More Rate Cuts to Come?

Bloomberg is reporting that the FED is certain to cut rates again before the end of the year:

"Government bond traders, who predicted six of the last seven recessions, say the Federal Reserve will lower interest rates again before the end of the year as the economy comes to a standstill."

Just to be clear, the FED is crazy to lower interest rates at a time when the United States' government depends so much on borrowing money from other countries. But the real question should be "How can a savvy investor use this information to make money?" Aside from gold and the gold funds that have previously been recommended, one way to take advantage of the prospect of lower interest rates is through American Century Tarket Maturity 2025 (BTTRX). Tim Middleton offers an explanation:

"The fund owns nothing but zero-coupon Treasury bonds maturing in 19 years, and therefore is a pure play on the direction of interest rates. If they are headed lower, as they would in a recession, this fund would soar."

The most savvy of savvy investors would have purchased shares towards the end of June; but that doesn't mean that tomorrow isn't a good time. The fund peaked at the beginning of September and has since dropped about five percent and appears to be gearing up for another shot up. And of course there's a very real possibility of a recession and more rate cuts, which make this fund worthy of consideration.

President Bush and Economic Optimism

The United States should be relieved; President Bush is optimistic about the future of the economy:

"President George W. Bush sought to assure the public that the U.S. economy remains fundamentally sound even as the country is experiencing 'unsettling times in the housing market.'"

"'Inflation is down, job markets are steady and strong,' Bush said today at a White House news conference. 'The fundamentals of our nation's economy are strong.'"

Is the President's steadfast optimism in Iraq the same kind of steadfast optimism he has in the economy? It would be nice to know where this optimism comes from. Maybe it comes from all those economics classes Bush took in college:

"'You need to talk to economists,' he answered when asked if there was a risk of recession in the US economy. 'I think I got a B in Econ 101. I got an A however in keeping taxes low, and being fiscally responsible with the people's money.'"

How is the President being fiscally responsible? Is he being fiscally responsible when our national debt has exceeded nine trillion dollars? Is he being fiscally responsible when he permits no bid contracts? And about that "B":

"President Bush as an undergraduate at Yale did not in fact receive a grade of B in his economics course. Bush received a grade that would correspond with a C-."

Oh....That's what I thought...

Dow(n) Drops Another 200

Stocks took another deep hit today as the Dow dropped another 200 points. Amazingly, the bulls decided that a better than expected GDP growth report wasn't enough to quell the risky fundamentals. From Yahoo:

Wall Street extended its steep decline Friday, propelling the Dow Jones industrials down more than 500 points over two days after investors gave in to mounting concerns that borrowing costs would climb for both companies and homeowners. It was the Dow's worst week in nearly five years.

The credit squeeze is on. Investors are facing the hard fact that homeowners and businesses alike are seeing a tightening lending trend. For months, investors ignored the fact that the mortgage rate reset was going to get worse and worse this year. The reset chart has been available on the internet since the beginning of the year. It wasn't hard to find with Google. And there have been news reports warning of the looming problem. On July 10th, there was an article on CNN Money warning that October of 2007 was to be a record month.

Despite that the Dow surged up to 14,000. Psychology was trumping fundamentals. Now, the tide has turned.

A Bad Omen: Subprime Defaults Drop the "Sub"

It's not just a subprime problem anymore. Countrywide has reported that mortgage defaults are now starting to affect quality borrowers:

"The subprime mortgage meltdown has begun to spread to prime loans as even credit-worthy borrowers have started to fall behind on payments."

"'Unable to afford their own homes, [borrowers] turned to increasingly risky mortgage products,' said Amy Klobuchar, a member of the House of Representatives from Minnesota, speaking Wednesday before a hearing of the Joint Economic Committee examining the national foreclosure crisis."

"Some home buyers, caught up in red-hot markets and afraid of getting locked out of homeownership forever, overpaid for houses."

Home prices rose so high in the early part of this decade, that most people couldn't afford a traditional 30 year mortgage. Well, I guess they couldn't really afford non-traditional mortgages either.

The inability to live within your means and to recognize the limits of your means is going to make a relatively small problem (subprime defaults), a very big problem. This is the kind of widespread problem that could wipe out the middle class in this country: going into a loan based on highly inflated property values that then begin to deflate. As mortgage rates reset, more and more families will find themselves upside down in terms of property values versus loan balance. That will not be easy for the economy to iron out.

But wait, there's more:

"Analysts said the trend could continue, particularly in areas of the country that have been hardest hit by job losses in general or seen a decline in speculation-driven construction, such as South Florida, parts of California and Las Vegas."

Job loss? Rising mortgage payments? Rising energy costs? Rising food costs? This doesn't sound very good, considering consumerism accounts for over two-thirds of our economy.

Serious Reading: 1920s Style

I've been reading some chapters from a book that gives a synopsis of the 1920s and I've found that the last chapters have offered some chilling parallels to our times. I'm not done reading, but I think the comparisons are scary. Market Oracle alerted me to the publication. You can find it here. I'm reading (per M.O.) the eleventh through the fourteenth chapters: "Home Sweet Florida" through "The Aftermath" are the ones to focus on. I'll review with full quotes and comparisons in a day or two.

Bloomberg.com: Put Options Indicate Pullback

According to stock option data compiled by the Bloomberg news service, the market could see a correction of between five and ten percent:

"Bets in the options market against the Standard & Poor's 500 Index have exceeded wagers it will rise by a 2-to-1 margin for a month, the longest since Bloomberg began compiling the data in 1995."

"That's seen as a warning sign the market is due for a decline of 5 to 10 percent after the S&P 500 rose to two records last week, say managers of almost $1 trillion at Morgan Stanley Global Wealth Management, National City Private Client Group and Russell Investment Group."

At current levels, a ten percent decline would knock the Dow down to around 12,555, while the S&P 500 would be at 1,394. It's certainly nothing devastating and it's definitely due. The current bull market has been one of the longest in history without a correction, thanks in part to the Federal Reserve pumping liquidity into the economy nonstop since the dot.com bust. Now, ten percent would be easy to swallow, but that's assuming it's only ten percent:

"The Leuthold Group, whose flagship fund has beaten 99 percent of similar funds over the last five years, expects the S&P 500 to slide as much as 19 percent by the end of the year."

Okay, now we're venturing into uncomfortable territory. A 19 percent pullback would leave the Dow at 11,300 and the S&P 1,255. These numbers would be a bit tougher to handle. Investor dollars would fly out of the country and unemployment rates would soar. Consumers, already hurting from the deflating housing market and the increasing gas costs, would spend even less. I think the sector with the most to lose is retail. I briefly mentioned the problems they're experiencing last week:

"Another sector that could feel the hurt is retail. Fewer homeowners refinancing mean less being spent at home depot or at the mall. We've already seen home depot's hurt. Bed Bath and Beyond has also lowered it's expectations in the last few weeks. The housing downturn might be blamed as the number one reason, but subprime is not far behind. And as the noose tightens around lending standards, the infusion of cash that has helped fuel earnings in retail will evaporate."

It's the housing market, and the tighter lending restrictions, and the rising food costs, and the rising energy costs. Individually they're containable; collectively they could do some damage.

Irrational...Illogical?

I'm confused. Are retail sales strong or weak? On the one hand, we have this:

"The Dow surged to a record on Thursday as Wal-Mart reported better sales, suggesting consumer spending is holding up despite rising oil costs and falling home prices."

"The encouraging retail figures and merger activity in the mining sector drove up the Dow up more than 1 percent to a lifetime record high of 13,828.48, and propped the Nasdaq to its highest in more than six years."

First of all, I think it shows complete ignorance to view WalMart's sales as some sort of retail bellwether. Although I agree that they've been a mega-strong player in retail, their sales are representative of the lowest prices in retail. That alone should be a reason NOT to give them much weight in terms of predicting the rest of the retail industry. Perhaps it's indicative of the fact that people cannot afford as much as they used to; thus, WalMart racks up more sales. But what happens when people decide against shopping at all other places because their prices are 'too high'? Then, we've placed all of our eggs in the WalMart basket and the rest of retail declines.
Secondly, I noticed this report:

"The big chain stores beat very low expectations in June, but total retail sales are expected to be anemic when the government reports its figures on Friday, economists said."

"'Consumption is looking anemic in the second quarter', said Leslie Preston, an economist for CIBC World Markets, in a note to clients."

Well, did we just place all of our eggs in the WalMart basket? I hope not (as I'm about to change course on a few items), but it does appear that the market was acting irrationally. To increase the way it did based on M&A activity and on a couple retail reports is ludicrous. I'm not a perma-bear, but I'd rather err on the side of caution in most cases, especially when the downside risk is so much higher than the possible returns. Tomorrow will be the day of reckoning. According to the economic calendar, retail sales are reported on Friday. Why all the hullabaloo prior?

Another reason why I'm bearish comes from an MSN Money article I've read in the last year. It comes from Michael Brush:

"Money managers chiefly put money in two assets: stocks and bonds. One way of deciding whether stocks are expensive is by comparing their performance to that of bonds. If bonds lag while stocks advance, according to some market watchers, fund managers will be more likely to sell stocks and buy bonds."

"To compare them, Goepfert contrasts the current ratio of the SPY to the TLT with the average ratio over the past three months. Since the ratio typically doesn't change much in 90 days, the two values should be about the same. Now, though, with the recent rally in stocks, there's a big gap. The current ratio has moved up to 1.58, compared with an average of 1.5 over the past 90 days. That may not sound like much. But since the ratio usually stays fairly constant in any 90-day period, this is a huge move compared with what normally happens."

That's a lot to quote, I admit, but dammit, it's important. The cost of owning stocks right now far surpasses the cost of owning bonds. Based on my personal projections, the 90-day averages go like this: the SPY is around 150.93 while the iShares Lehman Twenty Year fund is at about 85.70 for the three months ending 07/11/07. The SPY has increased by $7.53 while the TLT has decreased by $2.34. Currently, the ratio is at 1.76. The three month moving ratio for the three months prior to that is 1.60. So, either Michael is a goof and I followed the wrong advice, or he's right on and his prediction is way over due. Are stocks overpriced? I still can't tell, but I'm one day away from changing course on some ideas. Stay Tuned!

FED Releases Money Stock Stats

The FED released June's money supply numbers this afternoon. M2 increased again, while M1 declined slightly. Retail money funds, which are a component of M2, have increased by six percent since the first of the year. Institutional money funds have increased by 10.5 percent over the same period of time. Ironically, the Dow has increased by 11 percent since the first, nearly identical to the increase in institutional funds.
Since we can't count on the FED to corral the money supply, we have to estimate where these funds will be allocated. Currently, a heavier proportion is being placed in the stock market; thus, the Dow broke another record today. It doesn't matter if all the stocks deserve their current pricing or not. If there are extra funds laying around, institutional investors will place them somewhere. They buy the stocks, increased demand causes upward price pressure, and viola: record breaking numbers.
What I've been betting on this whole time is that the funds will be moving from stocks to commodities. It's just a little hard to believe that despite all the bad news in the housing sector and the subprime mortgage market, coupled with the increasing trade deficit and federal deficit and the consumer deficit, the stock market continues its upward trend. When will it end?

S&P, Moody's to Downgrade Subprime Securities - World Stocks Falter

Well, it's about time. How long has it been since we've known about the risks? Months and months. Finally, the two credit ratings organizations are coming around:

"Credit ratings on 612 classes of residential mortgage-backed securities backed by U.S. subprime collateral have been put on CreditWatch with negative implications, S&P said. Beginning in the next few days, the agency said most of these classes will be downgraded."

"That covers about $12.078 billion in rated securities, or 2.13% of the $565.3 billion in U.S. RMBS rated by S&P between the fourth quarter of 2005 and the fourth quarter of 2006, the agency noted."

Meanwhile, in a related story:

"Moody's cut ratings on 399 subprime residential mortgage-backed securities, or RMBS, and said that it may downgrade another 32 because of higher than expected delinquencies on the underlying home loans."

I don't know how many more securities there are that are at risk, but I would bet there are more. Any literate investor should have known for weeks of the great risk associated with subprime mortgage securities; the looming interest rate reset will be devastating. Here's the simple picture:

"A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money."

"S&P's announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust."

Unwinding this tangled mess is taking time; along the way, it will affect more than just the mortgage industry. Of course it has already hurt the homebuild sector. Higher foreclosure rates have contributed to a rising supply of homes; also, looser loans standards helped fuel a housing boom which assisted in creating future projections that were grossly inflated.
And the subprime mortgage fiasco has not and will not be kind to the banking industry. Depending on who's holding what, investors could be rewarded greatly for making the right bets.

Another sector that could feel the hurt is retail. Fewer homeowners refinancing mean less being spent at home depot or at the mall. We've already seen home depot's hurt. Bed Bath and Beyond has also lowered it's expectations in the last few weeks. The housing downturn might be blamed as the number one reason, but subprime is not far behind. And as the noose tightens around lending standards, the infusion of cash that has helped fuel earnings in retail will evaporate.

Today, just one day after flirting with a record close, the Dow faltered by more nearly 150 points. Following the Dow decline, Asian markets followed suit. Something will act as the catalyst initiating a world-wide economic slowdown. It could be subprime, it could be something else. All that needs to happen is for a spark to start the wheel spinning. The next couple weeks should give us a decisive answer.

Seventy Percent Say Economy Worsening

From Gallup comes this latest poll showing that seven out of ten Americans believes the economy is getting worse:

"The perception that the U.S. economy is getting worse has now reached as high a level as at any point since 2001. Seventy percent of Americans say conditions are getting worse. While this is statistically similar to the 67% saying this last month, it is up 10 points since April."

Ten points since April is a big jump in a small amount of time, and it's a great indicator of the economic conditions for the majority of the country. Don't forget that 2001 was a year of recession, and although 9/11 played a role in the economic recession, it didn't play a role in the pessimistic view people held back then:

"The last time Americans held such negative views was in early September 2001, just before the terrorist attacks on Sept. 11."

We shall see if the majority of Americans are right or wrong about the economy in the coming months. Either seventy percent of the population influences markets or thirty percent does. So far, it's been the thirty percent.

A Stampede of Bulls(hit)

Is there any member of the Bush Administration who isn't delusional and incompetent? If there is, it's not our Treasury Secretary:

"The major slump in the housing market is nearing an end and should not have a significant impact on the overall economy, Treasury Secretary Henry Paulson said Wednesday."

Sure Hank, whatever you say...

"We have had a major housing correction in this country," Paulson said in an interview with a small group of reporters at the Treasury Department. "I do believe we are at or near the bottom."

So, we have Hank P. trying to assure us that we are at or near the bottom of the housing correction. Now let's hear Ara Hovnanian, CEO for K Hovnanian Homebuilder, weigh in:

"There is not a recovery that is about to happen.''

Hmmm. And what about the recent homebuilder confidence index? Maybe that press release hasn't made it to Mr. Paulson's desk yet.

But back to Ara. He might be the only CEO willing to speak to the media about the current housing 'slump'. From CNBC comes this report:

"I'm blogging to you...in mid-town Manhattan, where I've never in my life seen so many freaked out CEOs. I say this only because not nine months ago I attended a similar UBS conference, where the homebuilder CEOs and their CFOs and their PR reps and their baggage handlers and their mother-in-laws were all fighting with each other to jump in front of our cameras to talk about the recovery shining brightly ahead in the housing market."

CEOs from Ryland Homes, Standard Pacific Corp, and DR Horton all refused to answer press questions regarding the current 'slump'. I guess if you don't have anything nice to say, don't say anything at all?

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From another bull comes this headline: "US Economy to Expand in Coming Months". Please tell me more:

"The U.S. economy should expand modestly in coming months as a healthy job market continues to trump weakness in housing prices, a gauge of future business activity showed on Thursday."

But Wait! What about this:

"Initial jobless claims rose by 10,000, a third consecutive increase, to 324,000 in the week ended June 16, the Labor Department said today in Washington."

Oh, I see you explain it by saying this:

"While the big increase was unexpected, analysts said it did not change their view that the labor market remains hardy."

So a "healthy job market" entails a "big increase" in jobless claims?? Oh well, they're the analysts, right? I'm sure any objections I voice can be explained away somehow or another...

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Not to be outdone, Marketwatch had this headline: "US Economy Weathered the Worst, Index Shows". This is great! Maybe these main stream perma-bulls have changed my mind after all:

"'These data may be suggesting that the economy has weathered the negative impact of the housing slump and the spring run-up in gas prices,' said Ken Goldstein, labor economist at the Conference Board."

Do "labor economists" specialize in energy or real estate? I always thought they were job market specialists. I'm not saying the man doesn't have the authority to speak on topics other than the job market, but it would've sold the story more if the guy commenting on gas prices was an "energy economist", or if the guy commenting on the housing market was a "real estate economist".
There are a few problems with what Ken said and what he didn't say.
What he said: the economy has weathered the housing 'slump'. What he didn't say: the housing 'slump' is far from over.
What he said: the economy has weathered the run-up in gas prices. What he didn't say: we don't know how long this 'run-up' will last or if the 'run-up' is done running up.

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The spin-cycle is running on high these days. Don't let the bulls confuse you.