Saturday, June 26, 2010

Top Ten Reasons to Be Bearish

This list tells you why I believe we are in the worst bear market of our collective lifetime.

10. Poor Outlook for Small Businesses – Small businesses make up more than 50% of non-farm GDP, employ about half of the nation’s private sector workforce, and create most of the nation’s new jobs according to the Small Business Administration. For the month of May, the National Federation of Independent Business reported that small business owners had a more negative outlook on job creation, capital expenditure plans, and future sales expectations. Considering that small business owners have more tenuous access to credit and are uncertain about cash outlays for healthcare and unemployment benefits, many are putting growth plans “on hold”. If 50% of GDP and employment remains “on hold”, it points to the strong possibility of a double dip recession and, in turn, another decline in the S&P 500.

9. Cash Outflows Are Trending Poorly – ICI reported that for the week ended June 16, domestic equity mutual funds saw $1.8 billion in outflows for the seventh sequential weekly outflow. Despite net activity of $5.2 billion for 2010 thus far, the first seventeen weeks of the year were comprised of $40.6 billion in inflows while the last seven weeks represented $35.4 billion in outflows. Should this trend continue, it will put managers in an awkward position of having to sell “winners” to meet redemptions due to the low levels of cash on hand. If both of these trends continue, one would have to believe it will have a negative impact on the S&P 500.

8. Tax Cut Expirations – Art Laffer, apparently not one for mincing words, wrote an excellent opinion piece in a recent The Wall Street Journal called, Tax Cuts and the 2011 Economic Collapse. While his title gets at the point rather well, briefly, in summary, Mr. Laffer made the very strong case, in my opinion, for the idea that income and production will be inflated above where it would be otherwise in 2010 since in-the-know individuals and businesses are shifting income, when possible, to 2010 in order to avoid the tax hikes that are coming in 2011. Not only did this happen in 1993 from 1992, but he believes “…this shift in income and demand is a major reason that the economy in 2010 has appeared to be as strong as it has. When we pass the tax boundary of Jan. 1, 2011, [his] best guess is that the train goes off the tracks and we get our worst case nightmare of a severe “double dip” recession.”

7. Deflation – In the most macro-terms possible, and at the risk of being repetitive, until the asset class at the eye of the financial storm – residential housing – heals via stabilized pricing, we are living in a world of deflation. This is reinforced by record low mortgage rates. In more micro-terms, over the last 12 months, the core rate of inflation has risen only 0.9% or well below the 2.0% average annual increase over the past 10 years. In addition, returning to small business owners, 28% reported making price reductions in May, an increase over April, while this price cutting contributed to a high percentage of such owners reporting declining sales. Lastly, the Fed’s extraordinary liquidity efforts of the last two years have led to stagnant money rather than monetary expansion. Should this transform into a true “liquidity trap”, stagflation is the best case scenario but outright deflation is more likely.

6. High Unemployment – 15 million Americans are out of work. Nearly half of those people lost their jobs after December 2007. Private sector hiring appears to be at a standstill with only 41,000 new jobs created in May. 46% of the unemployed have been out of work for more than 6 months or the highest percentage since this record has been kept back in 1946. The real unemployment rate, counting those who have simply stopped looking for a job, is nearly 17%. All in all, a rather bleak picture on the employment situation here in the U.S. and one that will lead consumers to remain on the spending sidelines and especially for houses.

5. Commercial Real Estate “Crash” – Various sources estimate that between $1.3 and $3.5 trillion in commercial loans is coming due in the next 5 years with more of it weighted toward 2012. This could be an ugly event. This is especially true if banks are unwilling or unable to offer new financing to the borrowers since commercial real estate owners will then be put in the awkward position of having to pay for multi-million dollar commercial real estate holdings in cash. While some will be fortunate enough to do so, there are others who will not and this will force mainly small and mid-sized banks, and insurance companies, to write down bad loans and determine what to do with portfolios of commercial real estate in a depressed market. This situation is so grave that chairperson of the Congressional Oversight panel, Elizabeth Warren, said that half of all commercial real estate loans will be underwater by the end of 2010 and the bulk of these loans are concentrated in small- and mid-sized banks. She even went so far as to say that this will devastate small-business lending and create “a downward spiral of economic contraction.”

4. Housing Double Dip – After a year of respite for the U.S. housing market due to the government’s tax credits and MBS purchases, residential housing is set to take another deep dip down. May’s non-government “owned” housing market activity was awful. Housing starts dropped by 10%, permits fell by almost 6%, mortgage applications were down, the homebuilders’ sentiment index dropped, existing home sales fell by 2.2% while new-home sales took a 33% nosedive. However, it is the combination of the S&P/Case-Shiller Index and annual housing starts that demonstrate that the housing market’s direction is down.

While this Tuesday’s CSI release may be to the positive as may be both July and August, the chart at top (click to enlarge) shows that there is a very real chance that pricing could level off where it had been in the late 1990s while housing starts are in unchartered territory having broken multi-decade support of about 1 million starts annually. It is difficult to see how the gravity of either chart can be warded off in the next 5 to 10 years, and thus to understand how the housing market can move in any direction other than down.

3. Financial Institutions Are Tied to the Housing Market – Putting aside the potential implications of the bank-reform bill and any links between U.S. banks and both European banks and sovereign debt, financial institutions are likely to have a tough go at it again. I spoke to a banking analyst yesterday who told me that if the decline in housing is accompanied by a worsening unemployment picture “it will really flow through” to U.S. banks and insurance companies. This “flow through” will show up in two places: (1) security portfolios, and, (2) loan portfolios. Remember the “toxic assets” of 2008? They still exist to the degree that they were not sold off or written down. If the upcoming decline in housing is aggravated by unemployment, it is likely to spur another wave of delinquencies and foreclosures.

This will hit the value of the security portfolios because much of the paper will become “toxic” again due to the non-performing loans layered in the various, and sometimes repackaged, tranches of debt. However, it will also hit the loan portfolios of banks, and this analyst thought this was the real danger, because banks will have to write off a new wave of bad loans and figure out to unload houses in a truly distressed housing market. All of this is why I continue to believe that until the asset class at the eye of the financial crisis heals – housing – we can be assured that the crisis itself is not over.

2. The World’s Unsustainable Borrowing Binge of the Last 30 Years – While not nearly as powerful as Mr. Laffer’s title, it does speak for itself. The private sector, and financial institutions in particular, borrowed in what proved to be an unsustainable manner between 1980 and 2007. “Unsustainable” because active borrowing as measured by the Federal Reserve collapsed in 2009 to -$611 billion from its annual peak of $4.6 trillion in 2007. That is a huge, almost incomprehensible decline in borrowing to have occurred in two years. The U.S. government has attempted to shoulder some of that load by borrowing about $2.9 trillion in the last two years, but it is a nearly impossible task. Should it prove to be more than the U.S.’s balance sheet can handle, it will result in foreign creditors demanding a higher rate of return on Treasurys as is happening in Greece today. This will devastate banks because their fixed-rate assets will be underwater, but more frighteningly, the U.S. dollar will become severely devalued if not collapsed.

1. The Ugliest Chart of All Time – Unless there is an act of God between now and 4 pm EDT this coming Wednesday, the chart of the S&P 500 will be forever altered for the worse. This chart is, of course, the basis for all of my work, or what I have called the Twin Peaks, or the S&P 500’s severe double top with a technical target that is far, far below where the index is today.

And there you have it, the Top Ten Reasons To Be Bearish and why I believe we are in the worst bear market of our collective lifetime.

Article from Seeking Alpha.

Monday, June 7, 2010

John Laughland: Why the Euro Will Fail

John Laughland: Why the Euro Will Fail

Throughout the history of European integration, its supporters have often used transport metaphors to sell their project.

In the 1960s, Europe was a bicycle which had to keep moving forward for fear of falling over. In the 1980s, Europe was a boat or a train which laggards were in danger of missing.

These metaphors were banal and nonsensical until 1999, when one of them proved to be prophetic. In the euphoria generated by the launch of the single currency, the euro, on Jan.1 of that year, a European official announced that Europe was now “on a freeway which has no exit.”

What he meant, of course, was that Europe wasn’t going back to national currencies. However, he hadn’t thought his metaphor all the way through. A freeway without an exit can lead to only one thing: a very serious car wreck. That is precisely the outcome that horrified European leaders are now being forced to contemplate.

German Chancellor Angela Merkel recently caused panic in the financial markets when she tried to shore up support for her huge bailout plan by warning that “the euro is in danger.”

Other European leaders, especially in France, rushed to correct the damage caused by such German tactlessness, insisting that, on the contrary, all was well. However, the idea that the euro’s days are numbered is becoming increasingly widespread in both the financial markets and the press.

The immediate cause of the crisis in the euro zone has been Greece, which has been teetering on the verge of default for months because it cannot even afford to reschedule its gigantic state debt.

One thinks of Greece as a country full of village squares where elderly men while away the day in the shade. This cliché does indeed reflect the reality of the country where people retire in their 50s after having been paid 14 months’ salary a year.

Greece has one million public servants for a population of 11 million citizens — the same number as in Britain, whose population is nearly six times greater. No wonder they can’t pay their bills.

However, the politics is worse than the economics.

The crisis has poisoned relations between Germany and Greece so badly that German tourists have literally canceled their holidays in Greece out of fear of the hostility to which they knew they would be exposed. The Germans, meanwhile, strongly resent having to tighten their own belts while the Greeks open another bottle of ouzo (a popular drink in Greece).

The multibillion euro bailout has also led to severe ructions between Germany and France, because many in Germany say, albeit under their breath, that the bailout is intended mainly to help French banks, who indeed hold the lion’s share of Greece’s debt.

Meanwhile, the French Finance Minister has complained that the euro is so structured that it necessarily benefits the German economy to the detriment of the other euro states, the implication of which is that the Greek crisis will be reproduced somewhere else soon.

The very thing which was supposed to bring the nations of Europe closer to one another — the euro — is in fact turning out to be a cause of division.

It is these political factors which will decide the euro’s fate. The strings of zeros being handed out to keep the euro zone together may spell economic disaster.

Certainly, large elements of the bailout (especially the May 10 decision by the European Central Bank to start buying government debt, i.e., to monetize it) will almost definitely lead to serious inflation.

On the other hand, what Europe is doing to save the euro is no different from what the United States has done to shore up the American banking system and the economy in general. Perhaps European leaders calculate that their currency will be no weaker than the other frail currencies all over the world.

The decisive factor isn’t the market, but instead the political incoherence of the euro project in the first place – an incoherence which, in my view, dooms the project to eventual collapse.

The euro is built on so many contradictions that it is difficult to keep track of them. It was supposed to de-politicize monetary policy by placing it in the hands of an independent central bank whose only goal was to drive down inflation. Yet it is the very centerpiece and foundation of the most ambitious political project since the creation of the Holy Roman Empire in the year 800, the project of uniting the whole of Europe under a single political and economic regime.

The euro was supposed to be based on strict rules of sound budgetary housekeeping, inspired by the German model. These rules have been constantly violated, including by the Germans who are now pontificating about how important it is to respect them.

The euro was supposed to foster economic growth and stability. It now threatens to push several European economies into a hopeless spiral of deflation and political turbulence.

The euro zone seriously pretends that all its member states are working to reduce their total state debt. In fact, all these states run annual budget deficits, i.e., they spend every year more than they earn.

The Greeks are accused of cooking the books to make it appear that they qualified for membership 10 years ago; yet the same is almost certainly true of Belgium and Italy, founder member states of the European Community whose exclusion from the euro zone is politically unthinkable.

There is a less polite term for these contradictions, and it is “lies.” Perhaps the biggest lie of all is that the euro is a true monetary union.

The European Central Bank fulfills neither of the two key functions generally associated with central banks. It is neither an issuer of currency nor a lender of last resort. Both these functions continue to be carried out by the national central banks, all of which still exist but which act (and decide) together how to run their common monetary policy.

The bank notes reflect this highly de-centralized structure, since each of them bears a secret code, in the form of a letter in the serial number, which indicates its national origin. In technical terms, it would therefore be as easy for the European Monetary Union to break up as it was for Argentina to abandon its dollar peg in 2002.

Even this lie, however, pales in significance against the sheer unreality of the European project as a whole. This project is based on the idea that the whole of politics can be handed over to administration by technocrats, and on the associated idea that nation states can and should be subsumed into an apolitical overarching European order.

Precisely what the Greek crisis has shown is that the national principle cannot be consigned to the dustbin of history. Indeed, to judge by the German and Greek national presses, nation-statehood, and even straightforward nationalism, are alive and well in the euro zone.

It is no exaggeration to say that the Germans think the Greeks are a bunch of lazy thieves and the Greeks think the Germans are a bunch of arrogant Nazis.

To be sure, any nation-state has tensions between its different regions but, when the chips are down, nation states usually pull together. By contrast, when the chips are down in an artificial structure like the euro zone, its component parts generally pull apart.

There is no such thing as an apolitical monetary policy.

On the contrary, just as huge swathes of modern history can be explained in terms of monetary decisions — the history of the French revolution is closely linked to the history of the state debt and the currency, while the history of the 20th century is closely linked to Roosevelt’s decision to forbid the private holding of gold in 1933 — so the fate of the euro will depend on the political see-saw of power between France and Germany.

In 1989, the original impetus behind monetary union was to contain a reunited Germany in an overarching European structure — abandoning the deutsche mark was the price the Federal Republic paid for annexing East Germany.

The newly powerful Germany responded in 1992 by trying to impose its model on the other future euro member states, and for a long time it looked as if it was going to succeed.

A series of “convergence criteria” were laid down and pundits (including me) spent years discussing which few select countries would fulfill them. But the powerful Helmut Kohl left office in 1998 and the decision was taken in 1999 to throw the rules out of the window and to admit all the states which wanted to join. The Greek crisis of 2010 is nothing but a case of chickens coming home to roost.

So the future of the euro lies in German hands.

However, the speculation so far has concentrated exclusively on the possibility that Greece or other Mediterranean states might abandon the euro and devalue. Little attention has focused on another possible scenario, namely that Germany might be the first to go, leaving behind an empty shell.

With popular opinion in Germany riding high against the euro, and with several of the key (German) principles for sound monetary policy having been grossly violated, there is now a definite political and perhaps even a legal case for leaving.

Given that any serious fear of German militarism has long since disappeared from Europe — however much Europeans may resent German economic arrogance — the original raison d’être of the euro itself, as of the European Union as a whole, has largely vanished.

Under such circumstances, it seems absurd to continue with a project concocted in totally different geopolitical circumstances and which, like everything else about the euro, no longer corresponds to any reality whatever.

John Laughland is Director of Studies at the Institute of Democracy and Cooperation in Paris.

Tuesday, June 1, 2010

BubbleOmics: 10 Predictions for 2010 Reviewed

Seeing that events move so fast these days … what with high frequency trading and trillion dollar bailouts being produced like rabbits out of a hat, and more discoveries about more creative ways to “fix” an audit or a credit rating being revealed by the second, I’ve decided to put out forecasts every six months.

Thus, I’m updating my January 1, 2010, forecasts (see in italics):

1) S&P 500

It won’t go above 1,300 in 2010 but it won’t go down much until hits at least 1,200, at which point it risks a 15% to 20% reversal that will be relatively short-lived.

It hit 1,200 for a few days, then it went down 13% (closing prices) and 15% intraday -- interesting that 1,200 was about (one of many) Fibonacci numbers. I was expecting it to carry on at least until 1,300 before a reversal; but the question I’m asking myself is whether 13% down is a blip, a reversal or a correction?

My view (a real minority) is that the S&P 500 is 20% or so below its “fundamental” (that’s based on working out what International Valuation Standards calls “other-than-market-value,” which I do using historical correlations between price and nominal GDP and long-term interest rates.

But, and this is the kicker; it’s in the slump that happens after a bubble pop which is when mal-investments made in the bubble get washed out. Typically (in the past) you don’t get big corrections (like over 20%) at that stage of the cycle, and although the drama-queens were all over the place with the recent “crash,” well 13% isn’t exactly Armageddon.

There's no reason to change January's forecast now, as then, it’s a “value-picker’s market.”

2) Oil

Oil will drift sideways between $65 and $85 unless there is an “event” of which the most likely is a war of some sort … it won’t go down below $60.

That is pretty-much what happened so far, and I don’t think it will go down below $65 unless more skeletons are found in the financial closet,. I still think that within a year it could be playing with $90.


The gold market is struggling to understand value and the path ahead is therefore likely to be choppy. This is great for traders to show off their surfing prowess but perhaps a bit risky for “buy and hold.”

My view then and now is that gold is a bubble and that its price is driven by fear. Interestingly, the view I had in January was probably the first accurate prediction I ever made on gold, it went down from $1,200 to about $1,000; then it went back up above $1,200, and like I said, it's great for traders.

With regard to the year ahead, who knows what terrors lie hidden? And who knows what other skeletons are concealed like plastic land-mines by the clever auditors and rating agencies? My view remains that at some point it’s going down to below $800, whether it gets there via $3,000 is anyone’s guess.

4) US House Prices

S&P Case-Shiller 20 City Index will drop 10% from where it was in October 2009 before the end of 2010.

In the New-Year there was talk of a “bounce,” that didn’t happen; and in any case house prices don’t bounce, they go “splat.” I still think there is a little to go down before the bottom, foreclosures are not going away, but then that all depends on how much taxpayer’s money (or the money of future taxpayers) is thrown at overcoming the forces of nature, which is impossible to predict.

5) UK House Prices

There is one more leg down to come, possibly to beat the previous bottom on the Nationwide Index, but this could be delayed by Labour artificially pumping up the economy (by borrowing) so that they can have a good showing at the election.

I was saying last summer that the “bounce” was an illusion, in the short-term that was clearly wrong, I’m a bit mystified by the strength of UK house prices, I suspect that might have something to do with (a) the fact most mortgages are adjustable and (b) the British have been doing a very good job of trashing the value of the pound.

Now that the election is over the next question is whether the New-Boys will continue the peculiarly British tradition of bribing the electorate with high house prices, or whether they will come around to the idea that the complex mix of subsidies for home ownership and restrictions on building that make UK such a nightmare for the poor, is bad economics.

I suspect that because most mortgages in UK are ARM (i.e. linked to short-term interest rates) meant that the necessary adjustment of prices down to an economically sustainable level have been kicked down the road, and will continue to be kicked down the road. As always, it’s hard to predict how far politicians will go selling the birthright of their children to hang on to power.

6) US 10-Year and 30-Year Treasury Yields

By end 2010 the 10-year yield will be at least 5% and the 30-year will be at least 6%.

Last September I was the odd man out saying that yields would rise and they did, a bit. But by December I had started to change my mind (my January prediction was lower than most), and by February I had gone 180 degrees, just in time to be the odd-man out again.

Nowadays even Nassim Taleb has come out of the closet and broken his golden rule “I never make predictions,” and has predicted that US Treasury yields will rocket, this is what he said on February 3rd:

Every single human being should bet US Treasury bonds will decline.

Then the 10-Year was 3.7% now it’s 3.3%. I understand that Nassim has taken up a consultancy position with ACA (the people who took the long-position on the CDO cooked up by Goldman (GS)).

My logic then and now is simply that there is a demand for good quality debt (US Treasuries, suspect as they may be, are the best quality you can buy, at least in any quantity), and since the supply of non-toxic-AAA is limited, and getting more limited now that euro denominated debt is suspect, demand is likely to exceed supply … regardless of whether or not the US Treasury sells $2 trillion more in the next year.

Remember in 2007 the “shadow banks” were creating $2 trillion a year of AAA rated garbage; and the suckers were lining up around the block to buy it.

So long as pension funds and insurance companies are obliged to keep a proportion of assets in investment grade debt, the demand will still be out there. I don’t see yields going up much in the next year, although it’s hard to imagine how they can go down a lot more.

One thing that is predictable though, is that this time next year, there will still be plenty of “economic experts” going on, and on and ... on, about hyperinflation just around the corner (just like this time last year).

7) US Commercial Property

It will bottom in 2010 and the Moody’s index will be up end 2010 on end 2009.

I think that’s right; there are more funds being put together to buy distressed properties, sales are up although the banks are being allowed to practice “forbearance” so there is not much to buy. I think it’s highly unlikely the market will go down much now and that end 2010 will be (slightly) up on end 2009, but it won’t be a “bounce,” just an opportunity for anyone who knows what they are doing (i.e. didn’t get hammered by the downturn), to go back in.

8) Hong Kong Property

This is not a bubble.

Well if it was it still didn’t burst, prices went up and although I would expect prices to be muted if, as looks likely, China starts to cool down. By the way I found a great site for property prices.

9) Dubai Freehold

If you can find something Dubai property is a reasonably good investment now (if you like that sort of thing).

There is no change, although it’s harder to get a bargain than it was nine months ago, then you could buy a “standard” villa on the Palm for $1.8 million, nowadays you would be lucky to find one for less than $2.3 million.

At the more “affordable” end of the market, the increase in inventory is still keeping rents down and will do for some time, although the economy is starting to grow (albeit on two cylinders and from a low base). Still hard to find anything that doesn’t have something wrong with it.

10) Shanghai Stock Exchange

This is not a bubble, it will hit 4,000 before the end of 2010 (up 25% on end 2009), but it could be choppy.

It looks like I got that one completely wrong. Today it’s down over 20% on the end of 2009; and well I did say “choppy”, but perhaps the Big Idea about bubbles is wrong?

The SSE had a big bubble in 2007 (5,900) and it bust down to 1,728 which according to the “Big Idea” should put the “fundamental” at about 3,000 in early 2008. And if China has grown since then well it should be heading up in the direction of 4,000.

OK there are still six months to go but 4,000 looks out of the question from here, although the “Big Idea” says that unless China implodes, and the world stops buying from them, it has to head up towards that number at some point. With regard to when, well that’s what you got your risk premium for.

On reflection, perhaps the part of the Chinese economy that is represented by the SSE is not growing as fast as the official figures say it is. China is effectively two economies (a) the Special Economic Zones who are the backbone of the SSE which generate 80% of China’s exports (b) the hugely inefficient and corrupt part of the economy outside the SEZ which is the part that is (allegedly) having a housing bubble and is the part where much of the Chinese “stimulus” was directed.

The “evidence” of what happened over the past six months is that although mainland China might be booming, the SEZ are not. Which makes sense, they depend on exports, and there is no huge reason to be in an SEZ if you are selling into the mainland.

For the next six months, I think the SSE is going to do whatever the world economy does, i.e. not very exciting, particularly now that European banks have stopped lending to each other; but I don’t think it will go down much.

Article from