The Current Market Atmosphere: Easy Money Hard to Come by

by: Mike Stathis

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.

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 (NYSE: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 (NYSEARCA: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 (NYSE:UNH) and Pfizer (NYSE: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. (NASDAQ: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 (NYSEARCA:FXF) and Japanese Yen (NYSEARCA: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 (NYSEARCA: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 (NYSEARCA: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 (NASDAQ: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 (NYSE:C) has considerable downside from here, as does Bank of America (NYSE: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 (NYSE: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 (NYSE: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).