Marc Faber's December Outlook

Marc Faber is out with his latest report which discusses his outlook for stocks, bonds, commodities, gold, and the dollar. Here are a few highlights:

Equity Markets--Last month, Faber was somewhat cautious on US stocks, saying that sentiment was overly bullish and vulnerable to a correction. So far, we have seen a slight decline in stocks as the QE euphoria fades and worries mount in the PIIGS. Faber thinks the correction could continue as things in Europe worsen. However, he does not expect the market to fall below the 1010-1050 range on the S&P 500 because of the Bernanke. Of all the developed markets, Faber likes Japan the most. He thinks a declining yen will help Japanese equities. Furthermore, Japan is under owned by institutions.

Emerging Markets--Those who are investing in emerging markets are late to the party. The market has mostly priced emerging markets to perfection, which makes further gains difficult. Faber favors frontier markets (especially those levered to natural resources) whose valuations are more favorable. Faber even likes developed markets (US, Europe, Japan) more than he likes emerging markets right now.

Gold & Silver--Faber still likes gold and continues to accumulate ounces, but he says a correction to $1200 would not surprise him. Gold bull market remains intact as the majority of individual investors and institutions remain under invested.

Bonds--Continues to hate US government bonds.The risk versus reward is not favorable as Faber does not believe bond yields will make new lows. However, he does like Russian and Central Asian corporate bonds, even though he expects interest rates to rise in the future.

Currencies--Euro is going down against the dollar and will likely fall further because of the EU debt crisis. Generally, a higher dollar leads to lower stock prices. Long-term the dollar will weaken but for now it continues to benefit as the world reserve currency.

Overall, Faber expects world equity markets to remain well supported in the medium-longer term because people have nowhere else to put their money. Once bond yields start to rise, all of those people who piled into bonds will redeploy funds into equities. Also, all of those people sitting in cash are getting tired of zero percent returns and equities make the most sense.

There you have it: Faber's outlook for December. Good luck trading!

Black Swan Insights

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Case Shiller Confirms Housing Double Dip

The most watched housing index Case Shiller was released today showing the housing dip is in full swing. Case Shiller's 10-city composite declined 0.7% in September, while the 20-city composite fell 0.5%. Home Prices are now down 2% for the third quarter and are down 29% from their peak back in July 2006. This, of course, does not come as a surprise as other housing indexes have revealed the same fact but is significant as Case Shiller is the most widely followed index. The only question at this point is: Will we break the lows reached in May 2009?  Most industry observers expect home prices to fall another 10% at least in 2011, which would bring the indexex to a new lows. The 20-city composite index, for example, would be around 130 if this scenario played out.  From the press release:
 “Another weak report; weaker than last month. The national index is down 1.5% from the third quarter of last year and 15 of 20 cities are down over the last 12 months. Other than Tampa, FL, there are no new lows this month but many analysts will argue that a double dip will be confirmed before Spring. While some of the bad numbers may reflect the end of the government’s tax incentive for first time homebuyers, there are other problems weighing on the housing market.” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor's. “The national economy is certainly the number one issue for housing. Additionally, there is a large supply of houses on the market and further, hidden, supply due to delinquent mortgages, pending foreclosures or vacant homes. New construction is running at less than half the pace needed to meet normal demand, so a sustained recovery could be a ways off.”
click chart for larger image

Note: Case Shiller uses a three-month weighted average for calculating prices (July, August, September), which means it is very slow in detecting rapid price movements.

If you look at the individual city numbers, you get a good sense of where the price declined occurred. The top five losers were: Cleavland down 3%, Minneapolis -2.1%, Portland -1.9%, Dallas -1.6%, and Phoenix -1.5%.

There were only 2 areas which saw price gains: Las Vegas +0.1% (unbelievable) and Washington +0.3%.

Regarding the housing market, it is safe to conclude the housing dip has arrived. It will be interesting if we get more housing related stimulus from the government. After all, one of the most powerful lobbyists in Washington is the National Association of Realtors which is always trying to steal money from taxpayers to boost their bottom lines. Maybe they could suggest another pointless home buyer's tax credit since it certainly juiced the housing market for about 9 months or so. These people have no shame because it is not their money at stake. As I have said before, the best thing for the housing market would be to let it fall until buyers come back into the market on their own. Housing is still overpriced, and there is little the government can do about that. The Fed, however is doing its best to debase the dollar to artificially increase nominal home prices, but that does not seem to be going too well.

Related Articles:
Home Prices Fall 2.8% Year Over Year in September--Corelogic
Get Ready For The 2011 Housing Double Dip---S&P
US Housing Market Reaches Depression-Era Milestone
Home Prices Decline 1.6% In October--Altos Research


Irish Bailout Flops--PIIGS CDS Surge

Well, it's back to the drawing board for the EU elite. Their bazooka style bailout for Ireland seems to have bombed with the market as all of the PIIGS CDS close higher following the announcement. About the only alternative for the EU is to send in the ECB to buy all of this debt. If the ECB is not in the mood for debt monetization, the Fed could step in and legally buy foreign government bonds (yes, they have the power to do this).

Below are the current 5 year CDS for the PIIGS:

  • Ireland--CDS hits a new all time high of 601 bps, and this is after the official bailout!
  • Portugal--up 6% to 536 bps, indicating it is only a matter of time before they, too, get a bailout.
  • Spain--up a staggering 8.2% to 350 bps. You can add them to list of countries waiting in line for an EU bailout.
  • Greece--down 1.7% to a banana republic-like 970 bps.
  • Italy--up a mind-boggling 13.8% to 246 bps. I wonder, how do you say default in Italian?
  • Belgium--yes, I know, Belgium is not yet part of the PIIGs, but it soon will be. Belgium CDS up 15% to 186 bps.
And yet, after all of this bad news, the market reclaims most of its intraday losses. Amazing. You can thank the Fed and its POMO for today's stick save.

Here is a great video by Euroskeptic Nigel Farage who slams the EU elite.

Black Swan Insights

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Keynesians Show Their Hand---Dollar Devaluation

Below is an article from uber-Keynesian Barry Eichengreen whose main claim to fame was his work on the gold standard and the Depression. His "brilliant" insight, if you can call it that, was that countries who left the gold standard first recovered more quickly than other countries who maintained the monetary peg. The reason I am showing this article is because it reveals the Keynesian mindset and offers a glimpse into what their ultimate plan is regarding the dollar. As we know, every member of the Fed is a Keynesian. From the article, which was written back in March 2009:
Every day it seems more likely that we are destined – or should one say doomed? – to replay the disastrous economic history of the 1930s. We have had a stock market crash to rival 1929. We have had a banking crisis comparable to 1931. With the economic meltdown in eastern Europe we have the prospect of a financial crisis in Vienna, exactly as in 1931. We have squabbling among the major economies over the design of rescue loans, just as when the Bank for International Settlements was hamstrung in its efforts to contain the crisis in Austria. We have the prospect of a failed world economic conference in London to dash remaining hopes for a co-operative response, just as in 1933.

And if all this wasn't enough, now we have the dreaded spectre of competitive devaluation. In the 1930s, one country after another pushed down its exchange rate in a desperate effort to export its way out of depression. But each country's depreciation only aggravated the problems of its trading partners, who saw their own depressions deepen. Eventually even countries that valued currency stability were forced to respond in kind.

In the end competitive devaluation benefited no one, it is said, since all countries can't devalue their exchange rates against each another. The only effects were to fan political tensions, heighten exchange rate uncertainty, and upend the global trading system. Financial protectionism if you will.

Now, we are warned, there are signs of the same. The Bank of England is not exactly discreetly encouraging the pound to fall. And just last week the Swiss National Bank intervened in the foreign exchange market to push down the franc. Will Japan, the United States and China be long to follow? Will we all yet again end up shooting ourselves in the foot?

In fact, this popular account is a misreading of both the 1930s and the current situation. In the 1930s, it is true, with one country after another depreciating its currency, no one ended up gaining competitiveness relative to anyone else. And no country succeeded in exporting its way out of the depression, since there was no one to sell additional exports to. But this was not what mattered. What mattered was that one country after another moved to loosen monetary policy because it no longer had to worry about defending the exchange rate. And this monetary stimulus, felt worldwide, was probably the single most important factor initiating and sustaining economic recovery.

It is true that the process was disorderly and disruptive. Better would have been for the countries concerned to co-ordinate their moves to a more stimulative monetary policy without sending exchange rates on a roller-coaster ride. But, not for the first time, they failed to agree. Those in the most precarious positions had no choice but to pursue the new policy unilaterally.

In any case, monetary easing achieved through a process of "competitive devaluation" was better than no monetary easing. Those countries that shifted in this direction first were also first to recover. But in the end – the end coming after an excruciating five years – they had all moved in the requisite direction, and they all began to recover.
This almost sounds as it were written by Zimbabwe Ben himself--the self-proclaimed expert on the Depression, so they say. Whenever the Keynesian policies of borrowing, spending, and inflating plunges the economic system into trouble, their solution is to simply hit the reset button through large scale currency devaluations. To the Keynesians, devaluation is a way to stimulate more borrowing and debt to fund more consumption and investment and hence economic growth. Best of all, the government automatically lowers its debt in real terms, allowing it to spend even more. Nobody gets hurt, except the honest saver and this is acceptable because they should have spent that money anyway.

You will notice in the article, the author argues that while competitive currency devaluations did not work because everyone else was doing the same thing, it was still a good idea nonetheless. What is particularly disingenuous about this article is the artificial distinction between currency devaluation used in the 1930's and monetary easing of today. No doubt this is to confuse people and prevent them from understanding the dire economic conditions we face. You print money to debase your currency despite what the Keynesians say. Even Bernanke has said that QE will eventually lower the value of a currency. But the Fed does not want to openly state that their goal is to debase the dollar, so they call it QE. Quantitative easing has a better ring to it than devaluation, especially when you claim the goal is to "help" increase economic growth. The media runs story after story supporting this action, stating "Fed boosts asset purchases to boost economy" and other such propaganda. To the layman reading the paper, it almost sounds as if the Fed is looking out for the average Joe and trying to create jobs. However, the reality is very different. A currency devaluation/quantitative easing is nothing more than an illegal confiscation of wealth from responsible savers to the government. And best of all, it can be done without a popular vote!

One part of the article I agree with is the contention that we are facing a worldwide race to the currency bottom. This is especially true for the US, which is desperately trying to lower the dollar to increase exports. However, at the same time, all of our trading partners (mainly the Asians) are preventing their currencies from rising to maintain their export advantage. The end result is that the exchange rate moves very little. But money printing has real world consequences, as we have seen commodity prices surge across the board for little fundamental reason. Do you really think oil would be trading at $85 if the US and the world were not printing money? The fundamentals do not support it, especially considering the weak economic outlook for the US, EU, and Japan.

The real question for the Fed and other Keynesians is: What's next? They have printed $2.1 trillion only to "discover" that printing money does not help the real economy. Real unemployment remains high at around 17% and threatens to turn into structural (e.g. permanent) unemployment and remain a burden on the economy for years to come. About the only thing QE has done is boost asset prices, especially commodity prices, which is disastrous during prolonged economic stagnation. People's wages are flat to down adjusted for inflation, and yet their cost of living goes up at a furious rate as a result of currency debasement. The one asset they own--their homes are in free fall and could fall another 10% a least in 2011.

If Bernanke's own statements are to be taken seriously--which they should. The next step is to print more money until economic conditions improve (this would be in addition to QE 2). This seems like an overly simplistic action for a former economics professor with decades of experience, but in the end it is the only tool left for the Keynesians who want to preserve this flawed economic system at all costs. You note that Mr. Eichengreen, the author of the above article, stated that currency debasement/QE was better than nothing. It is perhaps revealing that in the roughly 70 years of Keynesian economic thought, Keynesian practitioners could never conceive of a better idea than currency debasement, which has been the tried and true method of every dictator throughout history.

Keynesianism has failed, but will not go down without taking the whole world down with it. As countries around the world race to print money and devalue, commodity prices will continue to rise. This dynamic will lead to millions of people starving in the third world and a lower standard of living for the Western economies. The last ditch effort will, of course, be a war, which history shows helps reinvigorate an economy.

Black Swan Insights

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Whale Watching: Bill Ackman Edition

Whenever I want to find good investment ideas, I like to take a look at what the top hedge fund managers are doing. This week lets review Bill Ackman's top 10 holdings.
Ackman is known for running a pretty concentrated portfolio, compared to other large hedge funds that sometimes own 100's of stocks.

Note: This should not be considered a comprehensive list because Ackman often uses total return swaps and other derivatives that would not show up on a 13F filing. Also this does not include his short positions, warrants, etc.

Here is Pershing Square Capital Management's top 10 long positions:

Data current as of 11/15/2010 and is updated to reflect Ackman's new ownership statement regarding General Growth Properties and Howard Hughes Corp.

1. General Growth Properties (GGP)----$1,427,797,056 Common Stock
2. Kraft Foods Inc (KFT)----$852,724,000 Class A Stock
3. Target Corp (TGT)----$755,850,000 Common Stock
4. Citigroup Inc (C)----$571,254,000 Common Stock
5. JC Penny (JCP)----$427,052,000 Common Stock
6. Fortune Brands (FO )----$367,529,000 Common Stock
7. Automatic Data Processing (ADP)----$365,687,000 Common Stock
8. Corrections Corp of America (CXW)----$269,917,000 Common Stock
9. Howard Hughes Corp (HHC)----$230,356,728 Common Stock
10. Landry's Restaurants Inc----$38,063,000 Common Stock

Ackman is probably one of the best investors when it comes to commercial real estate. Case in point: General Growth was considered worthless in late 2008, just when Ackman was buying the stock. It turned out to be a huge home run for his investors. Other notable holdings include JC Penny because of its large real estate holdings, no doubt. The idea is to force JC Penny to implement a sale/leaseback transaction  to generate cash and buyback stock. Fortune Brands is a relatively new investment for Ackman and he is agitating for a break-up of the company to unlock shareholder value.

Black Swan Insights

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Irish Bailout Only The Beginning--Endgame is EU Collapse

The much anticipated Irish bailout may be imminent, but CDS traders are still concerned. Today Irish CDS closed at 598 bps, just below the all-time high reached a few days ago. Furthermore, Irish 10-year bond yields are currently trading at 9.19%, signaling investors have little faith in the EU bailout. The reason for the uncertainty concerns the terms of the bailout, which could force ruinous stipulations on Ireland, including the favorable corporate tax rate and a 6-7% interest rate on the aid package. Of course, Ireland as the beggar nation has little bargaining power when dealing with the EU bureaucrats.

The real question for Ireland, along with Greece (and soon to be Portugal, Spain, Italy, and maybe Belgium) is: What happens in 2013 when the EU bailout fund is supposed to wind down? All of these countries will still be bankrupt and dependent upon EU loans. Do we simply remove the EU guarantees and let these countries default, or is this a permanent bailout, courtesy of German and French taxpayers? This could be the real reason the market has little faith in the EU bailout. It is only a temporary stop-gap measure by a desperate EU elite who want to hold the Euro together at all cost. This is why Greek 10-year yr bonds are still trading at 12%, despite an explicit guarantee by the EU.

The market is starting to realize that come 2013, government bond holders (the great gods of capitalism who never take a loss) will be forced to accept a major haircut to the tune of 30-40%. If this is true, and investors are pricing this in, then do not expect Irish debt to rally very much on Monday, when the bailout is announced. Oh sure, it may rally the first day, but it should remain elevated (above 8%) for the foreseeable future until there is more clarity regarding the EU bailout fund through 2013.

Personally, I cannot see the German and French taxpayers agreeing to a permanent bailout of the PIIGS. You have already started to hear Ms. Merkel of Germany suggest that some reform to the bailout terms must happen in 2013 and investors should suffer for their foolish investments. This leads me to believe the end game in 2013 will be a forced debt restructuring. All of the PIIGS will give the bondholders a choice-- either accept the new terms or get nothing. The new terms will be a 30-40% reduction in principal along with an extension in duration. As a sweetener bondholders may get a slightly higher interest rate.

The only problem with this outcome is that German and French banks are large holders of PIIGS debt and would be negatively impacted to the point of insolvency. The chart below shows French and German banking exposure to the PIIGS.

click chart for larger image

Any debt restructuring of PIIGS debt would require the French and German governments to bail out their banks to help cushion the large write downs, which are currently marked at par. But the advantage of this is that it will not be until 2013, so it buys the EU elite some much need time and follows their extend and pretend routine.

The End of The Eurozone

While the EU bureaucrats claim the Euro is strong and safe, the die has already been cast, and the Euro is destined to collapse sooner or later. The catalyst will be when either one of the PIIGS leaves the EU to escape the ECB and regain monetary sovereignty or when the German taxpayers revolt and refuse to bailout irresponsible countries. Trust me, one of these will occur in the next 5 years; the only question is when. Do the Irish (or Greece, Portugal, and Spain for that matter) want to suffer a depression for the 5-10 years through more austerity, tight ECB monetary policy, and loss of financial sovereignty after the EU bailout? Or do they want to choose the easy way out through currency devaluation and money printing (or call it QE if you want)? Historically, this has been the preferred method for countries which want to wash away their sins and move on because the alternative is so much worse. If the PIIGS go through with the prolonged depression, they will suffer large brain drains as young people and entrepreneurs leave to go on to greener pastures. The loss of these economically important people will make it that much harder for these countries to rebuild their destroyed society.

In fact, the only reason the PIIGs have not already left is because their leaders are part of the European elite who see the EU as a political priority. No doubt it will take numerous riots and civil unrest before the PIIGS leaders get out of the EU. It will take time for the angry mobs to understand that it is the EU and the Euro which bankrupted their countries. Right now their only concern is budget cuts and laying public workers off. But as the depression continues, they will finally see the real culprit and demand (by peaceful or violent means) out of the EU. The whole EU project was flawed from the start with the puerile idea that you could rapidly integrate all European countries under the same monetary policy. It never made theoretical or empirical sense but was approved because the EU was a political project from day one. The goal was to create a sovereign EU superstate with immense power for the European elite. Thank God, their dream is crumbling and will never be realized. The market has put an end to the whole concept. And some say markets don't work!

Black Swan Insights

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Which EU Bank Has The Largest Exposure To Ireland?
How High Does Irish CDS Have To Rise Before It Is A Crisis?


Investment Manager Sentiment Remains Bullish

The National Association of Active Investment Managers released its weekly sentiment index. Every week the NAAIM asks is members to report their total equity exposure. This number is used as a contrary index. Generally, you want to be long stocks when investment managers are uber-bearish and bullish when investment managers are bearish. This week's number came in at 66.67%, almost unchanged from last week. The number is not yet at an extreme which would indicate a market sell-off. You can see from the chart below that market tops usually coincide with a NAAIM number around 80%.

click chart for larger image

Black Swan Insights


AAII Bullish Sentiment Rebounds

After last week's sharp decline in bullish sentiment, the bulls started to come cautiously back. According to the American Association of Independent Investors bullish sentiment increased to 47.4%, up from 40%, while bearish sentiment fell 7.8% to 24.7%. Neutral investors increased slightly to 27.9%.

Over the last few weeks we have seen dramatic and often erratic moves in the AAII sentiment, which have not been particularly helpful for trading purposes. This week we see that bullish sentiment remains high, but this has brought upon the usual sell-off. Call it the QE 2 effect I guess, as investors begin to believe the market cannot go down because the Federal Reserve will simply print more money. Talk about moral hazard to the highest power! Never before has the Fed explicitly said it wanted higher stock prices.  

Here is a short-term chart of the AAII sentiment survey.

click charts for larger image

Here is chart of AAII bullish sentiment vs the SP 500.

Here is a chart which compares AAII bearish sentiment vs the SP 500.

Black Swan Insights


Dead Cat Bounce Continues For Michigan Consumer Sentiment

To have strong retail sales, you have to have some improvement in consumer confidence. If you tell people everyone is more optimistic,  it may create a self-fulfilling prophecy. Today it was reported that the final reading for consumer sentiment increased to 71.6 in November, up from 69.3 in October. Furthermore, consumer expectations increased to 64.8 from 61.9 previously. Will this be enough to save the retail industry, which can only survive by suckering Americans into spending all of their money on useless Chinese trinkets? We shall see. The Retail Federation certainly has high expectations this year and expects holiday sales to increase 2.3% year over year. You have to wonder how on earth will sales increase with 17% real unemployment. Charles Hugh Smith over at noted that the top 20% of the country controls 80% of the total wealth, so as long as they continue to spend retail sales should remain strong. The hell with the bottom 20%--they are not being good consumers; their only duty in American society.

click char for larger image

Black Swan Insights


Radical Solutions Needed To Solve Housing Crisis---Morgan Stanley

Morgan Stanley is very concerned about the ongoing double dip in the housing market and the implications for the general economy. The firm notes the housing situation is severely deteriorating and the government must do something to solve the problem before it causes a ripple effect. Morgan Stanley says there are two policy actions that could help the situation: 1) Modifications and refis 2) Write-downs of principal. You will note that the firm is advocating more government intervention, which has only prolonged the painful process of debt liquidation.

Regarding option #1, Morgan Stanley says:
Modifications and refis. Loan modification or refinancing programs like HAMP can be helpful, but have not put housing finance on track for sustainable improvement. Unfortunately, they do not address the fundamental supply-demand imbalances in housing, and they are not widely available. Beyond the factors restricting the supply of credit noted above, second liens complicate modification programs because they must meet certain criteria to be eligible for modification, which limits the number of mortgages that can be modified.

‘Streamlined' refinancing programs are one answer. The federal government could open the refi process to existing borrowers who cannot now qualify for a lower rate by recognizing the guarantee that already exists on the principal value of a very large portion of the mortgage market - specifically, the mortgages that are backed by Fannie, Freddie and Ginnie. Of the 55 million households with mortgages, 37 million have mortgages whose principal value is guaranteed by the federal government. Given the credit restraints noted above, we believe that perhaps 50% of the outstanding principal value of agency mortgages may not be refinanceable at present. If the GSEs were to allow those 18 million borrowers to refinance at 4.5%, it could reduce aggregate interest payments by up to $46 billion annually. Such a policy would apply only to refis, not new mortgages. It would not entail any new cost to the government, and the lower payment burden likely would reduce future defaults and thus credit risk for the guarantor of the mortgage (i.e., the US government).
I must say I think mortgage refinancing is one of the stupidest ideas in the world. Do you really think the problem is too high interest rates? If we lower the interest rate by 1.5-2%, are people going to be magically able to afford their homes? I think not. The problem is that people cannot afford their mortgages. However, this would be a politically popular idea because it extends the housing crisis for a few more years. You give everyone a new 4.5% mortgage, and within a year, 60% of mortgages are back in default. Perhaps Zimbabwe Ben could lower mortgages rates to 2.5%, and we can refi some more mortgages to help keep people in their homes. This bogus solution sounds like a winner to the incompetent pieces of filth in Washington. I have said this before, but I will say it again: People who cannot afford their home should be promptly foreclosed upon. Their should not be any government interference. It is a torturous process to follow, but it will ultimately lead to stabilization in the housing market, which is in every one's interest. Let's take a look at Morgan Stanley's next solution to the housing depression:
Option #2: Write-down principal. As the discussion above implies, write-downs or forgiveness of principal are the real solution to housing woes. Policy options to reduce principal take two forms: those encouraging principal write-downs to avoid default, including so-called strategic defaults, and those encouraging short sales, which allow underwater borrowers to sell their house at market value without writing a check to the current lender. Such programs exist, and some lenders have offered them to borrowers in lieu of foreclosure, but restricted eligibility has limited their success.

Adding incentives for both borrower and lender could make such programs much more attractive. The best approach gives incentives to both. For example, in March, the Treasury proposed the idea of ‘earned principal forgiveness', where FHA refinancing would be available to underwater but performing borrowers if the lender agrees initially to forbear principal and thus modify payments, and to forgive a portion of the forborne principal at the end of each year the borrower is current on the modified payments. Such a plan gives the borrower both payment relief and an incentive to stay current, with an option on future home equity, and it gives the lender a performing asset - one with a lower coupon but also with a lower probability of default. In August, HUD provided details on the FHA program, which was to start on September 7. We estimated that 300-600,000 borrowers within the non-agency securitized universe would likely participate in such a program. In contrast with the FHA program, HAMP 2.0 has focused on principal forgiveness for already-delinquent borrowers.

The jury is still out on both the FHA program and HAMP 2.0; each has been operational for only about three months. But two hurdles currently stymie broader participation in the FHA program: dealing with second liens and adding servicer incentives. Currently, there are no servicer incentives for the FHA program, and short refinancing will deprive servicers of fee income on performing loans. Without servicer incentives ($2,000-3,000 per loan would probably suffice), this program is unlikely to take off.

Streamlining short-sale programs would also help the write-down process for those borrowers who would otherwise go through foreclosure. Specifically, an expansion of the Home Affordable Foreclosure Alternatives Program (HAFA) beyond its current limitations could help to clear the market of such liquidations with minimal damage. To be eligible for HAFA, borrowers must have a verifiable financial hardship and either fail to qualify for a modification or else redefault. Servicers must consider every HAMP-eligible borrower for HAFA before the homeowner's loan is referred to foreclosure. But the process is slow, and some triage of the borrower pool could expedite the process for those cases with little chance of successful modification.
I actually like the idea of principal write-down for underwater homeowners. It would have to be rather substantial write downs like 30-50% in some cases, but it would make the mortgage more affordable for the homeowner. My only problem with this idea is that I do not like the idea of the government mandating principal write-downs. It is illegal for government to tell the banks to this. As long as the banks voluntarily do it, I have no problem. It is a free market solution by private parties. The only catch is that the banks do not own the majority of mortgages in this country. Most mortgages have been packaged into MBS so you would have to get the owners of these MBS to agree to any principal write-down,  which would be challenging. The servicers could not unilaterally make this agreement on behalf of the MBS investors. However, it is probably in the interests of the MBS owners to take a write-down instead of having to foreclose and sell the house in a depressed market.

From a moral perspective, I despise idea of a principal write down for irresponsible people who took out mortgages they could not afford. I do not like the idea of rewarding these people for their foolish gamble to flip a house at higher price. Furthermore, it is a general F-You message to all of those honest, hardworking, responsible homeowners who pay their mortgages on time. These people get to play the sucker as they did the right thing but don't get any rewards. But then again, these people are used to playing the sucker as taxpayers for bank bailouts. This seems to be way the cookies crumble.

If you want a real solution to the housing depression, we have to have lower prices plain and simple. Morgan Stanley talks about a demand-supply mismatch, but this is not the truth. The problem is that home prices are still overpriced, and until prices fall, demand will not return. The solution is to allow the market to fall another 10-25% or until the market reaches an equilibrium. Unfortunately, this solution is not politically popular. But it is what needs to happen before we will ever see a bottom in the housing market. The market will work, despite government and Fed intervention; the only question is how long they can delay the process.

Black Swan Insights 


Federal Reserve Downgrades US Economic Forecast

The Fed released its always anticipated minutes from previous meetings. Overall, the Fed downgraded its economic projections for 2011 across the board. Here are some of the highlights:

  • Revises down 2010 GDP--now sees 2.5% vs 3.3% expected back in June
  • Sees 2011 GDP growth at 3.0-3.6% vs previous estimate of 3.9%
  • Holds 2012 GDP growth estimate flat at between 3.6%-4.5%
  • Unemployment rate expected at 8.9%-9.1%, previous estimate 8.5%
  • 2011 unemployment seen at 7.7%-8.2% up from 7.3%
  • 2011 Core inflation (ex what you need to live) is expected at 0.9%-1.6% which is flat with previous estimate 

The Fed was finally forced to admit economic reality. The economy has been permanently crippled by the financial crisis and money printing does nothing to increases jobs. I still think the Fed is too optimistic about the US economy, especially unemployment. We discussed the issue of unemployment previously. But lets remember that the US economy has to create 100,000 jobs per month just to keep the rate steady. This will be much more difficult considering states and municipalities are laying off workers. The SF Fed estimated in order to reduce the unemployment rate to 8.0% by June 2012, the US economy would have to create 200,000 jobs per month starting in October 2010. Quite impossible! Indeed, according to the Fed minutes some members expect unemployment to rise in 2011 because of the weak economy.

The most important part of the Fed minutes was that it showed a growing rift between FOMC members regarding money printing. From the minutes:
"Some participants noted concerns that additional expansion of the Federal Reserve's balance sheet could put unwanted downward pressure on the dollar's value in foreign exchange markets." Several officials saw a risk the move could "cause an undesirably large increase in inflation."
We have discussed before that while it seems Zimbabwe Ben is in complete control, there is more disagreement between FOMC members than meets the eye and it is not just Hoenig. I have read reports which suggest numerous FOMC members were reluctant about QE 2, but did not openly voted against the Chairman (sounds like some Communist central committee where everyone is in fear). The 2011 crop of FOMC members should make it harder for Ben. Some, like Plosser and Fisher have openly said QE is a failed policy that should be stopped. Even the usually loyal Warsh has had some harsh comments about continued money printing in an op-ed in the WSJ.

The pressure is increasing for Zimbabwe Ben. But at least he knows he has one loyal friend in Congressman Barney Frank.

Black Swan Insights


Bernanke is Running Out of Friends But Still has Support of Barney Frank

You know things must be really bad for the Fed Chairman when the only person who is willing to defend your criminal actions is disgraced Congressman Barney Frank. For those of you who are unfamiliar with Congressman Frank, he was caught running a male prostitute operation out of his home, along with his homosexual partner Steve Gobie back in the late 1980's. Frank admitted that he paid Mr. Gobie, a male prostitute $80 for sex when they first met. The only reason Frank was not kicked out of Congress for his actions was because he threatened to out gay Republicans (and we know how many of those there are in Congress) Is this the only national figure who is willing to defend Zimbabwe Ben and his illegal money printing? Perhaps, if this whole Fed Chairman thing does not work out, Bernanke can always go work for Barney--who is always looking for more talent! Who knows, maybe a change of career would benefit the Fed Chairman, after all he has failed as an economist.

From the WSJ:

Rep. Barney Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, accused Republicans on Monday of siding with Chinese central bankers in their attacks on the U.S. Federal Reserve.

“The Republicans are joining the Central Bank of China in criticizing [Fed Chairman] Ben Bernanke,” Mr. Frank said Monday during an interview on Bloomberg Television. “This is really distressing to me.”

Mr. Frank was defending this month’s decision by the Fed’s policy committee, the Federal Open Market Committee, to buy as much as $600 billion in Treasury debt, a move that has been criticized by central bankers in other countries.

“I wish we had more fiscal stimulus,” Mr. Frank said. “In the absence of that, given inflation, (Mr. Bernanke) is doing a very reasonable thing.”

Frank's comments come at a time when Republicans are increasingly questioning Bernanke's QE. In a letter to Bernanke, prominent Republicans including Senator Mitch McConnell, soon to be Speaker of the House John Boehner, Senator Jon Kyl, and Congressman Eric Cantor wrote:

...we write to express our deep concerns over the recent announcement that the Federal Reserve will purchase additional U.S. Treasury bonds, the so-called Quantitative Easing 2 (QE2). While intended to improve the short-term growth of the U.S. economy and help maintain a stable price level, such a measure introduces significant uncertainty regarding the future strength of the dollar and could result both in hard-to-control, long-term inflation and potentially generate artificial asset bubbles that could cause further economic disruptions.

The Federal Reserve’s recent move has also generated increased criticism and action from other central banks and governments. We appreciate that such comments must be examined within the context of which they have been offered. However, any action taken by our nation or foreign nations that impairs U.S. trade relations at a time when we should be fighting global trade protection measures will only further harm the global economy and could delay recovery in the United States.

Perhaps most damaging, we believe that QE2 is giving the impression that the Federal Reserve will keep making new and different attempts to boost the short-term prospects for the economy. Our long-term growth depends on restoring confidence and certainty in our fiscal, regulatory, and trade policies — and not on government’s willingness to engage in additional stimulative measures. When asset prices increase due to anticipated Federal Reserve policy rather than economic fundamentals, it increases the potential for speculative action and erodes confidence in the economic outlook, making it more difficult to generate sustainable growth.

Bernanke is definitely on the defense and has been forced to defend his actions in recent speeches. His troubles will worsen when Congressman Ron Paul becomes Chairman of the Sub-Committee on Monetary Policy. No longer will Bernanke simply get a pass when it comes to his many crimes. Ron Paul will publicly expose the Fed for debasing the dollar and bankrupting the middle class through inflation. I hope Ron Paul uses Congress' subpoena power to force the Fed to release the bailout documents. That would really be the end for the Fed, because it has always been able to conceal its crimes from the public. But public exposure would increase the pressure on the Fed and could lead to Bernanke's resignation.

Black Swan Insights 


David Rosenberg: Buy Bonds Not Stocks

While I don't always agree with him, David Rosenberg is worth following if you want to hear the deflation case. Despite surging commodity prices, Rosenberg is still in the deflation camp and is expecting the 10 year treasury to fall below 2% in 2011. He says weak growth and low inflation should make bonds outperform stocks. One thing I never understood about Rosenberg is why he places so much trust in the government's inflation number. Usually, he is very critical of government data and questions its validity, but he apparently has full faith in the inflation number as a justification for buying bonds. Still I think he has one good point that reduced spending from state and local government will put pressure on US growth in 2011. From Dow Jones:

Rosenberg said in an interview with Dow Jones Newswires on Monday that safe-haven Treasury bonds provide better value than U.S. stocks. He especially favors 30-year Treasurys.

This assessment runs starkly in contrast with that of Goldman Sachs Asset Management Chairman Jim O'Neill's, another high-profile market participant, who said in an interview last week that he favors stocks based on an upbeat global economic outlook.

But Rosenberg argued that the U.S. has passed the peaks of the economic cycle and fiscal stimulus and noted that there are fresh headwinds ahead. He highlighted the spending cuts from state and municipal governments, the second-largest contributor to U.S. gross domestic product after consumer spending.

"Next year or two, you are going to see draconian cutbacks, which will have a reverberation through the broader economy. The pullbacks from state and local governments have already started," said Rosenberg. "Even if we avoid a double-dip recession, my sense is that growth will be sufficiently weak" to support my view that Treasurys will outperform stocks.

Rosenberg expects the U.S. to clock growth of 2% in 2011. O'Neill, in contrast, predicts a figure closer to 3%.
The weakening outlook is likely to suppress inflation further, said Rosenberg, noting that the core consumer price index, which excludes energy and food, rose only 0.6% last month compared with a year earlier. That was the lowest level for this adjusted indicator since records began in 1957.

Should the disinflation trend persist, Rosenberg said, the core inflation rate could fall below zero by the end of the second quarter of 2011. Over the past few months it has held below 1%.

That would trigger concerns about deflation, a phenomenon that discourages consumer spending and business investment, much as it has done in Japan since the 1990s. The Federal Reserve launched a program to buy $600 billion in Treasury bonds earlier this month aiming partly at warding off such a threat.

In any case, with inflation virtually nonexistent, Rosenberg said that 30-year Treasury bonds, including similar-maturity zero-coupon bonds, provide attractive value for investors seeking to preserve capital in a weakening economy. Inflation eats into bonds' fixed returns over time, so when it is low it boosts the appeal of holding longer-dated securities.

Rosenberg expects the 30-year bond's yield, which moves inversely to its price, to fall to 2.5% to 2.75% by the end of 2011 compared with 4.234% traded recently on Monday.

Meanwhile, he stuck to his forecast for the benchmark 10-year note's yield to fall below 2% in the coming year and predicted a range of 1.75% to 2% by the end of 2011. That forecast makes him one of the biggest Treasury bulls on Wall Street. The 10-year note recently yielded 2.840% Monday.

While the weak U.S. economic outlook may weigh on the dollar, Rosenberg said he is more upbeat about the dollar over the next year or two than the euro, given that the common currency faces sovereign debt problems.

"I expect the roller-coaster ride in the euro/dollar to continue in the coming year, given the different factors in play. But my money will be more on the dollar than the euro," he said, predicting a range of $1.20 to $1.40 per euro for 2011 with a tendency toward the lower end of the range by the end of the year.

For the broad foreign exchange markets, Rosenberg said he likes currencies in countries with strong balance sheet qualities, meaning a strong growth outlook and sound fiscal health, such as Norway, Sweden and Canada.

He said he is especially bullish on the Canadian dollar, betting that the currency will gain 20% against its U.S. counterpart over the next five years, even though the appreciation won't occur in a straight line.


Evening Reading---TSA, Naked Body Scanners, Groping Children, and the Backlash

A few links regarding the whole TSA groping scandal. I hope the police state backs down, but tyranny often responds to public protest with more aggressive tactics. We shall see how this ends. So far TSA has already agreed not to molest pilots. The picture to the right is your government at work.

1. Why Cavity Bombs Would Make the TSA Irrelevant---TSA no doubt has a solution: it is called a cavity search. Please bend over Sir, this won't hurt a bit!

2.TSA Enhanced Pat Downs : The Screeners Point Of View--even  the TSA screeners don't want to do these illegal pat downs of peoples' genitals.
Here is what one TSA screener said:

“It is not comfortable to come to work knowing full well that my hands will be feeling another man’s private parts, their butt, their inner thigh. Even worse is having to try and feel inside the flab rolls of obese passengers and we seem to get a lot of obese passengers!”

3. 'TSA Has Met The Enemy, And They Are Us' 

4. Members of Congress Exempt From TSA AIT Full Body Scanners---after all, they don't want the radiation.
5. Don't Tuch My Junk


Whale Watching: George Soros Edition

It is always interesting to see what the top hedge fund managers are doing with their money. Here are Soros' top stock positions as of 10-15-2010.

1. SPDR Gold Trust (GLD)-------$600,794,000 common stock + $90.1 million in call options

2. Monsanto (MON)-------$312,638,000 common stock   

3. InterOil (IOC)------$275,295,000 common stock + $17.1 million in call options

4. Linear Technology (LLTC) SR CV 3.125%27------$219,800,000

5. Lawson Software Inc (LWSN) SR NT CV 2.5%12 ------218,071,000 + 49.7 million in common stock

6. Plains Exploration and Production (PXP)------$180,858,000 common stock

7. Epicor Software Inc (EPIC) SR NT CV2.375%27------ $141,179,000    

8. Teva Pharmaceutucal (TEVA)------$128,942,000 common stock

9. Weatherford International (WFT)------$122,701,000 common stock

10.JDS Uniphase Corp (JDSU) SR NT CV 1%26------$118,529,000    

We can see that while Soros talks bad about gold, he certainly thinks it is a good investment as it is his top holding. Obviosuly he thinks the gold bull market has more room to run despite what the bubble callers are saying. One of the more bizarre holdings is Interoil, which has to be one of the more controversial stocks. The pumpers say it is sitting on a goldmine of natural gas and the bears say it is nothing more than a fraud. It seems Soros believes in the company's prospects despite the criticism.

Overall, it looks like Soros likes commodities and energy stocks, along with select tech stocks.

Black Swan Insights


Morgan Stanley: Get Ready For 1970's Stagflation

Morgan Stanley has a good piece today which predicts the US may be in for stagflation, similar to the 1970s. This means we can get used to low GDP growth and high inflation, in essence the worst of both worlds. The main reason, according to Morgan Stanley for the stagflation scenario is Fed policy, which actively encourages inflation. Furthermore, the Fed will be purposely slow to tighten monetary policy.

From Morgan Stanley:

How close are we to a 1970s scenario? There are similarities as well as differences.


• An international monetary system with ‘peripheral' economies importing the Fed's monetary policy stance through a currency peg or quasi-peg (see "QE20", The Global Monetary Analyst, October 13, 2010). It is, of course, no coincidence that the current monetary arrangement has been dubbed ‘Bretton Woods 2'.

• A glut of dollars due to superexpansionary Fed policy: China, Germany and others have made little effort to hide their discomfort over QE2, and the dollar fell substantially in foreign exchange markets before a renewed flare-up of the euro area sovereign crisis allowed it to recover somewhat.

• A two-track global economy: Similar to the early 1970s, the rest of the global economy is doing just fine - indeed many of the EM economies of the ‘Bretton Woods 2' periphery are, if anything, in danger of overheating. Note that by 2012, EM will make up 51% of the global economy under our coverage (measured in PPP weights) and the G10 the remaining 49%. And we know from recent experience that red-hot EM economies have a voracious appetite for commodities - for example, 33% of the increase in global oil consumption between 2003 and 2006 came from China.

• Structural change which lowers the economy's speed limit: The crisis has likely destroyed potential output and reduced the potential growth rate over the medium term as consumers deleverage and many economies retool from shrinking sectors such as construction towards expanding sectors such as manufacturing. Thus, again, central banks may be overestimating the amount of spare capacity in the economy.


• Structure of the oil market: Unlike in the early 1970s when the price of oil was fixed, oil quotes now adjust instantaneously to changes in the economic outlook. Indeed, since Fed Chairman Bernanke hinted at QE2 in August, inflation expectations have risen and oil has rallied. (Incidentally, that is as it should be: like stocks, oil is a real asset which should provide inflation protection in the long run.)

• The US economy is weak and unemployment is high: Yet US data have been improving before the Fed bought even a single QE2 dollar's worth of securities. Just as importantly, what matters for inflationary pressure is not the absolute level of the unemployment rate but the distance from the speed limit (the level of unemployment consistent with stable inflation). As mentioned above, it is very likely that, in the post-crisis world, this speed limit is substantially lower (the unemployment rate consistent with stable inflation substantially higher): inflationary pressure could therefore emerge at higher unemployment rates than before the crisis.

• The structure of the economy: no wage indexation: There is no question that widespread wage indexation contributed to the persistence of high inflation in the 1970s. However, the lack of wage indexation nowadays does not mean that inflation cannot rise in the first place. Besides, wage indexation was put in place in response to high inflation. That is, just because there is no wage indexation now does not mean that higher inflation in the future would not result in the indexing of wages.

All of this does not, of course, make inflation or stagflation a foregone conclusion. Yet in a global economic environment with the following factors, we think that in the medium term the risks are skewed towards an overheating of the global economy (especially in EM), elevated commodity quotes and ultimately higher inflation:

• The Fed will want to err on the side of caution with respect to draining excess reserves (a premature tightening of reserve requirements may have led to a recession in 1937 as banks responded by slashing lending in order to restore their desired level of excess reserves - see "Reversing Excessive Excess Reserves", The Global Monetary Analyst, October 28, 2009);

• The Fed will want to err on the side of caution with respect to normalising policy rates (Japan's premature exit from ZIRP (zero interest rate policy) in 2000 will likely serve as a deterrent) - this will likely keep real interest rates low;

• It is difficult to estimate the economy's speed limit (indeed, easy to overestimate the degree of slack in the economy);

• More generally, risk-averse global central banks prefer the threat of inflation to the one of deflation (see "Better the Devil You Know", The Global Monetary Analyst, August 18, 2010); and

• Public and private debt levels are very high, creating incentives to generate or acquiesce to inflation (see "Debtflation Temptation", The Global Monetary Analyst, March 31, 2010).

Related Articles:
US Economic Outlook--3 Possible Scenarios

Black Swan Insights


Video--Marc Faber on Bloomberg

Marc Faber was on Bloomberg today to discuss his outlook for the Chinese economy. Faber thinks that real inflation in China is much higher than what is reported by the authorities. Furthermore, he notes that China and the US are on a collusion course, both economically and politically.

Faber also mentioned US stocks, saying he does not believe they will hit a new high in the short run. He expects the market to continue to correct in the meantime.



Uncle Sam's GM Pump and Dump Scheme A Success

Whenever someone tells you the government is completely incompetent, you can now say that at least Uncle Sam is good at pump and dump stock schemes. Case in point: GM's much promoted IPO. For the past 3-4 weeks, there have been TV specials about how GM was back and going to make a great investment. Analysts provided the necessary research to support bogus price targets which encouraged people to buy the stock on the first day of trading. Even MorningStar was part of the con, placing a $46 price target on GM. The timing of the IPO came during a market correction which made it somewhat more difficult, but the government had a contingency plan. Suddenly and for no good reason, stock futures gap higher in the pre-market (the ramp began last night in Asia) to get those animal spirits roaring and, voila, you get to sell GM stock at $33,above estimates of $26-29. Those poor fools who were rushing in to buy at the open for $35 already have a nice loss as GM closed at $34.19. Bravo, Uncle Sam, bravo. It was a classic pump and dump scheme that went off without a hitch.

Regarding the outlook for GM, this is what Bill Visnic, a senior analyst at Edmunds had to say:
"In this business, consistency counts and for GM, consistency has never been a strong suit."

"Now that they've done the balance sheet dance and the Wall Street tango ... we get to see if they've got what it takes to make a go of it from an operational standpoint," he said.

"GM has done this before, where they've had a string of successful products and then backslid, where everything for several years was crap," he said. "In this business, you just can't do that."

Finally, I can think of a few reasons why GM is not a good investment:
  • Even after the IPO, the government will still control GM with a 33% stake. Political considerations will still triumph over economics. Think electric cars like the VOLT that have minuscule profit margins compared to SUV's and trucks.  
  • The UAW is a substantial holder of stock (17.5% before the IPO) and will likely try to claw back benefits lost in the bankruptcy. Most of GM's revival has been due to cutting costs to make them more competitive. Pressure from the UAW and government could force GM to increase benefits and wages.  
  • The company has accounting problems. Some keen observers have accused GM of channel stuffing their inventory to boost revenue. The chart below shows GM's dealer inventory. It is curious that despite GM reducing the number of brands it sells, inventory has continued to climb and is at record levels. This channel stuffing could be the reason GM has reported strong numbers in 2010. 
  • GM has been down this road before. The company has been in a long term decline, notwithstanding a few hit models which temporarily boosted their market share. Just when you think the company is turning the corner, it falters.

Black Swan Insights


Trader Goes Crazy At The Office--Video

This one of my favorite YouTube clips. After a frustrating day at the office, a trader simply lets loose and attacks one of his annoying co-workers.  LMAO!



Investment Managers Remain Bullish--NAAIM Survey

While the retail crowd was shaken by the recent market correction, the pros remain largely unaffected and continue to be long stocks. According to the NAAIM weekly survey, professional money managers have a 66.59% equity exposure, down slightly from last weeks number of 71.46%. The NAAIM number is a contrary indicator so we look for extremes in sentiment to predict potential market reversals. So while the number indicates that managers are bullish, it is not yet at an extreme. Historically, a number around 80% is a contrary sell signal, indicating stocks may have some more room to run.

click chart for larger image


Black Swan Insights

Related Articles:
AAII Bullish Sentimet Falls Off A Cliff
Investment Managers Increase Their Equity Exposure--NAAIM--11/11/2010


AAII Bullish Sentiment Falls Off A Cliff

The National Association of Independent Investors released its weekly sentiment survey. This week bullish sentiment nosedived 17.6 points to 40.0%, while bearish sentiment rose slightly to 32.5%, which was up from 28.5% previously. Investors who described themselves as neutral rose 13.5 points to 27.5%.

Talk about a schizophrenic market! Last week we finally saw capitulation by the retail investors as they plunged into the market, taking Zimbabwe Ben at his promise not to let stocks decline. After a slight correction in the markets retail investors immediately shed their bullish inhibitions and again went back to the sideline. This is really incredible action for the AAII sentiment survey. It shows how fearful retailers are and how quick investor sentiment can change from week to week. From a contrary perspective, this survey could be seen as slightly bullish because of the large decrease in bullish sentiment after a minor correction.

The last time bullish sentiment fell by this much was back on 8-20-10, when bullish sentiment fell from 51% to 34%. The result: 4 weeks later the market was 7% higher.     

Here are the charts.

click charts for larger image

The first one is a short term chart of AAII sentiment

Here is a chart which compares AAII bullish sentiment to the S&P 500.

Finally, here is a chart which compares AAII bearish sentiment to the S&P 500

Black Swan Insights

Related Articles:
Marc Faber's November Outlook
Marc Faber's October Outlook