to stay for the foreseeable future and that means no recovery in real estate for now.
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