YOU HEARD IT HERE FIRST:
The
Junk to Treasury spread is widening rapidly and you ain’t seen anything yet.
The
credit bubble has sprung a leak and it is beginning to unwind as lending
standards are being tightened all over the world. If this keeps up, the result
will be a shrinking worldwide money supply that will bring on a Stock Market Crash
followed by Recession and perhaps Depression. There is no better measure of
Investor confidence than the credit spread for it is a comment on both the
economy in general and investor sentiment in particular.
IT’S THE AVAILABILITY STUPID
Wall
Street’s and the Media’s talking heads who can’t see any further than their
nose can’t seem to figure out that it’s the availability of credit that is of
utmost importance, not how much you pay for it. Reminds me of when I got a job
as the Manager of the EF Hutton office in Great Neck NY in 1983 and bought a
townhouse; by the time I closed, the mortgage rate was 13% but from the day I
moved in, it started to appreciate at a rate of $10,000 a month. Yet two and a
half years later, although its price had doubled, the amount that they were
renting for had not changed. So I sold it and rented one instead. The moral of
the story is: It was not the 1% interest rate, it was the availability and ease
of getting a mortgage and the belief that prices would continue to appreciate
at a 25% clip that
caused the bubble. Now that the bubble has burst, cutting the interest rates
while imposing stricter lending standards along with a 20% down payment will
not ease the crisis one iota.
CREDIT CRISIS
As
creditors become more nervous, they also become more cautious and more
conservative. Who you know becomes no longer enough and the cushions that each
deal must have become ever larger, while the interest rates charged rise
sharply as risk is re-priced, regardless whether or not the FED lowers the Discount
or the FED funds rates. This will lead to the biggest CREDIT CRISIS in history
as everyone begins to recognize the cesspool of rotting debt for what it really
is.
The
first signs are already evident. Just look at the Blackstone losses and the
amount of troubled Private Equity financing that the Investment Bankers can no
longer lay off. If they can no longer package and find
buyers for their Guarantees, all Private Equity deals will cease and a major
pillar of support for the Stock Market will disappear.
Normal
issuing of corporate, high yield paper which was $25 Billion in June dropped to
zero by the end of July. The Global retreat from risk is spreading as great
quantities of debt became cannot find a bid and become virtually worthless
overnight.
MONEY SUPPLY
Over
the years, I have explained to you many times how “out of thin air” money is
created; not by the printing press, but through lending and that the FED has
lost control of the money supply. So I remind you now that as lending dries up
at any price, the money supply stops expanding and each default shrinks the money supply by a multiple of itself as the banks
are forced to call in loans: Remember the Multiplier effect? The Fed can counter somewhat the
effect of the necessity calling in of loans because of defaults by
adding liquidity through the use of REPO’s,
but only for a short period of time as they are only good for 30 day periods.
The
FED can lower interest rates all they want, but when FEAR prevails and lending
standards are being tightened across the board, very little lending takes
place. Fear is not conducive to lending, which is the basic foundation and prerequisite
of an expanding Monet supply.
DEFAULTS
= Shrinking money supply = Recession = Crashing Stock Markets.
MODEL BUILDERS
Successful
models sow the seeds of their own destruction. All models that appear to be
sure things, such as the carry trade, must eventually fail as they become more
and more popular until eventually someone notices that all liquidity has dried
up and no one can get out as everyone rushes to the exits at the same time.
Their non-tradable assets are re-priced overnight and they are forced to
liquidate any assets that are still remotely liquid (such as Gold) in order to
meet their margin calls in an attempt to stay solvent. For some reason, they
all make the same mistake and never include the liquidity factor into their
models. It’s a good bet there won’t be any billion $ bonuses this year and I wonder how much of
last year’s bonuses will have to be paid back, since they were all based on phony
asset prices. Oh to be a
JUSTIFYING
THE UNJUSTIFIABLE.
At
market peaks, Wall Street gets rid of all of the old guard and replaces them
with a cadre of recent graduates with no real world experience so they can
justify why PE Ratios of 16 to 20 are consistent with beginnings of new Bull Markets
rather than marking their end. The same is done with every other historical
method of calculating under and over valuation, such as Price to Book, Price to
Dividends, Price to Sales and others.
To
make matters worse, they now compare earnings per share to Wall Street
expectations instead of past performance: And using corporate cash or worse,
debt, to buy back stock at its all time high in order to increase earnings per
share is now readily acceptable. Is that a sign of a growing robust company
that should command higher PE multiples?
THE MARKET’S INTERNALS
NEW
HIGHS/NEW LOWS: The short term spike low on August16 had 648 issues making 52
week lows and that was with the market down only 10% from its all time highs.
Compare that to the highest number of new lows (917) made on
SMALL CAP STOCKS: For over five years, the Small Caps have been the market leaders, but
now for the first time, they did not make a new high when the rest of the
market did. There is an old Wall Street truism that I’m sure none of the Hot
Shot Young Guns know, “the market is not over until after the Cats and Dogs
have had their day.” Is their day over?
HOME PRICES
“We
are about to witness a drop in home (all real estate) prices not seen since the
Depression of the 30’s,“ said the CFO of CFC, that was once the nation’s
largest mortgage lender. Foreclosures are no longer restricted to the sub-prime
borrowers, they are quickly spreading all the way up
to AAA borrowers as well. Over 1,000,000 people will enter a stage of
foreclosure this year. I don’t even want to think of next year as the largest
contingent of ARM’s come up for readjustment. They will not be able to
refinance because the the outstanding loan is now 25% larger than the equity.
The
recently announced home sales and foreclosure numbers are only a hint of things
to come.
HISTORY TEACHES, BUT NOBODY WANTS TO
LEARN
No
amount of FED rate cuts are able to stem the tide of selling once the selling
has started. It didn’t work in 1929, nor did it work in
THE SOUTH SEA BUBBLE, which is similar in size and duration to today’s
Grand Super Cycle Top burst in 1720 and the subsequent Depression lasted until
1789 with its ending coinciding with the beginning of America’s first BULL
MARKET (the final Wave of which began in December 1974). The Mini crashes of
1987, 1990, 1994 and 2002 only served to convince everyone that we are in a new
paradigm of just buy and hold and the stock market will bail you out and make
you rich. Well we all know what happens to the sure things that everyone has
jumped in on. For those of you who don’t know, you are about to find out in the
not to distant future.
THE CHINESE MARKET is sure to follow or perhaps even lead as their
central bank, in its efforts to dampen the craziness and mass speculation as
well as hold down inflation, is pursuing the exact same strategies as Greenspan
did in 1999 and our FED did in 1929 - raise interest rates. Nobody listened to
Greenspan’s warning of irrational exuberance then and no one is heeding the
Chinese Central Bank’s warnings now.
A LIGHT AT THE END OF THE TUNNEL
September
has the most consistent record as being the worst month of the year for stocks,
while October – December is consistently the best period of the year. So, in my
opinion we have a good chance for the market to sell off for two weeks or so to
retest the August lows. This sell-off will then be followed by a last ditch
rally to a new all time high probably precipitated by a FED interest rate cut
of ½ % or more, setting the stage for the biggest BULL TRAP in history. To be
forewarned is to be forearmed. Luckily you have time to think before you are
forced to act. But for heavens sake, DO
NOT JUST LISTEN TO ME. Think for yourselves and then
make up your own minds. I am NOT you adviser or your money manager. I just write
for my own amusement and to help me clarify my thinking in my own mind.
GOOD LUCK AND GOOD BLESS September
5, 2007
Aubie Baltin CFA. CTA. CFP. PhD.
561-940-9767