The Current Market Atmosphere: Easy Money Hard to Come by

You've all probably seen or heard about the recently released Harvard Housing study. Among other things, the report discusses the fact that the median wage-earner is unable to afford the median priced home and forecasts a drop in real estate prices to the 1999 level. The fact is that the study comes about one year too late for investors and consumers.

• Yahoo Finance
• http://www.jchs.harvard.edu/

An excerpt from my recent article, 'Lawrence Yun Continues to Mislead on Housing' summarizes some of my forecasts in the real estate market, first released in 2006:

• Home Prices: from the peak in 2006, home prices will decline to pre-1999 levels.
• Commercial real estate market will also suffer
• Prime Mortgage foreclosures: the next trend in the housing correction will be a crisis in prime mortgages due to the weakness in the economy
• Rental Market: set to heat up, good investment opportunities

Those who read 'Cashing in on the Real Estate Bubble' understand that the book wasn't focused on ways to navigate the foreclosure and pre-foreclosure markets because the real opportunity will only come in 2009-2011, depending on the region. The real focus was to convince the reader of the full extent of the crisis by detailing the risks in the real estate and banking industries and advising investors to short the mortgage companies (LEND, NFI, FMT, FRE, FNM), home builders (LEN, TOL, BZH, KBH, CTX), and banks (C, BAC, WM, JPM).The results speak for themselves.

Another "stunning" prediction by the Harvard group was that America is "poised to see an increase in housing demand over the next decade." What would you expect the housing market to do after bottoming in the next 2 or 3 years? It can only go in one direction from there - up. The question is by how much. With 80 million boomers set to retire over the next two decades, there is a high risk of a continued although more modest housing glut for many years, as many sell their homes due to financial problems or to move to a retirement community. The failure of the Harvard study to point out this very credible possibility demonstrates the group really does not have a good understanding of all dynamics essential for making forecasts in the housing market and economy.

While the report does provide a nice presentation of what has already happened, it by no means sheds any light for investors because the information was already uncovered in advance by others who acted ahead of time. But when put into perspective, it provides some credible warnings during a period whereby almost every "expert" with a wide audience base has been dead wrong. You might recall some of the recent claims made by JP Morgan (JPM) CEO Dillon, which I commented on last month in 'JP Morgan, Bear Stearns: More Smoke from Wall Street.'

The Harvard study follows a widely discussed report from a JP Morgan (JPM) analyst released on June 11, which forecasts a potential fall in home values nationwide by 30%. Once again, I am not only unimpressed; I am wondering why it took them so long to figure things out. At the time of JPM's "revelation" home prices were already down by 21% from the 2006 peak according to the Case/Shiller Index. It doesn't exactly take a massive research effort to tack on another 9% from here, especially when many on Wall Street are now admitting that the real estate and banking crisis are far from over.

What JP Morgan (JPM) glossed over is much more interesting. Instead, of warning of a very nasty junk bond market, the analyst downplayed the accelerating credit risk:

 

U.S. home prices may fall as much as 30 percent through 2010 and push high-yield bond valuations close to levels seen during the last recession, a J.P. Morgan analyst said on Wednesday.

 

If you do not interpret this as downplaying the bond market, then you've underestimated the credit risk. As I mentioned in a previous post, not only will the collaterized debt market continue to get worse, there will soon be a surge in corporate bankruptcy filings.

The bottom line is that these reports and forecasts provide absolutely no value to those who know what is going on. The reports will only amaze, shock, or impress the sheep, of which most investors are.On a positive note, the reports by Harvard and JP Morgan may pressure the "experts" to stop hiding the truth. But nothing can stop pain. The domino effect is already in play. We are still only in inning 3 or 4 of the real estate and banking crisis and inning 2 of America's long and painful period of correction. I will guarantee you there are many more problems ahead – many, many bank failures, hedge fund blowups, corporate bankruptcies, the 1970s-like inflation and interest rate trends on the way, and maybe even a meltdown in the $40 trillion global credit defaults swap market. Either way, it is very likely this recession and real estate correction extend throughout the globe.

Removing Yourself from the Noise

Investors would be wise to ignore everything Wall Street, Washington, bank and real estate industry shills state about the real estate and banking crisis, the economy and the capital markets. By the time they confess the realities, it will be too late for you to do anything about it. In the meantime, their misinformation could cause you to lose a lot of money. Remember, a real investment expert is only as good as his last call. That means they need to be right before the consensus. Being right about something when everyone else shares the same view won't help you much even if it proves to be true. As we now know, almost all of the "experts" out there, from economists to Wall Street pros got it completely wrong and continue to deny the realities, while a few are trying to redeem themselves. Just don't forget where they stood two years ago.

The "experts" made available to the public have and will never alert you in a timely manner. That is why most people suffer during periods of crisis. Booms are always set up by Wall Street and publicized by the media. And when the bust occurs, Wall Street denies the truth, using the media as their partner while they exit. The few who make out big during busts are extremely selective about paying attention to only the most credible resources because their time is better spent doing their own analysis.

Many investors have formed their opinions about what will or will not happen to the real estate market, the economy and the capital markets based entirely on what they have read and heard from the media. Without realizing, they've let this misinformation serve as a basis upon which to crystallize their views. As a result, some think they can get rich buying distressed stocks because they fail to recognize the extent of the risks.

Investors have been brainwashed by Wall Street and the media to think that "buying low" is always a winning approach. What they do not realize is the difference between buying an undervalued stock and buying a distressed security. Buying a distressed security is not "buying low." Investment in distressed securities is a very speculative strategy because bankruptcy is very possible.

Most investors choosing to mess with these securities would better off gambling their money in Vegas rather than counting on biased coverage of the economy and markets by media hams that are usually wrong. Unlike Vegas, this market offers no chance of luck to anyone. Only those who are well-informed and very skilled will navigate this storm, taking the money away from everyone else.

There will be no easy money in the U.S. market for many years. There will only be easy loses. If you feel that these programs provide you with valuable insight, I would advise you to reconsider whether you should be in this market.

There are some periods that are best to be in 100% cash due to high levels of market risk. But you will never hear that from Wall Street or mutual funds because they only make money if you are invested. A few weeks ago, I warned investors they needed to go to cash and consider buying the Ultrashort Financials ETF (SKF).

Thereafter, the Dow lost 1400 points (see my May 5 article "Stay Clear of Traditional Asset Classes").Those who took my advise must be feeling pretty good right now, as the market has dropped from 13,200 to 11,800 since then. Meanwhile, the financials have gotten creamed much more.

Now, I am certainly nowhere near perfect. All I ask is to examine the person's track record – not by just looking at what they are saying now, but what they were saying in 2007 and 2006. It's easy to change faces when things turn against you because most investors have short memories. In the end, you can decide who to listen to. But if history is any indicator of my future accuracy, those who elect to bet against me are going to need some really deep pockets.

Investment-related Guidance

Going forward, if you insist on investing in the U.S. stock market, you had better be in oil and agriculture. Long term I still like healthcare (drug makers and HMOs) as an investment (UNH, HUM, WLP, AET, PFE, MRK, LLY, NVS), due to the boomer demographics and the very generous Medicare Part D subsidy – generous only to the drug makers. I especially like United Health (UNH) and Pfizer (PFE) at these levels although both are still showing considerable weakness. But if you think the market has much further to go, there is no need to pick these up now.Patience and cash preservation are critical. Finally, regardless how long your horizon is, you should keep a good cash position at all times.

Experienced traders might want to play gold and mining stocks (GLD, SLV, NXG). One particular mining supplier that has shown some real strength over the past couple of months is Bucyrus International Inc. (BUCY). If you chase it here you should be prepared to hold it for a while because a correction could bring it down significantly.

Those with long horizons should look to the Chinese and Brazilian stock markets and foreign currencies such as the Swiss Franc (FXF) and Japanese Yen (FXY). For those of you with no exposure in these markets, now is a good time to begin entering small positions especially in China (GCH, FXI). I think Brazil (EWZ) will offer a better buying opportunity down the road.

The current recession, although still denied by many, will most likely turn out to be the worst in decades. While I have little doubt the recession will spread globally, further corrections in foreign markets will represent excellent buying opportunities for investors with long horizons. Those with shorter horizons should consider maintaining a very large cash position and wait for interest rates to soar. There is going to be an excellent period to buy TIPS (TIP) once long-term rates go beyond 8% and when Washington is less able to suppress the real inflation data.

It is highly likely that over the next several years, we will see double digit interest rates due to 1970s-like inflation. After 2010, you should expect inflation and interest rates to really begin soaring. Of course, much of this will depend on what the fed will do with rates and the money supply. It is entire possible that Bernanke will continue to act irresponsibly towards consumers while protecting only the banks. Already we will pay an enormous price down the road for the $1.2 trillion bank bailout.Unfortunately, in my estimates the banks will need at least another $1.5 trillion to ensure liquidity over the next few years. All of this is going to come at a huge price. Keep that in mind if we see a big market rally in a few years.

A Final Word of Caution

Those of you looking to make easy money in the financials like E-Trade (ETFC) need to think again. The risk is too high right now. I find it amazing how so many who have taken a long position in ETFC cite the company's impressive book value as some sign of value or financial strength.Understand that book value is used in the event of liquidation of assets in bankruptcy and therefore usually has no impact for common stock holders. In addition, book values of financials are meaningless since the banks have overvalued their debt. Finally, book values typically have no way of fully accounting for the type of massive leverage the banks have built.If you were not aware of these basic facts, you really need to sit this one out, save your cash and wait for the next bull market, when nearly everyone does well.

Even Citibank (C) has considerable downside from here, as does Bank of America (BAC). Over the past year, I have made many recommendations to short the financials. Earlier in the year, my attention was focused on Lehman Brothers (LEH) and American International Group (AIG). The story on these guys is far from over but I would wait for a rally before going short again.

The next short to consider will be Merrill Lynch (MER). When MBIA (MBI) and Ambac (ABK) get another downgrade, Merrill will be in deep trouble due to their large exposure to insured mortgage debt. That said, you might be wondering why Merrill is already near a year low. It's quite simple. All that I have told you about Merrill's risks is widely known. But that does not mean it can't go lower. However, unless you are very experienced with shorting, you need to stay away from this strategy.

Will there ever be a time to pick up the financials? I doubt I will bother to pick up any of these (other than for short-term trading) even when I sense the bottom has been reached because the climb back up is going to be very slow and small. The dilution that has and will continue to occur will crush earnings for many years.

Disclosures: As of the date of publishing, the author owned the following stocks mentioned: PGH, HTE, PWE, HWAY, UNH, PFE, GCH and WM (only on valuation, intended for intermediate-term trade).

Comments

[Sneagle]

Mike,
Thanks for the article; I do have a question concerning ETFC.

It is my understanding that they were one of the first institutions to get hammered by the downturn and the first to deleverage and sell assets to raise capital levels. They have a large reserve and a decent capital level.

Listening to the CEO recent comments, barring a huge downturn in their portfolios’, the company appears to be operating very well and is on the rebound.

It seems that being the first to cut the cancer is a reasonable step in reversing the risk.

What are the main risks for this company in your opinion?

Thanks

[littlemog]

very insightful and sobering post... much thanks for it!

[rawgreed]

Mike, I couldn't have said it any better myself. Kudos for a great article.

[Ishortyou]

In respect to AMBAC and MBIA, they need to keep and save all the cash possible including stop paying dividends, deleverage from all their risky liabilities specially those CDS, CDO's, RMBS-ABS of uncertain value, in order to remediate their book values, once their book values are sound they need to reinstate their triple A rating again to write new low risk public bond insurance business. They can also open or extend a line of credit to make sure to continue operations and dissipate doubts.

They are already doing these, so it will take some time to deleverage their books from uncertainties and rewrite new business again. This coming back will be the best advertisement to recruit new clients.

[taco]

Great article. Thanks for keepin' it real !

[Pauly B]

Look at a 5 year chart of the VIX. Then look at where the VIX made a top. Now overlay the S&P over that. I think that is pretty good place to buy quality securities in equities and ride the market back up.

I always go by the saying "the market hates extremes"

Or as one of the Rothschild's said "when there is blood in the streets, you buy."

[Mazel Tov]

Mazel Tov!

[Blues Gal]

Unlike Zeninvestor, I think this was a very useful article, I guess we're
not all as knowledgeable as Zen is! Thanks for the info.

[CLH]

I never listen to people who foresee disaster. These are the same people who NEVER foresee good times when the money is made.

Those who foresaw 1987 did not profit from being out of the market because they were too frightened to ever go back.

[User 154037]

"Now, I am certainly nowhere near perfect" This statement of self evaluation was the most accurate thing you said in the whole article. It would take forever to debate all of what you suggest but I would like to speak

[pdd]

Thanks, enjoyed your thoughts. The housing part was easy, the financial derivative fraud isn't.

[AJ30]

A litle extreme perhaps, but I remember IBM bonds with a 12% coupon issued in th later 1970's.
The real question is where do you hide your cash hoard? If in US$ inflation will eat away a lot of your purchasing power. Sovereign debt will probably suffer as the US$ gets strengthened a little, to bring down the cost of gasoline. Commodities are already pretty pricey, real estate the usual money vault against inflation has many problems of its own to wade through. So where to hide?

[evergreen16]

People unable to afford homes? If you making the average 50K, it is easy to afford house at $300K (6x earnings). People, just stick your head out of the sand and look around. In western Europe, people with slightly lower income have to pay at least double that for a house. Now in historically poor eastern Europe - people are making on average about 15K, but the houses in smaller towns cost around $300K-$400K (20+x income), and guess what, there are no 5% down payments, people pay 50% down in most cases.
I think we need look around and learn from others, as America has a great potential!

[CM in MA]

Interesting article, but forming any opinion, thesis or course of action on "facts" such as "the median wage-earner is unable to afford the median priced home" is fraught with danger. I glanced at the study and am fairly certain it is using national medians. Well, we don't live in a median world. Wealth and earning power tends to cluster. Those earning at or below the national median wage in a high-wage area will likely find themselves consistently priced out of the local real estate market where most homes will tend to run above the median house price. Conversely, a person earning at or above the median wage in a low-wage area will be able to afford a home at the upper end of what is likely to be a below median priced housing market.

Facts and data only have meaning when put in context. And also remember that all studies have biases (yes, even at Harvard) and perhaps even hidden agendas.

[mythoughts]

There you go again ISHORTYOU with your nonsense about MBIA. Face it. They are going to disappear.

[buckmaker]

Good article because it exposes the symbiotic relationship between Wall Street and the Press. Next you should expose how they are both in bed with the Republican party which is running off with the profits they made on your dreams.

[Sophisse]

"Removing yourself from the noise" - excellent advice for all.

[Shatz]

Unfortunately, the govt has no choice but to protect financial institutions whose greed led americans to spend their piggy banks (home equity). Do you really think they can afford to let a FNMA go under? The entire Bush economy was driven by that spending spree. We have never been in these uncharted waters before. Unlike the stock market, real estate will most likely not overshoot before it finds a bottom. In the meantime, investing in the rental market seems a good strategy if one wants to remain in real estate. Else, invest in things that help the little guy survive, like Wal Mart.

[oldlures1]

I'm with Sophisse. Can't speak for everyone, but I think it'd do me a world of good to disconnect for a while; seperate from the "noise", and clear my head. Too much info - my circuits are about to short.

[Dean Plassaras]

As Marc Faber has said the next bubble is that of earnings. Watch the S&P500 reflect disappointing earnings over the next year or so.

[Bugs]

Bush has brought us two recessions and two bear markets. The President is always to blame or gets the glory. I long for the prosperity of the Clinton era.

[Bigbuilder]

There is simply no quick fix to the fact that we are VERY over levereged as a nation and as individuals. It will take years of savings to unwind and that saving effort will tap out the consumer and reflect the gross misapplication of capital into consumption (e.g. SUV's and lavish homes). Essentially we are in a marcoeconomic Chapter 11.

Those who sell investment products do so to generate income for themselves NOT to help their clients. All of Wall Street knew the last few years were based on lies, but they let it happen (with help from Republicans AND Democrats).

I think the future will be dark.

[nyinvestingmeetup]

The most important statement in this article is: "The "experts" made available to the public have and will never alert you in a timely manner". This is why the average investor can never make money in the market. The people who do make money understand this concept well and pay no attention to the investment advice offered through the media.

[Ben Williams]

Remove yourself from the noise is the best advice from this article. Don't follow the media hype and read all these posts with a grain of salt as EVERYONE has their own agenda they are pusing one way or another. Nothing is usually ever as good or as bad as the media and/or pundits would have you believe. Stick to your time proven principals and disciplines and you will survive the financial crisis now as well. The market will recover, just a matter of when, and that truly is something no one can predict with real certainty. If they claim they can, they are probably getting inside information and breaking the law, so don't believe all you hear and read. Keep piling up your cash during this downtime and do your homework to buy the few stocks out there that are bargains and not just junk disguised as a bargain and you will be fine when the market decides to roll again. Bottom line, know your risks, know your timeframes, keep saving money and keep investing also, just be selective and use your own brain at the end of the day.

[kdbaimr]

I was beginning to take the comments very seriously until Mike said the CEO of JPM was "Dillon." This might be a small thing, but if he is such an expert, wouldn't he be able to get JPM's CEO's name right? It calls into question the rest of his comments.

[notsosmart]

wal st.& vegas are the same thing only one is slower.

[Bob'29]

The word from the nypost is that J.P. Morgan has Washington Mutual on the top of its wish list of buys. I looked back to March of this year. J.P. Morgan's first offer for Bear Stearns was for $2.00/share. The buy out was finalized at $10.00/share. Does anyone know what the purchase price of WaMu might be. It traded as low as $5.05 (for good reason or not) today down from about $40. not too long ago.

[eva]

I agree 100% with CLH.
The writer: You should told us how soon should we commit suicide.?.

[Bob'29]

During the preceding days of the Bear Stearns buyout the stock did trade at close to $2.00/share, much less than the asset value of Bear Stearn's buildings, offices and real estate that it sat on. Those that bought at those prices made 400%-500% when the sale went through. Washington Mutual is not facing bankruptcy. The conservative S&P revised estimates WaMu at $7.00/share based on 0.3 price to book There are still very big, very well run mutual fund companies, like Oakmark Funds that still hold large quantities of WaMu. I think there might be a good buy in WaMu at these oversold prices.

[Depression Surfer]

The coming Deflationary Depression that the FED and the Bush Administration have engineered will most probably last 2 decades. I have no doubts that it will be worldwide, immeasurably deep and long lasting. The largest banks are insolvent and hiding their losses. And during the last 6 months of this administration, we are experiencing rampant commodity bubbles that are further engineered through corrupt government policies that allow Enron Type speculation. Pretty soon we will be paying $20 for a single patty burger at MCD's and rating them with tripple straws.
I blame this fiasco on both parties. Moreso on the republican brand of mis-government. At the end of this administration we will be lucky to have any form of retirement benefits, pensions or a solvent dollar. Have to admit G.W.B. is the worst president in the history of the U.S.

[tommy u]

tend to agree with you on your etf reccommendations.
You might want to add dba, rja, and the new livestock cow to your list. what do you think of japan?

[Zeninvestor]

Well, I got my post censored. I guess if you really LIKE something it stays, but if you simply post anything contrary it disappears. Hmmm. I restate that this is not insightful, just a 'rehash' of old information. Is that so harsh it need to be censored?

[Sarah P]

I totally disagree. Its never been a better time to buy.

If you have been responsible & accually have good credit, there are a number of lenders willing to finance at favorable rates & terms. In fact, I have just closed on a single family home a few days ago, & Iam able to receive financing for over 180% of purchase price. The beautiful thing is- THIS PROPERTY WILL STILL CASH FLOW AFTER PULLING OUT ABOUT 100K!!!

I LOVE THIS MARKET ALL OF YOU NAYSAYERS OUTTHERE!!!

[Sarah P]

BAD TIME TO BUY?!-

This is a fear driven market, thats when its a good time to buy. But i have to say, how can it be a bad time to buy if the prices have never been lower?

Well you can all not make money, while i go out and buy a couple houses.

[DanH]

Sarah P stop yelling. Go away.

[ETFC = $16 - $32]

ETFC current earnings estimates for 2011 are for $1.08/share.

www.nasdaq.com/earning...

At a PE of 15 that gives you $16.20.

But this a low-ball estimate as ETFC is paying down their debt at an accelerated rate and this estimate also understates ETFC’s true growth potential as being the best on-line trading platform hands-down.

$1.08/share could easily double by 2011.

Now you’re looking at a $32.40 share price, or least something in between $16.20 - $32.40.

This target will be reached before 2011, of course, as the market tends to race to true valuations prior to actual earnings materializing.

Also AMTD & other companies interested in acquiring ETFC are well aware of how rapidly ETFC share price is going to appreciate and have a vested interest in naked shorting the crap out of the stock down to levels that would make a cheap buyout offer appear reasonable.

(THIS HAPPENS ALL THE TIME)

So either way, short-term ETFC gets acquired for a decent return for shareholders, ($8.00 - $12.00) or she doesn’t get bought and appreciates on her own upwards toward $16.00 - $32.00 over the next 18 - 24 month.

The naked shorties know what this company is going to be worth and they want as many of your shares as they can possibly scrounge.

[fireball]

hey depression surfer cheer up. surely another world war will interupt before two decades. my old aunt used to say (everything we bought was made in japan then their planes came.).

[nick2511]

I am new at trading. I want to make my first trade by buying $7500 in etrade and hold for 1 - 2 yrs.
I mean how lower can the stock value go? In July of 2007 it was at $22. I guess the worst thing is bankrupcy which I think its unlikely.

Do you guys think it would be a good buy??

Thanks in Advanced !!!

[Blair]

I don't know whether anyone will read this late posting, but my put is the market is going back to the 2001-2003 bear market low.

What happens next is another story.

[DUPEY]

Sure would like to know where you got that 180% loan!


On Jun 28 11:20 AM Sarah P wrote:

> I totally disagree. Its never been a better time to buy.
>
> If you have been responsible & accually have good credit, there are
> a number of lenders willing to finance at favorable rates & terms.
> In fact, I have just closed on a single family home a few days ago,
> & Iam able to receive financing for over 180% of purchase price.
> The beautiful thing is- THIS PROPERTY WILL STILL CASH FLOW AFTER
> PULLING OUT ABOUT 100K!!!
>
> I LOVE THIS MARKET ALL OF YOU NAYSAYERS OUTTHERE!!!