Financial topics

[John]

From a web site reader:

> You can put anything I write you on the forums if you wish - I
> looked at writing this in there, but there wasn't (or I couldn't
> find) a forum for individual blog posts you've written.
> Anyways...

> I was a bit confused by the last part of the "Markets plummet"
> post, about the inflation vs deflation thing. The gist of what it
> sounded like was that because the US$ is the reserve currency, and
> many other currencies are in bad shape, it can't undergo
> significant inflation. It seems to me that there are two issues
> here - the relative value of the US$ (relative to other
> currencies), and the absolute value of the US$ (how much you can
> buy with a dollar). I think it is quite plausible that, relative
> to the euro (or even a basket of currencies), the dollar could be
> roughly stable, or even appreciate, if the euro and dollar both
> are inflating, or deflating. If one inflates while the other
> deflates, then obviously their relative prices (in the other)
> would change, but you have presented fairly strong arguments that
> BOTH the US and Europe (and much of elsewhere) are economic
> train-wrecks waiting to happen - so BOTH will suffer inflation or
> BOTH suffer deflation. If deflation occurs in the US, then
> arguments for it apply equally (if not better) to the rest of the
> world, so there is no inherent advantage to the US$.

> If the euro is disbanded and Europe returns to a multi-currency
> system not much changes (other than the financial havoc that
> creates) - but it'll be more complicated in terms of comparisons.
> BTW, I'd say that the euro would probably not be disbanded at once
> - rather one country after another would leave it (or be kicked
> out) due to local strains. I think it would end up as a currency
> for a rump of countries - France/Benelux/Germany, or even just
> Germany or France.

> "In the case of Germany's Weimar Republic, which suffered
> hyper-inflation in the 1920s, few people outside of Germany owned
> marks. In the case of Zimbabwe today, no one outside of Zimbabwe
> owns Zimbabwe dollars. But there are huge amounts of dollars
> outside of America -- Europe, China, the Mideast -- and all of
> those holders are as committed to the value and integrity of the
> dollar as America is. Forget about the dollar as an American
> currency. Think of the dollar as a world currency." This seems to
> me kind of self-contradictory: If we think of the US$ as a world
> currency, then there are no people outside the world that own
> US$s, so the whole world is like Zimbabwe - there's no one outside
> the world that owns world currency. Yes, people inside the world
> have a vested interest in maintaining the value of US$s. But then,
> so did people inside Zimbabwe (i.e. they had an interest in
> maintaining the value of their cash), but that didn't stop the
> inflation. In Zimbabwe's case people with good connections or
> influence could buy other currencies with their Zimbabwe currency,
> and so preserve the value of their cash, but they did that after
> the inflation set in - their currency sales did not cause the
> inflation. And average people were unable to do so, and so lost
> that value. In the case of the world currency, everyone is trapped
> (at least those who hold cash) if it inflates - but that won't
> stop inflation. (And a side point - the rest of the world held
> huge amounts of debt issued by the Weimar republic - they had a
> lot of interest in ensuring that those debts were paid back).

> "...there are huge amounts of dollars in countries around the
> world. Even if America no longer had any dollars whatsoever, the
> dollar would still be valuable on international markets as a world
> currency." This seems like an argument AGAINST deflation! If
> deflation starts to rear its head, then the US could pressure
> these holders of US$s to sell. "It's true that America is deeply
> in debt, inasmuch as we owe China, Japan and other foreign
> countries far more money than we can ever pay back. But that's not
> the issue." But it is the issue because the currency is a lot of
> IOUs. As I understand it, most US$ reserves are not held in cash,
> but in US gov't debt - that's the beauty of the system for the US,
> right? First the other countries buy up the extra dollars the US
> puts out to pay for imports, etc., then they use them to buy US
> gov't debt - pays interest - and so they end up funding the
> perennial US gov't deficit. I think even saying that the US can't
> pay back existing debt is ominous, as it's going to keep piling on
> more and more. I personally think it can and will pay them (my
> inflationary solutions) - there are two scenarios I can envision:
> a German scenario and a Russian scenario.

> In the German scenario there is initially significant inflation
> that whittles down the existing debt. Next, a generational crisis
> bloody enough and destructive enough on US soil to make other
> countries forgive some of the debt and forces the US ruling elite
> to step aside or change enough to stop the wholesale robbery of
> the productive economy. Then an austerity era like post-WWII
> Germany when the rest of the debt is dutifully paid off through
> honest economic development and growth. In the Russian scenario
> there is initially significant inflation, reducing the debt load.
> This leads to grinding poverty for most residents, but reinforces
> the power and wealth of the existing
> congressional-military-financial elite leading to the extreme
> income disparities of today's Russia. The rest of the debt is paid
> of through continuing inflation, the wholesale exports of natural
> resources, and remittances sent back by the many Americans working
> overseas. If deflation happens, the scenario I'd see is that the
> debt load will continue to increase both due to gov't borrowing
> and because deflation makes the debt worth more. Eventually the
> government will default on the debt as it becomes insupportable.
> US$ immediately loses it's reserve status, throwing world finance
> into disarray, and suddenly forcing the US to live within its
> means. Not sure of what happens next, but it wouldn't be pretty.

> "And you should take Jim Cramer's advice..." I can't believe
> you're recommending the advice of that shill! Sure, get out of
> the stockmarket, but I don't think anyone really knows if
> inflation or deflation is going to happen. In fact, if Cramer says
> to hold cash, I'd do the opposite! I'm sure that he's saying that
> to help his old hedge fund buddies in some way...

[Witchiepoo]

Meanwhile, you'd never know there was a problem if you listen to the
pundits on tv. They're debating whether the Fed should lower
interest rates by 1/4 point or 1/2 point to solve the problem.

Can you believe these airheads?

John

No, actually I can not believe the dumbf*** pundits on TV, about anything. That's why I don't watch them. Lowering interest rates now would be like trying to stop the bleeding by shoving the knife deeper into the wound. Not that it won't happen. Dumbf*** politicians.

The presidential debate tonight will be interesting, if only for the shocking lack of real answers on this issue, from both candidates. Or at least that's my guess. If I hear a candidate say something like "well, the growth of our economy has been artificially inflated over the last few years, and now we're gonna have to suck it up," that person gets my vote.

[John]

http://www.telegraph.co.uk/money/Alex/p ... late.jhtml

[John]

If I hear a candidate say something like "well, the growth of our economy has been artificially inflated over the last few years, and now we're gonna have to suck it up," that person gets my vote.

You always were a dreamer.

John

[Gordo]

Again from the best trader I know...

The mood in the worldwide financial markets has been quite gloomy (obviously). Below is an e-mail which was sent from a relative. The names have been changed to match well-known cartoon characters, but the rest of it is verbatim:

----- Original Message -----
To: Wilma Flintstone
From: Barney Rubble
Sent: Tuesday, October 07, 2008 11:29 AM
Subject: The Stock Market

Hi Wilma,

Betty and I put in a request to our broker today to sell stock in our portfolio to bring the portion of cash and bonds to 60%.

We’re hoping to avoid further losses this way.

When the bottom appears to be reached we’ll buy back in.

You and Fred may wish to do the same.

Love,

Barney

Imagine selling stocks now, after such a huge one-year pullback. Notice that “Barney” doesn’t give any advance clues as to “when the bottom appears to be reached”—assuming he has any plan at all (which is doubtful). This probably means that after the market has rebounded 50% by next summer, poor Barney will be buying stocks again just in time for a severe bear market, and once again recommending that the Flintstones do the same.

I have received numerous e-mails telling me that the next year will be awful and why the global equity pullback has a long way to go. Not a single one of these folks was anything other than staunchly bullish one year ago.

Reliable implied volatility indices such as VXO and VIX have reflected this fear. VXO reached an intraday high of 69.42 yesterday, and closed at 63.06 today. Since October 1987, even including major corrections such as 1990, 1997, 1998, 2001, and 2002, VXO had not exceeded its October 1998 zenith of 60.63.

People love to buy at multi-year highs and sell at multi-year lows. However, buying low and selling high is far more profitable. Most equity indices and funds currently stand at or near four-year and five-year nadirs. While additional downside is possible in the very short run, the extreme pessimism among investors is a classically reliable sign of a bottom being formed.

The XAU/spot ratio currently stands at a very depressed .117.

In the early and middle stages of most economic slowdowns, central banks are lowering interest rates to combat falling equity and commodity prices. What usually happens is that central banks eventually run out of options as economies continue to decelerate. They cannot cut rates further, as the federal funds rate (or overnight bank lending rate) is already close to or even below the inflation rate.

Therefore, central banks have to sit by and do nothing. As a general rule, this causes the recession to become more severe over the next year or two.

In other cases of recession, central banks are able to cut rates, but choose not to do so for political reasons. A classic example is Paul Volcker in 1980-1982, who intentionally raised the federal funds rate to 21.5% in order to aggressively combat inflation. He was aware of the recession risks and even bragged of intentionally causing a recession in order to fight what he considered to be the more serious disease of inflation.

From 1929 through 1932, the U.S. central bank also did not cut rates, which many attribute to exacerbating the economic situation and presaging the very severe recession which ensued worldwide.

However, the situation is very different in 2008, for the following reason: as global equities began to collapse in the second half of 2007 and in early 2008, commodities rose sharply.

The reason for this increase was entirely speculative and had nothing to do with fundamentals. The media tried to convince investors that people in India were suddenly eating twice or thrice as much corn or wheat as they had eaten the previous year, or that they were using three times the quantity of crude oil as they had been consuming a year or two earlier. While this was obviously nonsense, look at a chart of DBA from 2007-2008 and you will see how many people were fooled by this myth of “decoupling”. (I recommended shorting all of these bubbles.)

Central banks, however, could not ignore the higher prices—regardless of whether they were based upon fundamentals or speculation. Therefore, there was an orgy of central bank rate hikes in order to combat what was seen as a potentially grave danger of sharply higher inflation. Some countries experienced double-digit inflation rates, which induced them to raise short-term rates even further.

In the short run, this no doubt accelerated the equity and commodity collapse of the past several months, causing it to be substantially more severe than it would have been otherwise.

Every cloud has a silver lining (in this case, literally). Since central banks in numerous countries had raised rates so aggressively and repeatedly, and had caused a major global slowdown, this created unusual latitude for rate cuts later on, should the political mood shift from fear of inflation to fear of recession.

That is exactly what has transpired in recent weeks. While inflation was considered irrelevant at the beginning of 2007, it became the greatest threat to most economists just 1-1/2 years later in July 2008.

Today, a scant three months later, almost no one cares about inflation. Fighting recession has become a hot-potato political issue everywhere in the world where housing prices are falling, or unemployment is rising, or the GDP growth rate is decelerating—which means practically everywhere in the world.

Since central banks had raised rates by such a wide margin, they are now able to cut rates by a huge amount—and they are already beginning to do so worldwide. This will provide a very sharp stimulus to global stock markets, for several reasons.

One reason is that easier access to credit is always positive for equities.

Another reason is that many people have put money into time deposits which are yielding more than the inflation rate in many countries. As short-term interest rates continue to be cut, these time deposits will pay progressively lower returns, which will soon be less than the inflation rate.

With a negative real rate of return, investors will initially seek out equities, and eventually also commodities, as viable alternatives to time deposits.

Because of the sharp pullback in stock markets, investors have moved a lot of money out of equities into money-market funds and similar safe time deposits. Once global stock markets inevitably enjoy strong gains, even if just as a technical recovery from a deeply oversold condition, investors will gradually shift back in the opposite direction. The amount of potential buying power in time deposits today is greater than it has been at any time since the early 1990s.

Partly this is because of falling real-estate prices worldwide. When housing prices were rising, investors didn’t bother to save money, figuring that a house bought with little or no down payment was a complete retirement plan.

Now, people around the world realize that if they want money for their old age, they had better save more—and that is exactly what they have been doing especially during the past two years.

There are also many investors who love certain groups of equities or individual shares, but who have sold them recently solely out of fear. Once these groups or names recover, such investors won’t be able to stand watching them go up “without them”, and will buy back their favorite funds and shares at far higher prices.

The peak impact of lower central-bank interest rates tends to occur about one year following the initial round of rate cuts. Since central banks outside the U.S. began to cut rates several weeks ago, this suggests that stock markets around the world will likely peak in the second half of 2009.

This is consistent with Presidential cycle theory. A severe bear market which begins in the second half of 2009 will have plenty of time to fully mature well in advance of the next Presidential election on November 6, 2012. Equity markets worldwide will probably rally strongly for as much as one or two years in advance of that contest.

If you listen to the media, virtually the entire focus is on how much more equities can decline. At any major top or bottom, that is almost the only question which is considered: how much more extreme any given multi-year extreme can become. What is far more important is how much stock markets can rally over the next year as a result of numerous, aggressive central-bank rate cuts.

The most likely scenario is that we will get double tops with important resistance levels from the past year for most indices and funds.

Let’s pick a pessimistic outcome: that a relatively boring index such as the Nasdaq can only rebound to its August 15, 2008 high of 2473.20 by the summer or autumn of 2009. In other words, let’s adopt a particularly conservative thesis that the Nasdaq can only recover seven weeks of losses after nearly a one-year pullback.

Even in that case, this would represent a gain of nearly 41% from today’s close of 1754.88.

Sooner or later, investors will focus on that possible 41% gain in less than one year, rather than whatever the market is going to do the next day. If you are doubtful, remember what happened with corn, wheat, silver, crude oil, and Chinese/Indian/Russian/Brazilian equities that were supposedly “sure winners” less than a year ago.

Once any trend reverses, it nearly always wipes out several weeks or months of the previous trend within several trading days. That is because no one wants to be the first on their block to jump in. Once they see everyone else buying, they’ll go crazy about “missing out” and will jump onto the bandwagon. Multiply this by millions or billions, and the results are obvious.

[John]

That can't possibly happen, Gordo. The bubble has lasted 13 years, and by the Law
of Mean Reversion, the market will take roughly 13 years to recover. I estimate
that the Dow will fall to 1400, equivalent to what happened in 1933.

Also, I strongly disagree with your remarks about commodities being pure
speculation. We've had this conversation before, and you're overlooking
the vast demand generated by China's economy, which itself has been in
a bubble since 1980.

John

[The Grey Badger]

OH, John and the gang - I do have to post Dana Blankenhorn's column here. This morning's. Now, he has been urging the bailout as a financial laxative to get "The Big Shitpile" moving. I've filed that under "We'll see." He may have ben right - in the short run. But dig this:

October 07, 2008
Buying Opportunity

Jim_cramer It's official. When Jim Cramer says panic, you've got the buying opportunity of a lifetime.

I can't call the precise bottom. We're in a period of testing lows. We are not going straight up.

But we are going up. Here is why.

The Fed and Treasury Department are dedicated to freeing up liquidity, worldwide, and they will succeed in time. The CDOs will be unwound even if the $700 billion has to be invested several times. With Europe divided and Japan frozen in fear, the world has no choice but to accept those dollars and use them to jump start their own economies.

That's what makes this so delicious. It's like unclogging a drain. Once the obstruction is gone things will flow fast. At that point we will need to take back much of that liquidity. Inflation will be a worry. But you'll have the added liquidity, plus the unfrozen liquidity, all looking for opportunity.

Market goes up.

Dana_at_atlantic_station_close_up So now is the time to start picking up some bargains. If you don't need the money now it's time to pick up some good stocks. If you need the money soon stay in bonds. Government bonds will pay off over time. Cash, on the other hand, will degrade in value, because the interest rate you get on cash deposits is far less than inflation.

Why not use mutual funds? Because no matter how smart your mutual fund manager, your fellow owners are listening to nervous nellies like Cramer. The managers have to sell when the nellies decide to redeem, so you get hammered no matter how smart your manager is.

What stocks should you be looking for? I'm not going to make specific recommendations, but here are some good criteria:

1. You need to see a lot of cash on the balance sheet.
2. You want companies which generate a lot of cash.
3. You only buy companies that are leaders in their markets, nay dominant.
4. You want companies that make things people need, and save companies money. Exception, houses.
5. Buy American. First into trouble means first out.
6. The P/E "sweet spot" is under 15.

Traditionally markets bottom out at an average P/E of 10 and top out near 15. The last decade has seen P/Es ranging all the way up to 27. Those days won't be coming back soon.

Some specific names,with links to their Google Finance page so you can keep up in real-time:

* At $24.50 per share Microsoft's P/E is under 13.5. I'm just saying.
* At $17.15 per share Intel's P/E is about 14.25.
* At $22.25 per share GE's P/E is down near 10.
* At $100 per share IBM has a P/E of about 12.

I'm not recommending any of these stocks, specifically. I happen to like technology as a long-term play. Find your own. Then follow them down and when they look attractive buy 'em.

In five years you'll be glad you did.

[Witchiepoo]

In five years you'll be glad you did.

Allow me to explain why I think this attitude is a BIG mistake.

The California housing market, which started this whole mess, is still a few years away from hitting bottom. In 2005/2006, at the peak, homeowners of all kinds were still taking out huge loans with interest-only payments and adjustable rates. In 3-5 years, depending on the length of their ARM, these folks (including a few of my friends and relatives) are going to be hit with huge increases in their monthly payments that they can't afford. Especially with the slowing economy and increasing unemployment. So expect a continuing of the foreclosure crisis, regardless of what the federal government tries to do to stem the bleeding. Also, there are still homes in pockets of the bay area and southern CA that are increasing in price. Sooner or later, these mini-bubbles are going to pop too. Once that happens, THEN I think it's safe to say that we are near the bottom.

I'll be watching.

[The Grey Badger]

Uh, it wasn't me that wrote it. It was Dana Blankenhorn. Who I also think is making a huge mistake.

[John]

Market Summary, Wednesday morning, 8-Oct-2008

I had actually expected the markets to rally upward today, just based
on the wild oscillations that occurred in 1929. Panic buying is not
much different than panic selling.

However, this coordinated announcement among six central banks around
the world is going to get the credit instead. It's a shame -- it
would have been more interesting to see the rally occur on its own.

As of 11 am, the rally isn't lasting. Ironically, I think it might
have lasted longer without the central bank interventions, since the
interventions seemed so desperate.

Anyway, the Dow closed yesterday at 66% of its high -- which occurred
just one day short of a year ago.

If we count the "crash" as starting in August, 2007, which is when
the credit crunch started, then we're actually following the 1929
crash pretty closely.

With one big exception.

We haven't seen a major generational panic yet, where millions of
Boomers and Gen-Xers panic and try to sell everything.

Must such a panic occur? I believe it must. Generational theory
says so.

But this time it won't be just a stock market panic. It will stretch
much farther, into hedge funds, credit default swaps ($60 trillion)
and other credit derivatives ($1 quadrillion).

All the Fed interventions of the last years -- the TAFs and TARPs and
other stuff -- have been very successful it targeting specific points
of weakness.

If you imagine the global economy as a huge ballooon, then the Fed
interventions have targeted specific large holes in the balloon.

But there are thousands, perhaps millions, of tiny pinholes in the
balloon that have escaped the Fed's interventions, and so the balloon
as a whole has still be deflating. Even worse, as the balloon
contracts, the pinholes actually get larger -- the physical analogy
breaks down here, but the hedge funds that represent the pinholes
become more and more exposed as the market falls.

The two people that I quoted in my web log entry last night expect a
major selloff or panic event of some kind in the next week. I
wouldn't be so bold as to put a date like that on it, but it can't be
too far off.

John