But first, I wanted to share a picture I took while camping
in the eastern Sierras last weekend.
Sierra Wave
I’ll be heading back down there in a couple of weeks with
Josh for a little backpacking, and I can't wait. I'm
thrilled he still wants to hang out with his dad! (Who of
course doesn't know anything)
It is the best of times – The joy of stimulation
In what seems like an act of defiance, the market continues
to make new highs. Investors are clearly betting on a rapid
recovery, and the news has been pretty good. By all
accounts, the economy is improving, and the Leading
Indicators, which include the stock market, say just that.
This is right in line for what we have been saying for
sometime. The stimulus would have the desired affect. Just
ask Caterpillar (CAT), who reported far better earnings than
expected, which even they admit was directly related to the
governments stimulus spending. Add in 0% interest rates to
banks, which is an indirect form of stimulus, and you’ve got
welfare for the rich guys. Is it really any surprise that
Goldman and JPMorgan are making record profits on the
underwriting and trading side of the business? Hell, if I
could eliminate 80% of my competition, borrow at 0% and have
the government as my bodyguard, my profits would g row too!
Although, under the radar, JPMorgan's consumer credit,
credit card, and other business groups are losing money
big-time. How does it feel to know that we bailed out
Goldman who then parlayed it into record profits which will
translate into multi-million dollar bonuses (as the rest of
the country wallows)? Gotta love socialism, as long as your
friends with Politburo members that is!
The third quarter may be positive in terms of GDP. And that
is possible, but only for statistical and not for
fundamental reasons. For instance, lower imports are a net
positive for GDP. But lower imports mean a weaker economy.
Government spending adds to GDP. Normally, if the government
spends too much, then we get inflation, which is subtracted
from nominal GDP to give us real (after-inflation) GDP. But
inflation is low and getting lower, so there is not going to
be much to subtract from nominal GDP. Are government
spending and massive deficits a sign of fundamental
strength? It is quite usual for there to be a positive
quarter in the middle of a recession. Watch the
fundamentals: industrial production, unemployment, capacity
utilization, tax receipts, etc. When those turn up, or at
least level off, the recession is over. Then we get to the
long recovery. That said, the market is currently going up
and looks like it’s going higher because the data implies a
recovering economy. I think the biggest thing keeping this
market rising is the large negative investor sentiment. Put
simply, too many people are bearish and if it went down too
many people would be right. It NEVER works that way. As the
market goes higher, more and more folks will become
“believers” and subsequently more bullish. Then and only
then will some catalyst shake the foundation. For e time
being, the trend is your friend and although you should
never fight the trend, today’s fire danger is “extreme”.
It was the worst of times – Reality check around the bend
So let’s be real. What happens when the government stops
giving us our stimulation? I think you know. Japan tried
this, for about the last 20 years, and the best they could
get was a one quarter blip up for their GDP, and then right
back into the doldrums. Are we Japan? Heck no! They have
money, we don’t. This country is driven by consumer
spending. Over 70% of our GDP is driven from consumer
spending. Unfortunately for those that think this is going
to be a normal recession with a V shaped recovery, spending
is D-E-A-D! The demographics are clear. The 78 million baby
boomers have now passed their peak spending years and are
turning from net spenders to net savers. These are the same
people who are retired, close to retirement or one day HOPE
to retire, that are shell-shocked from their 401k’s turning
into 201k’s. Now add in a rapidly rising savings rate that
is likely to go from 0% just a few short months ago to
upwards of 10-12%, and you’ve got a lot of lost spending.
Worst of all right now is the massive deleveraging that is
going on. We hear this phrase all the time, but most really
understand its consequences. Deleveraging is the destruction
of assets with too many chasing too few liquid assets. The
first nail in the coffin was tapped in during 2004 when the
banking authorities decided it would be OK to allow five
banks to increase their leverage from 12:1 up to 40:1. Which
five banks? I bet you can guess: Bear Stearns, Lehman,
Merrill Lynch, JPMorgan, and Goldman Sachs. How did that
work out for us? Forty times leverage means that if you lose
a measly 2.5%, you wipe out all your capital. And we watched
as banks too big to fail were bailed out with taxpayer
dollars. Slowly, banks are buying time, writing down assets.
This is not really a bad strategy as time heals a lot of bad
debts, especially at a 0% Fed Funds rate. Banks that are
reporting so far t his quarter seem to be saying that the
write-offs will start to level off in about two quarters,
although that the level may stay higher than we think for
longer than we think. There are a lot of assets to write
off, and they are just now getting to the commercial real
estate problems. This is going to take time.
The next crises and thus the catalyst will likely occur in
Europe and will hit us just as hard. Once upon a time, UK
regulators allowed 20:1 leverage on a regular basis. It is
now almost 40:1. The assets of UK banks are about five times
as large as UK GDP. By comparison, for the US the ratio is
barely 2:1. Think about that for a second. The UK has
banking assets which are five times as large as the annual
domestic output of the country. They also had a housing
bubble. They have their own bailouts to deal with, which are
massive and will potentially get much larger. Just wait, it
gets better with the Euro-zone.
Leverage in Europe is now 35:1. How did 35:1 work out for
the US? Given the massive credit problems that Euro-zone
banks have with emerging markets as well as Spain's housing
bubble, which is every bit as bad as that of the US, and
pain is inevitable. The European Central Bank, at least as
of now, cannot step in and start saving individual banks.
How do you save a Spanish bank and not an Austrian bank?
Austria's banks have made large loans to Eastern Europe, in
Euros and Swiss francs, and are going to have large losses,
far more than 3%, which would wipe out their capital. But
bank assets in Austria are 4 times GDP. What we have are
banks that are too big to save for relatively small Austria
as well as for Italy, Spain, Greece, etc. Even neutral
Switzerland is a scary place. We think of Switzerland as a
stodgy, by-the-numbers, clockwork type of banking country.
Yet somewhere, somehow, UBS and Cr edit Suisse ran up a
little leverage. Before the crisis, they were over 40:1. And
now they're nearly at a nosebleed-high 70!
Municipal Bond –Warning Will Robinson
Taxes collected by the 50 states dropped by 11.7 percent
overall during the first quarter of 2009, compared to the
same period a year earlier — the largest such decline in the
46 years for which quarterly data are available, according
to the latest report on state finances from the Rockefeller
Institute of Government. Overall state tax revenues fell to
the lowest first-quarter level since 2005, according to the
Institute, yet spending has not. The decline in personal
income tax was particularly sharp as well, with an
unprecedented decline of 17.5 percent, as the weakened
economy continued to hammer state budgets. Forty-five of the
50 states experienced revenue drop-offs. Also, the peak
unemployment rate will likely exceed 11% in 2010 as we
reduce excess capacity for reduced spending. Such a large
unemployment rate will have negative effects on labor income
and consumption growth, it will postpone the bottoming out
of the housing sector, it will lead to larger defaults and
losses on bank loans (residential and commercial mortgages,
credit cards, auto loans, leveraged loans), it will increase
the size of the budget deficit (even before any additional
stimulus is implemented) and it will increase protectionist
pressures. We have become accustomed to believing that municipal bonds
are a safe place to invest. Sorry my friend, times have
changed. States can’t print money like the Feds can, so they
have to cut spending. In many cases they will have no choice
but to file for bankruptcy protection. Some bonds will do
fine while others will default, so you better be careful.
This is a little too much to write about here, so call me if
you’d like more info on this.
Investment Strategy – Risk vs. Reward
Regardless of the long term dangers, the market is rising
and going higher. For how long, nobody knows, but there are
many cycles that turn negative at the end of August, so
there’s not much time left. As I mentioned above, a top will
likely be reached when sentiment turns more positive. Right
now, too many think that’s it’s “obvious” that the market
must go down from here. Well, if it’s obvious, it’s
obviously wrong! When it goes up it leaves most on the
sidelines, desperate to get in. When it drops, it hurts the
most people. That’s just the nature of the market. There is
no doubt in my mind that this is a bear market rally and not
a new bull market. Even after this rally, the Buying Power
Index is still lower than it was at the March 9th market
low! There has never been a single case in which Buying
Power dropped to new lows during the early months of a new
bull market. Also, volume in bull markets generally expands
as investor confidence grows, while in bear markets volume
tends to contract. Throughout the vast majority of the rally
from the March’09 low the 30-day moving average of Up plus
Down Volume has been consistently drying up and is currently
at its lowest level since Feb’09. There have also never been
a time when the 30-day moving average of Up plus Down Volume
contracted throughout the first four months of a new bull
market.
In fact, this looks eerily like 1929. Then, the market
initially fell 48%, then rallied about 50% over the next 6
months, then had another more devastating drop to be down
89%. Considering that bar market rallies tend to last 4-6
months, and September 6th will be the 6 month anniversary,
and 10,000 on the Dow would be a 50% retracement (a perfect
Fibonacci number), all but the most aggressive traders must
be on alert. I’m not looking for that kind of drop, due to
the many safety nets we now have compared to the depression,
but it could be close.
Our proprietary process of building tax efficient portfolios
incorporating our Top-Down Tactical approach, TDT™, (over
buy and hold/hope) has been very successful. It’s been a
great couple of years for us. Stick with “real returns” by
focusing of high dividend paying stocks and high yielding
corporate bonds, but be super careful which issues you pick.
(Make sure you’re advisor knows what he is doing!) Although
it has gotten more difficult to find bargains as many of the
issues we like have moved up substantially, there are still
great opportunities. We are a firm believer in getting
60-80% of the upside with only 30-40% (or less) of the downside risk. We still believe the stimulus will continue to
have an effect and move the market higher in the short term,
and we will be positioned for great returns and be able to
sleep at night. However, the time is fast approaching where
the risk outweighs the reward. Is a 10% return on the upside
worth a 50% risk on the downside? 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
916-925-8900
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 |
