The Contrarian's View s published 11 times per year on a mostly-irregular schedule, and the views expressed are those of the author and editor, Nick Chase. Because nobody can predict the future, results of past suggestions or recommendations are no guarantee of future results. My own material in this publication may be freely quoted provided proper attribution is given to its source; quotes from other people are subject to fair-use copyright restrictions. Subscription rate: Free on the Internet. Using your favorite Web-browsing program, open URL http://onashi.org. Former paid subscribers to the printed version are now receiving LIFETIME subscriptions, and subscriptions to the printed version are no longer being accepted. Unsolicited material sent to us by UPS or by courier other than the postal service is refused and returned to sender! ISSN 1536-4429 Phone: (508) 757-2881
Let's say for the sake of argument that by the end of the next decade it is likely that the average person will live 5 years longer and by 2025 will be living 10 years longer, numbers that Dr. Michael Roizen (YOU: The Owner's Manual) says are reasonable guesses. You can make a real case for those numbers. Some would say they are conservative. We are not talking immortality. Just that the diseases that kill people today will be dealt with. More people will live long enough to die of simple old age.... Today, if you make it to 60, the odds are that you will live at least another 20 years and the last surviving spouse will live for 30 years. What if that goes to 25 and 40 years?
My friend Ed Easterling at Crestmont Research did some very interesting analysis a few months ago. You have saved and invested, and now you want to retire. You decide to take out 5% of your total portfolio to live each year and increase the amount for inflation, so that you can maintain your lifestyle (a number which a surprising number of investment advisors would say is ok). Let's say you are an aggressive older couple and decide to stay in the stock market because that is where you are told that you can get the best returns over time. And you know that you have the probability of living 30 years. On average you are going to get 7-8% or more, right?
Ed calculates what you would get for 78 different 30 year periods since 1900. Let's say you start with a million dollars. On average, this has been a good bet. You could maintain your lifestyle and end up with $3.6 million. You've been pretty conservative, right?
Wrong. Because the returns you get over the next 30 years are highly dependent on the P/E ratios at the beginning of those 30 years. Let's break up those 30-year periods into four quartiles of beginning valuation. If you start in a period when P/E ratios are in the highest quartile, you find that over 50% of the time you end up penniless, on average, within 22 years. Here's that data from Ed:
Where are we on valuations today? You go to S&P's web site and you find that core P/Es are 17.4, at the upper end of the second highest quartile. Notice that even when starting with the lowest-quartile valuations that 5% of the time you ran out of money within 23 years. Want to take a lifestyle bet that you have a 1 in 20 chance of losing? As Ed points out, it will not be fun to have to go to work as a Wal-Mart greeter at 80.
Now, let's throw my assertion that one of the surviving spouses is going to live on average 10 years longer. The failure ratio, meaning that you run out of money, gets a lot higher. And it gets worse if you use a traditional mix of stocks and bonds, because bonds lower the overall return.
The point is that retirement planning is going to get a lot more difficult. And we are going to have a generation who will be in their 70s when they realize the good news is that they will live longer but the bad news is that they can't afford it. And the bad news is that they are going to want the government to step in and help. And by that I mean they are going to need more tax dollars.
Let's think of some of the implications. First, we already know that the large majority of US citizens have not saved enough for retirement. But for those that think they have, they may be budgeting for a future that is going to be a lot longer than they plan.
Second, this is going to cause a massive problem with pensions and annuities. Defined-benefit pension funds and annuities are based on current mortality tables. If you add 10 years to their future budgets in 2025, they become massively underfunded at some point in the latter part of the next decade. This is especially worrisome for smaller annuity firms, as they have no source of new infusions. They were funded on the basis of an initial cash input.
Third, public pension funds at the state and local levels will be in real trouble. They are already underfunded by perhaps as much as $1 trillion. In 40 states it is illegal to cut or change pension guarantees. Many cities are already battling with underfunded fire and police pensions, as politicians made deals with unions that future generations will have to pay for.
In both Europe and the US, where governments have promised pension benefits, their costs are going to go up. Social Security in the US will start to be more painful in just 15 years than the pain we have already projected today. Don't even get me started on Medicare. Yes, we will be less sick, but those new treatments and therapies will not be cheap. And since the largest part of medical expenses occur in the last year of life, we will just be postponing the costs, not getting rid of them....
Let's look at some of the consequences. Because of the ever-increasing costs of public pensions, you can look for substantially higher local taxes in cities where they have old legacy pension programs. That will mean that newer cities which did not make the pension fund promises will have a relative ad vantage.... moving to and working from lower tax venues is going to be easier than ever.
You can count on higher income taxes in the US, and a shift in where funds are spent in Europe. Most agricultural subsidies will be history by the middle of the decade in both the US and Europe. Ethanol subsidies will go by the end of the next decade.
You can make book that Social Security and their equivalents in Europe will be means tested and taxes raised. Pension payouts from private funds will have to be scaled back. All this will cause a lot of angst among voters, and politicians will put off any meaningful reform until there is a true crisis.
But there are a few opportunities. Life insurance companies are going to benefit, as their payout schedules will lengthen due to longer-lived policy holders. Major new health-care and drug companies will be created. We will need more housing, as longer-living Boomers will need to live somewhere. I think there will be a real opportunity in real estate in certain countries where it is cheaper to retire....
Quickly, there are some things that should be done to mitigate the problems, but they are unlikely to be done in the current political environment. We should raise the retirement age more quickly. When Social Security was started, the average lifespan was 65. We have only added a few years to the age when you can first receive benefits.
We should go ahead and put Boomers on notice that means testing will gradually be introduced. We should make the growth of the payments less in the early years. We should encourage more immigration so as to have more people paying into the system.
The likelihood of any of these happening in the next six years is slim to none, and Slim left town, as my Dad would say.
(reprinted from John Mauldin's "Thoughts from the
Frontline" commentary of April 20, 2007. For further
information, contact John Mauldin at John
@FrontlineThoughts.com.)
GDP measures debt-fueled consumption -- it really only measures the rate at which America is going broke. - Addison Wiggin
It seems he [Greenspan] thinks there is a one-third chance that the US could dip into a recession. Considering that most 81-year-olds are putting their laundry in the fridge and their butter in the dishwasher, it surprises me that the market still listens to him. - Ryan O'Gorman [fixed income sales, TD Securities New York]
We are in the midst of a queer mixture of severe monetary inflation, damaging high price inflation, yet an economic recession, weighed down severely by a housing bust and a mortgage finance crisis. Yet, the USGovt & Dept of Treasury & US Federal Reserve tag team are pumping money from the printing press like there is no tomorrow, in utter futility. They had better push harder on the accelerator, since the crises and shocks have only begun. We are in for a wild ride. - Jim Willie
As of their recent February highs that so captivated the bulls, the S&P 500 was still down 4% since 2000, the NASDAQ still down a whopping 50%, and the Dow 30 up a modest 9%. These are catastrophically bad returns for 7 long years even before the pernicious effects of inflation. The Great Bear that awoke back in 2000 is very much alive and well despite the powerful stock rally since 2003.... As mere mortals, we humans are really not allotted much time at all to build our fortunes. If the average investor finally starts getting serious at 30, and plans to retire at 65, he only has 35 years to multiply wealth. But if he is unfortunate or foolish enough to get trapped in a secular bear, he could lose nearly half of his entire investing lifespan and emerge with no nominal gains and big inflation-adjusted losses. - Adam Hamilton
One of the things to worry about is how much markets are worrying. A contagion in the credit markets based on fear is a possibility, though we don't think that's the most likely scenario. - Andrew Tilton [senior U.S. economist, Goldman Sachs]
If the assumption is correct that global liquidity is tightening - at least relatively - as a result of a stagnating US trade and current account deficit, the asset markets that benefitted the most from surplus liquidity should come under some pressure. I am thinking here in particular of the extended emerging stock markets, which in this scenario could be vulnerable to corrections of between 20% and 40%. In turn, a decline in these peripheral markets should have an impact on Japan and, in particular, on the Yen. - Marc Faber
We have gone from a country that used to save, under-consume, invest and produce, to a country that has a negative savings rate. We now live on debt and no longer produce much. We just borrow and consume. That is an economic model that does not work. - Jim Puplava
America's biggest export is its fiat currency - which foreigners are increasingly hesitant to accept. Can you blame them? They have begun to figure out that we have no way of repaying them and that the "full faith and credit" of the United States is about as reliable as a Ken Lay-managed 401(k) retirement plan. - Mike Whitney
We should not be mad at foreign interests. We are the ones borrowing from others so we can consume beyond our own production and savings, thereby creating unprecedented debts and trade deficits PLUS excessive government spending. While America's debt used to be nearly all owed domestically, increasingly huge portions are now controlled by foreign interests. America, therefore, is less and less independently in control of its economy - - not a nice bequest we are creating for our children and grandchildren. - Michael Hodges
The only way central banks even have a hope of temporarily stemming a stock-led decline into a depression, if things get bad enough, is through literally monetizing the entire world stock markets! Who knows, the US and Japanese plunge protection teams may try it.... They won't succeed. - Christopher Laird
And by this I mean the infamous Plunge Protection Team, where the Treasury, the Federal Reserve, big banks and unnamed others all get together to bail us out of any market mishap by buying, buying, buying, using money created by the Federal Reserve expressly for the purpose. And you can be sure that they are out there, right now, doing exactly that thing, in response the to recent market losses. And furthermore, the market will obediently go up as long as they keep buying, buying, buying and all the money floods into the economy, which will also, theoretically, benefit from this deluge of new spending, and thus, they think, mission accomplished, applause, applause, applause. But whether or not they succeed this time or not, their efforts to prevent the collapse of such a preposterous economy will one day fail, and the dollar will fall to relative worthlessness, and money and wealth will be lost by the supertanker-full, and there will be misery and suffering to extents beyond your nightmares. This is the classical end to an eternally-classic situation; a government spent a country into bankruptcy. - Richard Daughty
Point blank, assuming the boomers in aggregate actually do retire, their need for real liquidity will be meaningful. Very meaningful. Remember, we're referring to a baby boom generation who has "learned" to become relatively dependent on asset inflation (real estate, bonds, stocks) for a good many years now to generate household "liquidity". Asset inflation that has truly acted to underpin consumption. Unless we can bank on asset inflation continuing (forget housing inflation), implying that asset inflation will "fund" boomer retirements, just where will retirement funds/liquidity come from? This is the issue, and it's clearly of longer term importance as opposed to being something influencing the open of trading tomorrow morning. Can the Fed fund boomer retirements by simply printing money and inciting ever greater household asset inflation? Can the boomers "borrow" their retirement lifestyles by taking on ever greater leverage? Given that we are looking at over 75% of household assets in real estate, tangibles and bond/cash assets, again, where does future liquidity come from for the boomers ahead? Of course the most obvious answer is the sale of financial assets. Not necessarily proactively, but by sheer default. - Brian Pretti
Over 20% of the U.S. population - the baby boomers - are now beginning to retire, and most of them have nowhere near enough savings to enjoy their senior years. So they'll be absolutely dependent on the Social Security and Medicare promises they've been hearing all their lives. Politically, those promises are impossible to renege on. Financially, they're impossible to pay. And along with the government's other unfunded entitlement programs, they add up to $50 trillion of off-the-books debt.... We're in a box canyon with a floor of quicksand, and the only exit is blocked by a landslide. Investors who take a business-as-usual attitude are not going to have a nice day. - Doug Casey
So if the government has a trust fund full of its own IOUs, it's got nothing.... all these projections about when the Social Security trust fund goes bankrupt, they are all nonsense because they all don't assume bankruptcy until the trust funds are depleted. But they are already depleted. So the real date of bankruptcy is the minute they start paying out more than they collect.... When is that? Probably in 5 to 10 years - that happens pretty soon. And the minute that happens, it's all over with because now they have to raise taxes, or do something. That's because there is no trust fund they can draw on; that money was spent a long time ago. - Peter Schiff
For those who grew up in the 1950s and 1960s, the world was a different place. An average guy with a high school education could support a large family. His wife didn't have to work. He could save for retirement. He could pay down, or even pay off his mortgage by retirement. According to the US Census Bureau, Department of Commerce, the average family income in 1950 was $3,300. But then the average cost of a loaf of bread was 14 cents. That wouldn't pay the sales tax on a loaf of bread today. These days you need two paychecks to support a family, usually with no more than one or two kids. Both parents need college degrees to get good jobs. They have little or no savings and their kids will be saddled with student debt if they go college. How can a middle class family be worse off today than 50 years ago with a booming economy, low interest rates and "minimal" inflation? - Tony Allison
For three decades after World War II, the average American worker's income grew by 2-3% a year after inflation, and stateside consumer spending grew apace. But after the mid-1970s, these income gains slowed to a crawl, while spending growth continued at the same pace. But Baby Boomers felt that the 2%-3% average annual real income growth enjoyed by their parents was their birthright. And when they didn't get it, they settled for "the next best thing," 2%-3% average annual spending growth financed by artificial means. The result is that the average American is now spending at a level not sustainable by income, but only by asset values, specifically in real estate. And when those asset values collapse, and they're doing so as we speak, so will U.S. consumer spending and overall economic growth. - Thomas P. Au
Most regular readers.... are not surprised that inflation may be much greater than is reported. Unfortunately, many, many others are unaware of the pervasive nature of inflation and how this "invisible tax" is wreaking havoc with our economy, our retirements, and potentially our societal fabric. You can't get rid of inflation by changing how it's calculated. And no nation in recorded history has ever been able to create prosperity by printing increasing amounts of its currency. Smoke and mirrors only buys time for elected officials to gain reelection and sweep the problem temporarily under the rug. However, more Americans are discovering their quality of life is in retreat. If the CPI is really 10%.... then those 4.5% Treasury Bond yields don't look so good on a real return basis. While the cost of many consumer goods has fallen over the last few decades, especially electronics, the cost of living has risen relentlessly. The easier availability of credit has helped many to survive, but ultimately the debt load becomes a burden that cannot continue. - Tony Allison
The bursting of the technology stock bubble of the 1990s was simply the opening act. What we are about to experience with the real estate bubble is the main event. In that respect, though it may be March of 2007 it sure feels a lot like March of 2000. However, instead of a mild recession, this collapse will be followed by the most severe recession since the Great Depression. The main risk is that Ben Bernanke and his buddies at the Fed panic, producing something far worse; a hyper-inflationary bust similar to the one experienced by the Weimar Republic in Germany. Let's hope that cooler heads prevail, but get your wheelbarrow ready just in case. - Peter Schiff
Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants... With these advances in technology, lenders have taken advantage of credit scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers... Where once more marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending,... fostering constructive innovation that is both responsive to market demand and beneficial to consumers. - Alan Greenspan [April 2005. Nick's comment: Wrong again.]
Credit for financial speculation is available at liberty. Expectations for weaker economic activity only foster greater financial sector leverage. Why such unusually aggressive speculative expansion in the face of a slowing economy? The apparent explanation is that the financial sector intends to make the greatest possible profit from the coming decline of interest rates, promising further rises in asset prices against falling interest rates. While the real economy slows, the leveraged speculation by the financial fraternity goes into overdrive. Principally, there is nothing new about such speculation. New, however, is its exorbitant scale. - Kurt Richebächer
How blind can they be? As our phony economy begins to unravel before our eyes, it is amazing how few people can actually see it. The collective wisdom of stock market pundits, economists, and Federal Reserve officials gives the impression that everything is just fine. Although some acknowledge that housing is slowing down a bit, that there are isolated problems with subprime mortgages, and that inflation is not moderating as quickly as they hoped it would (let's ignore surging oil prices), few can see any grave threats to continued economic expansion, or the bull market in stocks, bonds or real estate. Earlier this week a CNBC anchor asked a guest if the "economic baton" might now pass from housing to the consumer, much the same way it previously passed from the stock market to housing. I'm not exactly sure where the anchor believes that consumers will now be getting the money to lead us out of the economic morass. With adjustable rate mortgages now re-setting higher, home equity disappearing, credit card debt mounting, personal savings at record lows, and the cost of basic necessities continuing to rise, the consumer is all tapped out. In fact, consumer spending is not just going to slow down; it is going to fall off the edge of a cliff. - Peter Schiff
The economy is slowing far faster than most think by the three best leading indicators one can find (the yield curve, rates of change in M-prime or monetary base, and housing). Financial speculation as evidenced by growth in M3 and the final buildout of retail stores already under construction are all that is keeping the good ship Credit Bubble afloat. - Mike Shedlock
This credit collapse is an unequivocally important event. Because the ability of anybody with a pulse to get a loan for any amount is what drove the real estate market, and the real estate market is what drove the economy. Sometime in the next three to six months, the real-estate market will basically just freeze up. Of course, inventories are going to explode and prices will eventually drop rather dramatically as a vicious cycle feeds on itself. - Bill Fleckenstein
The fact that Congress is now holding hearings on the fallout from the second major asset bubble in the last decade should prompt some broader questions. For example, what role did the Fed's loose monetary policy from 2002 to 2004 play in fueling the housing bubble? Should the Federal Reserve re-examine its policy of ignoring asset bubbles? Asset bubbles are harmful for the same reason high inflation is: Both create misleading price signals that lead to a misallocation of economic resources and sow the seeds for an inevitable bust. The unwinding of today's housing bubble is not merely an academic question: It is likely to inflict real hardship on millions of Americans. - Andy Laperriere
So now that the subprime disaster is too big for anyone to ignore the new conventional wisdom is to try to minimize the extent of the problem. The new consensus view is that "this is only a sub-prime niche problem that is contained and will have no spillover and contagion effects to other mortgages, to the credit market, to the economy and to the US growth rate". This new consensus is as wrong as the systematic ignorance since last summer by the consensus of that unfolding housing, mortgage, financial and economic train wreck. - Nouriel Roubini
There are roughly 75 million housing units in the USA. About 25 million of those homes are owned free and clear. That leaves 50 million homeowners with sharing (roughly) $10 trillion in total mortgage debt. The risk of "resets" (that is, monthly payments that will go up after the introductory period of time) will affect 75% of all mortgages.... 4.5 million homeowners will have to come up with lump-sum, "balloon payments". 10 million have taken out piggyback loans to avoid a down payment on their original purchase. 12 million have either 2 or 3 mortgages outstanding. And, of the homeowners who have taken out "conventional" loans via FHA or VA, nearly 10% are having difficulty making their payments. Get the picture? The problem is not safely "contained" in the subprime market as Bernanke and Paulson confidently suggest. This is a massive economy-battering tsunami which is sweeping through the real estate market on its way to Wall Street. (60% of the mortgages have been "securitized" and sold off to hedge funds and insurance companies) By the time the dust settles, the stock market and the mortgage industry will be reeling. We are likely to see the first bank failures since the late 1920s and, perhaps, one or two major hedge funds will go under. Collateralized mortgage debt has been integrated into the stock market, insurance industry and banking business. Any downturn in housing will inevitably ripple through the entire system. - Mike Whitney
You're going to see foreclosed houses dumped onto an already weak market where homebuilders are struggling to sell their spec houses. And so the price declines that have started will continue and maybe even accelerate in some of the hotter markets. I would estimate that housing prices in '07 will decline at least 20% in a lot of markets from where they are today.... What you're going to see is the biggest housing price decline since the Great Depression. - Ken Heebner [co-founder, Capital Growth Management]
The current housing bubble and bust serves as vivid testimony of the failure and inability of free people to manage money and a monetary system, without the discipline and rigorous enforcement of a gold standard. When we run out of new available bubbles to puff, we will earn a new system, which is most likely to be less friendly and less gentle with liberties and freedom. Like now! - Jim Willie
I am really amazed at how entrenched the belief is that the housing market will continue as it has for the past few years, and that whatever negative occurs due to the subprime debacle will be a hiccup.... That view is just plain silly, as the impact is already beginning to seep into various economic statistics.... I expect by sometime in the next three or four months, it will be quite clear that the economy is headed for a serious consumer-led recession. - Bill Fleckenstein
For many decades, meddlers have been urging the credit industry to provide more loans and encourage home ownership among poor people. Now they've gotten what they wanted. In the last few years, after lenders figured out how to make a buck at it by laying the risk onto other investors, they complied. The poor got home ownership in spades. Bad credit? No problem. Low income? Who asked? No savings? Don't worry about it. But now that the industry has done as it was bid, do you think it will get any thanks? Not likely. Instead, the busybodies are likely to come around with a subpoena in their hands...if not a rope. - Bill Bonner
It will be the second wave downwards in the housing market that will catch everyone off guard and send the economy into a sharp, protracted consumer-led recession. And that second wave is about to hit.... It has now been over 18 months since housing peaked in the summer of 2005. But the average decline in housing starts from peak to trough is about 46 months. By that standard this decline has a long ways to go yet.... That second wave will strike when massive layoffs occur as the current projects are being completed followed by a decline on a lagging basis of commercial real estate. Already we are seeing an impact in residential construction employment. But do we really need more Wal-Marts, Pizza Huts, strip malls, nail salons, grocery stores, Home Depots, Lowes, and restaurants that follow? I think not; and historically, commercial construction follows residential construction with a lag. That lag is anywhere from 8 to 16 months.Commercial business hires people and lots of them. When that buildout ends, and we are at the beginning of the end now, there is going to be no source of jobs to replace those service sector jobs going forward. - Mike Shedlock
The typically stronger spring selling season has not yet materialized. These soft market conditions have been exacerbated by the well-publicized problems in the subprime lending market. - Stuart Miller [CEO, Lennar]
I sell investment real estate in the San Francisco Bay Area. Have been for 25 years. It's a nice business. I've enjoyed it, and I value my clients. My pappy's a realtor. My grandpappy was a realtor. My uncle's a realtor; so is my brother. Heck, some of my best friends are realtors (and it takes a big man to admit that). That's why it pains me to give you the bad news, to wit: Real estate in America is officially dead. But only for a generation or so. In other words, it is time to sell all of your real estate, save for possibly your home. If you don't, you will likely regret it. You will gradually watch all of your equity disappear into thin air. And then, unless you have little debt against it, you will likely lose your property to foreclosure. It's as simple as that. The far better strategy is to sell now, even if you are disappointed with the selling price, take your equity (less any capital gains taxes you must pay) and put it into safe, interest-bearing cash-equivalents for a while.... Eventually you will be able to buy all the real estate you want, probably including the stuff I'm happy to sell for you now, for literally nickels on the dollar. - Steve Moyer
I have a somewhat unique perspective on this problem, as I ran a family business selling manufactured housing.... I ran Coachman Homes - a manufactured housing business started by my father in 1968. The manufactured housing business peaked in 1998 and 1999 when lenders were flush with 'Wall Street' cash and were willing to put just about anybody into a manufactured home. The party came crashing down in late 1999 and 2000 as a couple of the major lenders started to have problems with foreclosures.... and therefore began to tighten lending standards. The manufacturers were slow to realize this was not just a temporary slowdown and kept building homes as quickly as they could get them produced. We soon had a glut of home inventories, and the lenders wouldn't approve as many buyers; so naturally the prices of homes started to come down. This caused several new homeowners to suddenly become upside-down in their home loans (they actually owed more than the home was worth) and so they just decided to 'walk away' from the homes and 'give' them back to the lenders. Suddenly, the new home retailers were competing with bank foreclosures chasing after a decreasing number of approved buyers.... I use this as an example of why I don't believe we will see the full effect of the housing downturn for some time. Yes, builders are now scrambling to offer incentives to buyers of their 'spec' homes. But what about all of the homes which are going to start hitting the market due to foreclosures? - Chris Gaffney
When the bubble finally bursts completely, millions of Americans will be looking for someone to blame. Look for Congress to hold hearings into subprime lending practices and "predatory" mortgages. We'll hear a lot of grandstanding about how unscrupulous lenders took advantage of poor people, and how rampant speculation caused real estate markets around the country to overheat. It will be reminiscent of the Enron hearings, and the message will be explicitly or implicitly the same: free-market capitalism, left unchecked, leads to greed, fraud, and unethical if not illegal business practices. But capitalism is not to blame for the housing bubble, the Federal Reserve is. Specifically, Fed intervention in the economy -- through the manipulation of interest rates and the creation of money -- caused the artificial boom in mortgage lending.... If housing prices plummet and millions of Americans find themselves owing more than their homes are worth, the blame lies squarely with Alan Greenspan and Ben Bernanke. - Ron Paul [R-TX]
The subprime-mortgage market is big, but it's not big enough to push the U.S. economy into a recession by causing a credit crunch. - Robert Froehlich [chief investment strategist, DWS Scudder]
Could the scare stories over the sub-prime lending debacle be the final wash-out phase of the U.S. housing market correction? I think it could be. It's certainly typical of past wash-outs of bear markets and as usual the mainstream press is doing a stellar job of exaggerating the negatives and trying to scare the country out of its collective wits.... I take this barrage of pessimistic headlines to be a contrarian indicator that the worst has already been discounted by the markets and it shouldn't have that great of an impact on the national economy. This isn't to say that the sub-prime mortgage problem is just going to vanish overnight without any pain or negative consequences, for there almost certainly will be more. But as far as major national economic pain...doubtful. Sub-prime borrowers are more often than not equity rich and yet don't always pay their bills on time. It's not as if they're dirt poor and one paycheck away from the curb as the media would have us believe. - Clif Droke [Nick's comment: I probably should make a greater effort to print more quotes that differ from my own point of view, and this is such an attempt. But I do wonder what Clif's been smoking.... subprime borrowers are "equity-rich"?]
Here's how it works: Real Estate loans go bad. Politicians call Bank Regulators in on the carpet, demanding to know how this happened. Bank Regulators dance while their feet get shot at, hat in hand, then return to their fiefdoms unable to sit like they used to be able to. They decide they don't like that experience, feel they have a mandate to catch and stop bad loans, and instantly become overzealous. They schedule more frequent exams, tighten arbitrary standards, and rate good loans as substandard, and substandard loans as doubtful, and force writeoffs all over the banking world. Bank earnings take a hit -- not from actual bad loan losses, but from subjective downgrading by bank examiners which requires transferring earnings into provisions for possible loan losses expense. Fearful any good loan has too high a chance of being rated as a bad loan by a bank examiner, banks put the brakes on lending. This causes a credit crunch, and sends an already weakening economy into the tank. Once the recession is publicized, public outcry demands solutions from politicians. Politicians then tell regulators to back off, after it is too late, demanding they let money flow again through the bank lending function. - Robert D. McHugh, Jr.
It will not be loan losses that threaten future economic growth, however, but the tightening of credit conditions that are in part a result of those losses. To a certain extent this reluctance to extend credit is a typical response to end-of-cycle exuberance run amok. And if one had to measure this cycle's exuberance on a scale of 1-10, double-digits would be the overwhelming vote. - Bill Gross
Credit spreads in sub prime have blown out, and many a sub prime lender has simply been blown away in the winds of credit market repricing. This has happened fast. Moreover, as I see it, when looking at the pyramid that is mortgage financing in this country, we've just stripped away the entire bottom layer of the credit pyramid. So what happens to the real world of nominal dollar housing sales when your marginal buyer has now been shut out of the game? Can pricing really hold up in thin air above the now non-existent bottom level of the mortgage credit structure? The mortgage credit food chain of recent years just lost its most important marginal driver. And as always, change at the margin can be incredibly powerful in terms of ultimate trend change. - Brian Pretti
You can't believe how bad it's going to get before it gets any better. It's going to be a disaster for many people who don't have a clue about what happens when a real estate bubble pops.... Real estate prices will go down 40-50 percent in bubble areas. There will be massive defaults. This time it'll be worse because we haven't had this kind of speculative buying in U.S. history.... When you have a financial crisis, it reverberates in other financial markets, especially in those with speculative excess. Right now, there is huge speculative excess in emerging markets around the world. There will be a lot of money coming out of emerging markets.... This is the end of the liquidity party. Some emerging markets will go down 80 percent, some will go down 50 percent. Some will most probably collapse. - Jim Rogers
I don't want to be too sophisticated here, but 2007 is going to suck, all 12 months of the calendar year. - Don Tomnitz [CEO, D.R. Horton]
Now, let me tell you about one nearby development called Cielo. It's a community of townhomes that Lennar started building a while ago. It's getting closer to completion every day. A quick check of the Palm Beach County Property Appraiser's website shows that a fair number of sales closed between August and November of last year. Here's one for $492,365... another for $509,990... and another for $559,990. There's just one problem - Lennar is still sitting on a pile of available inventory at Cielo. It had two-and-a-half pages of listings on its website earlier this week. The asking prices ranged from $349,990 to $389,990. Just a few weeks ago, they were over $400,000! And compared with those sales that took place a few months ago? Forget about it! Now, differences in square footage, model type, options, and other things can account for some of the difference in pricing between a given set of housing units. But those variations wouldn't account for such a sharp drop. In other words, the neighborhood "comps" (comparable sales, which appraisers use to determine the value of homes in a given area) are coming down. Look, I'm not trying to single out this particular neighborhood. After all, I live not too far down the road! But here's my point... Ignoring the reality that home prices are generally falling doesn't change the situation. - Mike Larson
For those of you who like to talk about Sunday's football games by the water cooler on Monday morning, the last year or so has gone something like this: First the real estate speculators, fully leveraged and able to buy four and five condos at a time with little or no down payment as long as the prices were going up (does that sound anything like dot.com stocks in 1999-200?), suddenly started losing money as the speculative soda predictably lost its carbonation. In no time, those speculators exited from the party, stage right. Market activity then began to slow down substantially and everyone from ordinary home buyers to big land developers started walking away from previously-negotiated purchase contracts. Statistically, "average home prices" have not shown an appreciable drop yet because condo sales have gone dead (thereby artificially raising the average selling price of a "home"), but as no-money-down and other goofball loans go the way of Nehru jackets, it is only a matter of time before "declining home value" stories will be headlining the evening news. Every night. - Steve Moyer
Once the US is no longer the consumer of last resort in the global economy, our relationship with the rest of the world is going to change dramatically. If we have nothing to offer them in terms of shipping their foreign goods here, or essentially using their outsourced labor, then we become marginalized; and you've already seen it, at least in some of the hot spots - so Venezuela calling the US, "the devil;" Russia and China almost going their own way to a certain extent, (and more so over time), where they say, "well, what do we need the US for?" - Michael Panzner
Everyone was looking to the Federal Reserve meeting earlier this week wondering whether they would raise rates to combat runaway core and headline PPI and CPI. The true answer is, they can't. Federal Reserve governors Moskow, Poole, etc. can say anything they wish to push back at the psychology of inflation. But the compounding of under-yielding investments has now gotten to the point where if they even wanted to tighten they couldn't, as the financing that underpins previous highly-leveraged asset purchases will collapse when the valuations crater during the tightening, and the repricing of the risks they really engender. Unfortunately for all of us their ability to effect a tightening has been effectively removed from their policy options... The only option is more and bigger injections of money and credit, forever! Just as a heroin junkie always must get a little more each time just to get back to a little less high than the previous one, the monetary authorities must do the same with money and credit. - Ty Andros
With Helicopter Ben talking incessantly about the supposed 'threat' of 'inflation', it didn't take a rocket scientist to figure out that inflation was the least of his concerns. Like the rest of us, the Fed chairman has known all along that the 'good' kind of inflation - the kind that pumps up everybody's assets so that those assets can be hocked to the moon - is all that stands between our spectacularly over-leveraged economy and a Second Great Depression. - Rick Ackerman
This time it's different: Even though we eventually discover to our sad consternation that this time it's never different, when it comes to a 1930s-type depression, the Fed governors and our economists have us believing that this time it really will be different, because they have learned from the mistakes of the past - or so they claim. Oh, if it were only so. There are two main reasons why history repeats. The first is simply because nobody bothers to study history; the second reason is that even if there were people who did take the time to study the past, most of recorded history is not altogether factual, as it is written in a politically-correct fashion. - Aubie Baltin
There is currently $370 trillion in derivatives, hedge funds and over-leveraged marginal investments. There is no coherent relationship between this mass of cyber-wealth and actual deposits or investments. It is merely a fractional banking scam on steroids; computer-generated capital with no basis in reality. As the sub prime market comes under greater strain, hedge funds will teeter, derivatives will tremble, liquidity will dry up and the whole debt-plagued system will crash in a heap. The frantic efforts of the PPT with their flimsy bits of scaffolding will amount to nothing. Wall Street is quick-stepping towards the gallows and there's little hope of a reprieve. - Mike Whitney
The U.S. economy excels in the art of facing up to error -- of identifying it, reappraising it and then repricing it. Loans, especially the risky kind, have been mispriced. They were, and are, too cheap. They will be repriced -- as they were, for example, in the aftermath of the junk-bond and real-estate troubles of the late 1980s and early 1990s. Borrowing costs will go up, and the value of the things that debt financed will tend to go down. In an attempt to ease the pain, the Federal Reserve will print more money. - Jim Grant
The bursting of two bubbles seven years apart - dot-com and housing - holds the key to the macro outlook. While different in many respects, these sharp swings in asset markets share one thing in common - the initial belief that any spillovers would be limited and that the rest of the economy and financial markets would remain unscathed. Just as that view turned out to be wrong in the early 2000s, I fear a similar outcome today.... What's especially worrisome about the current situation is that real GDP growth has already slowed to just 2% over the past three quarters - far short of the 3.7% annualized pace of the previous three years. Yet this downshift is largely an outgrowth of a steep recession in homebuilding activity, together with collateral impacts of a recent downtrend in business capital spending.... Should the consumer move into a more meaningful period of consolidation - precisely the risk as equity extraction from residential property now slows in a post-housing-bubble climate - then macro contagion could become an increasingly serious problem.... It would take a Volcker-like toughness to bring this insidious process to an end. Yet both Greenspan and Bernanke seem to be cut from a very different cloth. - Stephen Roach [Nick's comment: Bogus government CPI understates inflation, thereby overstating real GDP, which is probably already negative, not +2%.]
Most of what passes for hedonic adjustments in the price indexes is simply another way of reporting the improvements in technology. Another name for this is, of course, "productivity". Technological advances, hedonics, and productivity are all names and measures for the same fundamental fact: technological advance allows for the increase in productivity that is translated into the hedonic adjustments.... If our government was fair and money and credit growth were restrained, I estimate the dollar could purchase about two percent more each year, and we would be living in a saver's paradise. Taking productivity out of the Price Index means that when the CPI shows three percent, in reality it's more like five percent. Our government gains by doing this because as the world's largest borrower, they benefit from increases in productivity. On the other hand, savers and those on fixed income really get ripped off. In a $14 trillion economy, the two percent productivity rip-off is likely to amount to a cool $280 billion, and the total inflation tax on five percent is over a half trillion dollars. That is enough tax revenue to pay for a not so little war! - Richard Benson
This week the Harper crew issued its budget. I watched the TV set with rabid enthusiasm, fully expecting to hear some kind of a reprieve for the Trusts in response to the cries of foul from Canadian investors. But I heard nothing. Instead I heard more nastiness. Turns out Mr. Harper has a bit of a "green" streak in him. Seems he favors "green" energy. On that note, he is moving to take away the accelerated tax depreciation bonus for oil sands projects. So effective now, any company seeking to begin development of an oil sands project will be able to use accelerated depreciation on capital costs only for another 2 1/2 years (until 2010). Just what Mr. Harper is thinking...I do not know. But clearly he has lost touch with the Canadian oil and gas industry. This is not only foolish but also dangerous. If a lack of investment capital is going to be the prevailing theme for the Canadian energy sector, I can assure you there is plenty of foreign capital eagerly waiting on the sidelines. Foreign capital that will snap up Canadian energy assets at firesale prices. Yes indeed. Canada is for sale.....How sad....How truly sad..... - Merv Burak
Unknowingly (I pray), Bush and the Congress have come up with a great solution for the illegal immigration problem. Instead of feeding the world with the essential staples of corn, soybeans and rice, the beltway crowd has decided to flush these vital foods down the gas tank in the form of ethanol, thereby starving out the poor of the world by making tortillas and beans, etc., unaffordable. Corn is the most universal agricultural and widely applied staple in the world. My expectation is that dramatic food cost inflation is unavoidable and lies just ahead. - Kevin Kerr
The sad-but-funny part is that turning corn into ethanol requires as much as 70% of the energy that comes from the ethanol itself! HAHAHAHA! The only worse choice would have been wheat, which needs about 90%. It would have been much, much better (and seemingly a lot smarter) to get ethanol from sugar cane (10%), or cellulose (25%), or soybeans (37%) or even rapeseed (40%)! But we chose corn at 70%? We're idiots! - Richard Daughty
Iran's operatives are swarming all over southern Iraq. Iran has exported insurgency to the Palestinian Territories, Lebanon and other hot spots in the region. Iran's nuclear program has crossed a tight line in the sand drawn by the United Nations. Each of these processes has a life of their own. It's going to be very difficult to reverse them. Expect an air war and surging oil prices. Then, immediately thereafter, expect a new surge in defense spending in the U.S. and in the region. - John Burke [defense stock specialist, Weiss Research]
One of my favorite quotes is, "Give a man a fish and you feed him for a day. Teach a man to fish and you
feed him for life." Today in order to teach a man to fish, you need two fishing licenses, a state boat sticker,
OSHA approved life jackets, EPA approved weights and hooks, you pay a park fee, obtain a fire permit to
cook the fish and an EPA permit to dispose of the waste. Thanks to the government, fish you catch costs 8
times as much as the fish you purchase in the supermarket, caught overseas. - Clyde Harrison
Absent some sort of systemic problem, one would expect stocks to behave just about as they have been, rising slowly under the pressure of the 11%-per annum rate of expansion of the money supply, a good chunk of which reaches stocks via private equity buyouts. (This may turn out to be the next bubble, after tech stocks and housing: Private-equity deals.)
But now we enter the seasonably-unfavorable period for stocks, May to October, and I expect the market to be neutral at best for the next six months; likely worse, possibly much worse, because of the collapsing housing bubble impacting the economy.
The odds that a systemic failure (mini- or otherwise)
will occur have reverted to about 2 in 3 between now
and December. After that, we'll see.... in 2008 the
leading edge of the baby-boom retirement bulge
begins, and boomers can't eat stocks; they have to
sell them (or borrow against them) to raise money for
living expenses.
A. "Inheritance" - real (normalized) "dividend and interest distribution" portfolio:
SUMMARY - "Inheritance":
Original cost: $100,000.00 (normalized)
Present value: $113,926.42 (see below)
Increase: $13,926.42 [+13.93%]
COMMENT on "Inheritance": There are three changes to the portfolio for this issue. The first is that, after some thought and agitation, I decided I really wasn't comfortable owning a large-bank stock as we head into a housing-bust-induced recession; so I sold my remaining shares of Wells Fargo, even though the position I was carrying was "pure profit" from the level at which my stepmother's money manager bought them. ("Sell to the sleeping point", J.P. Morgan said.) Warren Buffet is (or was) accumulating this stock, and he probably will turn out to be right and I wrong.... but I really didn't want to ride these shares through the bear.
The second change is the addition of Provident Energy Trust, yet another Canadian royalty trust, which (like PennWest in my IRA portfolio) is likely to continue to prosper in spite of the impending hostile tax changes. Provident has long-life assets, some of them in the western U.S. (through BreitBurn LP) and is, so far, successful in increasing its oil/gas reserves.
Also added last month were 50 more shares of PrimeWest (as part of a strategy to capture the short term capital loss of the shares bought last fall).
Yes, I know that the portfolio is heavy in energy (and cash). But I look at the central banks of the world increasing their money supplies at rates of (on average) 11% per year, knowing that the result is consumer price inflation in the pipeline, and I simply feel more comfortable owning (proxies for) assets that can't be printed or depreciated by stupid politicians and their cronies. There is a risk that a major worldwide depression following a systemic failure would impact these, because reduced energy consumption might overpower the decrease in oil production as the world's major oilfields go into decline. Conversly, there is the possibility that some geopolitical shock could send energy stocks to the moon. But, most likely, they'll just grind along as they are. (Sometimes, linear projection works.)
Incidentally, there are many more high-quality Canadian royalty trusts which trade in Toronto and in the NASDAQ pink sheets. But they can sometimes be a bit tricky to buy electronically (without broker intervention) in the U.S., so I have stayed with those trading on U.S. exchanges.
The portfolio cost (normalized) is $108,982.99 with $48,498.39 currently in cash or near-cash.
B. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG":
Original cost: $10,699.00
Present value: $21,575.58
Increase: $10,876.58 [+101.70%]
COMMENT on "PIG": I continue to "roll over" 3-monthT-bills, one per month.
C. Roth IRAs - real portfolio:
SUMMARY - Roth IRAs:
Original cost: $29,766.19
Present value: $36,768.70
Increase: $ 7,002.51 [+23.53%]
COMMENT on Roth IRAs: There is no change from the last issue.
D. TIAA/CREF 403(b) and (non-Roth) IRA retirement plans: My TIAA-CREF and Fidelity non individual-stocks retirement investments, both the part from which I am making monthly withdrawals and the parts that are "resting", are invested as follows: TIAA traditional, 74.72%; T-bills and money-markets, 4.54%; TIAA-CREF inflation-indexed bonds (retirement), 16.64%; TIAA real estate, 2.96%; MLPs, 1.10%; TIAA CREF High-Yield II, 0.04%.
COMMENT on non-Roth IRAs: As I noted in the last issue, on the theory that the Fed may be driving down short-term interest rates sooner than most observers expect - in an attempt to stave off the rapidly-onrushing recession - I am shifting some money out of T-bills and into other high-yielding areas. For the traditional IRAs I have settled on master limited partnerships, because in an IRA I don't have to deal with the crappy Schedule K-1 paperwork. (MLPs can be held in IRAs in limited quantities without triggering an Unrelated Business Income tax.) I don't carry a portfolio listing in The Contrarian's View for these non-Roth IRAs.... only the percentages given in the previous paragraph.... but when I add an MLP I'll make note of it here. My first MLP purchase was Eagle Rock Energy Partners (NASDAQ: EROC) at $19.68 on March 14.
TIAA-CREF values, 20Apr2007: stock, 258.65; equity-index, 100.48; MM, 24.08; bond, 80.83; inflation-indexed bond, 47.50; real estate, 286.64; TIAA current yield in SRA, about 4.82%. COMMENT on NYSE "Timer's Trend": We are currently on a BUY signal of March 8, 2007.
COMMENT on NASDAQ "Timer's Trend": We're on a BUY signal given April 12, 2007.
NEXT ISSUE - will likely appear in May 2007.