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BEAR MARKET RALLY
Much to the frustration of the bulls, stocks have gone nowhere this year. They consider the 2000-02 bear raid a bad dream and believe the 1982-2000 superbull run resumed in 2003. Indeed, that year the S&P 500 index jumped 26% (not counting dividends) and a fall rally added another 9% in 2004. Stocks seem to have a lot going for them lately: the new 15% maximum tax rate on dividends and capital gains and the strong economy. Real GDP grew at a 3.8% annual rate in the first quarter, the 8th consecutive quarter it has exceeded the 3% long-term trend. The unemployment rate dropped to 5% in June from 6.3% two years earlier. Also, low Treasury yields make bonds less competitive with stocks. Plus investors are not scared, as witnessed by the low level of market volatility and their shrugging off $60 crude oil and the July 7 London terrorist attacks.
Nevertheless, a number of forces have offset these positives and make the stock outlook grim. The economic expansion is in its 44th month and getting old. By my reckoning, the average length of an expansion since the early 1950s is 42 months. Energy prices are a big tax that will further depress economic growth as Americans realize they are not temporary. By my firm’s analysis, per-barrel oil costs of $60 versus $20 transfer 1.5% of U.S. GDP to foreign energy producers. Excess global capacity is restraining U.S. capital spending, and the huge monetary and fiscal stimuli of the early 2000s are history.
So future economic growth depends on consumers’ willingness and ability to continue to reduce saving and increase borrowing. But the Fed is raising short interest rates, which usually results in a recession. The salutary effects of the low rates we have enjoyed soon will be memories – cheap borrowing against home equity, for instance. Stratospheric and climbing house prices have made Americans feel wealthy and predisposed to save less and borrow more. But house prices and activity have long since departed from reality and are in the speculative stage.
Past housing bubbles were regional, driven by local economics. This time the housing boom is much bigger and national. When, not if, the housing bubble bursts, the effects will be devastating. While half of U.S. households own stocks, 69% own their homes. Furthermore, the median-income American has much more of his net worth in his house than he ever had in stocks, even at their peak. The likely nosedive in house prices will end the two-decade-long consumer borrowing-and-spending binge and launch a saving spree. Since consumers account for 70% of GDP, U.S. growth will suffer. Export-driven countries that depend on America, notably China, will be hurt more. Chinese officials are succeeding in cooling their white-hot economy, and a recession in that global growth generator is likely. They lack the policy tools to effect a soft landing in what is only a semi-market economy.
Even without a tapering-off of economic growth, corporate profits would probably disappoint. Aftertax profits skyrocketed from 3.6% of GDP in Q3 2001 to 7.9% in Q1 2005 as business slashed costs and constrained employment. In the long run profits can do no better than track GDP; a reversion to the 5% average of profits to GDP is likely. Earnings will tell the tale for stocks. Price/earnings multiples are too high to expand in coming quarters, and dividend yields are too low to support most equities.
So the stock advance since October 2002 may be a bear market rally with the final lows yet ahead. After the severe 1973-74 decline, the S&P 500 index, inflation-adjusted, rose 47% from September 1974 to December 1976, and the bulls looked for more of the same. Then the S&P fell 40% (in real terms) to its final low in July 1982. The bugaboo for stocks in 1973-82 was rising inflation, which transferred earnings to labor and government while hiking interest rates and depressing P/Es. Now it is deflation. Sure, I continue to predict the good deflation of excess supply, but the transition to it may be rough. Don’t expect a big year-end rally in 2005.Link here.
STOP FRETTING ABOUT OIL (AND A FEW OTHER THINGS TOO)
Have you allowed yourself to be scared out of the stock market by high oil prices? If you have, you are falling prey to a media myth. It is fascinating how often the media get away with a story claiming X causes Y when an abundance of statistical evidence exists to disprove the connection. It is routine now to see stories blaming a drop in stock prices on a rise in oil prices. Data-mine all you want. You are not going to find a credible cause-and-effect relationship between oil and stocks. There is no connection between the two.
There are a lot of myths about what drives stock prices. Here are some other factors uncorrelated with stock market performance: the market’s overall P/E ratio (I have looked carefully at this one, across the globe and many time periods), high volatility as measured by the VIX index, gold, trade deficits, the dollar’s level, consumer sentiment, investor sentiment as measured by the “Investors Intelligence” data. So don’t panic when any of these go up or down. Buy good stocks and hold them.Link here.
COMMODITIES SURGE A BLIP, SAYS SERVICE
In the face of a buoyant resources market, Access Economics warned of significant commodity price falls over the next two years and denied that commodity markets were in the grip of a price supercycle. But the warning is unlikely to be heeded, coming at a time of record copper prices, strong production reports from miners, and better-than-expected economic growth in China. Copper prices in London hit an all-time high last week with inventories at 31-year lows.
In its latest Minerals Monitor report – Supercycle Me? – Access warned that commodity analysts generally were expecting an inevitable rise in production to suppress prices. While the industrialization of China and other major emerging economies such as India and Brazil might herald the advent of a supercycle in commodity demand, it warned that, for most commodities, new supplies would inevitably dampen prices. “History would suggest this is just another blip. A supercycle – a large step up in global prices lasting for a decade or more – is unlikely for those commodities where supply can catch up with demand.”Link here.
THE FALLACY OF INTERNATIONAL COMPARISONS
Always in search of new and improved forecasting tools, the macro soothsayer has come to rely increasingly on cross-country perspectives as a means to divine the future. Japan comparisons have been the rage in recent years – not just in assessing the U.S. deflation scare a couple of years ago but now in defining the China currency debate. Similarly, the prognosis for America’s housing bubble is widely viewed through the lens of UK and Australian experiences. Unfortunately, these comparisons are often more misleading than helpful in unlocking the economic outlook. They can lead to a false sense of complacency, which can easily send a forecaster astray.
Consider the case of Japan – the world’s second largest economy, with a track record that no one wants to emulate. It was not always that way, of course. For the first 40 years of the post-World War II era, the “Japan miracle” was the envy of the world. I remember all too well the western fascination with Japan’s manufacturing revolution – breakthroughs in inventory control, supply-chain management, quality circles, and cross-ownership arrangements. But the miracle went to excess and the rest is now history. Fully 15 years into Japan’s post-bubble era and this deflation-prone economy is only just now beginning to see daylight again. Both the U.S. and China repeatedly emphasize the lessons of Japan. America’s Fed insists that the mistakes of Japan shed considerable light on how to avoid post-bubble shakeouts. Meanwhile, China maintains that it has learned a different lesson from Japan – the need to resist U.S.-led political pressure for currency appreciation.
But how relevant is the Japanese experience to the challenges now facing the U.S. and China? While asset bubbles in both the U.S. and Japan suggest that the two economies have many risks in common, there are some key differences that need to be stressed as well. In particular, Japan’s excesses were concentrated in the corporate sector – financial and nonfinancial businesses, alike. America’s excesses, on the other hand, are concentrated in the consumer sector. Japan’s subsequent fallout was concentrated in its banking and corporate sectors. By contrast, the U.S. corporate sector – banks and nonbanks, alike – emerged relatively unscathed in America’s post-equity-bubble era. However, the saving-short, asset-dependent, and overly-indebted American consumer looks to be in much worse shape than the Japanese consumer was in the latter half of the 1980s. Largely for those reasons, I would argue that the travails of post-bubble Japan may well provide little insight into what lies ahead for the U.S. economy.
Nor is it clear that the Japanese experience offers great lessons for China. On the surface, there do seem to be some astonishing similarities between these two economies. But pre-bubble Japan was wealthy and well-developed, whereas today’s China is still quite poor and has only just begun its development journey. In terms of the scale of their economies and financial markets, the differences between China and Japan are like day and night. In addition, China has a much more outward-looking development model than that embraced by Japan. In 2004, exports and imports, combined, hit 74% of Chinese GDP, more than three times Japan’s 23% share. Japan got into trouble in the late 1980s, in part by abdicating control over the yen and letting its currency soar from 259 versus the dollar in February 1985 to 121 at year-end 1987. China is not about to make the same mistake.
Closer to home is the steady drumbeat of cross-country comparisons of property bubbles. To the extent that both the UK and Australia seem to have succeeded in gradually taking the excesses out of their residential real estate markets without seriously disrupting their economies, there is hope that the U.S. can pull it off, as well. Anything is possible, but I think those presumptions miss an important and very basic contextual point: The scale of U.S. property holdings dwarfs housing values elsewhere in the Anglo-Saxon world. But it is the link between property and consumption that makes for the biggest difference of all. For my money, the U.S. has set the global standard insofar as excess consumer demand is concerned – a consumption share that currently tops 70% of GDP. This is well above the UK share of 63% and the Australian share at 60%.
On balance, the saving-short, asset-dependent American consumer has made a much more aggressive consumption bet than has been the case in either the UK or Australia. As a result, there is good reason to believe that the U.S. economy would be much more vulnerable to a bursting of its residential property bubble than might be implied by experiences elsewhere in the Anglo-Saxon world. The U.S. relies on its property bubble far more than the UK or Australia to square the circle of excess consumption and weak internal income generation. This relative desperation of the asset-dependent American consumer should caution us from drawing comfort from the seemingly gentle aftershocks of other post-bubble workouts.
Prospects in China and America are unique in many respects, and forecasters need to treat them that way. The fallacy of international comparisons tells us to be wary of blindly relying on precedents elsewhere in the world in divining the future of these two key economies.Link here.
WORRIES OVER ESTATE TAX? DREAM ON
The estate tax is back on the political radar screen. Senate Republicans want to permanently repeal the law that allows the U.S. Treasury to tax the net assets of deceased wealthy citizens. Two things often get glossed over in discussions about whether the estate tax is fair: 1.) The vast majority of Americans will never amass enough money and assets to have to pay this tax. 2.) The vast majority of Americans who do have enough wealth to be required to pay this tax usually do not. The IRS says that even at a threshold of $1 million, the estate tax affects only the wealthiest 2% of all Americans. But we all plan to be in that 2%, don’t we?
Whether our strategy for amassing wealth is through investing in mutual funds, buying lottery tickets or working for an employer with a generous pension plan, we expect to end the game of life as rich people. And that hopeful thinking leads many to blame financial underachievement on bad portfolio managers, not-so-lucky numbers or giant corporate downsizings rather than credit-fueled lifestyles, slack financial planning or stunted careers. President Bush’s desire to lessen what the federal government is obligated to pay future generations of retired workers is the issue that Americans need to keep their eye on, not the estate tax. That is especially true when you consider the many tools the wealthy use to avoid paying the tax, one of the most popular being the family limited partnershipLink here.
After all these years and decades of searching, we have found it at last: the ultimate, all-in-one Penny Stock With Everything. The company in question, which goes by the name of Globetel Communications Inc., is only one of many such in-your-face promotions that have lately sprung to life before the glassy-eyed stares of the regulators. Remember the name, because Globetel Communications is one penny stock company embodying so much of what is wrong with Wall Street that they ought to make it a case study in business schools. But do not tell that to the sleepy-heads at the SEC, you might wake them up.Link here.
ALAN, WE HAVE A PROBLEM
There are about 90 references to “housing bubble” on LewRockwell.com and you have read practically every article and blog. You sold your house, filled two safe deposit boxes with Krugerrands, and bought put options on the HGX (Housing Index). You even named your three bloodhounds Bonner, Corrigan, and North. Let’s face it, you are every bit as obsessed as the condo flippers, 20-something leveraged landlords, and Trump seminar faithful. Your wife is questioning your sanity and you are beginning to wonder if she is on to something. Sure, bust follows bubble as predictably as concussion follows a swan dive into the shallow end of a pool, but when? Can the powers-that-be keep the party going indefinitely? Can the HGX double, rendering your option strategy an exercise in futility and grounds for divorce? Can any mere mortal really know the timing of a bubble?
The honest answer is that recognizing folly is much easier than knowing its natural limits. As Sir Isaac Newton lamented in 1721 after losing his shirt in the South Sea bubble, “I can calculate the motions of heavenly bodies, but not the madness of people.” Although history rhymes, the great bubbles of at least the past century have followed a remarkably similar script right before they popped. As absurdly high valuations weigh on relentless injections of liquidity, the advance narrows. Former favorites are treated like lepers while the remaining beauty queens become the focus of intense adoration and pursuit. Eventually, even the central bank bubble blowers get cold feet and begin posting speed limit signs by raising rates. Initially the crowd runs right through the signs, taking their speculative vehicles on a reckless, parabolic joyride. As higher rates slow liquidity, speculators sell their losers in one last desperate attempt to get their hands on more fuel. The jig is finally, mercifully, up.
The Roaring ‘20s ended with the Dow peaking in August, 1929, well after the broad market, as represented by the NYSE advance-decline line, was in full retreat. In 1972, growth stocks like Coke, Polaroid, Xerox, and IBM were all the rage during a two-tiered “Nifty Fifty” market that ushered in the 1973–74 collapse – rivaling its 1929–32 cousin in inflation-adjusted terms. The March, 2000 Nasdaq peak was a similarly bifurcated affair, as the performance-chasing masses unloaded their Old Economy laggards in order to make room for more Internet, telecom, and technology stocks. The Nasdaq Composite proceeded to lose 78% of its value in 2½ years.
Before we fast forward the tape to today’s market, a word of clarification is in order. The bubble du joir is not so much in housing as it is in credit. We are hard-pressed to know who is crazier, the borrower swimming without a bathing suit or his Pollyannish lender. Not all regional housing markets are in bubble territory, but credit availability, rates, and standards are clearly detached from reality. Credit-related stocks, as measured by the Bearing Credit Bubble Index, rose 10-fold from 1995 through the end of 2004. Its 8 sub-indexes (banks, brokers, subprime lenders, etc.) were all in sync until mid-2003 when the government-sponsored enterprises began to lag. The speculative darlings of the past 2 years have clearly been the homebuilders (+170%) and subprime lenders (+107%). This year the subprime lenders hit the wall, leaving the homebuilders alone to carry the speculative torch. The remaining credit providers and facilitators (especially those weighed by heavy market capitalizations) are now either stalled or joining the GSEs in full retreat.
With the stocks of the country’s largest credit engines – Citigroup, JPMorgan Chase, and Fannie Mae – shutting down and nearing 2-year lows, this credit rocket is sputtering on fumes. Mr. Greenspan, we have a problem.Link here.
For whom the Toll sells.
Why are the Toll brothers selling their stock? Are they selling to conduct “personal financial planning?” Or because the housing market is topping out? Or because Toll Brothers, itself, is facing more challenging times? Or all of the above? We have no idea, but we are nevertheless intrigued by the size and frequency of the recent sales. Last month, the Toll brothers – the actual brothers, Robert and Bruce, not the home-building company they oversee – sold more than 2,000,000 shares of their company’s stock. The sales netted them about $120 million – also known as “real money”.
Insiders NEVER sell because they expect conditions to improve. That is what buying is for. If insiders are selling, should we outsiders be buying? If the Toll brothers are selling, what fate lies in store for the U.S. housing market? To be sure, the housing market need not fall, merely because Robert and Bruce Toll are lightening up on their stock holdings. But their hefty sales hardly inspire confidence. Curiously, very few insiders at other home-building companies are running for the exits. Perhaps the Tolls are merely the FIRST to sell. We would not dare to bet against home-building stocks just yet. Selling short the homebuilders has created a financial Gettysburg. Wave after wave of courageous short-sellers have assaulted the group only to tumble into a gnarled heap upon their fallen comrades. But if – repeat, IF – one wishes to wage war against home-building stocks, Toll might be weakest flank.Link here.
Home bubbles do not deflate, they burst.
Jamie Westenhiser, Playboy’s Playmate of the Month for May, says her disrobing days are over. With house prices in her home of Fort Lauderdale, Florida, up 105% in the past five years, the 23-year-old model told the magazine she is embarking instead on a career in real estate. U.S. housing is at its least affordable in at least five years, according to a National Association of Realtors index that has tracked median home prices versus incomes since May 2000. Federal Reserve Chairman Alan Greenspan said last month he sees “signs of froth in some local markets.” That is the Fed-speak for “God help the U.S. economy if consumers cannot rely on ever-higher property prices to boost their sense of economic well-being.” There is plenty of historical evidence from around the world that housing-market bubbles do not deflate, they burst.
The U.K., ca. 1989, provides the scariest horror story for what can happen when a supercharged housing market comes off the rails. …Link here.
For sale: Trailer with ocean vu, $1 million obo.
Malibu, California: So wonderfully Californian, Marsha Weidman’s home has it all – along the beach, far from noisy traffic, with a Jacuzzi used to watch sunsets over the Pacific. For this, she and her husband recently paid $1.05 million. For that, they got a trailer, built in 1971 … without any land. Plus, the family must pay “space rent”, which at two Malibu parks dotted with seven-figure trailers ranges from $800 to $2,500 monthly. The nation’s frenzied housing boom has come to this: Even trailer parks, long the butt of jokes about tornado targets and redneck living, are enjoying fat greenback prices.Link here.
Homeowners may be mortgaging their future with new loan products.
The feverish real estate market that hit a new peak last week has been fueled not just by historically low interest rates but also by a host of new home mortgage products that might make a banker of yesteryear keep a hand on his wallet. “You can literally walk into a bank and get a mortgage loan with no money down,” said Keith Gumbinger, vice president of HSH Associates, a New Jersey-based publisher of mortgage and housing market data. “Ten years ago, that was the stuff of late night TV.”Link here.
Our homes are our piggy banks.
The U.S. personal savings rate fell to 0% in June, only the second time since the Great Depression that Americans have spent as much as they earned in a month, the Commerce Department said Tuesday. How did they do it? For the most part by tapping into their home equity and by taking on more debt. In fact, the amount of cash extracted from homes in the second quarter dwarfed the gains Americans received from pay raises and from other income sources, such as bigger dividend checks or improved profits from a small business. Homeowners cashed out $59 billion in the second quarter by refinancing to a larger mortgage loan, mortgage giant Freddie Mac reported. In addition, homeowners have been borrowing about $50 billion per quarter against their homes through home equity loans over the past year, according to data from the Federal Reserve and the FDIC. By contrast, Americans got just $17 billion extra in their paychecks in the second quarter, Commerce Department data showed. Other income sources grew by another $18.5 billion in the quarter.
“Is a 0% personal saving rate cause for worry?” said Ken Mayland, president of ClearView Economics. “No!? It happens to be just about the best measure of consumer confidence there is.” Consumers do not take on debt when they are not confident, he said. Some economists say the personal savings rate is largely irrelevant, because consumers have a large capacity to borrow against their sizable wealth. Despite the steady decline in the personal savings rate from 11% two decades ago, the net wealth of U.S. households has increased to $48.8 trillion, or 5.4 times annual income, primarily because of the increased value of real estate and holdings of financial assets such as stocks and bonds.
Some observers think consumers are nearly tapped out when it comes to borrowing. The window of opportunity for cashing out some of their home equity could close if interest rates rise or if home values decline. The typical consumer is spending a record 13.4% of disposable income on servicing their consumer debt, including mortgage debt. Broader financial obligations including rent, car payments, insurance and taxes take 18.5% of disposable incomes, down from a peak of 18.9% two years ago. Among those who rent, financial obligations take 31 cents of every after-tax dollar.
“It seems like a party without end,” said Doug Henwood, editor of the Left Business Observer. “It’s like someone who’s been snorting cocaine for five years: Sooner or later, it will catch up to you.” With interest rates rising, “spending will be increasingly dependent on income in the second half of the year,” said Scott Hoyt, an economist for Economy.com. Freddie Mac expects the amount of cash extracted from refinanced loans to shrink to $69 billion in 2006 from $162 billion this year.Link here.
Housing boom echoes in all corners of NYC.
It may not replace the Empire State Building or the MetroCard, but the most fitting symbol of New York City today could be the knotty plywood wall enclosing a housing construction site. A newly completed residential and professional building on 65th Street in Bensonhurst, Brooklyn, contrasts with the single-family homes on the block. Many building permits have been issued in the area since 2000. From Bensonhurst to Morrisania to Flushing, new homes are going up faster now than they have in more than 30 years. In 2004, the city approved the construction of 25,208 housing units, more than in any year since 1972, and that number is expected to be surpassed this year. Already, officials have authorized 15,870 permits. Much of the development is being fueled by private money, a phenomenon not seen since the 1970’s. The mushrooming of housing development is an outgrowth of the city’s decade-long population boom, low interest rates, government programs and a slide in crime, housing experts and city officials say. It has affected every borough and most neighborhoods, reshaping their physical form, ethnic makeup and collective memories.
Throughout Brooklyn, in areas where single- and two-family homes have dominated for generations, six-story buildings are rising on every other block along some stretches, and their apartments are quickly being sold, often to first-time buyers. Large tracts of Queens, once home to factories and power plants, are being readied for apartment complexes to keep pace with the growth in immigration. In East New York, Brooklyn, once known for its crack trade and killings, single-family homes are rising for the first time in a generation. On Washington Avenue in the Morrisania section of the Bronx, where chop shops and abandoned lots of rubble and weeds once stood alone, a concrete mixer rumbles daily in front of a new eight-story building, complete with a limestone facade. “Development is a beautiful thing,” said Gertrude Sowell, who mulled the housing rising around her from her stoop in the South Bronx, where she has lived for 45 years. “The Bronx had to be revived. The soul was just dead, and everywhere you walked there were abandoned buildings and despair.”
The city’s foreign-born population increased to 2.9 million in 2000 from 2.1 million in 1990, accelerating the housing boom. Newcomers and native New Yorkers are settling into neighborhoods that the city and developers had written off a decade ago as unworthy of investment. “Housing is being built where 20 years ago people would not live,” Mayor Michael R. Bloomberg said in a telephone interview. “Other cities in other states have just not enjoyed this kind of boom. Each block is much more diverse than people realize. There is a cooperation and a spirit that we are here together and we’re going to live together.”Link here.
New York’s priciest pad$.
The full-block development at 200 E. 66th St. went for $1.072 million per apartment, the most ever paid. The building, which has 583 apartments, is being sold to the team of N. Richard Kalikow’s Manchester Real Estate and Jerry O’Connor’s O’Connor Capital Partners. While neither could be reached for comment, it would be expected that they would “work” lower rents up, while filing for a condo conversion. Sellers New York Life developed the superblock building of five white towers in the early 1950s, setting it between 65th and 66th streets and Second and Third avenues.Link here.
Retirees take housing gains to less costly states.
Like many baby boomers planning to retire in the next few years, New York City resident Oscar Chamudes plans to cash in on hefty real estate profits and move to another state where the cost of living is lower. The 58-year-old pediatrician, who lives in a two-bedroom Chelsea loft purchased for around $865,000 in 1999 that is now worth about $2 million, is mulling a move near Fort Lauderdale or Miami, Florida. He recently sold another home in Queens for $1.2 million, purchased 10 years ago for $240,000.
However, many retirees considering a move have not ridden the real estate gravy train on the way up and will have fewer choices, since prices in many coastal cities and towns on the East and West coasts have also skyrocketed. Retirees who dream of moving from Southern Alabama to Southern California for example, will be unable to do so, unless they are independently wealthy, said Mark Fagan, a sociology professor at Alabama’s Jacksonville State University, who studies retirement migration. The average price for a two or three bedroom home costs about $1.2 million in Santa Barbara, California, for example, compared to about $150,000 in many Alabama towns, he said.Link here.
Bad lands now hot property.
Valentine, Texas – For 19 miles, most of it bumpy enough to shake your bones, State Route 2017 runs down to the Rio Grande and the Mexican border. Drug smugglers and illegal immigrants pass through here. So do the Border Patrol agents that pursue them, and cowboys heading to a nearby ranch. No one else bothers. The land is sandy and bleak, full of gullies and rattlesnakes. Yet this parched ground is increasing in value faster than any Manhattan duplex or Malibu villa. In February, a California entrepreneur bought 7,408 acres for $65 an acre. He promptly sold them in small chunks to some people and in big chunks to others. Some of these buyers quickly resold to others, who resold to still others. The pieces keep shrinking while the price keeps going up. Buyers are now paying as much as $800 an acre, 12 times the cost six months ago.
There are thousands of other new owners all over sparsely populated West Texas. Nearly all the sales are for raw, undeveloped land, bought over the Internet or at seminars in distant cities. Most of the buyers are from California, Florida, New York and other places where the cost of homes has been surging. People on the coasts, who have to spend a fortune for somewhere to live, are spending more for somewhere they cannot. After four years of real estate mania, the message has sunk in widely and deeply. Land is good. More land is better. Land will always increase in value. Every moment you do not buy you are losing money. No need to see it before buying. There is no need to even see a photo. The most aggressive Internet auctioneers post a picture of land as lush as Ireland, and then warn on the photo itself that it has no relation to what is up for bid. In a similar vein, they warn that they cannot guarantee anything – including the condition, accessibility or even the location of the land. How could they? They have never seen it either. They live in California too.
Why buyers are unfazed by such caveats is a topic of considerable debate and amusement here in Jeff Davis County. One theory is that the buyers are looking for a greater fool to purchase the land from them before the bubble bursts. Another possibility is that they merely want to be able to brag at their next dinner party that they own a ranch in Texas. The most worrisome prospect: The buyers think someone is going to live here, despite the absence of water, electricity, sewers, roads and other amenities.
None of the locals seem to think the land is a good investment, no matter how rapidly it has been appreciating. Sure, it was smart 20 years ago to buy desert land near such boomtowns as Phoenix or Tucson. And most of Jeff Davis County is quite pleasant, so much so that it is being touted as a retirement center. But the fact that this land is being sold off piecemeal probably guarantees that it will never have electric power or streets. Developers want to work with large tracts they control, not hundreds of small plots whose owners are unlikely to agree on what improvements they will pay for. Developers also like to build within sight of growing cities. Valentine, however, is a long way from anywhere. El Paso is 160 miles west, San Antonio 450 miles east. That is a tough commute, even in Texas.
Services might be installed on an individual basis if the land were so stunning that people wanted to live on it. But the folks here say there is little chance of that, because the land is so ugly. They, unlike nearly all the Internet buyers, have actually seen it. Valentine peaked as a metropolis 70 years ago, when there were three times as many people as today. The ranching community’s heyday as a commercial center was even earlier, in 1890, when it boasted two saloons, a meat market, a hotel and a store. “Not much to do here now but drink beer,” said Robert Murry, who left a job with the circus six months ago to help his mother open a grocery store on California Street, Valentine’s main drag. It is the only business in town. A half-dozen gas stations and cafes lie abandoned nearby.Link here.
WHEN COMMON SENSE RARELY PREVAILS
The longer the term of the loan, the higher the yield: a 10-year Treasury Note, e.g., pays a higher yield than does a 2-year Treasury Note. The whole thing is as simple as it sounds – most of the time, that is. But every once in a while, things get turned around – specifically, the so-called “yield curve” gets “inverted”, which means that longer-term Treasury yields are lower than the shorter-term yields. This does not happen very often, and when it does, certain not-so-good things have followed in every case for the past 40 years. Common sense suggests that this is the market’s way of saying “Something is wrong.”
Of course, common sense rarely prevails among the folks who are supposed to study the not-so-good thing called a “recession”. You would think that when recessions have followed every instance of an inverted yield curve over a 4-decade period, economists would notice – but apparently not. I say “apparently” because in the most recent Wall Street Journal survey of dozens of economists, they ALL forecast positive GDP growth for the coming 12 months. Yet, the yield curve has been narrowing for the past TWO YEARS, and is a very short distance from the point of “inverting”. A chart of the yield curve shows that it now stands where it was in February 2001, just before the start of the last recession.Link here.
THE DOLLAR RALLY IS DONE…
I have to believe the dollar rally is not only done, but is also finished. Looking at the monthly returns, July was good for the currency markets with all of the major currencies up except the Japanese Yen, which was down only 0.05% versus the U.S. dollar. The rand was the best performer in July with a 4.33% gain, followed by the nordic currencies of Sweden (+3.12%), Norway (+2.61%), and Denmark (+2.2%). The Euro, which was down over 10% for the year, rose just over 2% during the month of July.
A confirmation of the end of this long dollar rally came on Friday, when GDP was reported at 3.4% for the second quarter of 2005. This is the 9th straight quarter exceeding 3%, something we have not seen since the Reagan years of January 1983 through March 1986. Adding fuel to what should have been a red-hot dollar rally Friday was San Francisco Fed President Janet Yellen calling for more aggressive rate hikes in the U.S. Despite all of this data and talk, the currency markets actually took the dollar down. When the dollar is rallying it goes up no matter what the data shows, and the opposite is also true. Even the hedge funds were selling dollars. The CFTC reported that hedge funds and other large speculators pared bets on the dollar’s gain recently. So the trading action we saw Friday, confirms to me that this 2005 dollar rally, which lasted longer and went further than we expected, is finally over.Link here.
“I hate to be the bearer of bad news,” Kevin Kerr apologized yesterday, “but the demise of the dollar is upon us and the future may be bleak for the once worshiped and almighty currency.” Kerr, whose knack for identifying important investment trends has amply rewarded the subscribers of his Resource Trader Alert, suspects that the dollar’s difficulties will continue powering a long-lived gold bull market. “Keep an eye on gold,” he advises. “Yesterday’s big gold rally may be the start of an important move in the precious metal.” No one knows, of course, the precise day when a long-term macro-economic trend will begin to affect short-term price movements, but that day for the U.S. dollar – and therefore for gold – may have arrived already, even if very few market observers realize it.
“Gold ETFs are one of the simplest ways to position for the dollar’s continuing slide,” says Addison Wiggin, author of the freshly minted book, The Demise of the Dollar. “The two gold ETFS that trade here in the U.S. both hold gold bullion as their one and only asset. You can locate these two ETFs under the symbol ‘GLD’ (for the ‘streetTRACKS Gold Trust’) and ‘IAU’ (for the ‘iShares COMEX Gold Trust’). Either ETF offers a practical way to hold gold in an investment portfolio.” Wiggin provides several other profit opportunities as well, of which all dollar-phobic investors may avail themselves.
Kevin Kerr, who specializes in trading option on futures, has been advocating the purchase of long-dated call options on gold. “Make no mistake,” says Kerr, “gold is the real deal. Gold doesn’t have a board of directors; gold doesn’t have scandal; gold doesn’t have an expense account or one-time charges. Gold is quite simply, gold. We call it the ‘flight to quality’ instrument because in tough times, times of fear and trepidation, investors flock to gold like rednecks to a NASCAR race. Gold is relatively cheap right now and options on it are a great deal. So it only makes sense to add some gold calls.” Kerr suggests buying out-of-the-money calls on gold for early 2006. Perhaps yesterday’s $5.00 gold rally was just another meaningless blip. Perhaps not. One thing is clear; gold does not lack for reasons to move higher.Link here.
DOES DELUDED BEHAVIOR DESERVE A DELUDED DESCRIPTION?
Hedge funds have become so popular in so short a time that they have run out of catchy-sounding names to give to the new hedgies that continue to multiply like rabbits. As for the name to give to hedge funds in general for the first half of this year, I am sure that “Mediocrity” is available, and it fits to a tee – The S&P Hedge Fund Index gained all of 0.13% in the first six months of 2005. Mind you, the entrance of the “average” investor into the hedge fund orbit was supposed to help “democratize” the markets, which is all well and good if you think that choosing an investment vehicle is like choosing a politician. Nobody wants to say that deluded behavior deserves a deluded description, after all. And you must admit that “democratize” sounds better than “the latest scheme to help people chase performance while we earn billions in fees.”
But if the hedgie restaurant is now too crowded to serve a satisfying meal, Wall Street seems to think that the appetite for risk has become so voracious that investors will forget the difference between stocks and commodities. Recently, exchanges in London, New York and elsewhere started to (or will soon) offer “securities” that trade based upon the movements of certain commodities. It is easy to dismiss these “Ever-More-Exotic Tools of the Trade”, and you probably should dismiss them as the kind of choices you would make for your portfolio. Yet they DO reflect something you should not dismiss, namely the symptoms of the state of market psychology.Link here.
TAN, DON’T BURN
Buy sunscreen, not Sun Microsystems … Such is the approximate message delivered by several stock market indicators, according to options pro, Jay Shartsis. A dizzying array of troubling signs, omens and auguries are warning that the stock market is due for a drop of some significance. Net-net, August of 2005 might be a much better month to buy coconut cocktails than common stocks. “This summer,” Shartsis says, “you’re less likely to get burned on a beach than on Wall Street.”
Since late April, all the major stock market indices have staged impressive rallies, lifting the S&P 500 and the Nasdaq Composite Index to 4-year highs. Not surprisingly, therefore, most investors have rekindled their passion for common stocks. Unfortunately, whenever investors begin to love stocks too much, stocks begin to abuse the affections of their admirers, by falling. “Several gauges of investor sentiment are registering more extreme readings than they did at the market top of March 7,” Shartsis notes. “The 10-day CBOE put/call ratio, the 10-day Daily Sentiment Index and the VIX Index of option volatilities are all showing higher levels of investor bullishness – and lower levels of fear – than they did at the market peak of March 7th. Before the March top, for example, the VIX dropped to almost 12. That reading seemed pretty darn low at the time. But guess what, last week the VIX hit almost 10, a new all-time low!” (VIX reflects investors’ consensus view of future expected stock market volatility. The greater the fear, the higher the VIX level.)
“Yeah,the VIX has become a somewhat less reliable indicator over the last few years, hasn’t it?”, we replied. “Very true,” said Shartsis, “but I still wouldn’t ignore the message it is sending. Investor complacency is high … and that worries me.” What else is worrying him? “Well, not that it makes any difference at all,” he replied, “but Vickers reports that insiders are selling more than five shares for every one they buy, and this reading is up from a recent 3.1 sells for every 1 buy.
“… maybe they’re just as stupid as the rest of the ‘smart money’ has been lately. I do find it interesting, however, that commercial futures traders have become heavy sellers of stock futures. This ‘smart money’ crowd of traders has been increasing its net short positions in Dow, S&P and NDX futures. In fact, the Commercials are holding their largest net-short position in S&P futures since late January – shortly before the market tumbled.”
“So who’s buying?” we wondered. “Who else?” Shartsis replied, “the ‘dumb money’. One of the most notorious ‘dumb money’ groups has become mega-bullish. The small-time option traders - those who buy or sell less than 10 contracts at a time – have been aggressively buying into the market. On only two prior occasions in the last five years – July 21, 2000 and Jan. 16, 2004 – did small-time options traders buy more call options than they did last week. On both of those two prior occasions, they soon regretted their buying binges … and they probably will again this time.”
Apart from the various sentiment indicators you mentioned, what other evidence of “toppy” price action does he see? “… just take a look at the percentage of stocks above their 10-week moving averages. In only about two months, the percentage of NYSE issues trading above their 10-week moving averages has gone from 16% to a recent reading of 80% – that’s a very overbought reading. Of course, it can stay overbought for a while. … if the percentage of NYSE stocks above their 10-week moving average were to drop to 70%, I would take that as a clear sell signal.
“For now, however, I’m just paralyzed,” Shartsis concluded. “This market is way too dangerous for my comfort level, but its positive momentum dampens my enthusiasm for selling stocks short. So I’m sitting on my hands. If I were long a lot of stock, I’d be selling into the current strength. But I wouldn’t sell the market short until we see some sign that the market’s positive momentum is breaking down. We haven’t seen that yet.”Link here.
IPO pipeline is percolating.
With many investment bankers who sell initial public offerings and investors who buy the shares poised to leave for their summer vacations, a quick burst of IPO activity appears to be in the offing. At least two dozen companies are slated to go public in the next two weeks, according to The Wall Street Journal. By way of contrast, just 14 companies launched IPOs in all of July. In June – the first month this year that the IPO market showed signs of coming alive – 20 companies issued stock for the first time, according to the paper. In the entire month of August 2004, 20 IPOs were also issued.Link here.
SERIAL BUBBLE BLOWERS
According to the consensus view, the U.S. economy is breaking out of its anemic growth pattern. A few signs of accelerating economic improvement are gleefully cited to support this forecast, such as the 8.2% spurt of “real GDP growth” in Q3 of 2003 and higher investment technology spending, up 22%; surging profits, and surging early indicators, among them in particular indicators such as the Institute of Supply Management (ISM) survey for manufacturing. Various indicators are at their strongest in 20 years. But do we simply accept the popular wisdom?
No, because many of the reported indicators are nonrecurring. If they are not really signs of a sustained pattern, the results are dubious at best. For example, the impressive Q3 2003 growth spurt was the direct result of a one-time splurge in federal tax rebates and a flurry of mortgage refinancing caused by low interest rates. As to investment spending, what is really going on? So-called investment in housing is distorted by the housing bubble, and what should matter is the change in total nonresidential investment – business factories and equipment, for example – a trend that has been flat for many years. There is no real growth in business investment.
The U.S. economy’s so-called improvement has one main reason: all the economic growth of the “recovery” years since 2001 is traced to a seemingly endless array of asset and borrowing bubbles. Quoting analyst Stephen Roach, “The Fed, in effect, has become a serial bubble blower” – first the stock market bubble, then the bond bubble, then the housing bubble, and the mortgage refinancing bubble. As a result, consumer spending has been surging well in excess of disposable income for years. But we must understand, this is not real growth. The idea behind the bubble economy is that sustained and rising consumer spending would eventually stimulate investment spending. This is like suggesting that overeating will eventually lead to serious dieting. As you might expect, rising consumer spending has not had the desired effect. In fact, consumer spending will slow down when consumer borrowing starts to fade. And that is just a matter of time.
The dollar is going to continue falling over the long run. It will fall as long as we continue to outspend our investment and production rates. If foreign investors were to slash their investment levels in the U.S. dollar and Treasury securities, that would cause a hard landing. Our credit would dry up rapidly. This would not just send the dollar crashing. A sudden rupture of private capital would also hammer the U.S. bond and stock markets.
The chronic U.S. trade deficit is caused by exceptionally high levels of consumption, undersaving, and underinvestment. Improving the trade deficit would require a major correction of these imbalances, and cannot be fixed simply by watching the dollar’s value continue to decline. An economic downturn would come as a rude awakening to most Americans, a cataclysmic shock. It would directly affect the other two asset bubbles, housing and stocks, in addition to the dollar value bubble itself. Imagine the uncertainty and turmoil this will create in the financial markets. Rock solid? We think not.
The U.S. economy is much weaker and much more vulnerable than official statistics make it seem. The Fed cushioned the impact of the bursting stock market bubble by manipulating new asset bubbles. Ultralow short-term interest rates and the promise to keep them there for a long time have fueled a housing and mortgage borrowing boom, which also extended the consumer borrowing and- spending binge. “Happy days are here again.” Indeed. The official word is that the exploding credit and ballooning debt in America are not signs of excess, but a testimony of the financial system’s extraordinary efficiency. Small prediction: a shock awaits the “nonproblem” crowd when we finally confront our economic realities.
The U.S. inflation rate is understated by at least 1.5 percentage points per year through economic/statistical magic, grossly overstating real GDP and productivity growth. Bond king Bill Gross discovered this fact of life and commented on it in 2004. An active proponent of inflation manipulation was Fed chairman Alan Greenspan, apparently because – and here again we find a recurring theme – “a low inflation rate fosters low interest rates.” The huge credit and debt bubbles in the U.S. have created a dislocated and imbalanced economy, so that a sustained recovery is going to be impossible without many painful changes.Link here (scroll down to piece by Addison Wiggin).
DROWNING IN DEBT?
Lke millions of Americans, Cathy and Scott Gabrielsen got used to a certain standard of living in the late 1990s, when times were flush and their Internet stocks were going gangbusters. So when times toughened as the stock market bubble burst at the start of this decade, the couple took a risk: They chose not to cut back. “The truth is, nobody wants to sacrifice their lifestyle,” says Cathy, 34. Despite steep losses in their portfolio, the Gabrielsens continued to upsize during the bear market. The couple – parents of two boys, now ages 5 and 3 – bought a 4,000-square-foot house near Philadelphia. That is double the size of their previous home. Then they had to furnish all that empty space.
They also upgraded their cars – Cathy, who works part time in sales, went from a Ford Bronco to a Volvo station wagon, while Scott, 40, a commercial real-estate broker, moved from a 5 Series BMW to a pricier 7 Series. Eventually, the expenses led to something else that was new: debt, including credit card balances. “It wasn’t like hundreds of thousands of dollars,” says Cathy. “But when it gets to be $10,000 or $15,000, you start to get concerned.” The Gabrielsens are not alone in their concern. Consumers and economists alike are looking over their shoulders at a growing American mountain of debt. Just how worried should most families be about what they owe? At the very least, economists fear that the indebtedness of the all-important consumer threatens U.S. economic growth, already slowed by record-high oil prices.
Household finances, like the economy, tend to run in cycles. Usually, when times are good, families assume things will be good forever, so they spend more and save less. When times get tough – as they did in the mid-1970s, early ‘80s, and early ‘90s – consumers tighten their belts, saving more and borrowing less. But in the most recent downturn, starting with the bear market of 2000 and the recession of 2001, belts did not get tightened. In fact, they were loosened. Household debt rose from 96% of personal disposable income (consumers’ take-home, spendable cash) in 2000 to 111% in 2003 to 113% at the end of 2004. “Just the fact that it’s growing isn’t necessarily a problem,” says Scott Fullwiler, an economics professor at Wartburg College in Waverly, Iowa. “My concern is that as a percentage of disposable income, it’s at an all-time high.”
At the same time, the savings rate – that is savings (not including home equity or investment gains) as a percentage of disposable income – has plummeted. It fell to 0.6% in May, down from as high as 3.4% in 2001 and 7.9% in the early 1990s. Americans are saving less partly because they are spending more, often because it has been so cheap to borrow money to do so. But, as always, there comes a time of reckoning. Consumer debt of all sorts – from home mortgages to credit card balances – has shot up. “There is an explosion in household debt taking place, and it’s a serious problem,” says Robert Parks, an economist and finance professor at Pace University’s Lubin School of Business. Chris Viale, chief executive of Cambridge Credit Counseling, says, “Americans are in big trouble right now.” He notes that 1 in 4 households is either behind on card payments or over the credit limit on at least one account. Yet other evidence, both statistical and anecdotal, suggests the picture is much more mixed. Delinquency rates have dropped, and Americans’ net worth has grown substantially.
Though Americans’ debt pile may be manageable while interest rates stay low, could consumers cope if rates rose? Some rates have been increasing since the Fed started tightening monetary policy in June 2004. In fact, the average credit card interest rate is nearing 17%, up from 15.7% in the past year. In the hottest housing markets, adjustable-rate loans account for over half of all new mortgages, according to Merrill Lynch. Millions could face higher monthly housing payments as rates rise. Households have to worry about inflation, too, says Cheryl Burbano, a planner with American Express Financial Advisors near Tampa. “You’re seeing key expenses rising, whether it’s gasoline prices or the cost of health insurance,” she says.Link here.
The dark side of subprime mortgages.
Loans to homeowners with less-than-sterling credit are the fastest-growing segment of the mortgage market as lenders reach out to those unable to qualify for conventional mortgages. So-called subprime loans have helped boost U.S. homeownership to a record 69% of households. They are being tapped by borrowers in all income ranges, who struggle with poor credit ratings stemming from modest incomes or excessive credit card or other debts. In Massachusetts, subprime loans, fueled by refinancings, have grown from 1.6% of mortgages in 2000 to 12.3% today.
But the industry’s growth has brought problems. Subprime lenders foreclose on properties much more frequently than do conventional lenders. About 3.5% of subprime mortgages and refinancing loans go into foreclosure, but a study by the University of North Carolina Kenan-Flagler Business School found that 20% of refinancings in 1998 through 2000 that were examined wound up in foreclosure. For conventional loans, the rate is 1.1% of mortgages and refinancings. The prevalence of subprime loans contributed to a 31% spike in foreclosure filings in the first half of this year in the state’s Land Court. If house prices in Greater Boston’s overheated real estate market fall, these loans could accelerate a downturn as overleveraged homeowners throw their houses on the market or lenders sell foreclosed properties at fire-sale prices.
To compensate for taking on these riskier customers, a subprime lender might charge one customer 7.5% for a 30-year fixed loan, while charging a customer with a lower credit score 8.5%. Conventional mortgage rates are currently 5.7%. David Bernotas, chief executive of Peabody-based East/West, said he cannot discuss a customer’s loans but said people with bankruptcy in their credit history pay higher rates. It “affects scores for up to 10 years,” he said. Subprime loans are among the newly popular mortgage products, such as interest-only loans, for people with strained budgets, including first-time buyers. Homeowners increasingly use them to refinance and consolidate household debts when their credit scores fall in the wake of bankruptcy, high medical bills, or other setbacks, said Kathleen Schreck, a mortgage banker and chair of the Massachusetts Mortgage Bankers Association.
The industry’s rich profits have sagged recently, due to a drop-off in refinancings from record 2003 volume and growing competition from traditional lenders invading the market. But Paul Collier, director of litigation for the Harvard clinical program at the Hale and Dorr Legal Services Center in Jamaica Plain, said his office receives frequent complaints from subprime customers. Subprime lending once primarily targeted low-income people, including minority borrowers. “It has,” he said, “reached the middle class.”Link here.
REAL ESTATE INVESTMENT TRUSTS EXPLAINED
REITs are companies that own, and in most cases, actively manage income-producing real estate such as apartments, shopping centers, offices, hotels and warehouses. Some REITs also make or invest in loans and other obligations that are secured by real estate collateral. In the U.S., one of the qualifying requirements as a REIT is that a company must distribute at least 90% of its taxable income to its shareholders annually. REITs can be classified as an equity, mortgage or hybrid.
Earnings growth normally comes from several sources, including higher revenues, lower costs and new business opportunities. The direct sources of revenue growth are higher rates of building occupancy and increasing rents. As long as the demand for new properties remains well balanced with the available supply, market rents tend to rise as the economy expands. Low occupancy in underutilized buildings can be increased when skilled owners upgrade facilities, enhance building services and more effectively market properties to new types of tenants. Property acquisition and development programs also create growth opportunities, provided the economic returns from these investments exceed the cost of financing.
Investors should understand some of the fundamental factors that influence the value of a REIT’s real estate holdings. One crucial factor is the balance of supply of new buildings with the demand for new space. When construction adds new space into a market more rapidly than it can be absorbed, building vacancy rates increase, rents can weaken and property values decline, thereby depressing net asset values. In a strong economy, growth in employment, capital investment and household spending increase the demand for new office buildings, apartments, industrial facilities and retail stores. Population growth also boosts the demand for apartments. However, the economy is not always equally strong in all geographic regions, and economic growth may not increase the demand for all property types at the same time. Thus, investors should compare the locations of properties of different companies with the relative strength or weakness of real estate markets in those locations before investing.Link here.
THE ECONOMY: IN THE PINK … SLIP?
The devil is in the details (or lack thereof) of the August 2 Commerce Department report. Things start off with astonishing clarity: “Consumers rediscovered their appetite for shopping in June,” as spending for the month grew by 0.8%, the largest increase since July 2004 – not to mention a 0.5% rise in personal incomes, slightly above the Street’s expectations. (ABC News) Stop there, and the nation’s financial future looks quite bright, as the “experts” made perfectly plain: “This is a fresh testament to the economy’s momentum as it headed into the third quarter.” (Reuters) … “Consumers are really on a bit of a tear. These are very strong numbers and they bode well for the near-term economic outlook.” (Bloomberg) … “Nasdaq surges to a four year high as Wall Street welcomed data showing increased consumer spending.” (MarketWatch)
OK. So that is the WHAT. It is at WHY and HOW consumers loosened their buying belts, however, that the dust starts to fly. See, according to the media outlets above, “the pickup dovetailed with an improved jobs picture.” (AP) They offer few figures to back up such a claim, being that it is impossible to turn dirt into diamonds. In other words, the available data on real job growth – not the sort found in the popular press – reveals that the true source behind the “rose” colored economy is actually a surge in pink slips.
On this, we offer the following facts: 1.) In June, layoffs rose to the highest level in 17 months, while a slew of big-named businesses warned of more firings to come in due time. 2.) Our chart of the Index of Help Wanted Advertising over the past four decades shows today’s number at a 44-year low. More pounding the pavement than mounding the paychecks.
The point where things become seriously blurred, though, is HOW. Consumers loosened their purse strings in June because a rise in personal income gave them more money to spend – so says the establishment. Wrong. Consumers had more money to spend because they double-dipped into their savings. If you had a magnifying glass on hand to run over the tiny fine print at the bottom of each mainstream article, you would come to the same resolution with this detail: The personal savings rate in June plunged from 0.4% in May to 0% – the second lowest reading since the Great Depression, marking ONLY the second time in history when the savings rate fell to or below zero (October 2001 being the first). This bold chart brings the picture into complete focus.
Think about it: with so little tucked away for a rainy day, the American consumer is now more vulnerable than ever to the slightest shock to the economic system. A moot point as far as the “experts” are concerned: The way they see things, financial rainy days are long and gone. A penny earned, to them, is a penny well spent. In the meantime, what they do not tell you AND what you do not know can be quite harmful.Elliott Wave International August 2 lead article.
THE IRA LAYS DOWN ITS ARMS: WHY NOW?
Socionomics main postulate says that a rising (“bull”) stock market indicates improving social mood and thus serves as a leading indicator of positive social events. In bull markets, feelings of happiness, concord, optimism and inclusion permeate a society. Conversely, a falling (“bear”) stock market signals a worsening social mood and thus forewarns of negative social events. In bear markets, the opposite feelings of pessimism, separatism, opposition, fear and anger prevail. Now, with that in mind, let us take a look at the big news from Ireland last week. On July 28, members of the Irish Republican Army, a nationalist organization responsible for numerous bombings, street battles and hundreds of murders since its inception in 1916, laid down their arms for good. No more violence, they said.
It is a truly historic moment. But from an Elliott wave perspective, the burning question is: why now? Remember, a bull market signals improving social mood and foretells positive events, while a bear market signals the opposite. So let us look at some of the significant dates in the IRA history and see where they fit on a chart of the Irish (and British) stocks markets. When social mood in Ireland and the UK was rising – as indicated by the rising stock markets – the IRA’s violent activities seemed to have subsided. As the stock market fell – indicating worsening social mood – the IRA would take up arms again. This relationship raises a number of questions. What does the new IRA’s decision portend for the Irish stock market? When Irish stocks go through another bear market cycle, will the IRA resort to violence again? Will the level of violence depend on the severity of the bear market?
Mind you, this short article is just a brief investigation of whether or not there is any correlation between changes in Irish and British social moods and the IRA’s activities. At first glance, there appears to be a strong correlation. However, we are now conducting a complete socionomic study of the IRA and the Irish stock market. We plan to publish the results in September – so stick around, it is gonna get a lot more interesting.Link here.
ROCKY MOUNTAIN RICHES
Outside the mine, it felt like any other midsummer’s day – hot and muggy. But down here, 500 feet deep in the bowels of a mountain they call Gold Hill, my fingers were slowly turning numb from the cold. “We’re finding rock samples down here no one’s seen since the 1890s,” said Kory, the mine’s resident mineral expert. “See this black spot here? It’s a telluride deposit … 40% gold, 40% silver and 20% tellurium.” We focused our headlamps on the vein and moved closer to the rock face. Gold speckles were clearly visible to the naked eye. I am in the hills above Boulder, Colorado to learn about gold mining. My hosts: Consolidated Global Minerals (TSXv: CTG), a junior exploration and development company with other properties in Tunisia, Canada and Nevada. They took me up to the project yesterday morning to meet the crew and tour the mine.
I am no expert in gold mining, geology, or even gold stock investing, and junior gold exploration companies like Global are risky investments. So I can only tell you what I saw, I cannot make a recommendation. Besides, I would never invest in only one junior gold mine. Rather, I would buy a basket to spread the risk around. But for the record, I was extremely impressed by Global’s operation. Optimism exuded from everyone I spoke to. The confidence was genuine yet conservative. I got the impression these guys expect the mine to produce a great deal of gold, and to produce it at a considerable profit. If you are in Boulder, we have secured a personal invitation from the mine’s manager specifically for our readers.Link here.
INTERVIEW WITH THE INVESTMENT BIKER
Jim Rogers, if you did not know, returned investors about 40 times their money in a decade, and then retired. Even more amazing, it was the decade of the 1970s, when stocks did absolutely nothing. We caught up with Jim by phone from Shanghai earlier this month, where he was apartment shopping. Starting with the recent news out of China, we will cover his thoughts on China in the first part of this interview …
“The Chinese are moving more and more towards making [the yuan/renminbi] more convertible. They’re letting Chinese institutions invest abroad now. Chinese tourists can get passports easily now … And they can take, I think, up to $6,000 if they go on a trip. So you’re starting to see huge amounts of Chinese travel. So China is taking very small steps toward making this a completely convertible currency. It will happen by 2007, under the terms of the World Trade contract they have – you know, they joined the World Trade Organization. And they’ve got the Olympics in 2008. So certainly by 2008, China is not going to be sitting around here with a blocked currency anymore. The consequences? Who knows? I’m sure there are going to be unexpected consequences. There always are, when an event is greatly anticipated.”
“I know that hundreds of billions of dollars are being poured into China to take advantage of the rise in the renminbi. First of all, whenever something like that happens, it wouldn’t surprise me if this renminbi didn’t go down for awhile, because all those people who poured hundreds of billions into China to speculate have got to get it out. But whether it goes up or down in the beginning, I don’t care. I’m going to be buying more of it myself. Because longer term, the renminbi’s going to be a big currency, a great currency. The consequences, again, there have been hundreds of billions of dollars of speculation on the renminbi, and that always worries me. So I know there are going to be some surprises. I just wish I were smart enough to know exactly what the consequences will be and what the timing will be. I’m not one of the people pouring money into China right now to speculate on the renmimbi, that’s for sure.”
On a hard landing in China: “… real estate is where the major speculation has been, and that’s where I’d expect the hard landing to center, if you will. It will reverberate out from there, of course. There will be other people who will suffer. That’s my view. I mean, some parts of the Chinese economy will never even know that there’s a hard landing in Shanghai real estate, say, or that a bunch of real estate speculators in Beijing went broke. The guys out there producing coal, or building power plants, won’t even know that there’s a hard landing in other parts of the Chinese economy. So I suspect it will certainly start with real estate, or something, and reverberate out… But parts of the economy will never know it.”
Should there be a hard landing in China, would Rogers anticipate a major consolidation in commodities? “Yes, I do. Something’s going to cause consolidations in commodities. We always have consolidations in every bull market in history, no matter what the asset class. In every stock bull market, there have been consolidations along the way. Again, I wish I were smart enough to tell you exactly what’s going to cause them, and the timing, but I’m not. It’s pretty obvious to me that if we suddenly see headlines in the Wall Street Journal of some kind of turmoil in China, that commodities would be having a correction, or would go into a correction. But that would be a chance to BUY commodities.
“You know, in the ‘80s and ‘90s, we had some huge corrections in stocks. In ‘87, stocks went down what, 35-40% in several months, but people who understood that this was in the context of a major bull market bought more stocks; they didn’t panic and sell. Likewise, in ‘94 or any of the other corrections along the way in the bull market in stocks in the 1980s and ‘90s, you made a lot of money. So if you see those headlines, I urge you to buy all the commodities you can. Probably buy all the China you can, too; but certainly, buy all the commodities you can, too. … Something’s going to cause consolidations, but buy ‘em, don’t sell ‘em.”Link here (scroll down to piece by Steve Sjuggerud).
INFLATION AND THE PYRAMID BUILDERS
Like waves on the seashore, an incessant drip of a faucet, or the perpetual nag of the proverbial mother-in-law, your dollars as a store of value and labor are continually clipped and filed down by the Central Bankers’ silent tax. From the pyramids to the billion dollar-a-copy gee whiz warplanes we get to see once in a while at an air show or parade, everyone below plutocrat status will pay for the symbols of empire. The treadmill runs faster, the crack of the whip grows more severe. Get ready to sweat, work harder, longer, and perhaps even die at your grinding stone. Your masters have a lot of bricks to pound into dust, and the grinding of the masses into dust is par for the course.
Occasionally you get a real deflation. Like a perfect red heifer, or an albino alligator, or perhaps that elusive blue moon. We all acknowledge it can happen. Sure, a great plague can wipe out a medieval population center, and put the laboring classes in the cat birds’ seat for a little while. But short of a mass extinction event where you are still standing, the chances of you hitting a moment in history where you will experience anything other than the steady din of your purchasing power ground down into dust is so remote as to make it a practical irrelevancy.
Most of us do not mind a little sweat and tears along life’s journey. But not everyone wants to take a turn at the oars. Some humans, the Pharaohs and modern equivalents, figured out a long time ago that one does not have to sweat if you can get someone else to sweat for you. Voila! Too bad you have to work so hard! We all know slavery is really all about some people wanting to evade the curse of work at the expense of others. Chains and nose rings are considered a little too crass, too vulgar, and just a little too messy. What would our friends in polite society think? Perhaps there is another way? Enter the Central Bankers, the direct descendants of the Pyramid Builders.
Yes, we all know the mission statements of the Central Bankers of the world go something like, “maintain price stability and economic growth consistent with maximum employment.” The CEO of Enron walked the plank recently. Why? The short answer is because the stock went to zero. Looking back over the history of the dollar, the Federal Reserve Bank’s proxy for their “Stock”, it has lost 97% of its value since 1913. For practical purposes, that is close enough to zero for me. The problem is no central banker has ever gone to jail or been held accountable and never will. Why? Because the real mission statement of the Central Bankers can be stated as follows: “To create an environment whereby the governments’ deficit spending and debt burdens can be inflated away and paid for through the gradual inflationary coin clipping of the populations’ currency thereby diminishing the currency as a store of value and labor.” The charts do not lie. Mission accomplished. Let us add, “Keeping the world safe for speculators and the financial elites at the expense of everyone else.” That feels about right.
From my perspective, the deflationists forget what side of the seesaw they are sitting on. The Feds are sitting opposite them and owe trillions and trillions and trillions of dollars. That side looks heavy. Sure, we may see some short duration deflations, liquidations, supply-demand driven price drops, and mania-busts, but the big trend is assured. How big is the real debt of all liabilities in present value dollars, both what we know about and do not? Is it 40, 50 trillion? More? How long would it take the American people to pay it back in real constant dollars? 200 years? 300 years? More? It ain’t gonna happen. Remember who owns the electronic and paper printing presses. The next time you pull out a Federal Reserve Note with an incremental cost of production near zero and the electronic version cost of absolute zero, remember what side of the trade you are on. They want inflation. They need inflation. We will have inflation.
So what advice might you want from a fellow sweaty life traveler? At the very least, exchange some of your dollars for some stuff that cannot be inflated or whose values cannot be easily manipulated through the money-credit creation process. Oh, and one more thing; stay healthy and plan on working harder and longer and sweating a lot because Pharaoh needs more bricks. The treadmill is accelerating and the speed control and cruel whip reside firmly in the unsweaty grasp of the Pyramid Builders.Link here.
CHINA’S REVALUATION: BIG JOURNEYS BEGIN WITH SMALL STEPS
Just because the financial markets and press have responded to the revaluation of the Chinese currency with a big yawn, as China continues to take small steps toward making the Yuan a complete convertible currency, the real question is “could the Chinese Yuan become a world reserve currency on par with the Dollar, Euro, and Japanese Yen? We are a believer in the “Big Yuan”. Investors are wondering what the consequences will be as the Yuan is slowly but steadily revalued upwards. For starters, the following is likely to occur: 1.) All Asian currencies will increase in value so Asians will be able to buy more for their money; 2.) As the Yuan and other Asian currencies rise in value, Wal-Mart, and other retailers, who import billions of dollars worth of goods from Asia, will have to pay more for imports. Price increases will ultimately have to be passed on to the American consumer; 3.) The demand for U.S. treasuries will go down as the China and Asian central banks move to a currency “basket” allowing for less dollar asset reserves.
Hundreds of billions of dollars are pouring into China to take advantage of the rise in the renminbi. Up until now, the only way to play the Yuan game has been to invest in China, which has attracted the usual hot-money, speculator crowd. However, there is something much bigger in the offing. China has a long way to go to complete its revaluation. The realization of an ever-rising Yuan, will rock the status quo. China can now go to Iran, Venezuela, and Nigeria and exchange renminbi for oil – and these countries will be better off than if they took dollars. Clearly, over the long term, the Yuan has the potential to become a great currency. What about other countries with resources to sell China? Would it not be in their interests to exchange Yuan for their raw materials?
So, what is China really up to? Not only is China looking at energy deals in Sudan, Zimbabwe, Algeria, Angola, Kazakhstan, Turkmenistan (and any other “oil-stans”), they seem to be everywhere, particularly showing up in places that need a big powerful friend to protect them from America, or the rest of the civilized world. Countries, such as Iran and Venezuela, clearly need protection from the U.S. The world is full of petty dictators that need friends. You may recall when Iraq wanted to shift from being paid for oil in dollars, to being paid in euros; the move did not win many friends at the White House.
China has a one party rule and dictatorship by committee and they know how to cut deals with strong men. With China showing up wherever there is oil and resources, rulers of the less than democratic countries must see a “win win” situation with China. If they accept the Yuan in exchange for their resources, not only do they get money that is better than the dollar, they shake hands with a very powerful friend that can sell them arms and keep them in power! Letting China have a reserve currency has major geo-political implications, and they are not all good for the U.S.
With a reserve currency, China’s government would be crazy not to start printing and spending. Before the Yuan revalued, the world was focused on the $700 billion in U.S. dollar reserves the Chinese could spend. Now, there are already signs that China is trying to buy U.S. brands, U.S. oil companies, and almost anything that is not nailed down around the world. China’s unprecedented and growing foreign exchange reserves can now be used as the largest exchange stabilization fund the world has ever seen! In Asia, dollar diplomacy, pushed by the IMF, will quietly fade into history. How will all this affect the stock markets? Remember: Big journeys begin with small steps! As an investor, shouldn’t you be interested in what China wants to buy?Link here.
DUMB DATA SETS RATES
Is there really a conundrum regarding today’s interest rates, as Alan Greenspan has complained? Or is the Fed chairman just missing the reason he has been unable to force borrowing costs higher? The answer came out last week and in a minute I will share it with you. But first some background on Greenspan’s predicament. In what has to be the most embarrassing boondoggle ever to have faced any nation’s central bank, the U.S. financial markets have repeatedly thumbed their noses at the Fed. Since June of 2004 the Fed’s policy-making Open Market Committee has raised the so-called federal funds rate 9 times – with imperceptible results.
And even though it has become more expensive for banks to get money overnight from the Fed, the rate at which you and I borrow is still incredibly and dangerously low. The result, of course, is an overheated housing market where people are probably paying prices that they will come to regret. This phenomenon has also come to be known as The Bubble. So, what is Alan Greenspan missing? And the Fed? One explanation is that as the Fed was publicly raising interest rates, it was at the same time, making so much money available to the banking system that borrowing costs were destined to remain low.
Good theory, but debunked by the fact that the nation’s supply of money has been growing only moderately and this should have helped to force rates higher. Then there is the other theory, as suggested in the Wall Street Journal. It goes something like this: the bond market has been keeping rates low because of confidence, bordering on arrogance, about inflation. And this has been diluting the Fed’s tightening effort. OK, the bond market is not cooperating with the Fed. But why? I have been around this block before – the economy is not as strong as people think. There is not a conundrum after all, just some bad bookkeeping from our government.Link here.
BIG OIL WARNS OF COMING ENERGY CRUNCH
International oil companies have advertising campaigns warning that the world is running out of oil and calling on the public to help the industry do something about it. Most of the executives of the world’s five largest energy groups generally maintain that oil projects are viable with the price at around $20 a barrel. But their advertising and some of their companies’ own statistics appear to tell a different story.
ExxonMobil, the world’s largest energy group, said in a recent advertizement: “The world faces enormous energy challenges. There are no easy answers.” And the companies’ statistics back up the sentiment. In The Outlook for Energy: A 2030 View, the Irving, Texas-based company forecasts that oil production outside the OPEC countrie will reach its peak in just five years. Chevron, the second-largest energy group, sends a similar message, but goes two steps further. “One thing is clear: The era of easy oil is over. We call upon scientists and educators, politicians and policy-makers, environmentalists, leaders of industry and each one of you to be part of reshaping the next era of energy. Inaction is not an option,” was the message in a recent advertising campaign. The company has even set up a website warning of the pressures of high demand and fewer fields and offering a forum of discussion.
One senior executive at an oil company not involved in the advertising campaigns speculated that his counterparts were attempting to buy themselves some slack to go after the messier, more expensive, dirty oil. Another executive said it may buy some sympathy for the difficulty many companies are having in growing developing their production and reserves. Total, the French oil company, this week made the latest acquisition in Canada’s vast Athabasca oil sands, where companies are extracting extra tar-like bitumen from sand in an expensive and environmentally tricky mining operation. Total’s director of communications, explaining the logic behind its campaign, said, “Tomorrow’s energy needs mean developing new energy techniques, going further and deeper in the search of oil and gas. That’s at the heart of Total’s work today.”
But answering the concerns of the consumer, even about the possible shortage of oil, is not the primary job of an oil company. Its most important stakeholders are its stock shareholders, some of whom have been left perplexed by the advertisements after hearing a very different message at last week’s earnings conferences. Neil McMahon, analyst at Sanford Bernstein, said: “We think these messages are at odds with the comments normally made to investors regarding future oil prices and the ability of producers to meet demand, and we wonder if perhaps those messages are actually a better indicator of the companies’ thinking.”
Consumers are also not the primary concern of an even more important group: the national oil companies of producing countries, such as Saudi Arabia. The kingdom has as its first priority its growing population and the stability of the regime. This – together with the increased difficulty of finding new oil – is part of the reason for the capacity crunch, analysts and executives agree. No amount of advertising is likely to change that dynamic.Link here.
U.S. LONG BOND RETURNS TO HAUNT JAPAN’S DEBT
It is not hard to figure out who the winners are as the U.S. resurrects the 30-year bond. Investors get another security to bet on, households can use it to plan for the future and the government may lower its borrowing costs. There is at least one potential loser: Japan. The world’s biggest government bond market – Japan’s – is also among the least international anywhere. Roughly 96% of Japan’s debt is held domestically. Seeking to widen the market and reduce borrowing costs, Japan has begun sponsoring investment roadshows in the U.S. and Europe.
Things will get even harder come the first quarter of 2006, when the U.S. Treasury issues new 30-year debt. While Japan has long-term debt outstanding, it is no match for bonds denominated in the world’s reserve currency. The U.S. Treasury market also is more liquid than Japan’s and carries AAA credit ratings. Yet there may be a silver lining in all this. Perhaps the U.S. Treasury’s move will encourage Japan to embrace an idea taking hold in Europe: 50-year bonds. Doing so might boost the status of Japan’s bond market globally.
Among Japan’s reservations about issuing such bonds is the risk of increased long-term borrowing costs. It is a valid concern; because of the uncertainties inherent in buying long-term debt, investors demand higher yields. That should not deter officials in Tokyo. For one thing, demand wil not be a problem. The world is arguably in the midst of a long-bond shortage as pension funds and various investors look to match their portfolios against long-term liabilities. For another, Japan is quite adept at maintaining calm in its debt market.
After all, Japan seems to have found the Holy Grail of debt management: issuing mountains of IOUs without the usual surge in interest rates. Even though Japan has a debt-to-GDP ratio in the neighborhood of 150%, making it the world’s most indebted industrialized economy, 10-year yields are just 1.37%. Considering the U.S. pays 10-year investors 4.30%, Japan’s debt managers are as skilled as they come, and markets know it. In some ways, Japan’s bond market is not so much a market as a mechanism for transferring wealth from households to the government. Well aware of the bond market’s pivotal role in the economy, the Bank of Japan is equally loath to let yields rise. The bond market is too big to fail, and the BoJ will turn its full efforts to supporting bonds.
Selling 50-year debt may go a long way toward globalizing the market. Officials here used to think letting foreigners buy debt would leave Japan’s finances vulnerable to outside forces. Recently, they have changed their tune and sought to increase the nation’s customer base. Yet getting more foreigners to buy bonds is easier said than done. Even though Japan has had deflation for more than seven years, the trajectory of its debt worries many overseas investors. The nation’s graying population and failure to engineer a more vibrant recovery means its debt may keep growing. Even so, greater variety could help attract more investors. And who knows, issuing ultra-long debt might just prod Japan toward fiscal discipline. Ten-year investors know Asia’s wealthiest economy will not default before their securities mature, but 50-year investors might become antsy if Japan’s debt load increases in the years aheadLink here.
(MIS)LEADING ECONOMIC INDICATORS?
The most recent scandal to strike the world of baseball was the August 1 report revealing that Baltimore Orioles first baseman Rafael Palmeiro tested positive for steroids. But on August 3, an online exclusive Barron’s article takes the story to a whole new level, from the sports field to the realm of finance. “When we look back at the recent period of economic homeruns,” begins the column, “we will recall it as a season of steroids. Like major leaguers, the data is on juice.” The data at hand being the composite index of Leading Economic Indicators (LEI).
Consider these few facts: 1.) 8 out of the past 10 LEI readings have been in negative territory. 2.) The growth rate of the LEI has slowed from a peak of 10.3% in October 2003 to 1.2% in June of this year. 3.) As of August 1, rates on 2-year Treasury notes were just 24 basis points from creating an inverted yield curve against the 10-year note: Outright inversions have preceded every single U.S. recession over the past 40 years.
Three strikes and you are … IN – for a major “revision”, that is. See, according to a July 1 Wall Street Journal survey of 56 economists, not one sees as much as a single negative quarter of GDP growth through the middle of 2006. The problem, in their world, is NOT the U.S.u economy; it is the “outdated” LEI index. So last month the Conference Board came up with a solution: change the index. Done: As of July 21, “only the cumulative sum of the yield spread will be taken into consideration.” Translation: the yield curve can flatten to the width of a pancake if it wants without Wall Street batting an eye. Now, an “actual inversion” must occur before the future of economic growth looks compromised.
So, how much did the alterations boost the performance of the LEI? We stepped up to the plate with these startling figures: “In one fell swoop, the index went from showing an 18-month crash, from 4.7% year-over-year growth to –1.9%, to showing a four-month rally, from a -0.7% to 0.9% growth.” Also, by the revised index standards, the LEI increased at a 1.3% annual rate during the past half year. Under the old methodology, the rise would have been 0.5%.
Re-jigger a company’s financial audit to that degree would land you in the cross-bar hotel – just ask any CEO who was caught trying . But in this case, the Conference Board’s actions were applauded by the mainstream media for bringing the index more in line with economists’ forecasts. In the words of a July 27 Wall Street Journal, “The necessary improvements have resulted in sharp upward revisions, erasing one of the few arguments that doves have been clinging to as support for projecting a weakening economy.”
Ask the Conference Board and they would say the recalibration was done to better reflect the – if not actual – then certainly inevitable state of the economy. It is only a matter of time, they would conclude, before the yield curve widens and the LEI reconciles itself to the positive revision. “Economists,” observes the August Elliott Wave Financial Forecast, “are so positive now that the LEI is actually being changed to reflect not the old standards for judgment but their opinion about where they think it should be.” Does that opinion have its eye on the right ball?Elliott Wave International August 5 lead article.
AN AIR OF FIN DE BUBBLE
When we began The Daily Reckoning, six years ago, the U.S. was in the throes of a stock market mania. “This cannot continue,” we said. But it had already continued for longer than we thought it would. We still looked for the end of it, but after a while we got tired of craning our necks. Now, the nation is caught up in an even bigger mania. It is not just investors who have taken leave of their senses … it is ordinary people with little sense to take leave of in the first place. That is why we can set aside our old thoughts for a day or two … but we still need them.
What needs to happen still has not happened. Until it does, we cling to our old thoughts like a bottle of vintage Bordeaux. We will drink it down and get rid of it; we are just waiting for the right occasion. Most people celebrate America’s property boom … its growing economy … its high priced stocks. We would too, if they were not all mountebanks, frauds and ponzi schemes.
The countertrend in the dollar seems to be over. The buck is back on a downward slope. The countertrend in the Dow must be getting close to its end too. Corporate profits are up 13.6% over last year. But the trend is down. S&P earnings growth was cut 6 times in the last 12 months, says Richard Bernstein. “The fundamentals are eroding,” says he. That is the problem with the dollar, the Dow, and the American economy in general. The fundamentals are much worse than they were 6 years ago … and are still wearing down.
On the world market, American companies cannot compete with European firms, because the Europeans make better products. They cannot compete with Asian companies because the Asians make cheaper products. And in the homeland, consumers are running out of money. Their debt-to-wealth (inflated house prices) ratio may be calm and collected, but their debt-to-real income ratio has become almost desperate. We have gotten tired of waiting for the end of it. But that does not mean the end will not come. Then, at least, we can celebrate. We will open up this bottle of old thoughts and drain it down … and be finally rid of it.Link here.
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