Bail Everybody Out!

I was recently talking to various office workers, asking them what they thought of the outcome of the recent election. They were excited. I asked them why? They pointed out that the Government bailout of mortgages and the advertised 90 day mortgage moratorium on foreclosures, gives them a unique opportunity to: (1) have their Mortgage Interest Rate reduced; (2) gives them a 90 day grace period for which they don’t have to make mortgage payments; (3) will allow them to get a major discount on their unpaid principal.

They stopped making mortgage payments, and look forward to Foreclosure. MANY PEOPLE CAN MAKE THEIR MORTGAGE PAYMENTS, BUT SEE A FREE LUNCH COMING, THANKS TO OUR WONDERFUL GOVERNMENT BAIL OUT PROGRAM. The Feds will probably allow an upside for the Mortgage holder but who’s going to monitor this? The “defaulters” tell me that their credit rating will be hurt in the short term, but who needs credit? Nine months from now their credit rating will be fine. Obviously the Lunch will be paid for by us – the US Taxpayer. Our Government calls this program “Mortgage Forbearance and Mortgage Modification”. Don’t you love it! Anybody want to become a Mortgage Lender?

On another front many Banks have applied for hand outs from the Feds. They don’t need the Capital, but since it’s there, why not take it. Only in America. I can’t make this stuff up. Meanwhile, the Banks that are really in trouble can’t seem to get help. Finance companies have now become Banks (American Express Goldman Sachs etc)

The stimulus program that was implemented this summer with Tax Rebates to the poor - backfired. The poor saved their money or paid down debt, rather than blowing it on a big screen TV’s. Now comes another boondoggle spending stimulus program. Caroline Baum, an Economist for Bloomberg writes that a Federal Stimulus program is coming, and will pass congress quickly (like in the next 60 days). To get the program started quickly, she writes, “The spending will be focused on infrastructure, things like roads and bridges. Unless this time is different, the money won’t necessarily be allocated efficiently.” In the same article, Jim Glassman, senior US Economist at JP Morgan Chase & Co says: “…there is no plan to assess the cost of sitting in traffic jams, for example. So we get irrational things: The money goes to building bridges.”

The theory that the Stock Market does much better with a Democrat as President is nonsense. Greg Mankiw (Harvard University Economics Professor) says “…the perceived relationship between the president’s party and the stock market is meaningless.” Geoffrey Hirsch, editor in chief of the Stock Trader’s Almanac says that the Stock Market prefers gridlock. That is, no one party controls the ability to control legislation. Hirsch’s data support the idea that gridlock is best for the stock market with a Democratic president and GOP Congress yielding the maximum results: an average gain in the Dow OF 19.50%. No such luck for 2009-2010.

The talking heads tell us that you have to buy stocks for the long term. Ten Years, long enough? Below is the Monthly Compound Yield at Nominal Annual Rates for a ten year holding period from December 1909 to November 30, 2008.



Note that anybody that bought the SP 500 in November 1999 lost money for the ten year period which includes dividends. To go 10 years and lose money on anything is just awful. Also note, that those that bought stocks in 1930 lost money. Although the average yield for the period of 10 years was 9.38% (a Standard Deviation unit of 4.90%), I think the days of holding stocks for ever is not well advised.

Now take a gander at the chart below that provides the same information but is adjusted for inflation. Now the game changes, as the average yield is 6.89% with a Standard Deviation Unit of 5.36%. Not a lot of room for error. If you further adjust this for Federal and State Income Taxes (the tax rate on dividends, and capital gains) the yields have to be even worse.

When I was a senior in College (1958), the text books on investments said the value of any asset today is equal to the present value of the Cash Flow (income) plus the present value of the Residual (principal) using an appropriate interest rate. The Dividends were relatively easy to project over a given time span, but the Residual was always tough.



In theory it’s a great idea. However, in implementing the math to figure out the correct value of a stock is mind boggling. To compute the current value of a stock based on a 5 year projection you need to estimate: Earnings Growth, the Estimated PE multiple in 5 years, and what your required investment yield is over the next 5 years. There are 5,000 financial wizards willing to give you their research identifying all the variables outlined above. However the reality is an earnings estimate is at best close to the truth and at worst totally bogus. Look at the Banks Earnings. If you believe any their Earnings Reports, you must also believe in the Tooth Fairy. Who in the world can forecast correctly the Growth rate of earnings, over the next 5 years? How about forecasting correctly the PE multiple in 5 years? Do you know your required yield to justify buying a given stock? How do you know when stocks are cheap? Are they cheap relative to the past?

In the good old days (prior to the creation of retirement plans), Most stocks paid dividends of about 6.00% and had modest PE multiples (6 to 12 Times). The common investor had a shot at making some money. With the advent of 401K’s and other “tax free” retirement plans, Wall Street responded. Mutual Funds grew at an alarming rate offering the poor working man a potpourri of choices that included: Growth-Big Cap, Growth-Small Cap, Blended Growth, No Growth-Big Cap etc. Then Wall Street gave us ETF’s (Exchange Traded Funds) that allows an investor to get into any single purpose investment medium you can think of. You name it, they got it. FAN is a ETF that owns Wind Mill generating Companies, TAN is an ETF that owns Solar Energy Companies. You can buy shares in ETF’s that represent every Country on this planet: India, Russia, Hong Kong, Brazil, Mexico, and Bulgaria. They even have an ETF (symbol VICEX) that invests in Tobacco, Liquor and Firearms stocks. All these choices, for which the pour individual investor has no idea what he just bought, and worse yet, has no idea how the Economy Works.

The bubble in my opinion is not only in Real Estate, but just about every investment alternative on this planet. There are too many Common Stocks, too many Mutual Funds, too many ETF’s, too many Bonds, and too much money chasing too many securities. God help us!

Below is a chart of the ratio between the S&P 500 Stock Index and the price of Gold per Ounce. In December, 1947, .3123 ounces of Gold bought 1 share of the S&P 500



By December 1968, 2.5262 ounces of Gold bought 1 share of the S&P 500. The low of the graph was in January, 1980 when .1573 ounces of Gold bought 1 share of the S&P, and the high was booked August, 2000 when 5.4135 ounces of Gold bought 1 share of the S&P 500. Note the decline in the S&P relative to Gold since 2000.

As Richard Russell said recently in his daily newsletter “Dow Theory Letters” (http://ww1.dowtheoryletters.com/dtlol.nsf), (I Paraphrase) - Buy lumber and paper stocks, the Federal Reserve will be printing money at an exponential rate.
He said this with tongue firmly in cheek, but the part about printing money is for sure. You can count on it.

Congress, the new President, and the Federal Reserve will not allow our Economy to go into deflation. Our Government Deflation therapy suggests bail everybody out. If you are not a Bank, Investment Company, Insurance Company, a Business with no profitable business plan but lots of employees, or totally stupid in understanding what you agree to, you are on your own!

The Auto Companies will surely be bailed out. Why? Because - they are too big to fail. They probable would have said the same thing about the Buggy Whip business it its time. Look at General Motors Financial Statistics since 1992. Average profit margin on sales = .43%. Average growth in earnings = negative 10.71%. Net Earnings for the year 2005 = Loss $10.567 Billion, 2006 = Loss $1.978 Billion, 2007 = Loss $38.732 Billion, Quarters ending 3/31/08 = Loss $3.251 Billion, Quarter ending 6/30/08 = Loss $15.471 Billion. Net tangible Net Worth 6/30/08 = Negative $58.04 Billion. They are technically bankrupt. And we are going to save them!

Boys and Girls and members of the Jury, you’re on your own. This is the new era in which the stupid get bailed out, and we get the bill.

Hold on to your Capital. Keep it save. Get out of Debt. Love your Family, and hang on! This will be a long Recession, manifested by the Bozo’s that now run our lives - Washington.

I Just Love "Bail Outs"!

“THE NATIONAL BUDGET MUST BE BALANCED. THE PUBLIC DEBT MUST BE REDUCED; THE ARROGANCE OF THE AUTHORITIES MUST BE MODERATED AND CONTROLLED…IF THE NATION DOESN’T WANT TO GO BANKRUPT, THE PEOPLE MUST AGAIN LEARN TO WORK, INSTEAD OF LIVING ON PUBLIC ASSISTANCE”
CICERO (106BC - 43 BC), 55BC

The “bubbles” have burst. The “bubbles” I am referring to (not necessarily in any meaningful order) are: Residential Housing, the Stock Market, Commodity Prices, Bank Credit, All Bonds collateralized by other assets such as Mortgages, Credit Cards, Rents etc, Derivatives of any kind, the US and Foreign Economies, and anything else you can think of that uses leverage. When interest rates are held artificially low, personal and Government spending run amuck, and credit is given to one and all without regard to repayment, you get bubbles.

I have attached some charts that tell the sad story of the consequences of too much credit. The chart below shows the poor consumer’s ratio of installment debt to personal income (in %). It’s no coincidence that the ratio is at all time historical highs. Just imagine what happens when you assemble a pool of this kind of debt (Credit Cards) and issue Bonds secured by the cash flow of debt payments. When credit card debt is not paid, the bonds can’t pay their principal and interest, and the holders of this toxic asset are out of luck.



What’s next for credit card debt and bonds issued against them? More credit contraction and/or Bail Outs. So the Consumer is up to his norkis in debt and now unemployment is on the rise. The chart below shows the unemployment rate (inverted scale). Below +1 is abnormal and recessionary. It probably will go to +2 or more over the next twelve months. This event has happened only 3 times since December 1968. The consumer is in trouble.

Next we have a friendly chart of what Economists call the Monetary Base. The in crowd calls it High Powered Money. The Monetary Base consists of Currency in circulation (which the Federal Reserve does not control, and Bank Reserves (which the Federal Reserve does control). This “money” determines how much Money Supply can be created (“Printed”). In the Depression, currency in circulation increased dramatically due to bank failures, (the folks decided to take their money out of the banks and put it in their mattress). This in turn decreased the amount of money the banking system had to lend (Money Supply), which added fuel to the fire in aiding and abetting the depression. Normally when this indicator rises you can expect the Inflation Rate to rise within 6 to 18 months. The Federal Reserve increased the Monetary Base materially the past two months. Note the current spike reflecting their pumping reserves into the banking system. The reserves were increased to save our wonderful Financial System. Expect bigger spikes over the next 12 months.





Below is the S&P 500 Stock Index Annual compound yield including Dividends, from December 1901 to October 2008. Note the negative yield in October 2008, is the lowest since the Great Depression and World War 2. Also shown is the Annual Compound % Change in the S&P 500 earnings per share. The earnings from the fourth Quarter 2008 through 2009 are estimates made by our trusted stock brokerage financial analysts. It is highly probable that their estimates are too high.

The stock market Gurus have decided the market has hit bottom, and we should all be buying. Note in the Depression, the largest decline occurred well after the initial collapse in October, 1929.





The pundits talked about a de-coupling of our Economy from the rest of the World. They were obviously wrong. What happens in the US affects the Economies and Markets of the World. The US and World economies are and have been in a recession. In my opinion this will be a long and drawn out decline. Rising Unemployment and the decline of Business and Consumer spending will continue to drive down the Economy. The Federal Reserve and your and my Congress have created an expansion of the Credit, Bank Reserves, and Money Supply that is unparalleled in our wonderful but short history. Although these actions are inflationary in the long run, they will tend to stabilize credit over the next 12 months. Below is a chart of my leading indicators through September 2008.



The indicator is below -1 and heading towards -2. Below or equal to -1 is a recession. I think the above chart will approach or decline more than the 1974 recession. Note, I have estimated the recession lasting through 2009.

So what does this all mean? We have a major adjustment in our Economy regarding spending and credit habits, a credit contraction, a major asset contraction (housing, commodities and the stock market) and increasing US debt and Money Supply. This translates to Deflation and Inflation. Debt contractions are Deflationary and Increasing Money Supply is Inflationary. It is the War of the Gilas Monsters.

In the great depression, 90 day T-Bill rates were negative, and 30 year Treasury Bonds yielded less than 3.00%. As of November 3, 2008 the 90 day T-Bill Yielded .49% and the 30 Year Treasury bond Yield was 4.321% and appears to be rising. The Bond market is of no current help, other than reflecting the tug and pull of the contrasting economic conditions. The short rates reflect fear, and the long rates reflect inflation expectations, yet the spread on 10 year T-Bills and the 10 Year US Inflation index Bond implies low inflation expectations. The War is on. The winner will be determined within 12 months.

The stock market has been seriously injured, and should take a long time to recover. The average investor has lost 50% of his capital and is not real happy. Retirement plans have been destroyed. The mob psychology of a Bear Market is ugly. Many of the participants do not return to the market for long periods of time. In the 1974 fall, many individual investors “swore off” the stock market and never returned. The only thing that brought the market back was time and Retirement Plans.

The Chart below indicates the Annual yield that occurred if you bought the S&P 500 Index and held it for 10 years, and collected all the dividends. For the 10 years ended October 31, 2008 the Annual Yield (with monthly compounding) for 10 years was .22%. That means for a $1 invested in October 1999, you would have got back $1.022 for a profit of 2 Cents. Not real shiny. However, don’t give up on the market since the average annual yield for a 10 Year holding period from December 1909 to the present was 9.3861%. That means you would make $2.5471 times your investment in 10 years for a profit of $1.5471.

So the question is - if you are a long term investor, do you invest now?



Those that invested in October 1919 and sold in October 1929 received a 10 Year yield of 12.92% (not bad). If you had invested in October 1929 and sold in October 1939 you would have a yield of minus 1.20% (not so good). If you invested in October 1929 and sold 1 year later in October 1930, you would have a minus 32.61% yield. However, if you had the good fortune to invest at the all time market low of 4.77 in June 1932, and sold one year later in June 1933, your yield would have been 126.01%.

My answer is simple. Due to the damage done to the market by the recent collapse, I think new lows are ahead. I would rather preserve capital and watch from the sidelines as events unfold. Market bottoms are impossible to time, but easily recognized after they occur. To miss a bottom is not a sin: to buy into a false bottom is. In the interim, I choose to preserve Capital.