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Econophile is Jeff Harding, a real estate investor and former lawyer in Santa Barbara, California. He is a principal of Montecito Analytics, LLC. He has many years of experience in business cycles, real estate investments, and finance. He also was financing director of a home builder. He was... More
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The Daily Capitalist
  • Commodities Were So 2011: This Year It's Tech's Turn To Pop & (Maybe) Top

    By DoctoRx*

    Large IPOs often mark tops within sectors and within stock markets as a whole. In June 2007, shortly after the S had begun to hit the fan in the financial stocks, the Blackstone Group (NYSE:BX) was able to get a multi-billion dollar IPO in. About a year and a half later, BX was down about as much as the Dow Jones fell between its 1929 peak and its mid-1932 nadir--almost 90%. Talk about getting out on the last helicopter leaving Saigon!

    Fast forward a few years until the indigestion amongst Western investors allowed them to stomach a "hot" non-Chinese IPO:

    Last year, Glencore (a gigantic commodities trading company) announced it was going to float an about $60 billion IPO in London and Hong Kong. It went public in May; the stock promptly went straight down, just as Blackstone had done 4 years earlier. Was it a coincidence that spring 2011 also marked the top for most commodities and almost all commodity stocks?

    Then, last year, memories of the crash had finally faded enough that it became time for U.S. investors to become the quacking ducks that, as always, Wall Street had food for. And of course, tech was there as the most palatable food. First there was LinkedIn (NYSE:LNKD) in May, then Pandora Media (NYSE:P), which is half off its high; then Groupon and Zynga.

    Recently, Facebook decided it was time to liquefy its stock. This is the Big tech IPO for this cycle. This IPO will make the year for many in the financial community. The valuation is bruited to be around $100 B. We are definitely not at a 1999 level of insanity, as all the above companies are "real". But these stocks are, in general, overvalued-or at least were, at the times of their 2011 IPOs as listed above (it's too soon to comment on FaceBook). These companies have few tangible assets and have immense competitive challenges to justify their current valuation. I know from an insider at FB that the private market valuation -soon to be the public valuation- has skyrocketed over the past year-and-a-half. But I doubt that there has been all that much surprise in that same time frame in its operating results- after all, Facebook was the clear winner in its space by 2010. So my view is that the price has been marked up for retail distribution. All in a day's work for the Street.

    In the period until the FB IPO is expected this spring, I would be on the watch for market patterns to recur, and here are two examples of how they are currently in fact happening.

    First- JPMorgan Chase has now put out a detailed, bullish research report on AAPL. Now. Talk about being late to the party! JPM is not necessarily a player against which to be contrary, especially in the short term. But let us note that there are not a lot of avowed bears on AAPL's stock valuation in the mainstream investment community. Second, and even worse, a posting yesterday raised in all seriousness the question of whether there would be a shortage of AAPL stock should demand for it spike through the roof in the event the company declared a cash dividend. A shortage of stock? LOL- that reminds me of the alleged shortage of Treasurys in 2000 given the prospect for unending budget surpluses. When the media starts positing a shortage of stocks or bonds...uh-oh... (Note I am long AAPL.)

    All may be well, and all manner of things may be well in investment-land despite this discussion. What I am saying is definitely not a timing call, but my point is to remind readers that these major IPOs and runs of hot IPOs in a single sector do not happen in a vacuum. They are not the result of a philanthropic attitude amongst corporate insiders or the financial community. Facebook could raise every penny it needs, and more, from private sources. UPS stayed private for so long as it grew massively that a regular system of stock sales occurred to let long-termers cash out their UPS stock. Facebook does not need to become a public company to get known. If the insiders are planning to generate unanticipated profits on an undreamed of scale, why share them with us? Why accept the costs and scrutiny of being a public company?

    In contrast, there's nothing like investing in a neglected market or "discredited" but essential sector to provide a long-term margin of safety (i.e., think different)- for an individual investor trying to time hot plays. Might that be, for example, U.S. natural gas exploration companies or small strong community banks? Is Wall Street cheerleading either of those sectors right now? The answer is "No". Thus, there may be good long-term relative value in those sectors- as well as the usual garbage, one should point out.

    I think that most individuals should take a Roman view when the FB books are opened to the public.

    Caveat emptor: let the buyer beware.

    *DoctoRx is the pseudonym of an investor with a very successful 30-year track record. He writes for the Daily Capitalist where this article originally appeared.

    Disclosure: I am long AAPL.

    Additional disclosure: Please leave in the reference to my blog. Thanks, Jeff

    Feb 27 3:33 PM | Link | Comment!
  • The Coming New Recession: A Game Plan
    This article was written by DoctoRx and it first appeared on the Daily Capitalist. The Doc has 30 years of investment expertise.


    I wanted to summarize some major themes we have been addressing on the Daily Capitalist

    First and foremost, my view is that the markets and the mainstream media have been giving insufficient attention (if any at all) to the core problem that was revealed by the meltdown in 2008.  Massive amounts of capital was misspent ("malinvested") during the boom.  In order to finance the boom to its excess, financial companies ranging from small mortgage brokers in Orange County, California to titans of Wall Street burned through and pledged and hypothecated unbelievable amounts of capital.  Recall that at the time, the total amount of base money in the U.S. was around $1 T.  But the actual amount of bad loans and writedowns- not market value, which is a price that is evanescent- was gigantic.  So it is my contention that what happened in 2008 was bankruptcy on an incomprehensible scale. 

    In other words, much of the "money" that "cash-rich" individuals or companies had "in" the bank or on loan in a money market mutual fund may have been worthless, or nearly so, due to poor lending practices.  It is hard for me to see how Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, Bear Stearns, Lehman Brothers, Countrywide and Merrill if not acquired by BofA, various mortgage insurers, CIT, General Motors (a financial company with an automotive subsidiary, as it were), Chrysler, etc. could simply have imploded under any scenario other than gross near-insolvency of the financial system and mismarking of their assets and liabilities along with absence of prudent balance sheet management.

    This quantity of huge bankruptcies (and all the averted ones due to massive government intervention) is extraordinary and may be without precedent for any leading financial power in modern history.  But how often on CNBC or out of Washington have you heard matters framed this way?

    If you believe the above, then an additional great tragedy is the failure to examine publicly at the highest levels what went wrong for so many years to lead to this catastrophe.  Instead, the official explanation is that something unexplainable such as a Hurricane Katrina hitting New Orleans with a defective protective structure that was breached.

    The deflationary events of the early 1930s saw almost none of this level disaster amongst the giant banks, even though objectively economic matters were much worse by 1932-3 than in 2008-9, in real terms which were amplified by the massive price deflation that assets suffered then.  For example, the Bank of United States was based in New York City.  James Grant recounts it as not being especially well-run, but there was no embezzlement or fraud.  It went bust in 1930; it was not a giant.  There were no level 3 assets or CDOs, much less CDO squareds.  When the economic downturn  came, the bank simply had a duration mismatch/illiquidity problem.  It had financed good properties, but it had to go through bankruptcy.  Several years later and many deflationary price percentage levels lower, depositors recovered 83% of their money.  Given what happened to the stock market in the interim, these depositors did fine.  They may even have gained purchasing power.  Now, compare that to what you think you would have received if you were a depositor in Citibank if it was left to fail (let us talk about funds above the FDIC limit) amid a massive deflationary (price and credit, both of them) liquidation spasm that could have occurred in 2008-9 (and beyond) similar to the one that occurred in the early 1930s.  Remember that every big money-center bank paid 100 cents on the dollar back then to both depositors and bond-holders (if there were any bond-holders):  there were no insolvencies, and I have read that "only" about 2% of money deposited in banks was lost during this time period.  Does anyone think that things were anywhere near so robust compared to the 1930s amongst the banking companies that did not go bust in 2008-9?  There is no way to really know, of course, but remember that the big guys all did well enough then to survive in vastly more challenging situations than they were recently faced with.

    Thus I contend that matters were in many ways worse in 2008 than after 1929 even though the economic downturn was much less severe, and that we are paying the price for that but in a different way.  The result could be ZIRP on and on and on as the authorities continue to create enough new money to replace the immense balance sheet holes that the public is not allowed to see.  There's no way for me to know, but secrecy and complexity in financial matters speaks for itself, at least in the DoctoRx mindset.

    I contend that the current systemic instability is an (the?) absolutely fundamental reason that the Fed keeps "printing" money but there is no hyperinflation and that residential and commercial real estate prices have been falling again:  the newly printed money is partly overwhelmed (though only temporarily) by the ongoing depressionary forces.  The evidence of the ongoing depression is all around us.  Just look at the Bloomberg Consumer Comfort Survey, the NFIB survey, the Discover/Rasmussen Small Business and Consumer surveys.  Look at the Gallup survey that is posted daily.  Unfortunately I cannot post their daily charts, but if you go to and look at the trends in hiring/not hiring; daily spending; and living standards, the highest any of these got in the "recovery" was to early 2008 levels:  recessionary levels.  They may already be declining again.  Ignoring all the machinations in Europe, the U.S. has its own cyclical problems.

    Is it too soon for another recession?

    No, no, a thousand times no.  Since 1940, there have been 12 recognized recessions in 71 years:  one has begun less than every six years.  The last one began nearly 4 years ago.  According to NBER, the Great Recession ended in June 2009.  Thus it officially was a 19 month official recession.  The prior recession, as mild as the 2007-9 one was severe, ended exactly 10 years ago.  That means that in the past 10 years, the U.S. has officially been in recession only 19 months:  about average for the past 71 years.

    Can a recession occur with a positive yield curve?  Yes for at least two reasons.

    One is Japan.

    The other is that the Economic Cycle Research Institute says that it does use the yield curve to forecast recessions.  

    When the free market cannot match capital assets with what are perceived to be good investment opportunities, a somnolent future economic state is expected.  When the profit motive doesn't stimulate borrowing at rock bottom interest rates, and when there is so much capital available, my conclusion is that there is simply enough of most things. 

    So the central government goes on "filling a demand void" when the problem instead is a lack of real savings.  Borrowing/printing money to give $500 handouts to old people regardless of need simply because they "consume" is representative of all the wrong-headed but "nice" tendencies of American Keynesianism.

    To summarize:  the country ran out of a lot of its real capital during the boom/bubble 1996-2007 period.  This was masked by financial shenanigans but the lack of real capital was revealed when a mild recession forced the financial emperors to be revealed as nearly naked.

    The "Great Recession" did not cause the lack of capital.  Instead, it revealed it, just as the little dog Toto revealed the fake wizard behind the curtain in the merry, merry land of Oz. Only after that revelation did the recession become a depression. 

    So once again, in case I have not been clear, the (neo-)Keynesians may have the best of motives, but from the standpoint of stimulating healthy future economic growth, they have matters backwards.  What is needed for a true recovery is more useful savings, not more consumption paid for with borrowed or newly printed money.  Until real savings (real capital) is rebuilt, it is difficult for me to see other than a continuation of the current pattern:  limited economic growth and upward price pressures as the quantity theory of money gradually wins out.

    From a timing standpoint for investors, however, which is more of a micro than macro concern, my sense is that we are so far from the onset of the Great Recession that another down-wave in the depression (or a new recession if you go by NBER) is either here or due soon.  It may not be a severe downturn, as housing and autos would be falling from first- or second-floor windows in that case, but it would be occurring on the backdrop of a weakened structure, and thus the financial effects could be more severe than the economic effects (which could be severe or mild).  Remember that the mild 2001 recession was associated with about as severe a stock market crash as was the 2007-9 monster downturn.

    My suggestion is:  watch the ten-year T-bond rate, lower meaning more economic weakness; watch the gold:platinum ratio, which is already signaling recession; do not trade off of European developments (you will be front-run by those in the know); do not use trend-following techniques that used to work and equally, do not use counter-trend trading techniques.  For that last point, the algos will beat you most of the time in either direction.  Some markets are untradeable except by true pros.  So if one has a "good" investment, don't sell just because the price drops.  Some robot might be getting you out at the bottom of the move.

    As far as gold, I have recently suggested it would be quiescent for a while.  I stick with that view, with a positive longer-term view, though there is significant downward price pressure possible from this level should a new recession be recognized and lead to a temporary asset liquidation to gain access to plain old fiat U.S. dollars.

    Finally, I want to state the core paradigm that has worked reasonably well the past few years.  It uses the recent Japanese ZIRP experience and combines it with the very prolonged period of very low interest rates in the U.S. following the 1929 crash, even though price inflation resumed after FDR took office in 1933 and deflation never really came back.  In this scenario, real short- and intermediate-term Treasury yields can stay lower than one thinks for longer than one thinks and can be negative after accounting for inflation year after year.  Right now I favor the Japanese trend of yet lower long-term rates because I consider that the destruction of real financial capital was greater in the bubble years now than perhaps ever before, and whereas America went back to saving as quickly as it could in the 1930s, that has not been the case ever since Mr. Greenspan ramped the presses while Mr. Bush told us to go shopping right after 9/11 and ever since the Fed began QE1 in late 2008. 

    In this hybrid Japan-U. S. post-Depression scenario, long-term bonds have their best use as trading vehicles to be sold near the end of recessions, but given much (much!) higher stock valuations now than in 1933 and its aftermath, stocks have more crash potential now than they did at most points in that era (until the 1960 time frame and beyond, when stocks finally began to get frothy again).

    Financial matters are at best a confusing mix of matters, more so now, and central authorities will do what they will, when they will, without giving you a heads up.  And the robots and trading costs will beat you as certainly as the slots in Vegas if you try to trade where you are not an expert.

    People who think the Austrian way and go back to the first principles that the economic damage occurs because of malinvestments during the boom, and that the bust should be the healing phase, are way ahead of the game in contrast to Keynesians who misdiagnose a lack of real capital for some implausible anorexia consumptionosa of the public at large.  So long as the authorities keep doing what they are doing, I would analogize this bust as a wound that is not allowed to heal because the doctor keeps damaging the scab. 

    Sometimes it just is best to get up each day, go to work (or a coffee house), and not think too much or do too much about the financial markets, all the while increasing one's knowledge about things one has real interests in.  The world keeps turning, and one wants a coherent game plan for the period ahead when the times are not out of joint. 

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: Please leave in the reference to the Daily Capitalist and note that it was written by DoctoRx who writes market commentary for us. Thanks, Jeff
    Oct 25 1:23 AM | Link | Comment!
  • The Imminent Failure Of The Eurozone

    You know those movies with the bomb set to a timer ticking down to øø.øø where the sweaty hero nervously cuts one wire at a time while holding his breath and then at øø.ø1 he stops the bomb? Well Europe is like that except that the bomb goes off and kills everyone.

    Our planet has a problem. Its leading economies, the U.S., Japan, and the E.U. are declining. That is, about one-sixth of the world's population is losing ground. These big economies are the ones that lead the rest of the world, including China. Countries like China, India, and Brazil, depend on the health of the big economies to keep buying their products and commodities so they can grow and generate wealth for their citizens. 

    What is especially concerning is the blow-up that is about to happen in Europe. It is not something that is happening "over there." In a world that is so interconnected financially and by trade, a sinking Europe is everyone's concern.

    Their problems are much the same as ours with a twist. Their governments and central banks have also pursued reckless monetary and fiscal policies and now, effect is following cause. They have more or less followed the same policies as has the U.S., much to the same end. They spent large, engaged in Keynesian fiscal stimulus in a bailout attempt, ran up huge debts and deficits, and their economies are in decline.

    The twist is the European Monetary Union (EMU), known as the eurozone. It is as if here in the U.S. there was no federal government and each state was truly sovereign, but there was a Federal Reserve Bank. Some states spend more than others, funding deficits by borrowing huge sums to support programs their citizens wanted. The profligate states want the Fed to buy their debt and float them loans created out of thin air, or otherwise they will go belly up and they will take down many states' banks. The responsible states know they will be stuck with the bill.

    The EMU started on the idea that it would bind the EU closer. In essence it was a political decision rather than an economic decision. They passed a stern rule that said no state could run of deficits of more than 3% of their GDP. Except for Estonia, Finland, and Luxembourg, all countries, including Germany, now exceed the limit. Thus their politicians sacrificed fiscal probity for political gains.

    They have hit the wall: Greece will soon default on their sovereign debt. On Tuesday, yields on one year Greek bills  reached 60%.  It is a sign that investors have no faith in the Greek government's ability to repay their debt. 

    The EU, ECB, and the IMF are trying to establish a European Financial Stability Facility (EFSB) in order to further bail Greece out. They have already pledged €110 billion and they are trying to put another package together of €109 billion. But Finland insists that Greece puts up additional collateral, which is not possible. Since the collateral would be part of the bailout money, it would be, in essence, Germany and France guaranteeing Finland's contribution.

    Greece has missed every fiscal target it or its saviors has had. They are trying to get their deficit down to 7.6% of GDP through more austerity measures, but it looks like they will miss again (est. 8.5+%). Basically they are asking the Greeks to do something they don't want to do, and they will no doubt take to the streets again in protest.

    If they default, then that opens a can of worms. European banks, other than Greek banks, hold €46 billion of Greek sovereign debt. Belgium's Dexia hold Greek sovereign debt equal to 39% of its equity; for Germany's Commerzbank, it's about 27%. On top of that, EU banks are into private Greek companies for about €94B (France, €40B; Germany €24B). According to the Wall Street Journal, the total market cap of all EU banks was just €240. The same article also points out additional unknown liabilities to insurers and investment banks. 

    The International Accounting Standards Board (IASB) has warned banks they need to write down, or mark-to-market, the Greek debt they hold. Whether they do or don't doesn't matter. The fact is that these banks are undercapitalized and in trouble. Their "stress tests" are a fiction. Liquidity is starting to shrink in their banking system because of these jitters. Rabobank, for example, said it is growing cautious about interbank lending – now limited to overnight loans. More banks are stepping up to the ECB window for funds. Overall, credit is starting to tighten. Nervous Greek depositors are withdrawing funds from their banks. Rich Greeks never trusted their banks.

    In other words the Europeans have created a problem that they can't solve, easily at least.

    Here are their alternatives:

    1. Keep bailing out Greece, with the specter of Italy and Spain being the next target of market forces as EU economies cool off. This is not appealing to Germany and France who know their taxpayers will have to put up most of the money.

    2. Have the ECB buy as much Greek debt as necessary to keep Greece afloat. The problem with that is inflation and the prospect that they may be setting a bad precedent for other countries. 

    3. Have the EU issue bonds guaranteed by individual countries, which again is mainly Germany and France. Same problem as No. 1. As Sarkozy said they don't wish to guarantee debt they don't control – the spenders have no incentive to curtail spending.

    4. Opt for a fiscal union whereby Brussels controls spending and taxation. Or, at least, as Sarkozy and Merkel propose, coordinate their fiscal and tax policies and pass a balanced budget amendment in each country. Good luck with that. Chances: zero.

    Which one of those policies will best satisfy these three necessary goals required to ameliorate the worst damage:

    • Remove the need for the ECB to buy bonds continually on secondary markets;
    • Ensure that troubled countries have access to financing;
    • Prevent the strong countries from being dragged down by the weak.

    Which one of the above policies will prevent Greece from defaulting, will let the rich countries off the hook, will create enormous liquidity in the eurozone, and will bail out the banks?

    The answer is the obvious one, the one that won't hit the taxpayers of the EU's powerful economies, that reduces the net effect of debt to sovereigns, that bolsters the reserves of nearly insolvent banks (at least on paper), and puts the problem off for another day. That would be solution No. 2— quantitative easing, or monetization of Greek debt.

    It also lets the taxpayers of Germany, France, and Belgium, whose banks hold lots of Greek public and private debt, off the hook because Greece will be able to repay their obligations in devalued euros. That is, the taxpayers in those countries won't have to pay the tab to refloat their banks. Or, at least as big of a tab as if Greece defaulted.

    This plan solves nothing except in the very short-term. The day after tomorrow, inflation will melt away much of the eurozone's sovereign debt as well as private debt, and savers will be robbed of their capital. Capital will be destroyed and consumed by price inflation. Their economies will continue to stagnate, unemployment will remain high, tax revenues will eventually decline in real terms, and they will again be facing the same problems they face today. There is no way to avoid it. 

    The EU faces an insolvable problem, but it is one they created. You can't have a monetary union without a fiscal union. At least when no nation is obligated to play fair. They either terminate the EMU or paper it over. There is no other practical fix, at least when economies of member states are declining. They are the poster child for the failure of Keynesian-Monetarist economics.

    This article originally appeared on the Daily Capitalist.

    Sep 02 3:36 PM | Link | Comment!
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