What Would, Could, and Will Not Sink the Market

When I post here about the Economic Disconnect I try to point out conflicts between what the average person sees everyday with what they are told by talking heads on TV, read in magazines/newspapers, hear from government officials, and the general stock market. When I talk about the stock market, I mean the overall stock market (though the DOW tends to be the most recognizable by most). The post from yesterday titled "Moving the Goalposts for Goldilocks" was a perfect example of FED versus reality disconnect in regards to inflation. For full disclosure, I do trade stocks in a brokerage account, but its mainly smaller scale stuff. I stick to biotech (a snoozer for 3 years) and over the last 2 years I like metal stocks. I am no expert but adding to KGC holdings under $12 and PAAS under $25 has been an ok trade.
I, with all my vast expertise, will now reveal to any interested what Will, what Could, and what Will Not cause a major market downturn (by major, I mean 10% with no snap back rally in 1 week). Here it is:

What Will (may take a combination of two or three)

• The host of Economic Disconnect goes long the total market (that's a 20% correction)
• Existing home sales for 2008 after April are estimated at 3.0 million units (current estimate for next year is 5.78 million, and falling)
• The Dollar falls below the 70 level (its at 78.3 right now)
• Due to above dollar collapse, The FED hike rates to 8%
• Consumer spending drops by double digits % wise month to month (and no 5-9% won't do it)
• A major bank or brokerage fails (I mean BofA, Citi, Merril, the big ones.)

That's it. The disconnect has grown so deeply rooted only the above listed scenarios will tank the market.

What Could

• A slew of minor banks fail (something like the Miami Valley bank that failed)
• The FED not only does not cut rates this year, but raises 50bps by next March
• Every quarter for the next 4 quarters all the major banks have equal or larger write downs than we have seen so far
• Home prices are falling at a rate of greater than 10% nationally

This list, even if two or more happen, may not be able to bring the markets to their senses, but some money might be scared enough to pull out.

What Will Not

• Home sales (new and existing) continuing to fall at a steady rate (5-10% year over year even against a bad year this year)
• FED stays pat on rates
• Consumer spending is negative, but under a 5% decline comparably
• A major bank basically fails, but is propped up or "taken over" by another bank with the help of the FED
• The dollar anywhere over 70 on the index
• A major homebuilder goes under, or two, or three
• The host of this blog goes short the total market (that's a 25% pop to the upside)
• Unemployment rises to 5.3%

The what will not sink the market list is scary, but it will only succeed in causing serial "bottom callers" to harp on the worst is over line until the next data comes out, then that point is the bottom. If this list is occurring, talk of FED cutting will keep the market frothy and happy.

There is 3 lists that will be worth checking over time. My humble estimation of the 3 possibilities comes out like this for the next calendar year:

What Will = 10%

What Could = 10%

What Will Not = 80%

Sorry to disappoint any bears out there, but I figure we are looking at a dismal year for earnings, home prices, home sales, consumer sales, the dollar, employment, and inflation. And I do not think any of that will get in the way of Mr. Market. The current psychology is so out of touch, most are going to be buying all year so they do not miss the "bottom of the cycle" even though we are already priced for near top end of a cycle.

I think it will take into 2009 for reality to have crashed against the optimism for so long, that the market finally relents and starts down. I could be wrong of course, and I encourage any interested to leave comments. I will review and post on comments that add to the debate. Have at it.

And have a good night.

Moving the Goalposts for Goldilocks

Another banner day for the DOW, closing at a new (non adjusted for the dollar) record. As I had written on Sunday, the FOMC minutes seemed to be the only market moving news that had that special ability to be spun bullish no matter what the minutes may have stated. Here is the headline at Yahoo Finance:
"Stocks Bound Higher on Rate Cut Hope"
So again, the market went from the Goldilocks line of thought to the line where the FED is going to continue rate cuts to spur the struggling economy.
The minutes released are always a fun read. If you have never read one of these, they are real gems of intellectual prowess. I can sum up in one sentence "We have no idea whats going on in the inflation area, jobs numbers, consumer spending, and the banking mess, but we are ready to do something depending on the data we see come out". Powerful stuff.
There was a good sentence in the minutes that highlights the Economic Disconnect however:
"With economic growth likely to run below its potential for a while and with incoming inflation data to the favorable side, the easing of policy seemed unlikely to affect adversely the outlook for inflation"
I know I am not the smartest person in the world, but the logic seems poor to me. If economic growth is going to be so slow as to lower inflation, and you cut rates to spur growth, won't that just add to inflation? I have collected a few headlines from the past couple of days to highlight how inflation has been kept low by the wonder of the FED:

• AP Heating Costs Seen Jumping This Winter Tuesday October 9, 6:17 pm ET By John Wilen, AP Business Writer
  Government Predicts Heating Oil Customers Will Pay 22 Percent More This Winter Than Last
• From the FOMC minutes "Inflation risks could be heightened if the dollar were to continue to depreciate significantly." (Where you been checking the dollar chart dudes?)
• Kimberly-Clark Announces Price Increases For U.S. Consumer Products Businesses
  Increases Slated for Early 2008 Driven by Cost Inflation
  DALLAS, Oct. 9, 2007-Kimberly-Clark Corporation (NYSE: KMB) today announced that its consumer tissue and baby and child care businesses are notifying customers of plans to raise prices in the U.S. during the first quarter of 2008. The company said the increases are necessary to offset significant inflationary pressure from higher raw material and energy costs.
  Prices for Cottonelle and Scott bathroom tissue, Viva and Scott paper towels, Huggies diapers, Pull-Ups training pants, Goodnites youth pants and Huggies Little Swimmers swimpants will increase between 4 and 7 percent effective February 3, 2008. K-C's annual net sales for these products in the U.S. are in excess of $4 billion.

Compare with this money saving headline:

• Wal-Mart chops toy prices extra early
  World's largest retailer ignites holiday price war in October by announcing deep discounts on some holiday toys.
  By Parija B. Kavilanz, CNNMoney.com senior writer
  October 1 2007: 11:48 AM EDT

Good thing inflation is well contained. The Kimberly-Clarke announcement coupled with the Walmart news perfectly captures what is called over at Minyanville "Inflation in things we need, and Deflation in things we want". Here is the current state of things for the US consumer; If you want to buy some useless china crap your kid does not need, prices are falling and we have deflation. If, however, you need to collect your kids actual crap or wipe your own butt, we have inflation running wild! Its a tough choice, another lead paint toy for junior, or an E. coli outbreak at home.

The Economic Disconnect is at a fever pitch. The market, the FED, and all the mainstream media talking heads are continually moving the goalposts as it relates to earnings expectations, job creation, inflation, the dollar, etc. The current market attitude cannot go on much longer, but may go on longer than you think.

Just in case, I advise stocking up on diapers and toilet paper.

Have a good night.

"Bitter Renters" vs "Homeowners"

Quite a heated exchange going on over at Housing Panic:
http://housingpanic.blogspot.com/2007/10/i-assume-some-times-that-everyone-with.html

Over the last 2 years if you are a fairly regular reader of economic or housing blogs, you have seen the rancor that both "homeowners" and "bitter renters" have for each other. Usually confined to politics or favorite sports teams, your housing status seems to be a hot button issue now. While I am very aware that I am biased in this debate, I would like to share with the readers the exact moment that I stopped looking for a house to buy and relegated myself to the "bitter renter" life.

It was the fall of 2003, and my wife and I had looked at about four or five homes in the town we currently rent in. We are both employed in the biotech high tech area, and we both make a good salary (she makes more than me, Ouchie!). We also were sitting on a hefty windfall that I was able to secure form company stock option sales before the Nasdaq blowout (Angelo Mozillo from CFC read my book!). We went over our finances and figured a price range we were comfortable with given a fixed 30 year mortgage. We finally found a home that we liked a bit. It was reasonably priced (at the time, 2003 is a while ago) and seemed to have what we were looking for. The house needed a new roof, and the basement was not finished, like most of the other homes we had seen. The driveway was in serious disrepair, and there was no outside deck or patio in place. None of these things are major issues, and in fact doing the improvements was a hobby my wife and I were looking forward to. We went to see the house one more time before making an offer, and as we were leaving, another buyer pulled up to see the home for the first time. I was surprised to see a woman I went to high school and college with get out of the car. She had dropped out of the biotech program after 1 year, and instead got an associates degree in dental hygiene or some thing. Her boyfriend (not fiancee or husband) worked at UPS. Now the home we looked at was in a moderately upscale neighborhood for the area. That night we made out our offer sheet at list price. The next day the realtor called us and told us that the new prospective buyers made an offer on the spot for 12% over list price and also waived the home inspection contingency. The home sellers wanted to know if we could match the offer, as we were pre-approved for significantly above what we offered, while the current offer had no pre-approval. We declined to match, and the house went to the people I knew had no way of affording that home using conventional means. We stopped looking after that, and have instead saved and invested money over the last few years as renters.
So am I a "bitter renter"? You bet your ass I am. I would very much prefer to live in a larger home and not an apartment. I would like a yard to have a couple of dogs (we have a small pug now). I would like lots of things a home can give, but I will not become part of a silly bidding war for a home. I will not use leverage and exotic financing to gamble on real estate. A key difference between myself and most folks running around with a banks money is that if they lose the house, that's all they have to lose. I on the other hand have lots of capital and assets to lose in a home price implosion. Its a choice thing. Am I right or wrong? Depends. From 2003-2005 I looked like a fool. Since then I look pretty smart. Here in the northeast the prices are falling hard, and we are at 2003 pricing right now. I know of lots of people that really stretched to get in in 2005-2006. One couple I know got in a bidding war for a townhouse and hopelessly overpaid for the property. 1 year after moving in, they still have only patio furniture for the inside of the home, as the mortgage, property taxes, and condo fee eats up every cent of their income. They also have a baby on the way now as well. Its a tough spot to be in.
The way I see it the housing mania of the past 3 years was fueled by all the crazy mortgage and easy money out there. When home buyers tell renters they are throwing their money away paying a landlord, what they fail to see is the real truth of the issue. By using ARMS, option ARMS, negative amortization loans and the like, recent buyers have in effect not "bought" a home, but purchased an option on a home that depends on future appreciation. That appreciation is now gone, but the option is still in place. If a home's value drops 30%, you are in effect paying rent to a bank on a miss priced asset.
That's my take on the issue. I know its a emotional debate. Sadly, many people equate where they are in life and how they feel about themselves with what kind of home, car, entertainment center, etc they have. The housing price explosion is a manifest of a society that values looks over substance, get rich quick over long term growth, and the "don't care how, I want it now!" (to borrow a phrase form Willy Wonka film).
Most average people are unaware of the dangers of leverage, and they have little experience with large sums of capital. I think over the next few years there is going to be a hard lesson taught.
Have a good night!

The Week Ahead

This week is a snoozer for financial data points. Almost nothing market moving until Friday, and then only some crappy inflation readings, and we know how good those are. Some fun might be had on Tuesday when the minutes of the September 18th FOMC meeting are released. All kinds of readings into whats released will be done, but it would have been fun to be at that meeting!
With no real major news, be aware that there will not be any confessions from banks, home builders, or mortgage companies this week as they will have no cover. I imagine the week will be an up week, as the market wants to go up, and indeed it will.
I wanted to say thanks to everyone that has stopped by so far, I appreciate the read. Feel free to use the comments section to suggest blog post ideas, or anything else for that matter.

For a change of pace for Sunday, I would direct you to a boxing match from 1990 that hold some parallels to the current Economic Disconnect. The bout was between Julio Cesar Chavez and Meldrick Taylor for the Super Welterweight title. Both fighters were at the highs of their careers and undefeated. The fight was a classic, and I watched it live (I'm a HUGE boxing fan). The disconnect form reality comes from the fact that this was to be Chavez' last fight for the HBO network, his contract was expiring. HBO had locked up Taylor however in a long term deal. During the wonderful fight, the commentators continually praise Taylor's efforts, and minimize any Chavez moments. I don't remember exactly, but the HBO had the fight scored 9 rounds to 2 for Taylor going into the fateful 12th round. I had the fight scored almost even with Taylor ahead by 1 point. The disconnect come from the fact that as the commentators were saying that Taylor was winning the fight easily, Taylor himself was a total mess. Both eyes were closed, his nose was bleeding, his lip was severely cut, and he had taken horrific body shots all night. After the fight it was found that Taylor had a broken orbital bone, bruised kidneys, had swallowed a pint of blood, and my have sustained brain damage. The fight effectively finished him as a top flight fighter. The take home point is that saying something is so, does not make it so. Chavez finally is too much to overcome, and the fight is stopped with 2 seconds to go. Will the stock market and the US economy, seen by most as winning the fight, likewise be knocked out soon?
Maybe.

Check it out here:
http://www.youtube.com/watch?v=QXJDbb5C35A

Saturday Disconnect on TV

I think I may have figured something out which could shed a little light on the Financial Disconnect that we are seeing as it relates to housing and banking lately. I usually watch the financial block of shows on FOX Saturday mornings (mostly for comedic value). I started to pick out a theme that was repeated by numerous guests. The idea is that the subprime losses are now done, and that banks are having to show those losses from the summer. Going forward these "one time impairments" are fully discounted by the stock market, and it is a great time to buy. Never mind the validity of the thought for now, and try to see how the mainstream financial commentators fundamentally misunderstand the current situation. They are using the usual business cycle filter that they know, and trying to apply it to a radically different asset class. First an example of a (purely hypothetical) typical business problem, the correction process, and then I will contrast it with housing assets.
Example 1 Defective Computer Boards by Microsoft
Suppose Microsoft built and shipped out 1 million new computers over the last 6 months. After about 2 months of normal usage, the mother boards of the computers short out and fail. Microsoft would have to diagnose the problem, and offer a fix for the sold units. They would also have to re manufacture the boards going forwards with the fix in place. The cost of the fix and replacements for the purchased units would show up as a write down or impairment charge for Microsoft. The stock would certainly go down (maybe!) to reflect the new earnings of the company. After all is said and done, the problem is fixed, the boards are replaced and Microsoft goes on with its business. The entire process may take anywhere from 3-8 months at best.

If you see things through the filter like in the example above, you will not be able to understand what is happening to real estate right now. Its that simple. If you the reader are running through the differences in housing to the above example you already know where I am going with this. Some key issues that perhaps the usual suspects on TV are not taking into consideration:

• Most people do not take out a mortgage (especially a negative amortization ARM) to buy a computer.
• Not every single mortgage foreclosure that will ever occur happened in August of this year. There were a ton before, and there will be a whole lot more later.
• Not just one company has nonperforming assets that need to be written off, mortgages, through the wonder of securitization, are spread out amongst banks, hedge funds, pension plans, etc.
• Houses are highly illiquid assets
• Real Estate is subject to psychology of buyers more so than other assets classes.

I could list many more, but the point I am trying to make is this:

The current euphoria on Wall Street that the mortgage mess is over after a tough August is lacking in basis in any reality. Home values are dropping, and will continue to drop over the next 3-6 years. This means that mortgage losses are going to come in waves as ARM resets and financially strapped homedebtors lose their homes in record numbers. This is NOT a 1-3 month process but a long drawn out one that will take years to settle out. Absolutely none of these facts are accounted for by the market at this time.

As a reference, please look over information related to the housing bust of the late 1980's that lingered and persisted well into the 1990's. A wonderful chart can be found at the following site:

http://masshousemarket.blogspot.com/2007/03/bear-markets-how-deep-how-long.html

Very instructive Indeed!

Friday Distraction

Second week of this blog, and I think 5 people have visited! Thanks guys I do appreciate the visits. I submit for your listening pleasure the GREATEST SONG EVER RECORDED.

The tune is Ozzy Osbournes "Crazy Train" with the genius of Randy Rhoads on guitar. It was recorded at a concert in the early 1980's before Randy's sad death. The video was released to promote the Ozzy Osbourne/Randy Rhoads "Tribute" album, one of the most powerful shows ever done in my humble opinion. "Mr. Crowley", "I Dont Know", and "Children of the Grave" are all stunning performances on the live album, and I recommend it immensely.

Anyways, have a good weekend folks!
on YouTube
http://www.youtube.com/watch?v=7hwq3nNHyPI

The Future's So Bright I Gotta Wear Shades

The DOW closed up 91 points, ever so slightly below my call yesterday for a 100+ point close. Through the Force I can see the future, but its always in motion and hard to see final exact numbers, HA!

The jobs report came in pretty good looking, and the whopper (want cheese?) is that the "terrible" jobs report from August that prompted all the hand wringing was revised upward, wiping out all those job losses (4000 jobs lost is a big deal anyway?).
Thoughts on the jobs number baloney:

• The number probably finishes the rate cut hopes going forward, or at least it should temper expectations. One of the MAJOR bullish arguments out there is that the FED will be cutting rates aggressively into the end of the year. If that argument took a kidney punch today, then shouldn't some kind of downward pressure shown up on stocks? Heck No! Goldilocks had her heart jump started by paddles at the last minute and now we have the perfecto economy we were enjoying before all this nonsense, bullish once again.
• If the FED felt the credit crunch was severe, and that the poor August jobs number was reason to do something, they certainly look a bit misinformed as of now. If the so called genius at the FED cannot foresee the total evaporation of the credit issues and that the jobs were actually not lost, do you really have confidence in them going forward?

The second point of hilarity come from the unending earnings reports form the big financials. Today we get the scoop that Merril will lose 50 cents a share this quarter based on losses from the mortgage morass. Key data from Yahoo business: "The $5 billion writedown essentially erases more than half of Merrill Lynch's net income during the prior 12 months." WOWZA! Of course the stock rallied strongly on the info, because you know, those losses are the only losses Merril will have going forward, and the market is a forward looking indicator!

But wait, theres more! Next up was Washington Mutual. Key data from Yahoo business: "Washington Mutual Inc. said Friday that the weak housing market and the recent mortgage crunch will lead to a 75 percent drop in its third-quarter net income, making it the latest financial institution to warn investors it took a major hit over the summer." Holy toledo! The stock was up as we would expect as the losses were only for the summer, and going forward.... you get the idea. A few thoughts:

• The current accepted wisdom is that the losses at the banks are both less than expected and over with. When its apparent that the losses are going to continue the market is going to need some kind of story to spin it positively.
• If having massive losses causes a stock to go up, I would advise the banks to say they lost somewhere in the area of 2 TRILLION dollars, as this should rocket the stocks up by at least 200%.

The Economic Disconnect is growing at a good clip, and this week was another good one. We can have at the same time an economy that is close to collapse that needs immediate intervention from the FED and an economy that is solidly growing with wonderful job and wage growth. Any way you slice it, its a nice pie. Sadly, the wheels are going to come off pretty soon and the pie is just whip cream topping on a base of doggy poo and it wont taste good!