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.

The Second Debt Storm.

Who will bail out the countries that bailed out the world's corporations?

SAN FRANCISCO (MarketWatch) -- The financial crisis never really went away.

The debt mountain that brought down some of the world's biggest banks and dragged the international financial system to the brink of disaster has simply shifted to governments. Now it's threatening countries around the globe -- and, if left unchecked, could rip the very fabric of Europe's economic system and wreck economic recoveries in the U.S., China and Latin America.

The impact on markets has been severe. The euro has slumped more than 12% against the dollar since the sovereign-debt crisis flared in southern Europe. Gold has marched to new highs as investors seek a safe haven and, perhaps most alarming, it is now more expensive to buy insurance against national default than it is to insure against corporate failure.

"The sovereign-debt crisis spun out of control in the past week, and we see no easy way to resolve it," said Madeline Schnapp, director of macroeconomic research at TrimTabs Investment Research.

Some investors and analysts are increasingly concerned that governments may be no more capable of repaying their debts than the banks and insurance companies they saved. And, they warn, if a major country comes close to default, it could trigger a financial meltdown that would eclipse the panic that followed the bankruptcy of Lehman Brothers in 2008.

The world has seen sovereign debt crises before. Latin America, Africa and Asia have all experienced upheavals sparked by excessive debt. These crises were all accompanied by stunted economic growth, inflation and weak stock market returns, which make it even harder to pay off debts. As investors and government officials ponder the current state of affairs, they see ominous signs that the developed world may be facing a similarly bleak future.

"The problem of the western world is that we have too much debt," said Daniel Arbess, who manages the Xerion investment strategy at Perella Weinberg Partners. "Rather than reducing our debt, we've been moving it from one balance sheet to another."

"All we're doing is shifting chairs on the deck of the Titanic," he added.

Europe's bailout

Some governments have started to respond to market pressure, with the U.K. pledging billions of pounds in spending cuts this week. Spain and Portugal also unveiled austerity measures. But the problem is so big that investors remain wary. Check out Portugal's plans.

Stock markets plunged and credit markets shuddered last week on concern Greece and other indebted European countries like Portugal and Spain might default. See the story on market impact.

"What's happened on a corporate level is now happening on a national level. The first nation to experience this is Greece, but other nations will, too," Schnapp said.

To stop Greece's debt troubles turning into a run on the euro and a global stock market rout, the European Union unveiled an unprecedented package of almost $1 trillion in emergency loans, stabilization funds and International Monetary Fund support on Sunday.

In the days that followed, the European Central Bank bought the government debt of Greece and other countries on the periphery of the region's single-currency zone, such as Portugal, Spain, Italy and Ireland, investors said. Such a drastic step has been shunned by the ECB until now. Read about the market response on Monday.

"Temporarily the crisis in terms of liquidity has been averted, but the underlying problem hasn't gone away," Schnapp added. "Giant debt and expenditures by governments are still there." TrimTabs cut its recommendation on U.S. equities to neutral from fully bullish on Sunday, in the wake of the European bailout.

Protection

The sovereign crisis has been brewing for months. For much of the financial crisis, investors worried about financial institutions defaulting, rather than sovereign nations. But that pattern has been upended.

In early February, the cost of insuring against a sovereign default in Western Europe exceeded the price of similar protection against default by North American investment-grade companies. That was the first time this had happened, according to data compiled by Markit from the credit derivatives market.

The move "symbolizes how credit risk has been transformed from corporate to sovereign risk, as the solution to the financial and economic crisis was government intervention," Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch, wrote in a note to investors at the time.

Since then, the cost of insuring against sovereign default in Western Europe has climbed further, hitting a record of 169 basis points on May 7.

The European bailout pushed that down to 120 basis points on Tuesday. But that's still more expensive than default protection on North American corporate debt which cost 100 basis points on Tuesday. (In the credit derivatives market, 100 basis points means it costs $100,000 a year to buy default protection on $10 million of debt for five years).

'100%'

Market Edge: Debt Crisis Enters Second PhaseThe global debt crisis is in its second stage as governments deal with the debt absorbed from the private sector, and record gold prices have been reflecting these worries, according to SCM Advisors strategist Max Bublitz. Laura Mandaro reports.

While much of the concern has focused on Western Europe, unsustainable government debt is a global problem. And it is developed world governments that are accumulating the biggest debts, not emerging market countries -- a big change from previous sovereign crises.

"Looking beyond the immediate crisis in Europe, I am particularly worried about the next stage involving the U.S., the U.K. and Japan," Xerion's Arbess said. Debt to GDP ratios in the world's advanced economies will top 100% in 2014, 35 percentage points higher than where they stood before the financial crisis, the IMF estimated last month.

Three percentage points of this increase came from government bailouts of financial institutions, while 3.5 percentage points was from fiscal stimulus. Another four percentage points has been driven by higher interest on government debt and 9 points came from revenue lost from the global recession, according to the IMF.

"Public finances in the majority of advanced industrial countries are in a worse state today than at any time since the industrial revolution, except for wartime episodes and their immediate aftermath," Willem Buiter, chief economist at Citigroup Inc. /quotes/comstock/13*!c/quotes/nls/c (C 3.92, -0.17, -4.16%) and former member of the Bank of England's Monetary Policy Committee, wrote in a recent note on sovereign risk.

Even though the current epicenter of the crisis is focused on the euro zone, the overall fiscal position of the single currency area is stronger than that of the U.S., the U.K. and Japan, he noted.

"Unless there is a radical change of course by those in charge of fiscal policy in the U.S., Japan and the U.K., these countries' sovereigns too will, sooner (in the case of the U.K.) or later (in the case of Japan and the U.S.) be at risk of being tested by the markets," Buiter said.

Ultimately, these countries face the risk of being "denied access to new and roll-over funding, that is, of being faced with a 'sudden stop,'" he warned.

Economic drag

Once government debt levels approach 100% of GDP, things can get tricky. That's because a lot of a country's income from taxes and other sources has to be spent on interest payments.

John Brynjolfsson, chief investment officer at global macro hedge fund firm Armored Wolf LLC, illustrated the point with a simple example. With debt at 100% of GDP, interest rates at 3% and real economic growth of 3%, all the extra income collected by a country would be used to pay interest on its debt.

If a lot of government debt is owned by foreigners, like the U.S., the money leaves the country rather than being invested in more productive ways. This dents economic growth.

A study published this year by economists Carmen Reinhart and Ken Rogoff found that, over the past two centuries, government debt in excess of 90% of GDP produced economic growth of 1.7% a year on average. That was less than half the growth rate of countries with debt below 30% of GDP.

The Greeks' debts a lesson on corruption

IF someone wants to get a driving licence or a building permit, all that he or she needs to do is to fill a little envelope with some money and give it to an officer to smoothen the process.

A filled envelope can work wonders: businessmen could win bids for public contracts or hire lowly paid illegal workers. Does this sound familiar? However, this isn't what goes on anywhere near home.

This is about the day-to-day life in Greece, which has slipped to the brink of bankruptcy and is now getting aid from the big brothers in the euro zone. The reason Greece has sunk so deeply into a whopping debt problem is because of its ballooning budget deficit, which is equivalent to 13.6% of its gross domestic product (GDP), although the actual ratio could be higher, according to Eurostat.

Economics textbooks tell us that a country's budget deficit will start yawning when the government spends more than it earns, that is what it collects in tax revenue. But in Greece, even the man in the street who has never studied economics knows the root cause of the debt crisis, which is roiling their country, is corruption plus cronyism.

According to the Wall Street Journal, a Transparency survey shows that last year, 13.5% of Greek households paid bribes of €1,355 (RM6,775) based on last year's exchange rate on average.

In an article titled Tragic Flaw: Graft Feeds Greek Crisis, the newspaper said ordinary citizens handed out cash-filled envelopes to get driver's licences, doctor's appointments and building permits, or to reduce their tax bills.

In the past three years, senior politicians had resigned or been investigated over allegations that included taking bribes for awarding contracts, employing illegal workers and selling overpriced bonds to public pension funds, the report noted.

Cheating the government, especially on taxes, is widespread in Greece. Government procurement bribery and political patronage have bloated the Greek government's spending, and pervasive petty bribery eroded its authority over taxpayers, the newspaper wrote.

“The core of the problem is that we don't have a culture of civic society,” Stavros Katsios, a professor at Greece's Ionian University who specialises in economic crime, was quoted by the journal as saying. “In Greece, complying with the rules is a matter of dishonour. They call you stupid if you follow the rules,” he added.

In 2007, the government was found to have sold billions of euros of overpriced complex securities to public pension funds, resulting in large loss es at the funds. The shortfalls have to be covered by the government, and that widened the budget deficit further.

Economists estimate one quarter of all taxes owed are not paid in Greece. The newspaper quoted a senior government official as saying that if an individual or company owes €10,000 in taxes, they slip €4,000 to the inspector, keep €4,000 and pay €2,000 to the Inland Revenue.

Clearly, it is a classic example of plundering the public coffers. Back home, there is mounting concern about Malaysia's budget deficit after the two stimulus packages to revive the economy. Compared to Greece, Malaysians could probably breathe a sigh of relief that the country is still a long way from where the Greeks are now.

The country's budget deficit swelled to 7.7% of last year's GDP but the ratio is expected to drop to around 5.6%. Malaysia isn't in that alarming stage at all. That said, the debt crisis in Greece should raise alarm bells about the ugly fact that there are some similarities between the situation facing the Greeks and us.

One of the differences is that Malaysians are lucky enough to have oil money to replenish almost half of the country's coffers. Imagine if we were without the oil money, would the country's deficit still be so manageable? Could the government continue running the country the way it is doing today?

At a conference organised by the Associated Chinese Chambers of Commerce and Industry of Malaysia, YTL Corp Bhd's Tan Sri Francis Yeoh told the audience that he didn't need to know the former British Prime Minister Tony Blair to win the bid for Wessex Water.

What about his experience at home? Did it contain a hint which he didn't share with the audience?

Written by Commentary by Kathy Fong (The Edge Daily)

Weighing the Week Ahead: Are You Scared Yet?

If you find the current market action frightening, you are not alone. There is a bull market in disaster predictions, with a chorus of pundits predicting "another 2008." Sentiment indicators show increasing fear. Improvement in corporate earnings is seen as more evidence that something is wrong. After all, a market that cannot rally on good news is showing weakness.

The chart of the S&P 500 from the last year makes the case for a market that moved too far, too fast. Some see a new bearish leg -- not a correction but a major move to the old lows.

There is another perspective. Conditions are much different from the time of last March's low and also from the October, 2008, post Lehman period. A decline of ten percent or so after a big move is to be expected. Let us look at the S&P 500 with a two-year time frame.

The indicators in the two charts are the same, but the context is dramatically different. The fear from 2008 is ever with us. Patrick J. O'Hare, writing Briefing.com's regular feature, The Big Picture, summarizes it this way:

After the credit crisis of 2008/2009, which clearly presented a systemic risk few portfolios were positioned to deal with, there will be hyper-sensitivity to staying out in front of the next systemic risk.

To this point, consider for a moment how often the word "bubble" is tossed out to explain any uninterrupted rise in asset prices. Before the technology stock crash of 2000, the word "bubble" was rarely invoked in the marketplace, and when it was, it was typically used in association with an exposition on the South Sea Bubble of the early-18th century.

What there is today in the stock market is a bubble in the use of the word bubble.

That is a clever and accurate summary. He might have added that black swans are not found in herds.

Last Week's Action

Let's start with a look at the key data from last week. As usual, I am not trying to be comprehensive, nor am I taking a viewpoint. I will highlight what I found significant.

The Good

The earnings news is petering out for this season, but the general pattern of strength continues. Positive guidance is beating negative guidance by the widest margin in nearly a decade, according to Bespoke Investment Group. This is unusually good news, and eventually it will matter.

Some celebrated the weekly decline in initial claims. This reverses a couple of weeks of poor data. I disagree. The weekly series is just too noisy. Next week's data will be distorted by weather, as will next month's payroll employment data. (The payroll survey is done during the week including the 12th of the month).

The Bad.

The trade balance was a bit worse than expected and inventories a bit lower. The revisions will make the 4th quarter GDP increase lower. The revisions to the initial estimate of GDP come as we get more data. The news is not good, but neither is it some big conspiracy as some maintain.

Regular readers know that I find the University of Michigan sentiment indicator to be important and helpful. This month's reading was lower than expected, and certainly not at the bullish levels of the ISM. This is a helpful indicator for employment and job creation, so the report was bad news.

The bond auctions were weak, with long-term rates moving higher. The ten-year has moved to about 3.7% and corporate spreads have also widened. This is bad for stocks, since corporate bonds are a viable asset allocation alternative.

The news about Greece is certainly a negative. Regardless of the outcome, investors need to worry about the extent of sovereign debt problems in Europe and what it means for the U.S.

Briefly put, there was plenty of negative news.

The Ugly. Volatility! When the market makes major moves lower on little news, and seems dependent on Germany's attitude toward Greece ----- well, that is a problem.

Much of this translated into a stronger dollar. While I have demonstrated that a strong dollar is just fine for stocks in the long run, the current relationship is a strong negative correlation. The hot money sees a pattern like this and it becomes a self-fulfilling prophecy -- at least until it quits working.

The Week Ahead

My focus for next week is on Wednesday. Building permits are a good leading indicator of construction activity. (These cost money and reflect actual plans). Industrial production is also important.

I do not find the "leading" indicators to be very helpful nor am I concerned about the PPI and CPI right now. I do not expect any surprises from the Fed minutes.

The European news and the dollar will continue to be important.

Our Trading Forecast

Our own indicators (see our regular ETF updates for an explanation) continue as bearish, and that was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

1) Only 13% (down from 67% two weeks ago) of our ETF's have positive ratings. This is extremely weak.

2) The median strength is -22 (down from -15 last week), very negative.

3) 87% (up from 35% two weeks ago) of the sectors are in the "penalty box," showing much higher risk than in recent weeks.

4) Our Index Package has a negative rating. We own SH and DOG, the inverse ETF's for the S&P 500 and the DJIA.

A Helpful Insight

This is a good time for investors to think about long-term needs and goals. There are some simple solutions for those who are afraid of a repeat of 2008.

I had some reader questions after last week's update, wondering whether asset allocation models had triggered. Mine have not. The "correction" is still relatively small when compared to the recent gains.

We watch the asset allocation carefully for clients, and the indicators are closer to a conservative stance, but not there yet and certainly not short.

The average investor can try to do this at home. There are plenty of ideas online. You need to find a good method, continually update your indicators, avoid emotion, and execute the trades in a timely fashion. Few investors can do this, even when trying to follow a "lazy" portfolio. That is one reason why they trail the market by 4 percent a year while top advisors beat the market by solid margins.

Unless you are exceptional on these fronts, you might look for a good financial advisor. If you do, insist on someone who has personal service -- who understands your specific needs, risk tolerance and requirements. If the fees were low enough, and the stock picks were good enough, this would be better than you could do on your own. Over many years, it might be the difference between a comfortable retirement and a few more years of work.

Whatever you do, you should still pay careful attention to your investments. We no longer live in a "buy and hold" world.

Greek Risk Explodes To 327 bps, All Time High As Sovereign Risk Again Front And Center

Dubai - meet Greece. Apparently credit traders appreciate biblical allusions, as Greek Prime Minister George Papandreou "promised" for the third time today that all is good in the debt-stricken country, claiming there is "no way" the country would leave the euro or seek aid from the IMF.

The ECB's reponse: Greece's draft law on the restructuring of business and professional debts "could have negative impact on market liquidity." Credit's response: Greek CDS surges to an all time high of 327 bps, and the country now represents 24% of SovX risk.

Yet will Greece really be the cause of the latest bubble pop? Earlier Kyle Bass, recapping Dylan Grice's report word for word, noted the increasingly critical situation in Japan, courtesy of its demographic shift, which may soon lead to a funding crisis in the world's second largest economy.

Also note Kyle's observations on why the government is stuck in never equitizing failed financial firms: the trade off - alienating the traditional bond buyers. However, with both China and Japan becoming increasingly second-rate players in US sovereign funding, does this imply the TBTF picture is about to shift, and the next time the financial system collapses, are equities and even sub debt tranches going to be wiped out?

Citibank's Problems Are Far from Over

While there are a lot of numbers reported in Citibank's (C) recent quarterly earnings there is ONE critical comparison that is missing -- that is the sequential analysis of the credit losses (Q1 vs. Q2). I believe this is critical information not just for Citibank but for all financials.

First, here are the links to the Q1 report and Q2 report.

Getting to the point on credit losses:

April 17th report: Credit costs of $10.3 billion, up 76%, consisted of $7.3 billion in net credit losses, a $2.7 billion net loan loss reserve build, and $332 million of policyholder benefits and claims. The total allowance for loans, leases and unfunded lending commitments was $32.7 billion.

July 17th report: Credit costs of $12.4 billion, up 81%, consisted of $8.4 billion in net credit losses, and $3.9 billion loan loss reserve build. The total allowance for loans, leases and unfunded lending commitments was $37.0 billion, up from $21.9 billion in the prior year period.

As seen from these numbers, from Q1 to Q2 -- credit costs are STILL RISING. Losses were up by $1.1B and loan loss reserve is also higher by $1.2B. Unfortunately, from these reports, we do not get details of early delinquencies vs. late delinquencies; so a greater analysis of month to month trend is not possible based on these reports (companies like E*Trade Financial provide such details).

But given that on a quarterly basis numbers are still getting worse is an indication that problems at Citibank are FAR from being over. Indeed, increasing unemployment and recent indications that early stage delinquencies may be on the rise. For example, foreclosureradar.com's California report for June 2009, showed the HIGHEST number of notice of default on record ever.

Notice of default is the "first" step towards foreclosure and is the early stage indicator of things to come. June 2009 being worse than the entire last year and this year is indeed quite scary and banks like Citi, Wells Fargo (WFC), Bank Of America (BAC), JPMorgan Chase (JPM) etc. are more likely to be impacted by this than some of the other banks. And this is only mid-summer. Seasonally, things get worse in real-estate late-summer and fall.

While I wish to remain optimistic, and have net long position on financials (through XLF) - it is hard to remain optimistic in light of these numbers. I have tried to hedge my long position in financials with some FAZ.

Why Stocks Will Collapse This Fall

Written by Graham Summers
Thus far, 2009 has been a virtual repeat of 2008 for financial markets.

So far, both years have had:

• A Crisis/ Market low in March (Bear Stearns & March collapse to 666)
• A Government/ Federal Intervention (Bear Stearns & Stimulus Package)
• Gold testing/ breaching $1,000 in the first quarter (March & February)
• Stocks rallying into the summer on worsening fundamentals
• Stocks rallying close to their beginning of the year highs in May/ June
• Commodities rallying into the Summer on the China story/ inflation concerns
• Various government figures using the rally to claim that the “worst is over”

Stocks rolling over in earnest in June as fundamentals take hold

Even the charts are similar… except for the fact that 2009 has been like 2008 on steroid (the chart has been rebased to 100).

The Fed claims that it cut interest rates and pumped trillions into the market to lower volatility and return stocks to “normal” trading action. Looking at 2009’s performance compared to 2008, I’d say their efforts have been a complete and utter failure. The stock market has become more volatile with larger swings.

As I’m sure you’ll recall, stocks completely collapsed in the fall of 2008. I think that stocks will suffer a similar fate in 2009. My reasoning is simple:

1) The Fed’s moves have not solved the critical issues facing financial markets
2) The economic and financial fundamentals have worsened dramatically

The primary issue facing the financial markets is system solvency. In extremely simple terms there is too much debt, too many crummy assets, and not enough capital. Debt permeates our entire economy from the consumer level to the federal government. Debt became some out of control that at its peak, people could buy the largest single asset of their lifetime (a house) with no money down.

Since that time, Americans have done the sensible thing: deleveraging by paying off debt ($40 billion in credit cards debt Feb-May) and raising capital (saving their money). The In contrast, the Federal Reserve (the alleged back-stop for the financial markets), has done quite the opposite: issued more debt and spent even more money. Small wonder volatility has worsened.

The other critical issue facing the financial markets is accounting. To this day, no one knows the real value of the assets sitting on the banks’ balance sheets. No one knows if the banks are even solvent (I have my doubts). No one knows what the financial markets would look like without the Fed’s props in place.

To use a metaphor, the Fed has propped up a collapsing home with a few stilts and buttresses. Has the foundation improved? NOPE. Is the structure more stable? Definitely NOT. Do we even know the extent of the rot or damage that needs to be fixed? NOPE again. Have we spent a ton of money on the issue? YEP.

Now, onto issue #2 (economic and financial fundamentals are worsening dramatically). Sentiment and trading patterns may dictate short-term moves, but ultimately the market is driven by earnings. Well, earnings have fallen off a cliff. Consumers are not spending as they used to (they probably won’t ever again).

Year over year, retail sales are the worst seen in the post–WWII period. The last few months have shown the rate of collapse is slowing… but getting horrendous at a slower pace isn’t a sign of a turnaround.

Moreover, unemployment is rising which means even less spending (who goes on shopping binges to celebrate getting fired?). And this is happening at the same time that oil and other commodities are rising (which means operating costs will go up).

In very simple terms, higher costs + lower sales = much, much lower earnings. It’s simple math, but Wall Street analysts don’t seem to get it. Neither do any of the “green shoots” crowd.

So in summation, we have a MORE volatile stock market, rallying even harder on worsening fundamentals, with no real solutions to the structural issues plaguing the financial system.

If this isn’t a recipe for a potential Crash, I don’t know what is.

Good Investing?
Graham Summers

Courtesy From Jesper Lee - Cimb

U.S. Debt Crisis as Treasury Bond Prices Collapsing and Interest Rates Surging

Martin Weiss writes: Just as we’ve been warning, the United States Treasury is the next and largest victim of this great debt crisis. Right now, the Treasury’s finances are collapsing … its bond prices plunging … its interest rates surging.

Indeed, the Treasury’s financial crisis looms so large, it could wreck more havoc on the economy and deliver more pain to average Americans than the subprime mortgage disaster, the housing bust, the banking crisis, and the collapse of General Motors put together … It could create a rising tide of interest rates that wipes out the effects of any stimulus, undermines any recovery, and sabotages any new bailouts …

But unlike GM, Fannie Mae, Citigroup, AIG, and the many others that the U.S. Treasury has bailed out in recent months, there is no institution on the planet big or rich enough to bail out the U.S. Treasury itself. Further, unlike all prior episodes in this great debt crisis, the Treasury’s financial troubles cannot be covered up, papered over, or kicked down the road like an empty tin can.

Already, Treasury bond prices are crashing, and doing so with greater speed that at any time in history. Already, interest rates, which automatically go up when bond prices fall, are surging, with the rate on 10-year U.S. Treasuries nearly DOUBLING in a half year — the most dramatic surge during any recession since the founding of the Republic. And already, the interest rates on 30-year fixed mortgages, auto loans, commercial loans, and other debt are going through the roof.

This Is a Game Changer!

If you’re not paying attention to this new phase of the debt crisis, you’re making a grave error. And if you’re not taking swift action to protect yourself, you’re taking your financial life in your hands. In this issue, I’ll show why it’s going to get worse, why the Federal Reserve is powerless to stop it, how it will impact each major sector of the economy, and what you must do immediately to protect yourself and your family from the inevitable fallout.

Why This Is Just the Beginning of the Treasury’s Crisis. Why It’s Going to Get a Heck of a Lot Worse This Year. And Why It Could Continue for Years Beyond 2009.

It’s widely known that America’s federal deficit is out of control. But so many dire deficit warnings have been issued so often, they now fall mostly on deaf ears. Wall Street pundits roll their eyes. Washington politicians laugh at those who would cry “wolf.”

What they don’t realize is that this time, due to a series of devastating facts they’ve chosen to ignore, the day of reckoning is here:

Fact #1. Sheer size. According to the government’s official estimate, the federal deficit for fiscal year 2009 will be $1.84 trillion, or 13.4 percent of GDP!* It is the worst deficit in U.S. history.

It means the deficit has now exploded to a level which is so far beyond the range of anything we’ve experienced before, it’s impossible to imagine any scenario in which it does not have a devastating impact.

Fact #2. The actual deficit could be much larger. The administration’s $1.84 trillion deficit forecast presupposes a dramatic turnaround in the economy, which, by definition, is virtually impossible with the government running trillion-dollar deficits!

How can the administration possibly predict an economic turnaround when its own Treasury Department is sucking nearly $2 trillion in funds out of credit markets — the same credit markets that derailed the economy late last year?

Similarly, how can the government predict a turnaround when its own borrowing frenzy is already driving up mortgage rates and undermining real estate, the one sector that’s most responsible for the economy’s decline in the first place?

Fact #3. No end in sight. Since the United States declared its independence nearly 233 years ago, the only time the federal deficit approached or exceeded 10 percent of GDP was during major wars — the Civil War, World War I, and World War II. But in each case, the deficit financing began promptly — and ended promptly — with the war.

Unfortunately, that’s not the case this time. Although the U.S. is fighting wars in Iraq and Afghanistan, their cost represents only a small fraction of the budget shortfall. Even if the Iraqi and Afghan wars could be ended tomorrow, America’s great budget crisis would still be just beginning.

Fact #4. Today’s deficits are far worse than those of the Great Depression. America’s first big, multi-year peacetime deficits came in the 1930s. Tax revenues plunged with the sinking economy. And in the years that ensued, government expenditures — mostly for a series of programs to bail out the economy — went through the roof.

But even with a 90 percent collapse in the stock market in 1929-32 and even after three years of double-digit GDP declines that make today’s look mild by comparison, the federal deficit in 1933 was just 3.27 percent of GDP, less than one-fourth of what’s projected for this year.

And subsequently, even when the U.S. government embarked on the most ambitious stimulus and bailout programs of its 150-year history, the biggest single deficit — in 1936 — was 4.76 percent of GDP, only about one-third the size of today’s.

Fact #5. Structural deficits. Our nation’s second encounter with giant peacetime deficits was in the 1980s, but with a big difference: This time, there was no Great Depression. This time, the government’s fiscal woes were mostly structural — deeply ingrained in the bloated size of government and in our society’s dependence on government for much of its sustenance.

And even then, the federal deficit never rose to more than 5.63 percent of GDP, less than HALF its size today. The big difference today: Our current structural deficits are far larger than in the 1980s because the government is now liable for $65 trillion in future payments for Social Security, Medicare, government pension benefits, and other obligations that are now kicking in at a quickening pace.

Fact #6. Massive new commitments. Beyond the $1.84 trillion of red ink projected for 2009 and beyond the trillions more in future obligations, the U.S. government has just assumed responsibility for nearly $14 trillion in new loans, commitments, and guarantees to bail out brokers, banks, insurers, auto makers, and the broader economy.

If just one of these suffers greater-than-expected losses, we could see wave after wave of new demands on the government to honor its guarantees, bloating the deficit far further.

Why the Federal Reserve Can’t Stop Treasury Bonds from Falling

I can assure you, it’s not for lack of trying. In a massive attempt to boost Treasury bond prices launched March 25, the Fed has now bought $145.5 billion in Treasury notes and bonds, the most ever in such a short period of time. But despite all the Fed’s buying, T-bond prices have continued to plunge and interest rates have continued to surge.

Plus, in an even larger effort to support mortgage prices — and to suppress mortgage rates — the Fed has poured a whopping $507 billion into direct purchases of mortgage-backed securities (MBSs). But again, even after spending more than a half trillion dollars to bid them up, mortgage prices have still collapsed and rates have still surged.

In sum, the U.S. Federal Reserve has failed to stop this new phase of the crisis, and one of the key reasons is obvious:

To buy bonds, the Fed must print money. But the more it prints, the more it fans inflation fears and the more it chases away bond investors, who realize they’ll be paid back in cheaper dollars. Some pundits seem to think the Fed can simply print all the money it wants to finance the massive deficits. But in the real world, it doesn’t work that way.

The reason: As I explained last week, the government has not one, but TWO debt problems simultaneously:

A. The NEW debt problem:Massive Treasury borrowings of close to $2 trillion just to fill the gaping holes in the current federal budget.

B. The OLD debt problem: $14.5 trillion in Treasury securities, government agency securities, and MBSs outstanding.

The problem: If just 10 percent of those are dumped on the market, it would trigger the sale of $1.45 trillion worth, easily overwhelming the Fed’s purchases. The dilemma: The main reasons investors sell — fear of inflation and damage to the U.S. government’s credit — are, themselves, fueled by the Fed’s money printing and bond buying. End result: The more the Fed buys bonds, the more it risks triggering massive investor selling. So if you’re counting on the Federal Reserve to bail out the U.S. Treasury Department, forget it.

In the government’s grand balance sheet, printing money does nothing more than shift debts from one government account to another. It does not create wealth. It certainly does not stop bond prices from plunging and interest rates from surging.

Far-Reaching Consequences

Never underestimate the impact of surging rates — especially with near double-digit official unemployment and the worst debt crisis since the Great Depression.

Rising rates in this environment will be pure poison for:

• The nation’s insurance companies loaded with long-term corporate and government bonds.
• The nation’s banks counting on low interest rates to raise funds for close to nothing.
• Utilities that must continually borrow huge amounts of long-term money to finance their massive investments in power plants and facilities.
• Home prices that can only fall when available credit in the nation is hogged by Uncle Sam’s massive borrowing and when mortgage rates rise.
• You! Stocks, long-term bonds, and virtually all types of real estate properties are extremely vulnerable to surging interest rates.

Your Action Plan

FIRST: Get the heck away from long-term bonds and shift to shortest term securities.

SECOND: Use the resources provided with my new book, The Ultimate Depression Survival Guide, to find a truly safe bank near you … or to bypass banks entirely.

THIRD: Use any temporary market recoveries as an opportunity to SELL off assets you don’t need, such as investment real estate and vulnerable stocks. Keep your 401(k). But within your 401(k), shift to the safest, shortest term alternative available.

FOURTH: To profit from falling bond prices, consider inverse ETFs designed to rise as Treasury bonds fall.

Good luck and God bless!

Martin

* The 13.4 percent of GDP assumes the following: Deficit — the $1.84 trillion projected by the administration; GDP — the 3.3 percent GDP decline proposed by the banking regulators in their bank stress tests. However, the actual deficit in that scenario could be larger.

Financial Markets and Economic Crash, The Next Leg Down Will be Worse

Collapsing home prices and credit markets continue to put downward pressure on consumer spending, forcing the Federal Reserve to take even more radical action to revive the economy. Last week, Fed chief Ben Bernanke raised the prospect of further monetizing the debt by purchasing more than the $1.75 trillion of Treasuries and mortgage-backed securities (MBS) already committed. The announcement sent shock-waves through the currency markets where skittish traders have joined doomsayers in predicting tough times ahead for the dollar.

Foreign central banks have been gobbling up US debt at an impressive pace, adding another $60 billion in the last three weeks alone. That's more than enough to cover the current account deficit and put the greenback on solid ground for the time-being. But with fiscal deficits ballooning to $3 trillion in the next year alone, dwindling foreign investment won't be enough to keep the dollar afloat. Bernanke will be forced to either raise interest rates or let the dollar fall hard.

Export-led nations are looking for an edge to revive flagging sales by keeping their currencies undervalued. But the strong dollar is making it harder for Bernanke to engineer a recovery. He'd like nothing more than to see the dollar tumble and reset at a lower rate. That would reduce the debt-load for homeowners and businesses and send consumers racing back to the shopping malls and auto showrooms. Perception management is a big part of stimulating the economy.

That's why the financial media has been air-brushing articles that focus on deflation and shifting the attention to inflation. It's an effort to kick-start consumer spending by convincing people that their money will be worth less in the future. But deflation is still enemy number one. Rising unemployment, crashing home prices, vanishing equity and tighter credit; these are all signs of entrenched deflation.

Bernanke faces three main challenges to put the economy back on track. He must remove the hundreds of billions in toxic assets from the banks balance sheets, reignite consumer spending to offset the sharp decline in aggregate demand, and fix the wholesale credit-mechanism that provides 40 percent of the credit to the broader economy. Treasury Secretary Timothy Geithner has taken over the distribution of the remaining TARP funds, and created a new program, the Public-Private Investment Partnership (PPIP), for purchasing toxic mortgage-backed assets.

The PPIP will provide up to 94 percent "non-recourse" government loans for up to $1 trillion of assets which are worth less than half of their original value at today's prices. The Treasury's plan is an attempt to keep asset prices artificially high so that the losses will not be realized until they've been shifted onto the taxpayer. Here's how John Hussman of Hussman Funds summed up Geithner's PPIP:

"From early reports regarding the toxic assets plan, it appears that the Treasury envisions allowing private investors to bid for toxic mortgage securities, but only to put up about 7% of the purchase price, with the TARP matching that amount - the remainder being "non-recourse" financing from the Fed and FDIC. This essentially implies that the government would grant bidders a put option against 86% of whatever price is bid.

This is not only an invitation for rampant moral hazard, as it would allow the financing of largely speculative and inefficiently priced bids with the public bearing the cost of losses, but of much greater concern, it is a likely recipe for the insolvency of the Federal Deposit Insurance Corporation, and represents a major end-run around Congress by unelected bureaucrats.

Make no mistake - we are selling off our future and the future of our children to prevent the bondholders of U.S. financial corporations from taking losses. We are using public funds to protect the bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own.

All our policy makers have done to date has been to squander public funds to protect the full interests of corporate bondholders. Even Bear Stearns bondholders can expect to get 100% of their money back, thanks to the generosity of Bernanke, Geithner and other bureaucrats eager to hand out the money of ordinary Americans." (John Hussman, "The Fed and Treasury - Putting off Hard Choices with Easy Money, and Probable Chaos, hussmanfunds.com)

The second part of the Fed's plan is to fix the wholesale credit-mechanism, which means restoring the securitization markets where pools of loans are transformed into securities and sold to investors. Until Bernanke is able to lure investors back into purchasing high-risk debt-instruments comprised of student loans, mortgage securities, auto loans and credit card debt, the credit markets will continue sputter and growth will be flat.

Structured-debt creates the asset base which is leveraged though traditional loans or complex derivatives. Credit expansion maximizes profit, inflates asset prices and establishes the structural framework for shifting wealth to financial institutions via speculative asset bubbles. This is the basic financial model that US banks and financial institutions hope to export to the rest of the industrial world to ensure a greater portion of global wealth for themselves and a stronger grip on the political process.

Bernanke's Term Asset-backed Securities Loan Facility (TALF) provides up to $1 trillion in non recourse loans to financial institutions willing to buy AAA-rated debt-instruments backed by consumer and small business loans. So far, the response has been tepid at best. For all practical purposes, the market is still frozen. Bernanke knows that there will be no recovery unless the credit markets are functioning properly.

He also knows that the TALF won't succeed unless he provides guarantees for the underlying collateral, which is loans that were made to applicants who have no means for paying them back. Bernanke's guarantees will cost the taxpayer billions of dollars without any assurance that his plan will even work. It's a complete fiasco.

From the Federal Reserve Bank of San Francisco Economic Letter, "US Household Deleveraging and Future consumption Growth" by Reuven Glick and Kevin J. Lansing:

"More than 20 years ago, economist Hyman Minsky (1986) proposed a "financial instability hypothesis." He argued that prosperous times can often induce borrowers to accumulate debt beyond their ability to repay out of current income, thus leading to financial crises and severe economic contractions.

Until recently, U.S. households were accumulating debt at a rapid pace, allowing consumption to grow faster than income. An environment of easy credit facilitated this process, fueled further by rising prices of stocks and housing, which provided collateral for even more borrowing. The value of that collateral has since dropped dramatically, leaving many households in a precarious financial position, particularly in light of economic uncertainty that threatens their jobs.

Going forward, it seems probable that many U.S. households will reduce their debt. If accomplished through increased saving, the deleveraging process could result in a substantial and prolonged slowdown in consumer spending relative to pre-recession growth rates. Alternatively, if accomplished through some form of default on existing debt, such as real estate short sales, foreclosures, or bankruptcy, deleveraging could involve significant costs for consumers, including tax liabilities on forgiven debt, legal fees, and lower credit scores.

Moreover, this form of deleveraging would simply shift the problem onto banks that hold these loans as assets on their balance sheets. Either way, the process of household deleveraging will not be painless. (The Federal Reserve Bank of San Francisco Economic Letter, "US Household Deleveraging and Future consumption Growth" by Reuven Glick and Kevin J. Lansing) http://www.frbsf.org/publications/economics/letter/2009/el2009-16.html)

The economy is in the grip of deflation. Commercial banks are stockpiling excess reserves (more than $850 billion in less than a year) to prepare for future downgrades, write-offs, defaults and foreclosures. That's deflation. Consumers are cutting back on discretionary spending; driving, eating out, shopping, vacations, hotels, air travel. More deflation. Businesses are laying off employees, slashing inventory, abandoning plans for expansion or reinvestment.

More deflation. Banks are trimming credit lines, calling in loans and raising standards for mortgages, credit cards and commercial real estate. Still more deflation. Bernanke has opened the liquidity valves to full-blast, but consumers are backing off; they're too mired in debt to borrow, so the money sits idle in bank vaults while the economy continues to slump.

In an environment where businesses and consumers are rebuilding their balance sheets and paying off debt, there's only one option; inflation. Bernanke will keep interest rates will stay low while increasing monetary and fiscal stimulus. The ocean of red ink will continue to rise. Still, the systemwide contraction will persist despite the Fed's multi-trillion dollar lending programs, quantitative easing (QE) and Treasury buybacks.

The "Great Unwind" is irreversible; the era of limitless credit expansion is over. David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, believes that the equities markets have undergone a "gargantuan short-cover rally" and that stocks will retest the March 9th low, which was a 12 year low for the S&P 500 Index. Rosenberg said he doesn't expect the economy to recover in the second half of the year.

"I'm seeing no revival of consumer spending in the second quarter," Rosenberg said. (Bloomberg). The conditions that supported the explosive growth of the last decade no longer exist. The credit markets are in a shambles, the banking system is hanging by a thread, and the consumer is out of gas. Traders are clinging to the slim hope that the worst is over, but they could be mistaken. There's probably another leg down and it will be more vicious than the last.

By Mike Whitney

S&P: Banking Crisis Could Go on for Another 3 or 4 Years

Despite the cautious optimism creeping into the financial markets, in light of what some believe are better-than-expected results from the government stress testing of 19 large banks, Standard & Poor’s Ratings Services believes that “banks are far from a recovery, and the banking crisis has merely entered a new phase.”

…although our analytical time horizon for losses extends only through 2010 … there’s nothing to say that this banking crisis can’t go on for another three or four years. - Tanya Azarchs, managing director at Standard & Poor's

One thing is clear, however: banks will have a tough time surviving unless they have “more capital than even Basel envisioned,” according to Azarchs. The Federal Reserve Board’s stress testing, the results of which were announced May 7, found that 10 of the 19 largest banks need a total of $75 billion in capital to maintain at least 4% of common equity Tier 1 capital if the environment becomes a lot more adverse than experts currently expect.

This compares with Standard & Poor’s assessment of an $18 billion need for these 19 banks on the basis solely of credit stress testing. “Despite the significantly higher capital requirements determined by the Fed’s stress tests as compared to our stress tests, we do not see this as an unmanageable amount, and most management teams of the identified banks promptly issued statements about how they would raise the capital (see “The U.S. Federal Reserve’s Stress Test Results: The Beginning Of The End Or The End Of The Beginning For U.S. Banks?)

Standard & Poor’s completed its own base-case stress testing of banks’ loan portfolios, focusing on credit and earnings risks and their impact on capital adequacy (see What Stress Tests Reveal About U.S. Banks’ Capital Needs.) On May 4, S&P placed ratings on 23 financial institutions on CreditWatch with negative implications. The results, and the rating actions, are wholly independent of the stress testing regulators conducted and indicate widespread, though not necessarily severe, capital needs that could result in downgrades of several notches.

S&P says the Fed’s stress test has been just another step toward the eventual recovery of the global financial industry, but the industry still faces challenges presented by these developing trends:

• Industry risk is generally creeping higher rather than stabilizing;
• Losses during this downturn will likely be greater than the industry thought when it began;
• Franchise stability and market confidence are increasingly critical components of credit;
• There’s a greater focus on capital adequacy;
• Government support is now explicit in our ratings for highly systemically important U.S. banks;
• Hybrid securities appear to be riskier than we thought;
• The industry structure is changing;
• Volatility appears to be here to stay;
• The originate-to-distribute model is being rethought; and
• Regulation is generally increasing.

The Worst Isn't Over Yet.

The stock market has had a great rally since March 9. As someone who has a large pile of cash, I’ve was wondering if I missed a buying opportunity, but on the other hand, my large pile of mutual funds (such as my VFIAX) has come back to levels of early February — only 15% below Election Day and 33% below the end of August.

Still, I’ve stayed out because this felt like a sucker rally. (Peter Cooper at Seeking Alpha agrees). Perhaps the market was oversold: I’m not a technician, nor do I play one on TV. The rally could also be due to a change in sentiment, and I’m no expert on mass market psychology.

But as a young investor, I recall Charles Schwab’s advice to look for economic signs in your daily live to guide your investment decisions. (iPhones among Silicon Valley housewives might seem like such an indicator, but first I’d like to see their counterparts in Des Moines and Birmingham).

The indicators that I’m seeing suggest that firms have lost their pricing power, and are scrambling to cut prices (or pretend to cut prices) to gain sales, sometimes at any cost. This will depress the bottom line and probably the top line as well.

Of course, everyone knows auto sales are down and bankruptcy-prone GM and Chrysler are doing anything they can to attract sales. Here in California, car sales (and other big ticket items) will be down for months, because legislators raised the sales tax this month by 1% as part of an ugly end to an uglier budget mess. Buyers will also be postponing purchase of other big ticket items, whether HDTVs or Caterpillar (CAT) earthmovers.

Beyond this, home improvement stores are also aggressively trying to attract business. Conventional wisdom is that in a down economy (or when financing is tight), homeowners remodel in place rather than buy a new McMansion, but that doesn’t seem to be happening right now.

Here we have three main stores — Home Depot (HD), Lowe’s (LOW) and OSH Hardware — and all three are promoting more aggressively than any time in the 6.5 years I’ve lived in the Bay Area. Perhaps they are quietly cutting corners on the quality, such as by pressuring suppliers to ship shoddier Chinese-made tools, or lowering the grade of building materials — but it still seems as though their earnings will be depressed for the rest of 2009.

The NYT wrote Monday about how the home improvement and other retailers are aggressively repositioning themselves as value havens during the down economy.

Another area that’s supposed to do well in downturn is fast food, and indeed McDonald’s (MCD) has held its market value compared to the broader market. However, in the overall fast food/quick serve market, the last 3 months has seen a dramatic increase in the emphasis on bargain menus — items in the $1-1.50 range.

Locally, it started with our sub shops (Subway, Togo’s, Quiznos) which are at the high end of the fast food/quick serve price bracket, but now it's hit all of the FF/QS market. (Some of these are phony price cuts based on reduced portion sizes). All of these depressed profits will not help stocks. Falling revenues and profits (into losses) would also bring more layoffs, and layoffs will reducing pruchasing power and consumer confience.

This morning, the Merc published a SVLG survey of SV CEOs about their expectations for the economy, which are expecting more job cuts this year.Finally, economists at UCLA’s Anderson Graduate School of Management are predicting real GDP declines through September, and unemployment peaking in 2010 — at above 10% for the US and nearly 12% for California.

Even ignoring Anderson’s good forecasting record, I don’t see how a recession this strong will turn around substantially in 2009. So my expectation is for ugly corporate earnings for several quarters. Banks may be off their firesale prices, but it’s hard to see much upside for the overall economy for the next 6-9 months.

Article from Seeking Alpha.com

Sucker's Rally Approaching an End

Whatever the technical reason for the 25 percent rise in the S&P over the past five weeks, or a more modest eight percent bounce in GCC regional stock prices, the absurdness of this sucker’s rally ought to be obvious to all.

Unemployment is still rising, house prices are still falling, and the fundamentals of bank balance sheets are still deteriorating with total bad debts unknown except that we know they must be getting worse. Global trade fell off a cliff in the first quarter of the year. Even Mercedes car sales to the oil rich of the GCC fell 23 per cent. The collapse of the world’s second largest economy, Japan, has been unprecedented.

Bad news coming

Nor do you have to look hard to see what the bad news to come might be: US banks will have to reveal all in government stress tests to be published at the end of this month; the bankruptcy of Chrysler and General Motors (GM) loom, two companies of vast importance to Main Street USA with a million jobs in jeopardy and huge borrowings to be written off by the banks.

The stock market pattern in 2008-9 has so far been a mirror image of the crash of 1929-30 with a halving of prices from the autumn followed by a 25 per cent rally from March lows. In April 1930 stocks moved sideways and then they crashed another 50 per cent into the summer.
What possible reason is there for optimism to believe that history will not repeat itself?

Government stimulus packages have more than likely been too small and too late to prevent another down leg in stocks, and will take time to revive the real economy, if indeed they can do so. They might just stop the worst possible scenario but are they going to prevent the plunge downwards? Governments have not managed it so far.

Consumers and unemployment

At the commonsense level you have to ask why should an economy show signs of recovery as it lays off hundreds of thousands of people: the unemployed are not big consumers, and it frightens the hell out of people left in work who stop spending and save.

Consumer demand is the most important fundamental in modern economies and the confidence of consumers is being blown to pieces. It will take more than weasel words from US bankers and ‘green shoots’ in the waffle of President Obama to put things right.

Eventually global stock markets will reach a bottom but they are not close to having visited it just yet. Wall Street and its friends are playing investors as suckers but they are in danger of overdoing it. For once these guys are impoverished where will the next bunch of fools come from? Goldman Sachs' (GS) results this week might well mark the top of the rally, beyond that the only way is down.

Article from Seeking Alpha.com

6 Reasons I'm Calling A Bottom And A New Bulls

Forget Roubini: I'm the new Dr. Boom, ahead of Dr. Doom (again!)

ARROYO GRANDE, Calif. (MarketWatch) -- OK, so you're one of millions of investors impatiently waiting on the sidelines, sitting with $2.5 trillion cash under your mattress, waiting for the right moment, that signal screaming: "Bottom's in, start buying!" Yes, it'll go down again, but the bottom's in, thanks to a great March, possibly the third best month since 1950, so it's time to jump back in and buy, buy, buy!

You heard me, I'm calling the bottom, beating Dr. Doom to the punch again (yes, again). Last time we were predicting the recession. This time we're calling the market bottom and a new bull.

Dr. Doom? Of course I'm referring to you-know-who, Nouriel Roubini, the notorious "party-boy economist," as Portfolio magazine calls him, the ubiquitous New York University professor with his well-oiled PR hype machine (and bon vivant lifestyle) that's made him the "go-to" media darling with endless economic predictions.

Portfolio pinpoints Roubini's claim to fame in his February 2008 blog, "The Rising Risk of Systemic Financial Meltdown: The 12 Steps," where he announced the recession actually started in December 2007. We also covered it as a 12-act Shakespearean tragedy.

But today Roubini's got a huge problem, one that'll hurt his fans, investors and credibility. Last December, Newsweek reported Roubini was predicting "the recession will last until the end of 2009," about nine more months.

He also boasted that "eventually, when we get out of this crisis, I'll be the first one to call the recovery ... Then maybe I'll be called Dr. Boom." He made the same boast in Portfolio.

Roubini is a great showman. A century ago he would have outdone P.T. Barnum with his incredible boast, a prediction rivaling historic ones made by other well-known New Yorkers: Babe Ruth's famous home run in the 1932 World Series after pointing his bat into the center field bleachers and Joe Namath's prediction of an upset win over the heavily favored Colts in the 1969 Super Bowl.

Warning: Here are 6 reasons why Roubini can never fulfill his promise ... why he may go down in history, as Portfolio suggests, as the designated "one-hit wonder" ... but worse, any investor waiting for a Roubini "call" is playing Russian roulette, a loser's game ... you will miss the market's real turning point:

1. The stock market turns before the economy bottoms

Regardless of what Dr. Doom or any economist boasts, the stock market has a mind of its own, it's a leading indicator. Stocks historically kick into action earlier than the economy recovers, often six months ahead of the economy's bottom. Witness March.

So while economists' predictions pinpointing a recession may appear earlier than bear market predictions by the notoriously optimistic Wall Street pundits, the cycles work the other way in a recovery: A stock market bottom and new bull may occur six months before the economists call the ending of a recession and an economic recovery. So Dr. Doom's "call" will naturally come months after the stock market in fact turns.

2. Stocks make big money fast then go to sleep

Back in January, Wall Street Journal columnist Jason Zweig reported on some fascinating research: "History shows that the vast majority of the time, the stock market does next to nothing. Then, when no one expects it, the market delivers a giant gain or loss -- and promptly lapses back into its usual stupor."

And the numbers back it up: "Javier Estrada, a finance professor at IESE Business School in Barcelona, Spain, has studied the daily returns of the Dow Jones Industrial Average back to 1900." He "found that if you took away the 10 best days, two-thirds of the cumulative gains produced by the Dow over the past 109 years would disappear. Conversely, had you sidestepped the market's 10 worst days, you would have tripled the actual return of the Dow."

3. No one can predict the next big move

Unfortunately, markets are notoriously unpredictable, ruled by mobs of irrational investors who are all bad guessers, No one can predict in advance when those "10 worst" or "10 best" days will actually occur. Not on Main Street. Certainly not on Wall Street.

Why? In his classic, "Stocks for the Long Run," Wharton economics Prof. Jeremy Siegel studied all the big market moves between 1801 and 2001. Two centuries of data. Siegel concluded that 75% of the time there was no rational explanation for big moves up in stock prices or big moves down. Lesson: Market timing is a loser's game.

4. Famous media-darling pundits inevitably flameout

A month ago Newsweek's science columnist and former Wall Street Journal legend Sharon Begley wrote a fascinating piece, "Why Pundits Get Things Wrong." Her opening: "Pointing out how often pundits' predictions are not only wrong but egregiously wrong -- a 36,000 Dow! euphoric Iraqis welcoming American soldiers with flowers! -- is like shooting fish in a barrel, except in this case the fish refuse to die. No matter how often they miss the mark, pundits just won't shut up."

Think of all the media darlings you know as Begley reviews the data: And "the fact that being chronically, 180-degrees wrong does not disqualify pundits is in large part the media's fault: cable news, talk radio and the blogosphere need all the punditry they can rustle up, track records be damned."

The data comes from Philip Tetlock, a research psychologist at Stanford University: "Tetlock's ongoing study of 82,361 predictions by 284 pundits" concludes that their accuracy has nothing to do with credentials such as a doctorate in economics or political science, or on "policy experience, access to classified information, or being a realist or neocon, liberal or conservative."

What matters? "The best predictor, in a backward sort of way, was fame: the more feted by the media, the worse a pundit's accuracy. ... The media's preferred pundits are forceful, confident and decisive, not tentative and balanced. ... Bold, decisive assertions make better sound bites; bombast, swagger and certainty make for better TV."

They can be totally wrong, so long as they're assertive and entertaining. "The marketplace of ideas does not punish poor punditry. Few of us even remember who got what wrong. We are instead impressed by credentials, affiliation, fame and even looks -- traits that have no bearing on a pundit's accuracy."

5. Even the best economists make huge errors

Go back a decade to that classic article in BusinessWeek, "What Do You Call an Economist With a Prediction? Wrong." Four years later in "So I Was Off by a Trillion," BusinessWeek punctuated the message, reporting on Michael Boskin's classic error. Boskin, a Stanford economist and former chairman of the Council of Economic Advisers under Bush 41, "circulated a startling paper to fellow economists.

In it, he argued that the future tax payments on withdrawals from tax-deferred retirement accounts ... were being drastically undercounted. That meant federal budget revenues could potentially be in for a huge, unforeseen windfall ... of almost $12 trillion."

That also meant a political boost for Bush 43: "Larger than the sum of the 75-year actuarial deficits in Social Security and Medicare plus the national debt." Later, however, Boskin checked his numbers and "concluded that he had made a serious mistake: A key term had been left out ... possibly wiping out most of the estimated $12 trillion in savings." No surprise: Political ideologies often motivate "objective" economists.

6. Will the real Dr. Doom please stand up?

Roubini actually shares the Dr. Doom title with many others, including Hong Kong economist Marc Faber who publishes the "Gloom Boom Doom Report;" legendary Salomon Bros. strategist Henry Kaufman; and Houston billionaire Richard Rainwater, whom Fortune mentioned as Dr. Doom.

In addition, in one of our columns last summer, we reported on many others whose predictions of a coming recession predated Roubini's claim, though not called "Dr. Doom." They include: Pete Peterson, a Blackstone Group founder; Pimco's Bill Gross; Harvard financial historian Niall Ferguson; Warren Buffett; former SEC chairman Arthur Levitt; Jeremy Grantham whose GMO firm manages $100 billion; "Black Swan" author Nassim Nicholas Taleb; and long-time Forbes columnist, economist Gary Shilling.

Noteworthy, way back in 2004 Shilling specifically warned: "Subprime loans are probably the greatest financial problem facing the nation in the years ahead." And later in June 2007 Shilling said: "Just as the U.S. housing bubble is bursting, speculation elsewhere will come to a violent end, if history is any guide.

Some astute pioneers, including Richard Bookstaber, who designed various derivative-laden strategies over the years, now fear that financial derivatives and hedge funds -- focal points of today's huge leverage -- will trigger financial meltdown." Then in a November 2007 column, "17 Reasons America needs a recession," Gross predicted a bailout of "Rooseveltian proportions" ahead. Yes, we were warned. In fact, seems everyone knew. But our denial was too powerful, hidden under our new culture of infectious greed.

The examples go on and on ... strongly suggesting that the "Roubini Hype Machine" may well be the "one-hit wonder" Portfolio calls him. He was not ahead of the competition with his December 2007 recession call. So if you're one of America's 95 million investors waiting for Roubini to call a bottom before getting back in the market, you'll miss the real turning point.

One final, crucial warning: This next bull will be short. First, it will suck money out of the mattresses of investors who are sitting on cash. Then Wall Street will recreate the insanity of the '90's dot-coms and the recent subprime-credit mania.