Economic Update:
“I will gladly pay you Tuesday for a Hamburger today!” This is obviously the approach the government is taking to the economy. Spend spend spend, but don’t worry I’ll pay you Tuesday. The good news is that we seem to have averted a complete meltdown, and make no mistake about it; we were closer than you think. I’ll never forget that Sunday when Merrill Lynch was about to go under. My whole body was literally shaking, both from the fright of the possibility and the excitement of being right on the economy and markets which I forecasted in my Economic Tsunami special report. All of this spending is trading a faster long term recovery for a smoother road for the short term. Proof can be seen this morning with Wells Fargo’s announcement that they will earn record profits this quarter. Its one thing for the tax-payer to pay for their solvency, but quite another to pay for their glory. It reminds me of a quote from Joe Kennedy (John’s dad): “Don't buy a single vote more than necessary. I'll be damned if I'm going to pay for a landslide”. The bad news of this massive spending is that by lessening the pain now, the recovery to real growth will be delayed.

Last week saw a continuation of the questionable policy response to this financial crisis, which seeks to address the downturn by encouraging more of what got us into this mess in the first place. Applying more leverage to the problem that got us into this…“leverage”, seems absurd to me. Doesn’t anybody agree with me? The U.S. Treasury's toxic assets plan, for instance, looks to "leverage" public funds (with the FDIC providing the "6-to-1 leverage") in order to defend the bondholders of mismanaged financials who took excessive leverage. At the same time, the Treasury plans to limit the "competitive bidding" to a few hand-picked "managers" who will be encouraged to overpay thanks to put options granted at public expense. This certainly seems like a recipe for the insolvency of the FDIC and an attempt to bail out bank bondholders using funds that have not even been allocated by Congress. The whole plan is a bureaucratic abuse of the FDIC's balance sheet, which exists to protect ordinary depositors, not bank bondholders.

The stock market cheered a move by the Financial Accounting Standards Board (FASB) to relax FAS-157 (the "mark-to-market" accounting rule), allowing nearly insolvent financial companies to use more discretion in the models they use to assess fair value. Of course, the irresponsibly rosy assumptions built into these models have been a large contributor to this near-insolvency, because they virtually ignored foreclosure risks. Now, the Fed is sticking it to the tax payer yet again by eliminating the mark-to-market provision just in time for the banks to sell their toxic assets to us, the tax payers. That means the tax payer gets to pay a higher price for these assets. Plus, the few specially chosen companies get most of the profit but we take most of the risk. Has Ralph Nader been kidnapped?

According to Bloomberg, the Treasury has injected over $955 billion in direct stimulus, $700 billion in the “Tarp,” and just over a trillion dollars in various other support or guarantee programs to banks and major corporations. Meanwhile, the Federal Reserve has commitments up to an astonishing $7.7 trillion in various lending, guarantee, and open market operations programs in an attempt to keep the credit markets functioning and interest rates down. The FDIC has separately added in $2 trillion in guarantees, bank bailouts, and “public-private partnerships,” and even HUD has chipped in a good $300 billion. This brings the total amount potentially spent, lent, or guaranteed by the Federal Reserve and U.S. Government to $12.8 trillion—not far from the total value of U.S. GDP at$14.2 trillion! And much more is expected in the years ahead. We are now looking at a $1.7 trillion deficit for 2009—assuming a better economy than we expect.

The greatest absurdity is that the government is projecting that we return to 4% GDP growth in 2010 and beyond; Hard to believe that’s even remotely possible given tighter lending standards and natural slowing in Baby Boom spending. If we are right about a worse downturn into 2010 and 2011, then we could easily see $3-trillion-plus deficits into as late as 2013. At some point in the next year it is going to look as if the U.S. government is racking up incredible debt with little results. That could cause a run on the U.S. dollar and a rise in long-term Treasury bond rates, despite efforts to keep rates down. A rise in long-term rates is the worst thing that could happen to housing now that short-term ARM loans and rates have been so disfavored. Thus far, lower rates continue to stimulate strong refinancing but only weak rises in home buying and new mortgages (outside of California)

Stock Market Strategy – Pray for peace…prepare for war
We currently have had a nice advance off the lows, and I do expect it to continue for a bit. However, there is not enough tangible evidence at this point to suggest that the current advance is anything more than another multi-month recovery within a bear market. Thus, the rally appears to be most appropriate for very nimble investors. That said, the rally appears to be the healthiest and most dynamic recovery since our original Intermediate Trend sell-signal, warning of a bear market, was registered on July 26, 2007. And the positive signs for this rally continue to accumulate: During most of the past 20 months, the occurrence of a 90% Downside Day was commonly followed by several more 90% Down Days, as investor psychology turned increasingly negative. But, the 90% Downside Day on March 30th was immediately followed by a series of progressively stronger days of rally, culminating in a 90% Upside Day on Thursday, April 2nd. This break of pattern indicates a positive change in investor psychology. The Dow S&P 500 Index, NYSE Index and the Nasdaq Composite have risen to new rally highs, above their previous March 26th peaks. Volume expanded on the rallies, generating the sixth 90% Upside Day for the NYSE during the past four weeks, and today looks to be another.

While these improved signs of strength are encouraging, they do not necessarily indicate that a new bull market is now underway. Extended bear markets in the past have frequently included strong rallies lasting two to three months before dropping to new bear market lows. There have even been some bear market rallies lasting as long as six months, such as from mid-Sept’2001 through mid-Mar’2002 and Nov’29 through April’30. Many bear market rallies are strong enough and last long enough to justify new equity purchases. But, the renewed strength can also cause buyers to throw caution to the wind, and become complacent just before the bear market resumes.

With regard to the economy, there is quite a bit of optimism that the recent market advance represents a forward-looking call that the economy will recover in the second half of the year. Indeed, some analysts have noted that year-over-year consumer spending has only declined very slightly, hailing this as evidence that economic concerns are overblown.

The difficulty is that consumer spending has never declined on a year-over-year basis, except in this downturn, so that slight decline is actually the worst showing for consumer spending in the available data. Likewise, capacity utilization has plunged to levels seen only in 1974 and 1982, both which were accompanied by far deeper valuation extremes than at present. The only way that stocks could be considered extremely undervalued here is if we assume that the record profit margins of 2007 (based on record corporate leverage) are the norm, and will be quickly recovered. While we never rule out the potential for surprising strength or weakness in the markets or the economy, the assumption that profit margins will permanently recover to 2007 levels is equivalent to assuming that the past 18 months simply did not happen.

Strategy: There are many investments doing very well, and many high dividend paying stocks and many high yielding short term corporate bonds. Use this period of “non-plunging” to re-examine your portfolio and tweak it for the current bear market and NEXT bull market. DO NOT get complacent. DO NOT procrastinate. If you are sitting on a portfolio built before this economic Tsunami hit, you probably need to make adjustments. If you lost more than you thought you should, could or wanted to, you definitely need to make some adjustments. Take charge of your finances while there is a period of calm so you can make rational decisions. If you would like a free honest 2nd opinion, just reply back or call me at 916-925-8900. I’ll tell you where you are going right, where you are going wrong and give you the resources to make proper decisions. If something doesn’t look good, I’ll tell you why and how you can improve. If you are in good shape, I’ll congratulate you on a job well done. I love happy endings.

Real Estate assessment – Nice spring break…can it last
The real estate market has had a nice blip up, especially in California. Unfortunately it’s only seasonal, as the housing crises will likely be around for a while longer and getting worse before it gets better. The obvious insight is the old demographic reality. Older people become net sellers and accelerate that trend from their early 70s and forward in age. The peak number of buyers for homes comes as we would expect between the ages of 30 and 34, due to starter home buying. Trade-up home buying at much higher prices drives up overall home purchases in dollars among those ages 35 to 39, despite declining numbers of buyers. Selling first bottoms in the 60 to 64 age range, and then accelerates from ages 70 to 74 and forward as people move into nursing homes or assisted living facilities and ultimately die. When you have an older generation that is as large or larger than the younger one, the net sales of older people cancel out or even exceed the new home purchases of the rising younger generation.

Hence, the paradox of home prices continuing to fall. People in the leading edge of the Baby Boom generation born from around 1937 forward are turning 72 in 2009, with massive numbers of net sellers coming for 24 years to follow. So, how will home prices recover substantially when there will likely be older sellers than buyers? We already have the real estate we need for decades to come except in areas with continued increases in migration—unless we see another surge in immigration, which isn’t likely at least for a decade. Hence, most areas are not likely to see home and commercial prices as high as they were in 2005-2007, even in the next boom period from the 2020s forward. Expect real estate will revert to being valued as a place to live or to do business rather than as an asset that appreciates substantially, and renting may make sense to more of the younger and older families. I would use this glimmer of hope to sell any real estate you don’t live in or love regardless of price.

On the Home Front:
Well, Josh is finishing up his first year at Christian Brothers, and I think he’s finally getting it. His grades have improved (under the penalty of home confinement this summer), and he’s doing pretty well. I’m a little strict, nothing under a B. Football will start up soon after school ends next month, and he’s getting in good shape for it. As the season starts, I’ll be sure to include a pic or two.

If you have any comments or questions about the market, the economy or your portfolio or simply want a free 2nd opinion on what you’re doing, just give me a call or reply back. I’d love to chat with you.

Cheers –Keith

Keith Springer is President of Capital Financial Advisory Services, a registered investment advisor, providing Wealth Management and Mortgage Consulting Services.  For more information on how to build and maintain a solid retirement plan, please contact Keith at
916-925-8900 or Keith@KeithSpringer.com