Sunday, March 28, 2010

Uh Oh.

You know that moment in the Road Runner cartoons where Wile E Coyote runs off a cliff and just hangs there in the air for a moment, looking at the camera, before falling several thousand feet to a dusty splat below?

I think the New York Times just Chronicled that moment for the stock markets.

Stocks Soar, but Many Analysts Ask Why
The unemployment rate remains locked in a range that recalls the economic doldrums of the early 1980s. Housing is stuck in a ditch, with foreclosures rising. And consumers are still reluctant to part with the little cash they do have.

Yet the stock markets are partying like it’s 2003, when hiring was brisk, real estate was booming, wallets were fat — and the major stock indexes started a four-year rally that would double their value and push them to new heights just before the financial crisis hit.

Judging from stock prices alone, one would think the economy was poised for a roaring comeback. But the federal government plans to unplug the economic life-support programs that stimulated production, kept interest rates low and placed a thick cushion under the real estate market.

Some analysts see ample reason for caution in equities, with many economists, including those at the Federal Reserve, forecasting tepid growth in the near term.

“The market is as overvalued now as it was undervalued a year ago,” said David A. Rosenberg, chief economist and strategist for Gluskin Sheff, an investment firm. “There’s a very high degree of complacency.”

The incongruity of it all can be seen clearly in an analysis of price-to-earnings ratios, a gauge of how expensive stocks are relative to their performance.

Ratios in the Standard & Poor’s 500-stock index are hovering about 13 percent above the average since 2005; a year ago, they were about 40 percent below the average. That suggests that investors are betting on robust earnings through the end of the year, a view that many economists do not embrace.

“The stock market has priced in a bit more than what we’ve got so far,” said Jeffrey A. Hirsch, editor of The Stock Trader’s Almanac. “We’re due for a pause.”

Recent rallies have been narrow, with a modest number of stocks reaching 52-week highs even when the broader market surged. There is a sense in some corners that stock prices will decline: investors are betting more on stocks’ falling now than they have since July.

Mr. Hirsch, citing historical patterns, predicts a 20 to 30 percent dip in the markets before they can climb again. The Dow Jones industrial average is more than 60 percent above its lows a year ago, flirting with 11,000 for the first time since the onset of the financial crisis, though it remains more than 3,000 off its prerecession peak.

The S.& P. 500 is up nearly 75 percent from a year ago, and the Nasdaq is up nearly 90 percent.

The first part of this year had glittering reports on fourth-quarter earnings and mildly upbeat news on economic indicators like retail sales and orders for durable goods.

In response, the broad-based S.& P. 500 has climbed 4.6 percent this year. Autos, consumer electronics, regional banks and home builders — all losers in 2009 — have led the way. Banking stocks, which drove much of last year’s rally, continue to surge, with many regional banks up more than 40 percent.

Even during some of the stock markets’ better weeks, jitters have seemed to lurk just beneath the surface. The Dow rode a rare eight-day winning streak this month, but trading was light and day-to-day gains were small, casting doubt on the significance of the uptick.

During much of the financial crisis, traders clung to bond funds for safety. But as the appetite for risk has returned, investors have begun snapping up stocks: over the last several weeks, new cash has poured into American equity funds at a brisk pace, and mutual funds have shown particular strength.

Many market participants expect the momentum to continue, with stocks ending the year 10 to 20 percent higher. While few expect strong economic growth this year, investors believe that the recovery is intact and that earnings will continue to grow.

“A lot of people believe the government will just keep pumping money into this,” said Doug Roberts, chief investment strategist for Channel Capital Research.

There are signs that some of investors’ optimism may be excessive.

Interest rates, kept at historical lows by the Fed during the financial crisis, are starting to rise because of the flight from bonds and concern over rising debt, particularly that of the United States.

Standard mortgage rates hovered near 5 percent last week after auctions of seven-year Treasury notes were met with weak demand, sending yields higher. A sustained rise in interest rates would crimp growth by making borrowing more expensive for consumers, businesses and governments. It could also attract some investors away from equities and into bonds.

Another concern is the nation’s intractable unemployment rate, which has hampered consumer spending and worsened a foreclosure crisis in the housing market. Employers are still not adding jobs, though the rate of job losses has declined in recent months, raising hopes that a turning point is at hand.

Consumer confidence has improved modestly from its low a year ago, but spending is still weak.

Some clarity may come to the market on Friday, when the government releases its monthly snapshot of the labor market. Forecasters expect the data to show 200,000 new jobs, with the unemployment rate holding steady at 9.7 percent.

When first-quarter earnings results begin trickling in next month, investors will be looking for signs that companies have put cost-cutting behind them and strengthened revenue.

“We’ve managed to at least temporarily suspend the financial crisis,” Mr. Roberts said. “The question now is, ‘You’ve gotten past the first act; what’s the encore?’ ”

Friday, March 26, 2010

Stock Market Correction Imminent

The markets are topping and the next three or four months should be very telling.

The decline from late January into early February unfolded in a very clear three-wave pattern, which indicates a corrective Elliott Wave situation. Since the markets all trend together, we knew the minute the Nasdaq topped its January high that the rally wasn't quite over.

Well, we now have much more clarity. It is in moments like these that Elliott Wave proves its worth, for there are not very many possible scenarios.

The near term count is a bit ambiguous, but that doesn't matter. We are currently near or at the end of a very small wave 3 of 5. In the next few days to weeks we will have a small downdraft (wave 4 of 5), then a final push upwards to complete this yearlong rally. The other alternative is that the little downdraft we had on the 19th and 22nd of March was the wave 4, and we are currently in the beginnings of wave 5.

Here is the significance of all of this.

If I am wrong and we are going to recover from this economic downturn, what follows will be a major buying opportunity. In the bullish scenario, we will have a large, three wave correction, possibly even retracing 100% of the rally from March 2009. That will be the time to buy.

In the bearish scenario, the decline begins again to new lows and the market will not bottom for another couple of years.

Either way, this is not the time to buy.

Since the stock markets and gold have been trending together, this is not the time to buy gold or silver either. You may even think about selling some and taking some profits off the table. As long as we don't decline below $920, the gold bull is intact.

Do your own due diligence. Make your own decisions.

Tuesday, March 2, 2010

How To Enjoy An Economic Depression

From the Christian Science Monitor

There are rules for making the most of a depression. Most important – cash is king.

By Bill Bonner

posted March 1, 2010 at 2:35 pm EST

The depression is alive and well!

Unemployment claims just came in higher than expected.And new house sales in January were at their lowest ever. Pundits were quick to blame the snow. But sales were off even in areas that had better-than-usual weather.

Household income has gone nowhere in 10 years. Stocks have suffered a lost decade too. And now Ben Bernanke says we’d better be careful… because the recovery ain’t no sure thing.
The Fed chief has no idea. But average people know what’s going on. They know how hard it is to find a job. If you’re in the building trades… or you have only a year or two of college… you’re pretty much out of luck. You may have to retire before you ever start work again.That’s why there was such a big drop in consumer confidence.But look on the bright side. Building more houses for people who couldn’t afford to live in them was not exactly the greatest business strategy. And all those people who were appraising, mortgaging and selling houses can now find more useful work. Real jobs. Doing something more useful. What are those real jobs going to be? We don’t know yet. But it could take a long time to find out. And in the meantime, we have a depression on our hands… So, let’s enjoy it…

How do you enjoy a depression? Well, the first thing is to make sure you’re not in its way… Dear readers may not know this, but in addition to writing The Daily Reckoning your editor also has a serious job…Yes, in the morning he is a moral philosopher… gratuitously insulting public officials, whole professions, and entire nationalities. He is grateful to them all… they make life so entertaining!

Imagine what kind of world we would have if people minded their own business and got on with their lives… People would be richer and happier, we don’t doubt it… but at whom could we point a finger and laugh? No, dear reader, the world needs its bumblers, fools, politicians (are we repeating ourselves?), grifters (sorry… we did it again!), and megalomaniacs. It needs someone to challenge the gods from time to time. Otherwise, the gods wouldn’t have the fun of whacking them. And we wouldn’t have the fun of watching. But getting back to the point… what was the point? Oh yes, the point is we have a serious job to do too. In addition to writing about the world of money, we actually have to live in it.

You see, we have a Family Office… a little group of researchers and analysts that actually has to make decisions… In the afternoon, we have to decide. What to do? Long or short? Buy or sell?

One thing we need to be on guard against is allowing our emotions to take over. For all our deep thinking and cynical detachment, we’re human too. We get emotionally attached to our own ideas. Then, we’re very reluctant to give up on them… no matter how bad they turn out to be.

We remember… sadly… our own feet dragging after the bull market in gold of the late ’70s. We didn’t want to sell. So we delayed… we hesitated… By the time we realized how wrong we were we didn’t have to sell. The bear market in the yellow metal was over! Gold had hit bottom. Gold was down 70% from the top. Much more in real terms.But there’s nothing like a 20-year bear market in your favorite asset class to sharpen your wits. We realized that we needed a better way… When you’re investing real money, you need some discipline… and some rules. At the Family Office, we’ve developed a methodical approach that let’s us choose investment themes very carefully – after much thought, consultation and deliberation. And then it prevents us from making any changes… again, except with much reflection and discussion. We also have our own timing index, which would practically take an act of congress to override. If the timing index says to get out… we get out.Why are we telling you this? Because you need to follow some rules too – or you’re going to suffer in this depression along with everyone else.

What’s the number one rule in a depression? Conserve cash. In a depression, cash goes up. Everything else goes down. Almost everyone loses in a depression. All assets go down. Against what? Against money… cash.

So, the thing to do is obvious. Get rid of your investments. Cut your expenses. Sit tight. Do nothing. When you’re given an investment opportunity, just say no. Wait until the depression has run its course.

If Japan is any indication, this could go on for another 10 to 20 years – with generally sinking prices for just about everything, but particularly for stocks and real estate.

It’s going to be hard to sit out a downturn that long. You’re going to be tempted to speculate… to get back in… You’re not going to want to be left behind.

And yet, in a real depression, getting left behind is the best you can hope for… A year or two ago, we would have thought that you couldn’t increase the monetary base so dramatically without grave inflationary consequences. Inflation – with a lag of about 18 months – was a dead certainty. Now that we’re closer to the situation, we see that inflation may be hard to avoid… but it’s hard to summon up too. Japan couldn’t do it. And now the Bernanke Fed can’t seem to do it either.

Central bankers are talking about increasing their inflation targets from 2% to 4% in order to give themselves more flexibility to deal with situations such as the crisis of the last 2 years. But they are dreaming. They can’t really control inflation that perfectly. Maybe they can’t really control it at all, except in the grossest, clumsiest way. They have tripled the world’s monetary reserves in the last 7 years. Prices for gold and oil have responded more or less in line with the monetary base. But most consumer prices are heavily dependent on capital investment in China…housing prices in the US…and a million other things that the economists at the Fed can’t begin to control.Of course, in extremis, as Ben Bernanke once told the world, a central bank can always create un-controlled inflation. They “have a technology known as the printing press,” he said. Crank up the presses… and let people know that you are cranking up the presses… and you’ll have price inflation lickety split.

But the financial and economic costs of cranking up the presses are so great that very rarely is any central bank… and certainly not any major central bank of a civilized nation… reckless or bold enough to do it. It’s the nuclear option of the monetary world. You have to be very desperate to take the nuclear option. We don’t think Bernanke and crew will get there… not for a long time.That said, there are also conventional weapons… such as those being used now. One in particular…quantitative easing… packs a lot of firepower. It’s not nuclear. But it can still make one helluva mess. Stay tuned.

Monday, March 1, 2010

Are Municipal Bonds a Good Deal?

You can usually tell what asset class needs to be moved by what the various "independent" financial product salesmen are pushing on their clients. Back in the "boiler rooms" where these decisions are made this is called "putting liptstick on a pig." I've now had two people of means approach me and ask me what I think of municipal bonds because their financial advisors recommended them as an investment class.

What are municipal bonds? They are bonds issued by a city, municipality, city agency, or county. Usually there is a tax advantage to them. Their returns are generally exempt from federal income tax and often from state income tax in the state in which they were issued. Because this tax liability is generally not present with municipal bonds, they generally pay a lower rate of return than corporate bonds.

One gentleman was promised a return of around 7%. Another was told he would get in the 4% range. Right now bank cd's are paying about 0.4% interest on a 12 month cd, so that looks like a pretty good deal. Now, one thing you need to understand. The riskier the person or entity is judged to be who is borrowing money, the higher the interest rate they will pay. It's just like an individual who is looking for a home mortgage. The higher your FICO score, the lower the rate of interest you will have to pay. The creditworthiness of an entity is usually judged by a rating agency, such as Standard & Poor's, Moody's, or Fitch Ratings.

When a city or city agency (such as a school system) or county needs to borrow money, they will float a bond issue. In buying their bond, you are basically lending them your money for a period of time, perhaps as long as 40 or longer. The money generally must be used within 3-5 years of the bond issue for the specific purpose stated in the bond issue. The construction of roads, sewers, power plants, water treatment plants, schools, etc is usually financed by municipal bond issue.

Where does the municipality get the money with which to repay the principle and interest? From the taxpayers residing within the bounds of the municipality. Generally these monies are collected through property taxes, though they can be collected from other fees and taxes.

So, here's the deal. Those people who are trying to sell you municipal bonds are trying to sell you the debt of a municipality who needed to borrow money. In a deflationary environment interest rates are generally low in the macro-sense, because the demand for credit is significantly reduced. In this ultra-low interest rate environment, these municipalities are having to pay anywhere from 4-7% interest, even with the tax exemption given to the bondholder on interest earned. Why are they having to pay such a high rate of return? Because their debt is considered risky. Why is it considered risky? Three reasons.

1. Municipalities are generally not building large capital improvements such as schools and roads right now because municipal budgets are tight. In South Dakota, for instance, the state budget needs to be slashed some 5% in order to make ends meet. Other states are in far worse condition. California is bankrupt. Why are budgets tight? Because tax revenues are down. Why are tax revenues down? The housing crash and the unemployment crisis. People who can't pay their mortgages also can't pay their property taxes. They also place a heavier burden on the system by applying for social safety net programs such as free school lunches, free medical treatment at county hospitals, and any other kind of relief.

2. So for what purpose are the municipalities borrowing money if not for capital improvements? To pay their police, fire, and teacher pension funds, which are radically underfunded thanks to the idiots who invested those funds in the stock market and all sorts of other bad investments. They also might go to pay salaries and healthcare premiums for municipal employees.

In other words, these municipalities doing what families do who are living above their means. They're borrowing money to meet operational expenses. They're living on their credit cards and hoping that they only have to do it for awhile and their tax revenue stream will soon recover to previous levels.

Now, there might conceivably be some future economic benefit to a municipality from a new school building or a new road system. Such improvements might conceivably pay actual dividends in the future in terms of increased tax revenues to the municipality. A factory or a corporation might move in to an area with a new, well planned road system. New people might move in to a district with a new, state of the art school building, thus increasing housing values and stimulating further homebuilding activity in that particular area. But using borrowed money to pay bills is non-productive debt.

3. Municipalities can and do declare bankruptcy and simply repudiate their debts. The holders of such debt lose part or all of the money they paid for the bond.

The housing sector is not going to be coming back to 2006 levels for at least another 20 years. Housing prices are still declining in most areas of the country, and will continue to do so for at least another 2 years, in my opinion. Perhaps for longer. After that there will be a protracted period of flat to very low growth in housing values. We are in the beginning stages of a Depression which will probably last a decade when it's all said and done. So tax receipts are not going to be rising anytime soon. Municipal, state, and federal government agencies have yet to adjust to that reality.

The bottom line is that municipal bonds are a bad deal. Anyone who is promising you more than about 2-3% return on your money right now is trying to sell you dodgy debt. There is an upside, however. In a deflationary environment, the value of money is increasing. So if we're having a 2% rare of deflation, and you're getting 2% interest on your investments, the net effect is a 4% increase in purchasing power, even though you are only paying taxes on 2% of that 4% increase in purchasing power (i.e. on the interest earned.)

Right now is not the time to be worried about return ON investment. It's the time to be concerned about return OF investment. You're not going to make your money grow very much right now. But if you still have money when things bottom in 2-3 years, you are going to be able to scoop up assets at once-in-a-century prices and do very, very well over the long term.

Therefore (I'll say it again!)
1. Get out of debt
2. Live frugally and beneath your means
3. Save money
4. Buy a little gold and silver