Wealth International, Limited

Finance Digest for Week of August 29, 2005

Note:  This week’s Offshore News Digest may be found here.


Crude oil at record high prices have inspired uncountable current articles on the inflationary effects of high energy prices and the historical ratio of gold to crude oil. As in his previous commentaries, the Optimist strives to present a positive perspective for readers to consider. The uplifting message for today is that high oil prices will not cause higher inflation, and that inflation adjusted oil prices will not stay this high for long. The Optimist hopes that helpful message will provide a soothing reassurance to consumers who must struggle to find the funds to pay the crude oil inspired increased prices for gasoline and heating oil, for food, and for everything impacted by higher transportation costs.

There are few more certain economic relationships than that rising energy prices will directly translate into escalating prices at the gas pumps, in the grocery store or restaurant, and in the mailbox at home when the monthly utility bills are delivered. Increasing transportation costs will also push a broad spectrum of prices higher. Although those persistently rising prices will feel like inflation, it is worthwhile to take a closer look. Since early 2002, crude oil has tripled in price from $20 to more than $60 per barrel. While it is obvious that a price increase of that magnitude has a continuing and substantial impact on the economy, the proper perspective is not that rising crude oil causes inflation to rampage throughout the economy. The high price of crude oil should be more clearly viewed as a tax on essential economic elements within our society. This could be more easily visualized if crude oil was still at $20 per barrel, with an additional $40 per barrel of tax imposed by our helpful benefactors and protectors in the Government of OPEC.

Although businesses must raise prices to pass increasing taxes along to the consumer, taxes are not inherently inflationary. Instead of raising the general level of prices throughout the economy, taxes increase the prices of the items taxed and at the same time absorb funds which might have been otherwise used for discretionary purchases. The net result is that taxed items become more expensive, but consumers have fewer funds for other purchases. When consumers will not or can not further increase their debt to continue unessential purchases at the same level as before a tax increase, then the added taxes result in less consumption and a slowing economy. It should be obvious that a very high tax rate focused on a few essential sectors will depress the overall level of economic activity, and that the slowdown will exert downward pressure on the prices of non-essential sectors.

The cumulative result of high real oil prices will be an economy which slips and slides toward recession. A slowing economy in the USA will reduce energy consumption both at home and in key Asian nations which will encounter a decrease in the level of their exports to us. A global reduction in the demand for energy will significantly reduce the price of crude oil in international markets. The Optimist is happy he can provide the welcome news that the inflation adjusted price of crude oil will be lower in the future, even if the reason for that good news is a world wide reduction in the rate of energy consumption due to the traumatic recession that high priced energy would impose on the USA.

So, do you think that maybe a brief recession would lower energy costs enough to put the USA back on track to a high level of growth and another decade of endlessly rising stock and real estate investments? If so, then you get my vote for the most optimistic person in the nation! As yet another example of “This Time It Really Is Different”, the Optimist concludes that the USA will not again have another simple recession which proceeds to clean out the excesses of the prior expansion, and sets the stage for solid economic growth in the future. The unimaginable levels of debt and leverage in the USA makes the economy unstable and incapable of supporting the type of normal recessionary slowdown that the nation has gone though so many times before. What would have been a simple and mild slowdown in the past would now be magnified to intense proportions by the debt and leverage. If not given a lifeline, a slowing economy would fall relentlessly into a deflationary depression much deeper that the 1930s.

But so long as the Fed is able to sufficiently ramp up the amount of money in circulation, they can be sure to reverse a potentially disastrous slowdown into a new illusion of growth. For each crisis that is solved by increasing the money supply, there must be a correspondingly higher inflation caused by an increase in the amount of fiat paper which is chasing the same amount of purchasing opportunities. Although it is clearly correct to forecast that inflation will push the ups and downs of crude oil prices into a series of higher highs and higher lows, it is not easy to use that forecast to make investment profits in crude oil now. Even as the low end of the inflation adjusted channel for crude oil prices rises from $20 in 2002 toward $30, the nominal price of crude can drop significantly from current levels if traders see the potential for an economic slowdown.

The investment strategy that is easy to implement is to buy silver and gold at current levels near the bottom (IMHO) of their long term up trend channels. No matter whether crude oil rises more or drops to $30 in a reversion to the mean, the Fed will insure continued inflation to prevent the economy from deteriorating into deflation. Silver and gold will shine as bright as ever in the environment of rising inflation ahead.

Link here. Soaring fuel prices finally prompt U.S. consumers to cut back – link.


The Federal Reserve is paying closer attention to the rising values of assets such as stocks, bonds and homes, as low interest rates encourage more risk-taking, Fed Chairman Alan Greenspan said. “Global economic activity in recent years has been influenced importantly by capital gains on various types of assets, and the liabilities that finance them,” Greenspan said at a symposium in Jackson Hole, Wyoming, devoted to examining his record. “Our forecasts and hence policy are becoming increasingly driven by asset price changes.”

Greenspan presided over the longest economic expansion in U.S. history and kept inflation in check. Yet he was criticized for his hands-off approach to asset bubbles such as the surging 1990s stock market, and for not responding to soaring house prices. Greenspan used his speech to address the asset-price issue and to define the legacy of his 18 years atop the central bank. Greenspan warned that increases in asset prices “can readily disappear” if investors who are now confident of long-term economic stability become more cautious. A growing chorus of economists is criticizing the Fed chairman for remaining sanguine in the face of what they say is a dangerous bubble in the U.S. housing market that poses risks to the economy.

“Such an increase in market value is too often viewed by market participants as structural and permanent,” Greenspan said. “History has not dealt kindly with the aftermath of protracted periods of low risk premiums.”

Link here.

Greenspan and the bubble.

Most of what Alan Greenspan said at last week’s conference in his honor made very good sense. But his words of wisdom come too late. He is like a man who suggests leaving the barn door ajar, and then – after the horse is gone – delivers a lecture on the importance of keeping your animals properly locked up. Regular readers know that I have never forgiven the Fed chairman for his role in creating today’s budget deficit. In 2001 Mr. Greenspan, a stern fiscal taskmaster during the Clinton years, gave decisive support to the Bush administration’s irresponsible tax cuts, urging Congress to reduce the federal government’s revenue so that it would not pay off its debt too quickly. Since then, federal debt has soared. But as far as I can tell, Mr. Greenspan has never admitted that he gave Congress bad advice. He has, however, gone back to lecturing us about the evils of deficits.

Now, it seems, he is playing a similar game with regard to the housing bubble. At the conference, Mr. Greenspan did not say in plain English that house prices are way out of line. But he never says things in plain English. What he did say, after emphasizing the recent economic importance of rising house prices, was that “this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent.” And he warned that “history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.” I believe that translates as “Beware the bursting bubble.”

But as recently as last October Mr. Greenspan dismissed talk of a housing bubble: “While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely.” Wait, it gets worse. These days Mr. Greenspan expresses concern about the financial risks created by “the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages.” But last year he encouraged families to take on those very risks, touting the advantages of adjustable-rate mortgages and declaring that “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”

If Mr. Greenspan had said two years ago what he is saying now, people might have borrowed less and bought more wisely. But he did not, and now it is too late. There are signs that the housing market either has peaked already or soon will. And it will be up to Mr. Greenspan’s successor to manage the bubble’s aftermath.

Link here.

The Greenspan Era: lessons to be learned in the future.

This weekend’s global central banker powwow at Jackson Hole sets off what will surely be at least five months of Greenspan – “the greatest central banker of all-time” – pomp and adulation. I will anxiously await the public release of this weekend’s papers from “The Greenspan Era: Lessons Learned.” They will be worth storing away for later reflection. His legacy has already become favored pundit subject matter, although I find much of the commentary misplaced.

No discussion of Greenspan’s possible legacy will stand the test of time without addressing the momentous financial sector developments nurtured under his watch. Ultimately, I expect that he will be judged most by the success or failure of the Financial Sphere he cultivated, sustained and endorsed. Curiously, I have yet to read or listen to any comments regarding the unprecedented buildup of debt under the Greenspan Regime. He has operated for too long as undisputed Master and Commander of what has evolved into today’s massive and unwieldy global pool of speculative finance. Disconcertingly, his impending exit will coincide with increasingly vulnerable U.S. mortgage finance and credit bubbles.

Truth be told, Mr. Greenspan is a monetary policy radical. He presided over the greatest expansion of speculative finance in history, including a trillion dollar hedge fund community, bloated Wall Street firm balance sheets approaching $2 trillion, a $3.3 trillion repo market, and a global derivatives market surpassing an unfathomable $220 trillion. During the late-nineties, when leveraged speculation was heavily infiltrating the financial system, he became the leading proponent of the “New Economy”. He became a powerful advocate of derivatives and Wall Street finance, all the time avoiding any discussion of the impact these new financial instruments and practices were having on credit growth, marketplace risk perceptions, speculation, asset prices, and the underlying structure of the economy.

Greenspan has stood idly as our current account deficit has ballooned to almost $800 billion annually, with foreign central banks accumulating several trillion dollars of claims on our economy. He watches as crude approaches $70. And now he warns us against the scourge of “protectionism”, an inevitable response to the gross global imbalances his activist inflationary policies have fostered. He ignored the most reckless of mortgage lending bubbles, and now warns us that prices, market liquidity and wealth/income ratios may not be sustainable. Worse yet, he is arguably guilty of committing the ultimate in central banker derelictions by targeting household mortgage borrowings as the primary mechanism for his post-technology bubble “reflationary” policies (policy error begetting ugly error). The “greatest central banker” incited history’s greatest real estate borrowing and speculating bubble, a legacy our financial system and economy will have to live with for decades.

There is today a joyous consensus view that Greenspan’s policy of not preempting asset Bubbles as they inflate – but rather being well-prepared to act aggressively when they burst – is pure policymaker genius. Well, bull markets do fashion abundant “genius”. Let there be no doubt, however, that the inevitable housing bear/bust will expose the grievous policy flaw of mitigating one bubble by inciting an only larger one. Greenspan’s use of the leveraged speculating community as a policy tool was also a grave mistake. There will come a day of policy reckoning.

In a metaphor Mr. Greenspan was known to employ back in the 1960s when he discussed causes of the Great Depression, there is a strong predilection for the Fed to repeatedly place “Coins in the Fuse-box.” It is his incomparable aptitude – as the Master of Where, When and How Aggressively to Place the Coins – that is most deserving of his legacy. And, in regard to lessons to be learned, at the top of the list is the necessity for strict term limits for the Fed chairmanship. It is a disservice on many levels when one individual so completely dominates policy and public discourse, especially over a lengthy period. This is especially true for Fed Chairmen that – in “good times” – lack sufficient oversight and effective checks and balances. I suggest that the most important lesson to be learned from the Greenspan Era is the necessity for the Federal Reserve to regulate credit, both liquidity extended throughout the real economy as well as leveraging within the financial sector.

The Greenspan legacy should rest upon his failure to effectively manage financial innovation, along with his weakness and incapacity for ever taking away the punchbowl. He has left many things, including his replacement, in most unenviable positions.

Link here (scoll down to last section on page).

For Maestro Greenspan, the song remains the same.

The maestro is back, just in time for his farewell tour. Alan Greenspan showed up at an annual Federal Reserve retreat in Jackson, Wyoming, last week and ran through a list of old standards – worries about deficits and consumer spending. Forget his earlier forays into new material – his uncharacteristic praise of tax cuts, shrugging off deficits, brushing aside of low personal savings rates, and even pooh-poohing of soaring housing prices. What we saw last week was the G-man in true form, playing straight from his “Irrational Exuberance” period.

Greenspan openly fretted about ballooning home values. People may be too easily seduced by paper profits, he warned, which is going to hurt if those profits evaporate. “Such an increase in market value is too often viewed by market participants as structural and permanent,” he said. “But what they perceive as newly abundant liquidity can readily disappear.” Greenspan, as he often does, put a voice to those hidden fears in the market, the unseen worries that nag at the fringes of our conscience.

After all, on paper, the economy is doing better. And yet, we worry. Perhaps it is because wages have not kept pace with other economic gains, which means that for many, the economy does not feel like it is improving. Or maybe it is rising energy prices. Which is why, with his dour comments, the maestro is again striking a a note of concern, just as he did at the height of the tech bubble [actually, it was well before the peak, but whatever …], when paper profits vanished and wiped out trillions of dollars in investor wealth. This time, he zeroed in on borrowers’ embrace of new financing tools, such as 40-year mortgages and interest-only loans.

Greenspan seemed to acknowledge the Fed was partly to blame for the problem. By keeping interest rates low in recent years, the Fed spurred a home-buying boom, which, in turn, boosted overall consumer spending. The downside, though, is the ballooning trade deficit that Greenspan now frets about. If buyers are taking on too much debt, it raises the question of how they are getting it in the first place. Lenders have become more aggressive, offering interest-only loans and adjustable-rate mortgages with seeming abandon. Lenders, of course, pass off a lot of that risk. They package loans and resell them to investors, a practice known as securitization. It allows investors to shoulder some of the risk if the loans crater.

Banks are slow to rein in overlending, allowing the value of collateral to fall before they cut back. If the housing market implodes, they, like their borrowers, are going to get caught – again. The maestro’s career is coming to a close, but he still knows how to strike a chord.

Link here.


As they happily watch their houses swell in value, Americans are changing their attitudes toward mortgage debt. Increasingly, a home is no longer a nest egg whose equity should never be touched, but a seemingly magical ATM enabling the owner to live it up or just live. Homeowners took $59 billion in cash out of their houses in the second quarter, double the amount in the 2004 quarter and 16 times the average rate of the mid-1990s, according to data released this month by mortgage giant Freddie Mac. People are cashing out so quickly that the term “homeowner” may soon be inaccurate. 50 years ago, Americans owned, on average, three-quarters of their house and the lender owned the rest. These days, it is approaching an even split.

The spending spree has a price. With the savings rate at zero, consumers’ eagerness to tap home equity is only worsening their retirement outlook, financial advisors say. If mortgage rates rise sharply or home prices fall, many homeowners could be in financial turmoil. They may be unable to service their loans, or could even find that their homes are worth less than their mortgages. Such a prospect seems unimaginably distant to Doug Levy, a university administrator in San Francisco. When his two-bedroom condominium rose in value by 10% – which took 9 months in the hot Bay Area real estate market – Levy refinanced. That increased the size of his mortgage but gave him $25,000 to pay bills and take a modest skiing vacation in British Columbia. He is considering tapping his equity again if his condo continues to appreciate. “It’s like I’m sleeping in my piggy bank,” said Levy, 44. “In this market, real estate is a liquid asset.”

“If you paid your mortgage off, it means you probably did not manage your funds efficiently over the years,” said David Lereah, chief economist of the National Association of Realtors and author of Are You Missing the Real Estate Boom? “It’s as if you had 500,000 dollar bills stuffed in your mattress.” He called it “very unsophisticated.” Anthony Hsieh, chief executive of LendingTree Loans, an Internet-based mortgage company, used a more disparaging term. “If you own your own home free and clear, people will often refer to you as a fool. All that money sitting there, doing nothing.” The financial services industry is doing all it can to avoid letting consumers be foolish.

The temptation to add debt can be overwhelming. Between 1997 and 2003, the percentage of people who owned their own homes outright, without any mortgage debt, declined from 38.9% to 34.6%, according to Census figures. “Why can’t people stay on diets? Because once you get down to a certain level, you start feeling good, and then you splurge,” said Richard Targett, a research analyst with Ernst & Young. “So when your home goes up in value, you take that cruise. You figure, I got money in my house, I didn’t earn it, let me spend some.” But he warned that if home prices stopped their rapid ascent – which might be happening this summer – Doug Levy woill not be the only one who has to have a job for the rest of his life. “If you’re not working, where would you get the two grand you need every month for your mortgage?” Targett said. “We’re living longer, retiring younger, and don’t want to give up our lifestyles. Something’s got to give.”

Link here.


Buy now, pay later: It has been the mantra of American consumers for decades. The results are obvious in the ballooning balances on credit cards and mortgage loans, and in the mushrooming U.S. trade deficit, which reflects the nation’s nearly insatiable appetite for cheap, imported goods. Low interest rates, especially since the end of the 2001 recession, have fed the debt beast at home, allowing American consumers to accumulate nearly $11 trillion in debt as they buy more homes, more cars, more clothes, more dinners out. At the same time, foreign investment in the United States is helping to keep the dollar strong, which holds down prices on those imports that Americans covet.

But what would happen if interest rates suddenly were not so benign, or if foreign governments, corporations and individuals stopped investing so heavily in America? Some analysts fear such actions could trigger doomsday scenarios in which the bills come due and Americans cannot pay, with devastating consequences for the entire economy.

Link here.


Like the old real estate adage, “Location, location, location,” we have only one question these days. We just ask it different ways. “Are we in a housing bubble?” … “Will home values decline?” … “Did I pay too much?” The attention is no surprise: Housing is our most widely owned asset. We are all stakeholders in this. Another reason is the incredible stories coming out of places like San Diego, Northern California, west Florida and Miami.

Last week, a Florida reader wrote to tell me about the options he had on Florida condos and how he would not go near anything as dangerous as the stock market again because he had been so badly burned in the Internet bubble. What that tells me, even if it escapes him, is that his habits of investing have not changed, only the venue has.

To me, California, Florida and much of New England look like a replay of Texas in the 1980s. Back then, we had savings and loans financing “see-through” buildings, condos and houses being sold with buy-down mortgages, and a long oil-bust recession. By the time it was over, the spine of Texas, Interstate 35, was littered with manufactured home repos from Dallas to San Antonio. Virtually every financial institution in the state was busted. Dallas, Houston and Austin condo prices plummeted: There is no market when people have to pay cash because no lenders will have them.

So here is a question: If the stories and magazine covers are not enough, is there any broad statistical evidence of excess? Yes. One indicator, cited in a recent issue of Grant’s Interest Rate Observer, is the dollar volume of home sales divided by GDP. The figure for 2004 was a near record, nearly 3 standard deviations greater than the average of the last 35 years. Moreover, examining data going back to 1952, residential homes are the highest percentage of our collective net worth they have ever been, 36.3%. Also, we reached a record for the value of homes compared with the value of our financial assets, 48.5%. Compared with the median values of the last 50 years, these are big shifts. Viewed statistically, values are at extremes.

The bottom line: Collectively, we are heavily mortgaged in a period of extreme prices. The return to normal prices could be as painful at the Great Texas Real Estate Crash.

Link here.

Homebuilder insiders on selling spree.

A rash of insider selling in recent months at red-hot homebuilders appears reminiscent of a similar trend right before the technology bubble burst in 2000, according to Merrill Lynch. “There has been record insider selling within the last 10 months across a broad range of homebuilding companies despite very few sell ratings by Wall Street analysts and the general perception by investors that the stocks are undervalued,” Richard Bernstein, the firm’s top strategist, wrote in a note to clients.

Based on data going back to 1985, Merrill found that insider net selling at eight major homebuilders – including bellwethers such as such as KB Home, Ryland Group, and Toll Brothers – has hit record levels at some point in the last 10 months. “Such insider behavior seems to mimic that of the technology sector around the peak of the technology bubble in March 2000,” Bernstein said.

Thanks to the sizzling U.S. housing market and low interest rates, has homebuilders have been enjoying an unprecedented boom. Over the past twelve months, the Dow Jones U.S. Home Construction Index (DJ_HOM) has leaped 53%. Yet the index has steadily declined in August on inflation worries, some brokerage downgrades and widespread publicity about perception of a speculative bubble in the housing market. Some analysts have suggested that insider selling in the homebuilding sector is simply the result of executives wanting to diversify their holdings. “However, we think there is a strong contrary message to investors if the stocks have appreciated so much that executives across nearly the entire industry feel the need to diversify at record pace,” Bernstein wrote.

Link here.


Talk about pricing power. Danny McNease, chairman and CEO of Houston’s Rowan Cos., is charging energy companies 30% to 50% more than a year ago to punch holes in ocean floors around the world searching for new oil and gas supplies. Of course, big energy companies are having no problem footing the bill. “It’s amazing how much those E&P [exploration and production] guys are making,” McNease told analysts in an August 2 Webcast. Yet it is equally amazing – and far less noticed – how much Rowan and other contract drillers are making these days, thanks to $60-a-barrel oil and natural gas at $7 per million BTU.

Link here.


You have got to give credit to David Tice’s Prudent Bear Fund. The $379 million fund, which aims to prosper when the stock market does not via such means as short-selling and owning gold shares, frequently turns in better results than the stock indexes might lead us to expect. Look at its record for the past year through the end of last week. While the S&P 500 Index has posted a positive return of 11%, the Prudent Bear Fund has declined a mere 4.8%. Over the last three years, Prudent Bear has declined just 5.8% a year while the S&P 500 has returned 10.3% per annum. In the last five years, the fund boasts a 12.9% annualized gain, compared with the S&P 500’s 2.8% per-year loss.

In the upside-down world of bear market funds, this stands as market-beating performance. However much the S&P 500 rises or falls, the aggregate results of those who bet against it would figure to be about the same in the opposite direction. Maybe worse than that, once costs are factored in. Tice has done a lot better. The trouble is, even with this display of acumen, the Prudent Bear Fund has not been a consistent money-maker over the long haul. Approaching its 10th birthday, the fund shows a net loss of 3.4% a year from the end of 1995 through July of this year.

Admittedly, the intervening years have included a mighty bull market. They also have encompassed the worst sustained market decline in three decades (the “tech wreck” of 2000-02), plus the Asian currency crisis of 1997, the Russian default of 1998, the terrorist attacks of September 2001, and assorted other bear-boosting adversities. Through all this muck and mire the S&P 500 produced a net gain averaging out to 9.3% – or right smack in the middle of its historical average of 9% to 10% a year. To paraphrase Charles Dickens, it was the worst of times, it was the best of times, it was typical of just about any time. The past 10 years demonstrate that even in the midst of turmoil on the world stage, you can wear yourself out trying to make money betting against the stock market.

Link here.


The role of American consumers in promoting economic growth in the U.S. and, indeed, in many export-driven foreign countries will be especially significant in coming quarters. The effects of the previous huge federal tax cuts and rebates are over. And the leap in federal spending for homeland security and military action in Afghanistan and Iraq is over, so federal spending’s share of GDP has leveled. At the same time, the stimulative effects of earlier Fed credit ease have been reversed. Housing remains strong but the bursting of that bubble may be near, I believe.

While the Fed’s rate increases have had little effect on housing or other economic activity, three realities are clear. First, tighter credit is simply not stimulative to the economy and in fact is constrictive, one way or the other, sooner or later. Two, history says that the Fed will tighten until something happens, and that something almost always is a recession. Third, with Treasury bond yields falling, the Fed will probably need to invert the yield curve to get short rates where it wants them. That situation is very rough on banks and other financial institutions that rely on a positive spread between the long rates at which they lend and lower short-term borrowing rates. In the post-World War II era, the Fed has precipitated recessions without inverting the yield curve, but when it does invert, a recession is almost assured.

Elsewhere in the economy, capacity utilization here and even more so abroad remains so low and business caution so subdued that a capital spending boom big enough to lead the economy is unlikely. Indeed, the first quarter weakness in nonresidential fixed investment growth may suggest even less stimulus from this sector in future quarters than earlier.

It appears that personal income growth in the quarters ahead will not be sufficient to provide the money consumers need to sustain rapid economic growth. But that will not necessarily deter them. They can fuel their spending the old fashioned way – by increasing borrowing and reducing saving. In pursuing these tried and true techniques, however, consumers do face some new challenges. One is the recent, tighter bankruptcy law, which makes bankruptcy much less desirable. Another challenge for consumers is that not only debts but debt service, the monthly payment of interest and principal, continues to leap and, in relation to DPI (after-tax income), is much above the mid-1980s peak. Interest rates are much lower now, but the principal owed has exploded.

Back in the late 1990s, many argued that the saving rate as structured by the National Income and Product Accounts was irrelevant because it excluded capital gains, which were plentiful at the height of the dot com bubble. With the collapse in tech stocks, those capital gains disappeared and so did the criticism of the saving rate definition. But with the recent leap in house prices, the idea that capital gains are saving is back. Some note that even though capital gains are not included in income as defined by the NIPA, the taxes on them are included in the income taxes that are subtracted from income to ultimately arrive at saving. So, they contend, even the NIPA definition understates saving.

Regardless of how personal saving is defined, unless house prices leap forever, or the stock bubble revives, most Americans’ assets are totally inadequate to support them in retirement. And, the almost nonexistent saving from current income means that those net assets are being augmented year by year at trivial rates. A recent study of Federal Reserve data found that the households headed by baby boomers had median financial assets of $50,700. With a 5% annual withdrawal rate, that would generate only $2,535 annual retirement income.

Link here (scroll down to piece by Gary Shilling).

Impending financial strains.

Another recent study found that personal savings will provide only 10% to 20% of retirement income, and when pensions and Social Security are included, the total retirement income will be just 59% of median current income for working Americans. Apart from saving out of personal income, investment gains are unlikely to provide comfortable retirements for many. It is a question of when, not if, the housing bubble collapses, in my view. Also, in the mild deflation I foresee, stock returns will average 4% to 5%, assuming 3% dividend yields, a far cry from the 20%-plus in the 1995-1999 era. After Treasury bonds rally with the advent of deflation, 3% yields will prevail.

Meanwhile, Social Security benefits will probably become less generous, given the impending financial strains on the system. And defined benefit pension funds are being frozen, terminated, converted to less generous cash balance plans, cut out for younger workers or turned over to the government’s Pension Benefit Guaranty Corp., leaving many employees to rely principally on 401(k)s that depend on investment results. So, Americans will need to finance much more of their retirements the traditional way – by saving more of their disposable personal income, but this will be difficult.

Despite these financial strains, Americans have yet to run up their saving rate and run down their debt and debt service levels. Instead, the housing bubble apparently has convinced many that their house (or houses since increasing numbers own more than one) is a huge piggy bank that allows them to borrow more and save less – and thereby generates all that money that will be needed to sustain rapid consumer spending and overall economic growth in coming quarters.

So, if my analysis is correct, the key to consumer spending and overall economic growth is the housing bubble. When it breaks, so will the economy as construction nosedives and consumers shift to a massive saving spree and debt repayment, and a serious recession or worse unfolds. Miserly consumers also will slash imports, to the detriment of the many nations that rely on Americans to buy their excess goods and services. With the Chinese economy cooling and headed for recession, aided by the small revaluation in the yuan, a global recession will result. Furthermore, a serious break in U.S. house prices could destroy so much net worth and so disillusion Americans that the good deflation of excess supply I foresee will instead be the bad deflation of deficient demand.

When will the all-important housing bubble break? Ah, that is the $64 trillion question. It looks like it is in the blow-off stage that is typical of the end of a speculation. Still, speculations tend to last longer and go to greater extremes than imaginable. I am watching closely for signs of a bursting in the housing bubble, and suggest you do too.

Link here.


On August 9 the Federal Reserve raised the fed funds rate again, the tenth such hike since June 30, 2004. In turn, August 9 saw Treasury Bonds and Notes restart a trend which has prevailed during most of the Fed’s rate-hike campaign: Treasury prices went up/yields went down. The linear-minded powers that be at the central bank have not been amused, since Treasury yields and interest rates are “supposed” to go in the same direction. In other words, the Treasury market has kept its thumb in the Fed’s eye for more than a year.

Such is the fate of linear minds that make assumptions about non-linear markets. The trend in Treasury yields is just one of many examples that show how limited the Fed’s powers truly are. If economists and media experts spent as much time studying those limits as they do parsing Mr. Greenspan’s speeches … well, you know how to finish the sentence.

Link here.


At the height of “the bubble”, just when the wheels started to come off, Mississippi John Law came up with a brilliant plan to save his company and the Banque Royale. The year was 1720 Paris, over the previous three years and by virtue of Law’s financial innovations, had become the largest and richest city in Europe. Law’s “innovation” was paper money. Apart from a several hundred-year stretch in China ending in 910, the world had never seen or used paper money. At the outset of The Mississippi Scheme, Law had demanded, on the pain of death, that his banker’s not print more money than could be redeemed in gold from their own reserves. The strict backing of the currency – what was essentially the world’s first gold standard – gave investors of the day such confidence that the currency actually traded at a premium.

But there was a problem. Law’s bank existed by virtue of a deal with the Regent of France, the Duc d’Orleans. The finances of the government in France following the reign of Louis XIV, his wars and the building of Versaille, were a mess. Seeing how much value was being placed in the new bank notes of the Banque Royale, the Regent set another precedent modern readers will recognize: he decided to print his way out of debt. He suggested Law issue currency up to 80 times what the bank held in redeemable gold reserves. Law, being rather preoccupied with the power and prestige the Scheme had bestowed on him, ignored his previous warnings, and let the printing begin.

The new notes flooded into the market and for a while held the value they had gained with solid gold backing. So many people got rich, the Aristocracy of the time coined a new term to describe the: “millionaires”. Stories of commoners making so much money fired the imaginations of thousands and thousands more investors and the frenzy got out of hand. New Orleans was founded at the time, named after the Regent, and meant to become the Paris of the New World.

When people started getting wind of the fact that there was nothing backing Law’s currency but rumours of future profits to be reaped in the New World, they started losing confidence in the new currency. Law trying to keep up appearances just a little longer rounded up all the beggars, bums and thieves in Paris, furnished them with picks and shovels, and marched them through Paris ostensibly on their way to New Orleans … and the mines of Mississippi. The quiet hiss of air leaking out of the bubble accelerated into a screeching “whoosh!” when the same old dirty faces began appearing in the same old dirty doorways and alleys.

In 1971 the almighty dollar was the last modern currency to be officially removed from the gold standard. Ironically, or not, the move was precipitated by the French government. At the time, de Gaulle realized that the U.S. had built up immense debts to governments around the world. If the U.S. wanted to pay the debts back, all we had to do was fire up the printing press, and the world was forced to accept our paper in lieu of these debts. De Gaulle thought he would redeem his paper for gold … a move that was still legal at the time. Nixon thought better of it. Said no way. And closed the “gold window”. Since that day, no one – not you, me or the president of France – can redeem their paper money for gold. And the value of the dollar is largely determined by the confidence investors around the world foresee in future success of U.S. economy.

Link here (scroll down to piece by Addison Wiggin).


Katrina’s psychological impact has carried to all corners of the country, including New York. Prices for nearly every energy market traded on NYMEX hit record highs Monday and Tuesday. Gains in gas and the product markets make crude oil’s surge past $70 seem paltry. Natural gas soared 20% in a single session and September unleaded prices have risen more than 50 cents per gallon in just two days. So for good reason, Katrina is everywhere in the news, including the commodities page. An L.A. Times headline from Tuesday morning is just one of many that say the same thing: “Hurricane Packs Punch on the Energy Markets”.

But this simple cause and effect explanation falls far short of telling the whole story. No matter how severe this storm turns out to be, Katrina is not “behind” the waves that have buoyed the energy complex to new heights. A year ago, analyst Steve Craig confronted a similar misunderstanding caused by Bonnie, a much smaller Tropical Storm. His explanation bears repeating now: “Even though industry participants are well aware of the weather, events like these [tropical storms and hurricanes] defy prediction much like an act of terrorism. While there is no denying the psychological impact, more often than not, the market reaction will fit into the larger Elliott pattern, even when it’s not terribly clear upfront.”

In other words, prices in freely traded markets are always a function of what the seller asks and what the buyer bids. Over time, many factors affect the psychology of the buyer and seller – yet when their minds meet, you get a price. And make no mistake: the meeting of those minds is, above all, psychological. That psychology unfolds in recognizable patterns.

Link here.

I should have written this yesterday …

Today’s Market Watch is one that I should have written yesterday. Alas, I first needed to see the long lines of cars at every gas station I passed on my way home, and then read about people paying $6-per-gallon prices in Atlanta; only then did I grasp how completely common sense had surrendered to irrationality. There is no shortage of any petroleum product – be it crude oil, gasoline, or for that matter Vaseline. Today brought more reports of long gas lines in places like Charlotte, N.C., even though local officials are “trying to dispel rumors about supply.”

I do not envy their task. Crowd behavior does not usually distinguish rumor from fact. On this page I speak not a crowd but to individuals. I can trust that you are swayed not by others but by simple facts, to wit: The U.S. consumes about 9.4 million barrels of gasoline each day. In its latest weekly petroleum report (Aug. 26), the Department of Energy said total U.S. gasoline stocks were 194.4 million barrels. In a special report yesterday, the department also said this: “Total commercial petroleum inventories rose by 2.4 million barrels last week and now stand above the upper end of the average range for this time of year. Total product supplied over the last 4-week period has averaged 21.5 million barrels per day, or 2.3 percent more than averaged over the same period last year.”

As for the refineries in the gulf region that were hampered by Hurricane Katrina, the New York Times reports that the two major gasoline delivery pipelines have restarted and are pumping fuel. Both expect to increase their operating capacity by the day. Crowd behavior is infectious, but you do not have to catch it.

Link here.


Europeans have always considered themselves one step ahead of the prudish Americans when it comes to tolerance for nudity. Turn on the TV in most countries in Europe, go to the cinema or a public beach, and the difference is obvious: most Europeans do not cover their children’s eyes or call the cops when they see someone wearing less than they “should”. Still, when the usually moderate Leopold Museum in Vienna announced its “experimental” policy during a recent, err, exhibition, it caused a bit of a ruckus. In August, the museum presented a 180-piece collection titled “The Naked Truth”. And anyone who showed up at the door “wearing just a swimsuit, or nothing at all” got in free (AP).

And show up they did – some “wearing only sandals and a black bikini bottom,” or just a pair of Speedos, or even less than that. One of the goals of the exhibition was to create a “mini-scandal”, said the museum’s commercial director. “We wanted to give people a chance to cool off, and bring nakedness into the open. It’s a bit of an experiment.”

Now, the only problem that I see with nudism is that too often, it is the wrong people who want to get naked. As one museum visitor put it, “What’s the big deal? We’re born naked into this world. Why can’t we walk around in it without clothes from time to time?” Ditto, and it is not the purpose of this column to be moralistic. As Elliotticians, when it comes to analyzing the news, we rarely focus on “Why?” Instead, we ask “Why here?” or “Why now?”

Indeed, why did this “mini-scandal” not take place in some other European city that is more notorious for shocking the public with risqué artistic displays? Why was it the “somewhat more conservative, overwhelmingly Roman Catholic Austria” that hosted the provocative exhibition? Take a look at this chart of the Austrian stock index. Notice that the ATX is currently standing at its all-time highs. While most other European bourses have barely recovered half of the losses they suffered in the 2000 bear market, the ATX has almost tripled in value over the past five years! Clearly, Austrian stocks have been in a major bull market. We have long observed that bull markets in social mood – as evidenced by the rising stock market – bring out the aggregate feelings of “adventurousness, permissiveness and friskiness” in people. And well, going to a museum naked is about as frisky as it gets.

Link here.


Great rushes of market euphoria have inevitably been followed by sudden loss of bids, overall liquidity, as well as the discovery that financial concerns have displaced celebration. Naturally, early symptoms of such fateful transitions are worth monitoring. These include the yield curve flattening with the boom and then reversing to steepening. The U.S. curve is still flattening, but the U.K. curve reversed in July. Another indicator of change is widening credit quality spreads. For high-yield corporates, the spread, over treasuries, resumed widening at 301 bps on August 2 and so far has reached 315 bps – 320 bps would lock in the trend towards concerning conditions.

One of the more interesting such indicators is not widely followed. At times, the gold/silver ratio seems to act like a credit spread in anticipating or confirming a boom by decreasing, or the same for contraction in increasing. The ratio increased to 81 in June, 2003 and, as it reversed, it confirmed that the boom would soar (see chart). The decline to 55 on June 1 (the spike-down to 51 in 2004 seems anomalous in the context of this discussion). However, since early June the ratio has had a significant recovery and today’s swoon in silver popped it above resistance at 64 to 65.5. Technically, this is breaking out of a reverse “head and shoulders” pattern which is opposite to that at the top in 2003.

At this stage of speculative euphoria, typically its exhaustion is signaled by dramatic plunges in silver relative to gold. This seems to be starting and it is worth noting that currently Brazilian and Indonesian credit spreads have been widening. The latter reminds of the Asian Crisis that started with the Thai baht on July 1, 1997. Buying of lower grade credits has been ambitious, if not reckless. On August 18, the Wall Street Journal headlined “Binge in Purchases of Corporate Debt”. There has been similar buying of low-grade emerging debt bonds. At times of almost relentless euphoria in lower grade bonds, it is worth reviewing the consequences of previous examples.

Link here.


The U.S. economy is vulnerable on so many fronts. Social emphasis is being placed on protecting ourselves against terrorists and the threats of nuclear and chemical attack. But perhaps an equally serious peril is being ignored: our dependence on Middle East oil, for example. We face a shrinking dollar, growing federal debt, increasing trade gap, record-high consumer debt, mortgage bubble, rising oil prices, inflation, flat productivity, falling wages-all part of the same trend translating to financial vulnerability, of course. But this economic sword of Damocles points the way to how everyone can change their investing mode, not only to avoid loss but also to maximize their investment profits.

If you accept the suggestion that big changes are going to be coming in these arenas, how can you reposition assets without also increasing market risks? Most investors are not going to sell their equity positions and go short on stocks, sell options, or sell futures. It simply is not within their profile to do so. The trick is to find ways to take advantage of the coming changes in smart ways, and there are several. The way you choose to change strategies should depend on your investing experience and knowledge, risk tolerance, and personal preferences. In seeking ways to reposition your portfolio, there are four major markets to keep in mind as places where you will want to either avoid long positions or seek ways to work against the trends: mortgage pools, oil, and gold.

A few years ago, mortgage pools seemed like no-brainers. Fannie Mae and Ginnie Mae, among others, were formed to buy up mortgages from primary lenders, package them into pools, and sell shares to investors. Because these pools consisted of secured debt in owner-occupied homes, they were described as low-risk. Not any more. Fannie Mae, caught tinkering with the books, has already dropped off its high price levels. Investors who understand the options market would be wise to look critically at mortgage pools and think about buying long-term puts. Fannie Mae has more than $1 trillion in assets, and it may prove out that its accounting problems will be the first blip on the mortgage crisis radar. Why? When the mortgage bubble bursts, higher levels of foreclosures and declining housing values could spell disaster in the housing market and in the mortgage pool industry.

The price of oil went over $50 per barrel more than once in 2004, and by 2005 it seemed inevitable that the price was going to continue upward. Remember, only three years before, barrel prices were down at the $20 range. The rise in prices was not as surprising as how quickly it occurred. There is no logical reason to expect oil prices to drop. Stocks in companies involved in oil drilling and exploration, as well as those supplying drilling ventures, will continue to be solid investment opportunities in the future. New demand for oil rigs and drilling will push profits and stock prices higher.

Look for stocks that will benefit as oil prices rise. For mutual fund investors, seek out energy and commodity funds. For the more advanced investor who is comfortable with options, consider buying long-term calls in oil-related sectors with the greatest growth potential. Consider the four major subsectors within the larger energy sector of the market: coal, oil and gas (integrated), oil and gas operations, and oil well services and equipment. Of course, looking for energy-related mutual funds and ETFs is also a wise move. With prices rising, oil and gas companies and their products will become more in demand in the future.

The ultimate dollar hedge investment will always be gold. Investing in gold through ownership of the metal itself, mutual funds, or gold mining stock provides the most direct counter to the dollar. As the dollar falls, gold will inevitably rise.

Link here (scroll down to piece by Addison Wiggin).


Every contrarian investor pledges allegiance to the following creed: Shun whatever the masses love; love whatever the masses shun. Whenever an investment idea becomes extremely popular, it usually becomes extremely unprofitable shortly thereafter. That is why innovative investors throughout history have attempted to devise gauges that indicate moments when investor sentiment becomes overly optimistic or pessimistic. We call these contrarian indicators.

Some of these indicators are more amusing than useful. There are indicators derived from Time magazine covers, and best-selling books and even Alan Abelson’s columns in Barron’s. Whatever idea these media venues promote, the theory goes, are the very idea that a prudent investor should avoid. The chatter one hears at investment conferences provides another particularly useful contrary indicator. While I was in Vancouver last month for the Agora Wealth Symposium, I heard a lot of enthusiastic talk about China. It seems that China was the main thing most investors wanted to talk about, including my cabbie. China headlines sell. People flock to hear about investing in China. Could this also be a warning sign?

It could be. But I am more interested in what people are NOT talking about. At a conference about global investing, I heard quite a bit about China and India, and even Brazil. I also heard a lot of talk about energy and the dollar … but not one word about Mexico. That is one reason I am attracted to Mexican stocks. As the nearby chart illustrates, the Mexico Fund has been performing admirably over the last few years. Yet China Fund has produced twice the gains. The Mexico Fund has been closing the gap recently, and I suspect this trend will continue. For one thing, Mexican stocks are much cheaper than Chinese stocks. The average price-to-earnings (PE) ratio of the stocks in the Mexico Fund, for example, is below 13, while the average PE of the China Fund’s holdings is above 20.

The Mexican bolsa offers a number of world-class investments opportunities that are selling for very low valuations. Some of the perceptions about Mexico stubbornly limit its appeal. Most people seem to have a relatively low opinion of the place … violence, corruption, poverty, illegal immigrants and ill will about NAFTA. I am not denying that Mexico is still a largely poor country with its share of emerging-market pains. But at a certain price, it becomes worth the risk. I would argue that if you do the micro work well, the macro stuff become less important. Cheap valuations, or a margin of safety, will pull you through a lot of adversity, like a sled dog though the Iditarod.

Link here.


Thin Asians and Fat Americans crowded into Disneyland last Thursday, along with your editor and his conspicuously lean family. Each of us ponied up $76 apiece to enter the “Happiest Place on Earth”. The food was not included, of course. But that did not prevent either the thin Asians or the fat Americans from consuming lots of it. In one particular eatery, we observed a diverse crowd of “thins” and “fats” chowing down the identical fat-laden grub. As your editor surveyed this scene, he imagined he was witnessing an epic shift in global consumption trends – a shift from West to East.

Even if we Americans tried to stuff more junk into our over-stuffed bodies and homes, we could not possibly keep up with the Chinese. Since the Chinese outnumber us 4-to-1, and since the Chinese economy is growing more than twice as fast as ours, the Asian nation is certain to overtake U.S. demand for many of the world’s resources. As present, Americans represent only 5% of the world’s population, but consume 26% of its resources. Purveyors of consumption, therefore, have prospered handsomely in the America of the last 40 years – McDonalds and Disneyland being two notable examples. But we would expect the next 40 years to belong to the purveyors of consumption in China.

When Disneyland opened for business in the summer of 1955, it featured 19 attractions and a family of four could walk in for less than $5 bill. The present-day Disneyland features many more attractions and costs about 60 times more money to visit. “But one thing,” Joel Beers, in a witty OC Weekly column, relates, “has stayed eerily consistent: the grub. Although the original park has expanded greatly, there are still only six more places to eat. And the food offered in 1955 is still, by and large, the food offered now: hot dogs, hamburgers, fries, candy, ice cream, fried chicken, cookies, sugar-saturated soft drinks, potato chips.” Disney-style junk-food may not have changed much over the last 50 years, but we Americans are eating more of it than ever. Over the last 35 years, the average American woman’s daily intake of calories rose from 1,542 to 1,877 and the average American man’s from 2,450 to 2,618.

Not surprisingly, therefore, the “fats” are getting fatter. And yet, we continue to consume ever-growing quantities of everything – from Big Macs to SUVs to home-equity loans. Clearly, we cannot help ourselves. Nothing short of an AA-style “intervention” could halt our over-consumption. But even as we try to gorge ourselves, we cannot possibly keep up with Chinese consumption trends.

In 2002, for example, the U.S. consumed more copper than any other nation. China now claims that distinction. Then, last year, China consumed twice as much steel as the U.S. China now consumes more oil than Japan. The increasingly prosperous Asian nation has also become a voracious consumer of agricultural products. While we add calories to our diets, the Chinese are adding protein. The feeding (and fattening) of America over the last three decades contributed mightily to the prosperity of companies like McDonalds. History is in the process of repeating itself: the feeding (and fattening) of China will provide opportunities for innumerable companies. The appetite of 1.3 billion individuals is not easily satisfied.

Link here.


Inflation, a pernicious stealth tax on purchasing power surreptitiously levied by immoral governments, is one of the greatest persistent obstacles to serious wealth generation. By creating fiat money out of thin air and spending it today, governments increase the amount of money in circulation. The larger the money supply grows, the more dollars bid on and compete for goods and services driving up general prices. These rising prices reduce the purchasing power of investors’ scarce capital, effectively expropriating it through a dishonorable “tax” that not 1 in 50 people truly understand. Inflationary policies increasing monetary growth are tax increases, no different in ultimate effect than directly raising marginal income tax rates. But since so few people, including sophisticated investors, really grasp this, governments often prefer inflation to politically unpalatable direct tax increases.

Interestingly, the groups of investors that seem the most savvy in considering real (inflation-adjusted) returns instead of the usual nominal ones are the contrarians investing in commodities. As I discussed last week, commodities investors often know exactly where key commodities like gold or oil traded in real terms over the past half century. Studies of real commodities price histories are fairly common in contrarian circles. But sadly mainstream stock investors are seldom if ever exposed to inflation-adjusted studies on the stock markets. Whenever Wall Street talks about secular gains, like in the Great Bull Market from 1982 to 2000, nominal stock-index numbers are used. This serves Wall Street’s interests well by seriously overstating the actual purchasing-power gains won by past investors, but it does a great disservice to today’s investors.

In order to analyze the impact of inflation on stock investors, we did some research work on the mighty S&P 500 this week. Using monthly data since 1950, we overlaid the usual nominal S&P 500 with a real S&P 500 adjusted for inflation. The U.S. Consumer Price Index was used for computing the monthly inflation adjustments, which is extremely conservative. The CPI is intentionally lowballed to understate inflation for political reasons.

So as you drink in this chart and its sobering implications, please realize that these numbers are the most conservative possible estimate of inflation that your ever-benevolent government wants you to believe. If broad M3 money growth was used to measure inflation as it ought to be rather than the controlled CPI, the results below would be far, far worse. CPI inflation truly is the best-case scenario for investors. The blue line is the usual nominal S&P 500 and the red line represents the CPI-adjusted real S&P 500, in constant 2005 dollars. At various major long-term highs and lows the actual index levels are noted, and the nominal (blue) and real (red) returns between these interim extremes are computed. Yellow numbers under these returns show the ratio between real and nominal gains. Ratios under 1.00 indicate that actual real returns were smaller than nominal S&P 500 gains.

The net impact of even conservative CPI inflation on long-term stock investors in the last half century has been staggering. Inflation matters, in a monumental way, for stock investors working hard trying to multiply their scarce and precious capital. Only fools ignore the long-term effects of inflation on investments. One of Wall Street’s greatest selling points, which is unfortunately a myth, is that stocks always do well over any long-term span of time. In reality the precise endpoints bracketing a particular long-term timespan are crucial for determining long-term investment success. And the ravaging effects of inflation act to magnify the paramount importance of exquisite buy and sell timing.

Note on the blue line above how the S&P 500 went from 108 in the late 1960s to 107 in the early 1980s for a small 1% loss. That is bad enough, to not earn any money over more than a decade, but if you look at the same slice of time in the red inflation-adjusted data, investors actually lost nearly two-thirds of their purchasing power over this same period! This illustrates one of the key points of long-term real returns. When stock prices are flat or declining, inflating money supplies accelerate the real losses borne by investors. Somewhat frighteningly, we have already witnessed this in the first downleg of the latest secular bear since 2000. Real losses were already running 1.05x the nominal losses and I suspect this multiplier will only grow as the years march on.

During the greatest bull market in U.S. history, in the 1980s and 1990s, nominal gains rocketed up a staggering 1317% higher. But after inflation was accounted for, investors only earned about half that, 0.53x or 700%, in terms of raw purchasing power. This reveals the unpleasant truth that fully half of the bull-market gains of legend in the last couple decades were illusory, solely driven by Washington and the Fed relentlessly expanding money supplies and driving up general prices. Now a 700% increase in purchasing power is excellent – but this 18-year period of 700% real gains is a major anomaly. Not only is it rare, but investors would have had to buy at exactly the 1982 low and sell at exactly the 2000 high. Perfect timing is not very likely in reality.

What if, instead of buying in 1982 at a major low where everyone hated stocks, investors had bought at a major real high in the late 1960s when everyone loved stocks? In November 1968 the real S&P 500 closed at 599 on a monthly basis. It would not hit this level again until December 1992 and not go materially higher until March 1995. Thus, investors buying at the wrong time during the late 1960s top would have waited 26.3 years before they earned even one additional percent of purchasing power! Ouch.

In the chart one truly huge timespan is delineated. It runs from 1950 to 2000. Now please realize that the U.S. stock markets made a major secular bottom in 1949 and a major top in 2000, so out of any times to buy and sell since World War 2 these are the most optimal by far. In this perfect best-case scenario, the S&P 500 rose by a massive 8801% over a half century! These are awesome gains, but once again they are nominal, not adjusted for purchasing-power declines. If we take the inflation-adjusted S&P 500 in constant 2005 dollars, the gain is gutted to merely 1111%. Over the past half century from the absolute best-case moments in time to buy and sell for the long term, fully 7/8th of the gains investors could have reaped are illusory.

The bubblicious real-estate industry today makes a big deal out of quoting nominal gains in houses over long-term periods often running several years to several decades. While inflation has a minor effect over several years, when you get into decades its effect is huge. Just as in stocks, the majority of any gains in a house from 1950 to 2000 are likely eaten up by inflation with true real gains only comprising a modest fraction.

As I outlined recently, unfortunately stocks are still near the 2000 top of their long cycles. It usually takes 17 years or so for stock markets to run from their secular peaks to their secular troughs, so unfortunately we are probably only a third or so into this current secular bear. Investors who buy stocks today and want to hold for a decade or more likely face flat markets at best. Flat markets may not seem like the end of the world, but when the Fed’s relentless fiat inflation is factored in it can lead to massive real losses over timespans exceeding a decade.

The only way to beat inflation is to ride the perpetual bull. There is always a bull market somewhere. Thankfully when stocks are in the bearish phase of their long cycles commodities are in their own bullish phase, and vice versa. The commodities markets tend to move exactly out of phase with stocks. Now today as stocks grind lower commodities are already marching higher in their greatest bull market in decades.

Link here.


Spurred on by the growing concern that America’s residential real-estate market is heading for a downturn, a number of top economists are producing lists that rank the metropolitan areas most likely to suffer a drop in housing prices. The problem is that these studies, which look at factors from local income to lending practices, come to strikingly different conclusions. Even so, the raft of data can provide useful clues for homebuyers and investors wary of getting in at the top. Economists at PMI Mortgage Insurance Co., for instance, recently calculated that the Boston area faces the greatest risk of a drop in housing prices among 50 U.S. cities they analyzed. But Boston does not even make the top 10 in lists of potentially overpriced markets compiled by researchers at mortgage lender National City Corp. and investment bank Credit Suisse First Boston, a unit of Credit Suisse Group.

The PMI ranking puts the New York area at No. 14 on a list of frothy places. But National City ranks the Big Apple at a mere 68 out of 299 metro areas – below such places as Flint, Michigan, and Duluth, Minnesota. National City is not claiming that Flint is pricier than New York, of course, but says Flint appears more overvalued in terms of supply-and-demand fundamentals.

No national study can take into account all of the factors that affect house prices, or determine whether a particular home or neighborhood is dangerously overpriced or a screaming bargain. Such assessments require the expertise of people in the local market. But the rankings do highlight certain cities and regions where buyers may want to be more cautious than usual. That is particularly true in the cases where the studies agree: The PMI, National City and CSFB rankings differ markedly – but all include Riverside-San Bernardino as an area where prices may drop.

The economists who churn out these rankings come to different conclusions for a good reason: They use different methods. One common technique is to compare the monthly costs of buying a house to rents. Because people can choose to buy or rent, the two costs should not get too far out of whack. Rents also represent the earnings potential of a home, so the ratio of home prices to rents is akin to the price/earnings ratio used by stock investors.

Edward Leamer, an economics professor at the University of California, Los Angeles, compared median 2004 home prices to the typical annual rent of a 1,500-square-foot apartment in various cities. He found that this price/rent ratio had risen fastest since 2000 in West Palm Beach, Florida; Orange County; and the San Francisco area. Leamer acknowledges the flaws in such an analysis. For one thing, apartments are not exactly the same as single-family homes. And the low interest rates that have allowed more people to buy homes also depress demand for apartments, pushing up the ratio. Even so, the ratio helps to identify places where prices may have risen too fast.

Another method is to compare house prices with local incomes to see how affordable houses are. Michael D. Youngblood, an economist at the Arlington, Virginia, investment-banking firm Friedman, Billings, Ramsey & Co., studies the ratio of median house prices to personal incomes per capita. Based on that ratio, he recently found that Santa Barbara, Salinas and Santa Cruz, all in California, were the nation’s least-affordable housing markets. But he says prices in those cities and some others are unlikely to decline significantly because of severe shortages of space and regulatory barriers to housing construction. Those constraints make these markets “dysfunctional”, Youngblood says. Los Angeles also has a relatively high house-price/income ratio but fewer barriers to construction than the dysfunctional markets, he says. He thinks the “bubble” in Los Angeles would only begin to deflate before the city experiences at least 12 months of decline in economic output.

Others toss more complicated blends of data into their computers. Richard J. DeKaser, chief economist at National City, examines the ratio of home prices to household incomes in metro areas and tries to explain the variation in these ratios on the basis of population density (a proxy for shortages of space), relative income levels, mortgage rates and historically observed differences in prices. (Those differences, he says, reflect such things as climate, schools and cultural attractions.) Based on that data, he estimates what house prices should be and compares those estimates with actual prices to determine whether a market is over- or undervalued. DeKaser found that as of this year’s first quarter, 53 metropolitan areas – accounting for 31 percent of the total U.S. housing market – were “extremely overvalued and confront a high risk of future price correction.” Santa Barbara topped National City’s list.

Link here.

What should you do about the housing bubble?

As more and more warning headlines about the housing bubble are popping up, even Fed Chairman Alan Greenspan felt compelled to address it last week. He pointed out that “history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.” Which, translated, means: Watch out. When mortgage rates go up and home prices stop increasing, it is going to be a killer for people who have overextended themselves and bought real estate they could not normally afford.

Well, it is good to see that Greenspan is finally ready to acknowledge what readers of Bob Prechter’s Conquer the Crash learned a few years ago: that too much credit (and easy credit, at that) has been helping to blow up a huge asset bubble around real estate. Bob is predicting a bear market so large that it will result in a deflationary depression, in which stocks, bonds, and – yes – houses will lose value. Read this excerpt from Conquer the Crash to get some advice on what to do to prepare for the popping of the housing bubble.

Link here.


I often refer to the all-too common folly known as performance chasing, whereby investors dump what they are holding and buy whatever has been “hot”. There is, however, a financial vehicle that private and professional investors alike have refused to chase no matter how well it performs. What is more, this vehicle has performed well indeed over the past five years. While all major U.S. stock indexes remain in the red for that period, this humble alternative never had a losing year, or even a losing month. It is also worth noting that the vehicle in question adds the unique value of being virtually risk-free.

By now you may have surmised that I am talking about cash and cash equivalents – the ONLY investment vehicle that meets the criteria spelled out above. And on a comparative basis, cash would have been at its most valuable five years ago: That is because back then, cash was as universally despised as stocks were universally loved.

Link here.
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