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What’s happening now – CPI lower than expected, no inflation in sight
The Bureau of Labor Statistics reported CPI for May increased a modest +0.1% from April. (The March monthly CPI was 0.0%) Today’s (6/17) CPI is less than the consensus estimate of +0.3%. Excluding food and energy, CPI was also up +0.1% for May, which is less than the +0.3% for April. The year over year CPI is down -1.3% and excluding food and energy Y-O-Y CPI was up +1.8%. Today’s (6/17) CPI data suggests the inflation genie remains in the bottle with no inflation in sight. This is in line with what I have been saying for a long time. Inflation is not the problem. Deflation is. Quite simply, assets are being destroyed faster than the government can inflate. What they really need is about $25 trillion to make a difference, and they don’t. (thankfully or they’d spend it)

Market update – Time to raise the warning flag
For the first time since I went bullish on March 11, I am getting a little nervous. The market seems to be over the “It’s not the end of the world” rally, and looking for real evidence of a recovery. A lack of selling appears to be the primary factor in keeping this rally afloat. The lack of Demand behind the gains over the past month is very evident in the behavior of the Buying Power Index. Although the DJI, S&P 500 and NASDAQ Comp. Index were all at new rally highs late last week, the Buying Power Index was far from its high reading, at 172, recorded on May 8. In fact, with yesterday’s drop to 124, Buying Power is now at its lowest level since March 17 (at 121), just six days after the March 9 market low. That reading might not be a surprise if the market indexes had just suffered a significant decline. But, two days after the major price indexes were at new rally highs? Certainly, the market indexes can advance while Buying Power is dropping and Selling Pressure rising. (See, for instance, the rally from October 2005 to May 2006.) Historically, though, such rallies usually occur well after a bull market has become established, not in the first 2-3 months of advance after a market bottom. Consequently, the contraction in Demand does not appear to be offering an environment favorable for a new, major move to the upside by the price indexes. Thus far, the recent decline appears to be driven mainly by a lack of Demand rather than by heavy selling. For example, during Monday’s big sell-off Buying Power fell 9 points while Selling Pressure rose 7 points. This pattern remained intact during yesterday’s downside follow through, as the drop in Buying Power was twice the gain Selling Pressure. Specifically, Buying Power was down 4 points while Selling Pressure rose 2 points. If a combined 9 point increase in Selling Pressure can produce a 3.3% decline in the DJIA and 3.6% decline in the S&P 500 over the past two sessions, the market could experience a rather swift and protracted correction if Supply starts to grow. A further decline on continued increasing volume and a more pronounced expansion in Supply would tell me that the rally is over. The bottom line is the lack of a bounce following Monday’s 90% Downside Day on the NYSE calls into question whether the buy the dips mentality that has dominated throughout this 3-month long bear market rally remains alive and well.

Economic Update – The new mentality of frugality
Are things really getting better, or is it just CNBC trying to convince us. I agree that sometimes just believing is enough. The market and the media are comforted by the fact that the long duration of this economic crises and the enormous government stimulus will bring an end to this long and painful recession. In the short term, I don’t disagree. It would be hard to believe that all the money being thrown around will not help and as important, psychology has shifted to being sick and tired of being sick and tired. Unfortunately however, the many long term obstacles still exist. Demographics are still pointing to continued slow consumer spending, the fuel for the economy's engine: the banks have made a mess that will take years to rectify, not to mention a mockery of the system: The system is still grossly over-leveraged: and commercial real estate is just starting to fall (off a cliff), like we needed something else. This is leading to a major shift in consciousness: a new “mentality of frugality”. Not only can people not spend anymore, but they don’t want to. Remember the 80’s where your status was to own things you can’t afford? Now it’s the opposite: To be able to afford it but not buy it.

To make matters worse, the ratings agency, “Fitch”, in a downgrade of yet another 543 mortgage-backed securities of 2005-07 vintage, gives us the following side notes: "The home price declines to date have resulted in negative equity for approximately 50% of the remaining performing borrowers in the 2005-2007 vintages. In addition to continued home price deterioration, unemployment has risen significantly since the third quarter of last year, particularly in California where the unemployment rate has jumped from 7.8% to 11%... The projected losses also reflect an assumption that from the first quarter of 2009, home prices will fall an additional 12.5% nationally and 36% in California, with home prices not exhibiting stability until the second half of 2010. To date, national home prices have declined by 27%. Fitch Rating's revised peak-to-trough expectation is for prices to decline by 36% from the peak price achieved in mid-2006. The additional 9% decline represents a 12.5% decline from today's levels."

Don’t let the deleveraging process fool you. It’s a serious problem that takes time to unfold. Currently, we have about two trillion dollars of actual cash in our economy and about $50 trillion in credit. If we all decided to settle and pay off everything, we couldn't do it because there is not enough cash. There would be massive asset deflation. We, as a nation, are levered 25 to 1. Now, that $50 trillion is in a real sense the money supply because that is what we are all pretending is real money. I lend you money and you pretend you are going to pay me back. Then you pretend he is not going to call your debt for cash, and we are all going to keep the system going. Because if we all try to pay each other back at once, we are all collectively -- and this is a technical economic term -- screwed.

So we keep the system going. Now, where are we today? We are at the Great Deleveraging. We are seeing massive losses and destruction of assets, on a scale that is unprecedented. There was massive destruction of assets during the Great Depression, which caused a lot of problems, and we are seeing the same thing today. We are watching trillions simply being evaporated. We are watching people pay down their credit lines, which is one way of saying the supply of money and credit is shrinking. Not just in the US, but all over the world. So we -- individuals and businesses -- are trying to find that $2 trillion in real cash and get some of it to pay down our debts. We are reducing that massive leveraged money supply down to some smaller number. The “Home” piggy banks are dry, the credit cards maxed and savings and retirement accounts crippled. Quarter 1 06 we had $223 billion in mortgage equity withdrawals. Quarter 2-2008 it was $9.5 billion. Is it any wonder we were in recession by 2008? By the third and fourth quarters there was no money to keep the treadmill going. That $50 trillion in credit was shrinking fast. We were imploding it. Further -- just as a little throwaway slide -- if you look at 2010 and 2011, we are getting ready for another huge wave of mortgage resets. Now, we've gone through the last wave and we saw what happened; it created a lot of foreclosures. We are not out of the woods yet. It is going to be 2012 before we sell enough houses to really get back to reasonable levels, because we had 3.5 million excess homes at the top. We absorb about a million a year, it takes 3 years, that's kind of the math.

There’s a lot of talk about a lost decade like in Japan. Recessions normally end everywhere because the monetary authority cuts interest rates a lot, and that gets things moving. And what we know in Japan was that eventually they cut their interest rates to zero and that wasn't enough. And, so far, although we made the cuts faster than they did and cut them all the way to zero, it isn't enough. We've hit that lower bound the same as they did. In their case, the problems had a lot to do with demographics of an aging population. That made them a natural capital exporter, from older savers, and also made it harder for them to have enough demand. They also had one hell of a bubble in the 1980s and the wreckage left behind by that bubble, in their case a highly leveraged corporate sector, which was and is a drag on the economy. This sounds all too familiar. There is a possibility that we get some perk-up as the stimulus dollars start to flow and an almost mechanical bounce back in industrial production as inventories are built up. But, without demand from our consumers we will slide down again.

Investment Strategy – Time to be proactive, the forecast calls for pain
Our trademarked investment tactical strategy, TDT™ and of concentrating on “real returns” by focusing of high dividend paying stocks and high yielding corporate bonds has been tremendously successful, and should be maintained. It’s been a great year. It definitely has gotten more difficult to find bargains, as many of the issues we like have moved up substantially, having approached or passed their sell targets. Although, there are still great opportunities. For instance, just yesterday you could buy a 26 month GMAC bond with a yield to maturity of 12.47% per year. Unbelievable. Why take the risk of simply being in the stock market? It’s just too high. We are a firm believer in getting 60-70% of the upside with only 30-40% (or less) of the downside risk. We still believe the stimulus will have an effect and move the market higher in the short term and sure the market could surprise us to the upside, but we will still be positioned for great returns and be able to sleep at night. After all, what if it doesn’t? And, if the market does test or make new lows, which will bring fear and horror like you’ve never seen, then we will still be in the right place…and sleep at night. It’s time to be proactive with your finances. Be the expert or hire one! – Call today for a free portfolio review or simply a free 2nd opinion. The risk of being wrong is much too great.

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