I am a bear and that should not surprise anyone at this stage of the game, but I have long positions and individual holdings. Just because I think the market is going to tank that does not mean I am opposed to being long. However, I am long very specific items and not, generally, long U.S. stocks except for a few biotech’s, tobacco and some defensive names. I am long fixed income and have been for some time, high yield and emerging market debt has been very good so far with about a 5% blended return YTD, not bad for bonds, but my real winning positions are Russia, Africa-Middle East and Poland, up between 8 and 11% YTD.
I guess I am saying that even a bear can be long and in my case I had sought international, yield and strong dividends. One might say my positions are boring, but boring means consistent and low standard deviation. Investors should be embrace boring yet they are not as they pile into AIG (that was, evidently, a short squeeze today) and other very low quality stocks. Typically, when you see crap catching a strong bid that should signal a top to the market, but we are in a continued melt up still so I just take the dash for trash stocks as a warning sign that things are probably about to change. I think the change is not going to be triggered by the Fed either.
What is interesting, even though I think he is bluffing, is the Great Hoenig from the Fed has “put the market on notice” about excessive risk. What that means will be realized soon enough, but I am convinced that interest rates are not going to be raised anytime soon. What Fed Chairman would raise rates with prices falling and unemployment pushing 10%? It is not going to happen. There is zero money velocity, no wage inflation, no significant rise in the PPI or CPI, and deflation is written all over the place, credit contracted again(!), which is very deflationary. All of that means rates are staying right where they are. Although they may raise the discount rate again, big deal.
The risk is not from the Fed at all. A simply look at the front page of any newspaper in the finance world will tell you were the risk is coming from, Europe. Greece to be precise, but I see Greece as one simple cog in a very broken machine known as the EU. Greece may have significant funding issues starting right about know as Germany is giving them a cold shoulder and, supposedly, are cutting them off from easy liquidity, as they should. In response to this lack of liquidity Greece’s bond yields spiked above 7% which will guarantee a default if they cannot get cheap money to borrow. The other broken cogs in the wheel are Italy, Spain, Portugal and Ireland. If Greece falls so will the rest of the PIGS and that will bring the Euro down and could trigger a run on the currency, we saw this story before in 1997 in Asia I believe.
The very reason the Euro is selling off is why I own and have advocated owning gold, silver, palladium and platinum as currency uncertainty means the value of these commodities will rise. Look at today as the dollar gained value gold and silver continued to break higher, that is not supposed to happen. The reason for the rise in metal prices is because of Greece and that issue seems to have some people concerned enough to run to hard assets. Can a European default really be a problem for the U.S? You bet. Consider that French, German and every other European bank owns some form of PIGS debt and U.S. banks hold European bank debt as well. Just remember, sub-prime brought down the mortgage market and sub-prime was tiny in comparison to the overall mortgage market, the same lessons apply here.
On top of the new debt problems, foreign banks if the PIGS default, U.S. banks are still holding all the same toxic assets as before. Another shock from bad debt could be the straw that breaks the camel’s back and as I said yesterday the government and the Fed are out of ammo. On top of the European issues, California was downgraded and about $1T in more sub-prime debt was downgraded. As hard as I tried today I could not find any good news out there. You also have to remember that the credit (bond) market is where all the smart money is so when they see trouble that means bad news could be just around the corner for stocks.
The bottom line is that earnings might be good for 1Q10 although I think top line revenue will be weak, but that might be meaningless as sovereign debt is rearing its ugly head again. There is no harm in going long equities, but with such a huge rally and shaky fundamentals I do not think it is wise to marry this market or have zero shorts. This melt up could very well be coming to an end as stocks cannot go up forever and there are serious problems out there that are completely unresolved and are not priced into this market. If these problems get priced into the market I can assure you the Dow will not even be close to 11,000.
I am watching the happenings in Venezuela carefully as this might be an indication of things to come in the US. While most people naively think that “it can never happen here” I would like to warn you that every country where these things have happened uttered that exact same phrase. Whether it happens because the Federal Reserve loses control over the devaluation of the USD or because foreign debt buyers just stop buying US debt the one thing I am sure of is that it can and will happen here at some point in the future.
What I am talking about is massive devaluation of the currency which leads to inflation or, in this case, hyperinflation. I have stated that for the moment we do not have to worry about inflation, and I stand by that prediction, for now, at some point we will have to cleanse our demons and massive balance sheet. The one and only thing that is saving us right now from inflation is our pitiful employment situation, which is not getting any better I might add. Without employment there will not be wage inflation and we will continue to have subdued demand for products with the exception of food and energy.
Even though I fully believe deflation is here for the near-term, reinforced by the Fed itself, there is one caveat to my prediction, the devaluation of the USD. I have made no secret that I believe that the Fed and the current administration, along with the former administration, have had an unofficial policy of maintaining a weak dollar. The reason for the weak dollar policy is simple, it boosts GDP and earnings in a globalized world along with a host of other seemingly positive economic stimulus. However, a weak dollar is not good long-term for a country and hurts the population as dollar sensitive products become very expensive, i.e. $140 a barrel oil marks the low point of the USD in 2008, and is inflationary without the benefit of actual inflation.
Let me explain, inflation created by excess money printing usually enters the banking system and is loaned out to the population. This is called money velocity and creates too many dollars chasing too few of goods. However, without money velocity traditional inflation cannot happen, but even if the excess money printing does not enter the economy it can still devalue the currency based on the future expectation of it entering the system. This is what was happening up until the last dollar rally and I would like to point out that the last dollar rally was because, depending on who you listen to, short covering, fear about sovereign default (i.e. people were afraid of another systemic meltdown which, in turn, initiated short covering. This is the scenario I favor), or people felt the Fed was actually going to raise interest rates which is absurd, in my opinion.
The dollar devaluation that we have seen explains why oil prices are on the rise as demand simply is not there. It also explains why metals have also climbed for most of 2009 as well. What is scary about both oil and metals going up, especially in 4Q09, are the fact that these prices increased in the face of a stronger dollar which is counterintuitive. Well, it is for gold at least as oil could increase with a strong dollar if there is sufficient demand, but, frankly, there is not as much demand as the price indicates. Regardless, rising energy prices when the economy is weak, to me, is a warning sign of a problem and should forewarn you of things to come, inflation.
If we continue with our insanity that Washington and the Fed is telling us we need it is inevitable that we will end up in a situation like Venezuela where we will either willingly or unwillingly have to devalue our currency. There are pluses to devaluation as your debt, assuming a fixed interest rate, will remain static and your earnings will eventually increase allowing you to pay off your debt faster. However, the negatives outweigh the positives by a long shot as your savings are worthless. This is why we saw the people of Venezuela go out and buy everything they could because goods will be worth more than the paper money.
What is disturbing though is the fact that even though devaluation creates higher prices the Venezuelan government shutdown some stores for “price gouging” which is humorous, in a sick way. The government intentionally creates inflation to make their balance sheet look better, but because new goods will cost more stores cannot compensate by charging more for products they currently have. How in the world are these stores supposed to stay in business or id the governments point to put them out of business? The next logical question to ask is how would this type of scenario play out in the US?
While we do not really have any past history to use as a bench market I think what we see happening in Venezuela is probably a very good example. Right down to the black markets that are more than likely popping up all over the place to provide goods and services the population cannot receive from the usual sources. What I would be interested in knowing is if these black markets are using another medium of exchange, i.e. US dollars, gold, silver, Euros, whatever it might be, to pay for these goods and services. I would be inclined to believe that is what is happening, but there is simply no proof and I am willing to bet no one wants to openly talk about such things for obvious reasons.
What is usually accompanied with this type of devaluation is the government imposing its will that its citizens continue to use its currency no matter what. We saw this happen in Zimbabwe, but just like in Zimbabwe the black market switched over to an alternative payment system, gold. It is important to note that gold is being used because dollars or other currencies simply are not plentiful in the country and gold can be mined, of course gold has also been used as currency for thousands of years as well and at current prices a little bit goes a long way. Basically, forced price controls and forced use of devalued, or worthless, currencies simply do not work, that type of system never has in 4,000 years.
I am not suggesting the US or Venezuela will turn into Zimbabwe, but I am saying that we are facing certain financial Armageddon at some point in the future. All the US has managed to do is kick the can further down the road for others to manage and we are running out of road, unfortunately. We will have only a few choices in the very near future and the most obvious, because it is politically easier, is to inflate our way out of our problems. While this seems like a good idea I am thinking that the 77 million soon to be retired Baby Boomers who are about to be living on a fixed income will like this strategy. However, it is unlikely that they will like the alternative either, much higher taxes, less Social Security and steep cuts in Medicare.
We live in unique times and the one certainty we have is that there is no certainty of anything. I do not believe that there is any question of whether or not we will follow Venezuela, in my mind it is only a matter of when it will happen, not if. However, before we go down that road you will be comforted in knowing that Japan or the UK will more than likely go down that path before us as they are in worse shape than the US. Regardless, watching what happens now will give you an idea of what could happen here and is also why I am a big proponent of investing in precious metals.
So far holding gold, silver, platinum or palladium has been a very sound move on my part, but I actually hope that these investments turn out to be horrible for me because that will mean I was wrong about the future of the US monetary system. While I might be wrong what concerns me is that there are many people who are a lot smarter than I who are sounding the same alarm I am. I would also like to not be naïve enough to believe that “it could never happen here” either because I am sure there are millions of people throughout history who would tell us that you should never, ever, utter those words because no person or country is special.
There have been several actions taken by both China and the US this year against each other both claiming dumping charges. The irony is that all the accusations are probably true given the fact that China does subsidize its industries rather substantially which allows them to bury overpriced US products. However, China’s accusations about US dumping of auto parts and cars is also true given that GM and Chrysler is also heavily subsidized by the US government as well, that is now undeniable and an embarrassment to all US citizens.
I realize that the US won the ITC, International Trade Commission, ruling today, but do you really believe that ruling was impartial? Considering the US provides a large portion of the funding for such organizations it would be doubtful that we would lose any case brought before them. I would compare this to the arbitration clause in your credit card application which was so blatantly slanted to the creditor that Congress basically was going to strip it of its powers before the industry ‘voluntarily’ got rid of that clause from its agreements. It stands to reason that when one party basically funds an organization to arbitrate disagreements between that party and third parties there is no objectivity, at all.
Regardless, how many actions is this now between the US and China? It started with tires, moved on to chicken, cars, seamless pipes and now steel grates. All of this while the US is trying to force China to strengthen its currency, which China would be nuts to do I might add. All of these actions smell of protectionism which will not be good for the average American in 2010. While the Fed wants to create inflation I think Obama misunderstood what type of inflation they were talking about, wage inflation not just price inflation. At this rate, and for the first time ever, the US consumer could be facing the same or lower wages with rising prices because this administration is picking fights with our largest supplier of goods.
The irony is that the media actually says that foreign nations actually love us now because of Obama. That may be true in Europe, but I could care less about Europe because the last time I checked we did not get the vast majority of our cheap everyday goods from Europe, we get them from China. Frankly, we are ticking China off by demanding that they do things they do not want to do and we are in no position to demand anything at this stage of the game. Especially since China is almost, if not already, the number 2 economy in the world with the largest population in the world. Did I mention they also hold a lot of US dollars as well?
Telling China, not asking them, to strengthen their currency is also protectionism whether you want to believe it or not. By asking them to make their currency stronger you are telling them to raise their prices on their goods which, in turn, makes products at Walmart more expensive. The goal, of course, is fruitless, but Obama figures that if Chinese goods are more expensive then you and I will opt to by a US made good instead. This is not a new idea and has been tried many times before, it never works, and it may trigger some pretty bad things to happen, but hey who cares about history and facts when we have perpetual bailouts going.
I have no idea how China will react to this politically, I am not a politician, here is what I do know. If we buy less Chinese goods that means our trade deficit legitimately gets smaller, a good thing right? Wrong. With some $5T in treasury debt to roll and issue this year we need countries like China to run trade surpluses so they are forced to buy our paper. If they are not running those trade surpluses then they will not have to buy our paper, they could if they wanted to, but they would not have to. That is the biggest reason in the world to not play games with them right now since our ‘recovery’ is shaky at best. If they do not buy our debt that means QE will continue and then we are in really big trouble because technically monetization of a countries debt is the final straw before it defaults, that is a historical fact not an opinion.
I am not sure if the current administration understands that or not, but somehow I doubt it. I believe they think that this forced ‘buy American products’ policy will work, but protectionism was what really kicked started the Depression, combined with bank failures, which we already have a ton of I might add. Maybe this is some type of payback to organized labor or something, who knows, but I see other troubling signs of protectionism as well. Japan is doing a cash for clunkers program that American car makers do not qualify for.
Now, US lawmakers made the rules and most c4c sales went to Japanese car makers and why not they make one heck of a car and the companies are solvent. The Japanese program is slanted towards only Japanese automakers, again, why not they make great cars and the companies are solvent, but now some representatives are upset about this. What are they going to do about it, I do not know, but they could do something dumb like put a tariff on Japanese cars or something, which I hear is being discussed, that is protectionism.
Protectionism and trade wars are bad, bad, news for everyone, but especially for the US consumer. Our government knows not what they do and they continue to do ridiculous things which make life increasingly more difficult for the everyday American, but let the people who messed up the economy off the hook, completely. If they do more to increase this blossoming trade war or initiate more protectionism legislation you have to act and tell them to stop. I want America to succeed, but on its own merits, not through legislation that punishes free trade.
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