Financial analysts and investment bankers love to predict the year coming. They have the illustrious track record of predicting the future correctly less than 20% of the time. This is a very low rate and therefore something that should not be taken too seriously, but the average person on the street listens with intent and then bases their decisions on these guesses.
So why predict? Well you have to have something to base your company growth (or lack there of) on. Furthermore, in the world of investments, your outlook is critical in planning where to allocate investment dollars for the coming year. Now as a trader I tend to hold an outlook only for as long as it takes to find some anecdotal evidence that my views are wrong and then I change gear. But with that said I will give it my best shot and we will see where we end up at the end of 2011.
My first prediction is that Santa will show up again and will place presents under trees all around the world. How many is the question that needs answering? It appears that the season will be relatively strong but for select products. For example, Microsoft's new Kinect video game product is flying off the shelves whereas Blackberry is struggling so be careful which retail stocks you buy.
Prediction two is that the Federal Reserve will blow through its next $600 billion with limited impact other than on stocks and commodities. It appears that even bad news is being rewarded in the stock market. To use one of Yogi Berra's quotes, "It's Deja vu all over again." Apparently any news is good news for the stock market as bad news means more easing and good news is always good! Well this is the same type of hysteria that occurred prior to the 2000 crash and the 2007 crash. Sure the Federal Reserve is printing money and interest rates are still being held artificially low, but the desired effect of lowering unemployment and supporting housing has not happened so in a last ditch effort the Federal Reserve is turning its attention to the markets.
They will create another bubble and they are already doing so. Take Salesforce.com as an example. It is trading at a price to earnings ratio of over 250 and its CEO is selling $1.5 million of stock every day, but the price continues to spiral higher. Does anyone remember CMGI or WorldcCom or any of the other myriad of higher fliers from 1999? I think you get the picture. This will not last and the Federal Reserve is setting us up for the biggest crash the world has ever witnessed.
Prediction three is that the market will continue higher for the first quarter of 2011. This is completely due to the continued printing from the Federal Reserve. This could be offset by the continuous plunge in the price of the long bond, but I believe that the Federal Reserve will soon turn its attention to propping up the price of these bonds. They have to or face the problem of a completely lopsided market where short term rates are at or near zero while 30-year rates move beyond 5%.
Prediction four is that at some point the USD will crater. A loss of faith in the US economy and continued money printing has to result in a weak dollar. This will drive inflation to an uncomfortable level at which point the Federal Reserve will have lost the battle.
Prediction five is that by year-end the market will sell off violently and we will experience a serious correct and maybe a complete collapse as all faith in US policy makers is lost.
What could change this outlook? A more austere government, a Federal Reserve that stops printing money and supports the dollar, a rapidly improving unemployment rate and a bottoming of housing prices. In fact I believe that we will need all of these things to happen to save us. What are the chances of this happening? In my view slim to none, but that is the peril of predicting, no sooner have you thrown your hat into the ring than everything changes. One thing I will say is that while all of this may not happen in 2011 it will occur at some point and delaying the inevitable will only make the drop worse.
Regardless of what happens be prepared to move with the changes, protect your downside and do not get too greedy. As the old axiom of the stock market says, "the bulls make money, the bears make money while the pigs get slaughtered." Happy holidays, see you all next year.
Tuesday, December 21, 2010
Tuesday, December 14, 2010
PPI Spike - Cause for Alarm?
Today it was reported that the Producer Pricing Index (PPI) increased 0.8% in November. This is the strongest increase since March and was well above consensus. Federal Reserve officials were quick to discount this spike as a one off and no cause for alarm. It is the opinion of this blog that this is the first sign of inflation (see blog Inflation Is Coming 10/14/10).
Now while one data point does not make a trend the signs for inflation are starting to feed into the numbers. Digging deeper into the numbers reveals the cause of the spike was energy and food. Readers of this blog should not be surprised as most commodity prices have been trending higher for months. Oil is over $90 per barrel, copper is up 31% since August, wheat, corn and soybeans are near highs, cotton is limit up today and almost at multi-year highs, sugar and cocoa are near to multi-year highs, so what exactly is surprising?
To me the most fascinating part of it all is that our so called "leaders" at the Federal Reserve continue to bury their heads in the sand and claim that they have everything under control. Australia, China, Brazil and other emerging markets are all trying to tame inflation while we continue to aimlessly print money. Now is this printing working?
One of the main uses of the money is to keep US interest rates low by buying US treasury debt. Looking at the 30-year Treasury Bond and the 10-year Treasury Note shows a completely different picture. The yields on these and other bonds around the globe are rising rapidly even with the Federal Reserve trying to keep them low. The market is essentially snubbing its nose at Bernanke and his team and is pointing to a rapid rise in inflation.
It is my contention that in the near term inflation will start to surge forcing the Federal Reserve's arm to look into raising rates. This could take effect by the middle of 2011 and would cause the market to sell off sharply. While I am no soothsayer, the signs are there, the bubbles are being created and a misstep at this stage of the recovery would put the economy into a tailspin.
Now while one data point does not make a trend the signs for inflation are starting to feed into the numbers. Digging deeper into the numbers reveals the cause of the spike was energy and food. Readers of this blog should not be surprised as most commodity prices have been trending higher for months. Oil is over $90 per barrel, copper is up 31% since August, wheat, corn and soybeans are near highs, cotton is limit up today and almost at multi-year highs, sugar and cocoa are near to multi-year highs, so what exactly is surprising?
To me the most fascinating part of it all is that our so called "leaders" at the Federal Reserve continue to bury their heads in the sand and claim that they have everything under control. Australia, China, Brazil and other emerging markets are all trying to tame inflation while we continue to aimlessly print money. Now is this printing working?
One of the main uses of the money is to keep US interest rates low by buying US treasury debt. Looking at the 30-year Treasury Bond and the 10-year Treasury Note shows a completely different picture. The yields on these and other bonds around the globe are rising rapidly even with the Federal Reserve trying to keep them low. The market is essentially snubbing its nose at Bernanke and his team and is pointing to a rapid rise in inflation.
It is my contention that in the near term inflation will start to surge forcing the Federal Reserve's arm to look into raising rates. This could take effect by the middle of 2011 and would cause the market to sell off sharply. While I am no soothsayer, the signs are there, the bubbles are being created and a misstep at this stage of the recovery would put the economy into a tailspin.
Monday, December 6, 2010
QE3 Already?
This weekend the "chief" of the Federal Reserve Bank, Ben Bernanke, spoke of a possible round three to the quantitative easing program. I say "chief" as it is becoming more and more obvious that he is a one man team on a mission to prove a point regardless of the costs. He is an "expert" on the great depression and he "knows" that he has the right answer and he will pursue his policies with no regard of the costs should he fail. The world has never seen money creation on such a large scale before. All previous attempts have ended in failure and it is the contention of this blog that this one will end in a similar state, although this time the mess will be on a far grander scale than anything previously witnessed.
Let's explore what he has done in printing all this money to date. On the plus side he did stave off an almost certain collapse of the global financial system as we "still" know it today. This was required at the time but since then he has continued to print money in leaps and bounds but from that moment forward the results have been poor. I say "still" as it is my contention that after the next wave of financial problems the financial landscape will be changed beyond my lifetime.
The economy is still in a quagmire. Unemployment is stuck at elevated levels, price stability is non-existent (specifically if you look at the massive swings in the VIX index, a measure of market volatility) and his admittance to the requirement of a further round of easing shows that he has little faith that round two will work and this is stated before it has even really begun.
A well known Austrian economist, Ludwig Von Mises, stated that "The idea of government interference as a "solution" to economic problems leads, in ever country, to conditions which, at the least, are very unsatisfactory and often quite chaotic." In answer to the question of is there a solution he said, : "I would say, yes, there is a remedy. And this remedy is the power of the citizens, they have to prevent the establishment of such an autocratic regime that arrogates to itself a higher wisdom than that of the average citizen. This is the fundamental difference between freedom and serfdom."
Does Ben Bernanke know what he is doing? Absolutely not. Does he think he knows what he is doing? Yes. Will it work? No-one will know for sure until the economy is stable and the money that is printed is paid back in an orderly fashion. Will this happen? It never has before and so it is my take that this time, as in all the past times, it is not different and history will repeat itself.
That is not to say that this will occur in the short term (3 to 6 months) but it is my view that once the globe and the market realizes that this strategy has failed there will be a huge loss of confidence in the Federal Reserve, the US economy and the government. At that point it is too late to repair any damage and the market will collapse. For now enjoy the rally while it lasts but hedge yourself against the imminent failure as it will be swift and, if I am wrong, there will still be plenty of time to make money in the secular bull market that would ensue.
Let's explore what he has done in printing all this money to date. On the plus side he did stave off an almost certain collapse of the global financial system as we "still" know it today. This was required at the time but since then he has continued to print money in leaps and bounds but from that moment forward the results have been poor. I say "still" as it is my contention that after the next wave of financial problems the financial landscape will be changed beyond my lifetime.
The economy is still in a quagmire. Unemployment is stuck at elevated levels, price stability is non-existent (specifically if you look at the massive swings in the VIX index, a measure of market volatility) and his admittance to the requirement of a further round of easing shows that he has little faith that round two will work and this is stated before it has even really begun.
A well known Austrian economist, Ludwig Von Mises, stated that "The idea of government interference as a "solution" to economic problems leads, in ever country, to conditions which, at the least, are very unsatisfactory and often quite chaotic." In answer to the question of is there a solution he said, : "I would say, yes, there is a remedy. And this remedy is the power of the citizens, they have to prevent the establishment of such an autocratic regime that arrogates to itself a higher wisdom than that of the average citizen. This is the fundamental difference between freedom and serfdom."
Does Ben Bernanke know what he is doing? Absolutely not. Does he think he knows what he is doing? Yes. Will it work? No-one will know for sure until the economy is stable and the money that is printed is paid back in an orderly fashion. Will this happen? It never has before and so it is my take that this time, as in all the past times, it is not different and history will repeat itself.
That is not to say that this will occur in the short term (3 to 6 months) but it is my view that once the globe and the market realizes that this strategy has failed there will be a huge loss of confidence in the Federal Reserve, the US economy and the government. At that point it is too late to repair any damage and the market will collapse. For now enjoy the rally while it lasts but hedge yourself against the imminent failure as it will be swift and, if I am wrong, there will still be plenty of time to make money in the secular bull market that would ensue.
Friday, December 3, 2010
Remove the Housing Tax Credit?!
It has been recently bandied about that one of the most effective ways to get America out of its debt problems is to raise more tax revenue. A simple way to do this is to eliminate all of the tax credits thereby raising the tax revenue without raising the actual tax rate.
While this may have some political merit (as no politician at this stage would agree to increasing the tax rate on the lower and middle classes), and while I agree that at some stage the tax revenue will have to increase, eliminating the housing tax credit at this stage of the recovery would be an economic disaster.
A recent study by the National Association or Realtors estimated that removing the housing tax credit would lead to another 15 percent decline in the value of housing. I personally think that that is a low ball estimate and that the effect would be far worse.
Many people (myself included) find that a house is affordable only because of the tax credit. Remove the tax credit and the disparity between a rental payment and a house payment swings heavily in favor of renting.
Furthermore. the current recovery is underpinned by the banks being solvent. A large portion of this "solvency" is due to the fact that performing loans are recorded at the face value of the note. Plenty of these performing loans are supported by real estate that has a value of less than the note (they owe more than the house is worth). Remove the tax credit and the benefit of paying on a debt worth more than the asset itself makes no sense. Turn these marginal loans into bad debt on the balance sheet of the banks and it is my estimate that this forced mark to market would reveal that our largest banks are insolvent.
We all witnessed first hand the effects of an insolvent banking system recently but this time around the economy would be without the Federal Reserve to support it. Why? The Federal Reserve would lose credibility if it printed more money. Interest rates would be driven through the roof dragging the housing market lower and creating further instability. The result would be another severe recession at best and at worst you wash the slate clean with a depression.
Therefore, why the politicians are even debating this is beyond me but if the vote is for removing the tax credit then watch out below. While I doubt that this will happen it is always good to be prepared.
While this may have some political merit (as no politician at this stage would agree to increasing the tax rate on the lower and middle classes), and while I agree that at some stage the tax revenue will have to increase, eliminating the housing tax credit at this stage of the recovery would be an economic disaster.
A recent study by the National Association or Realtors estimated that removing the housing tax credit would lead to another 15 percent decline in the value of housing. I personally think that that is a low ball estimate and that the effect would be far worse.
Many people (myself included) find that a house is affordable only because of the tax credit. Remove the tax credit and the disparity between a rental payment and a house payment swings heavily in favor of renting.
Furthermore. the current recovery is underpinned by the banks being solvent. A large portion of this "solvency" is due to the fact that performing loans are recorded at the face value of the note. Plenty of these performing loans are supported by real estate that has a value of less than the note (they owe more than the house is worth). Remove the tax credit and the benefit of paying on a debt worth more than the asset itself makes no sense. Turn these marginal loans into bad debt on the balance sheet of the banks and it is my estimate that this forced mark to market would reveal that our largest banks are insolvent.
We all witnessed first hand the effects of an insolvent banking system recently but this time around the economy would be without the Federal Reserve to support it. Why? The Federal Reserve would lose credibility if it printed more money. Interest rates would be driven through the roof dragging the housing market lower and creating further instability. The result would be another severe recession at best and at worst you wash the slate clean with a depression.
Therefore, why the politicians are even debating this is beyond me but if the vote is for removing the tax credit then watch out below. While I doubt that this will happen it is always good to be prepared.
Thursday, December 2, 2010
A Christmas Rally?
As we approach the end of the year it is looking more and more likely that a Christmas rally may be coming. The charts of both the 10-year Note and the 30-year bond are looking very bearish. If they break down there could be a flight of capital to the stock market.
On the other side of the coin stocks seem to be breaking out of their recent consolidation and appear to be headed higher. What could torpedo this is the continued strength in the dollar unless this strength is met with a change of sentiment.
Up to now market sentiment has been that a strong dollar will cause inflation and is bad for the market. This relationship will change at some point in the future if the currency strength is based on a fundamental shift in the economic outlook of the US economy.
Turning to the economic numbers that are coming forward it appears that there is a modest recovery on its way. It appears that the stimulus is finally taking hold and with the continued pumping of cash into the economy that there may be a glimmer of hope. To be honest I am not really surprised by this as if you throw enough money at something it will eventually either recover or blow up.
This time around it appears as if the world still has enough faith (unwarranted in my opinion) in the US economy and the Federal Reserve to cure the market ailments and therefore we will have to wait for the blowup to occur in the years to come. The renewed confidence seems to be feeding into more risk taking and a rise in the stock market. Should this take hold it could result in a rally in the market.
Looking further out I am still completely convinced that in our lifetime we will have a severe depression to deal with, but for now I will ride on the tail of the illusionary recovery until it rolls over and dies.
On the other side of the coin stocks seem to be breaking out of their recent consolidation and appear to be headed higher. What could torpedo this is the continued strength in the dollar unless this strength is met with a change of sentiment.
Up to now market sentiment has been that a strong dollar will cause inflation and is bad for the market. This relationship will change at some point in the future if the currency strength is based on a fundamental shift in the economic outlook of the US economy.
Turning to the economic numbers that are coming forward it appears that there is a modest recovery on its way. It appears that the stimulus is finally taking hold and with the continued pumping of cash into the economy that there may be a glimmer of hope. To be honest I am not really surprised by this as if you throw enough money at something it will eventually either recover or blow up.
This time around it appears as if the world still has enough faith (unwarranted in my opinion) in the US economy and the Federal Reserve to cure the market ailments and therefore we will have to wait for the blowup to occur in the years to come. The renewed confidence seems to be feeding into more risk taking and a rise in the stock market. Should this take hold it could result in a rally in the market.
Looking further out I am still completely convinced that in our lifetime we will have a severe depression to deal with, but for now I will ride on the tail of the illusionary recovery until it rolls over and dies.
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