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Market Timing: The Fed blew it.

Let's assume that you find yourself in a car that is rolling backward down a steep hill.  Naturally you will first try to stop the car and then try and drive the car back up the hill.  If the hill is too steep you won't be able to get enough traction and you will simply sit in one spot and spin your tires.  A rational person would recognize their dilemma and allow the car to descend to the bottom of the hill in a controlled manner.  Once at the bottom, they can juice the accelerator a little to build up some speed and easily make it back up to the top of the hill.  A less rational person may decide that it is too far to the bottom of the hill and they do everything they can to force the car to make it to the top.  They gun the engine, burn rubber and continue to try to make it to the top of the hill with no success.  At the end of the day they have no choice but to allow the car to roll down to the bottom of the hill, but now they are out of gas, have blown their transmission and their tires are bald.

This is basically what the Fed and our government has done with our economy.  It isn't even so much that they did the wrong things, it is the fact that they did them at the wrong time in the economic cycle.

For our economy to grow there has to be consumer spending and corporate investment.  Even though the Fed was able to arrest our fall, and even get a pretty significant rally going in the equity markets, there was never an underlying belief that we had hit bottom or even had stability in our economy.  Almost all of the temporary successes in our economy were a direct effect of government stimulus and was not sustainable after the stimulus ended.  Until consumers believe that we are back in a growth trend the government can continue to drop cash from helicopters, but consumers are going to stash it away or pay down debt with it, which is exactly what is happening right now and exactly why the stimulus is failing.

For our economy to rebound, it is critical for investors and companies to know which direction our economy is headed.  Uncertainty is a destroyer of economies.  Commercial real estate (CRE) is a perfect example.  Prices are down 35-40%, but most CRE investors still don't feel like this is enough.  First of all, the price that it is down from was an overinflated price during a time that it was believed that office space was in short supply, rents were continuously growing, and vacancies were not a problem.  The value of CRE is usually determined as a function of return on investment (or "cap rate") going forward.  Since vacancies are up and rents are down, in order to keep the same cap rates for investors, the prices had to come down.  But now, rather than there being a premium based on rents and occupancy growing in the future there should be a discount due to the uncertainty of the future.  Yes, CRE prices are down, but due to lower rents and higher vacancy, the discount for our future is not priced in and investors are sitting on the sidelines until it is.  Prices have fallen, but in some ways many properties have actually become more expensive.

I did an analysis of the CRE marketplace a few months ago and my finding was that CRE can, and probably will have to fall another 50-75% before investors start to buy in a big way.  And they will have to buy in a big way to overcome the massive glut that currently exists.  That's a long way from where we are today.

If there is a takeaway here for our government and Federal Reserve it should be that timing is critical.  At best, when our economy is taking a dive, they should use their powers sparingly to attempt a controlled descent.  It isn't until we hit the bottom of the hill that they should hit the gas.  Unfortunately I believe it is too late this time around and we are going to feel the effects for the next decade or more.  We are out of gas, our transmission is blown, and we are rolling back down the hill.



Disclosure: Long SDS