Mar 1, 2009

Where's the Bubble?

March 1, 2009

“A society that does not have the will to let its warriors die fighting will not long survive. A civilization that values its very being less than the dignity of its sworn enemies should be morally prepared to fail.”-David Goldich, USMC

Where’s the Bubble?
Mr. Obama proposed his first budget since becoming President, and it’s a whopper, coming in at $3.6 trillion. The plan proposes to allow our budget deficit to balloon even further than it has in the past eight years. The actual deficit will probably be even higher given the optimistic projections in the budget, including a GDP growth rate over the next 10 years which exceeds that of the past 10 years. The President, never one to shy away from making a promise, also announced that the budget deficit would be cut in half by the end of his first term. I’ll be interested to see what the starting number will be when we measure that “half” in four years.

Anytime there is this much capital being thrown around, bubbles are sure to arise. We will be studying the budget proposal over the next few weeks, and attempt to take advantage of the resulting bubble(s).

The Market

In the February 1st note we discussed that February was historically “the worst month of the market’s best six months,” and this past month didn’t diverge from that trend. The results below, for the month of February, show some pretty dismal returns. The market is has fallen so far over the past 16 months that, according to Michael Santoli of Barron’s “…not 2% down from here, is a point at which half of the entire rise from the 1932 Depression low to the ultimate October 2007 high will have gone away.” That’s 75 years of returns, wiped out in 16 months!

Monthly percentage performance for the major indices
Based on last Friday's official settlement...

INDU: -11.7%
SPX: -11.0%
NDX: -5.4%
COMPQ: -6.7%
RUT: -12.3%

Portfolio Manager Quote

“I find that whenever I go home worried that the entire world financial system is going to collapse and I’m going to need to take up hunting and foraging to survive…it’s usually the point we get the rally…that being said I’m still working on the hunting and foraging since the rally will likely be short lived!!!” This could explain the big surge in fire-arm sales recently.

I wrote this in an IM exchange with a portfolio manager, friend and reader of this note. We were discussing the problem with the bank bailout plan, and I wrote: “the problem, as you know, is that 1) they are insolvent and 2) the government is trying a solution that will both concentrate money in the hands of the poor operators and also consolidate assets into fewer hands, which increases the systematic risk at a time they should be reducing it. Too big to survive should be the mantra.”

Instead of providing tough medicine to the problem, what we are getting is more “trickle in” funding of the banks, as evidenced by the deal with Citi this past week. While we as a country aggressively criticized the Japanese during their banking crisis, we are repeating the same mistakes and appear doomed to repeat their “lost decade”. We are probably in worse shape than the Japanese were at the time given our high level of government and consumer debt versus the Japanese, which at the time had a savings rate of close to 10%.

Government Disclaimer

The statement below is true.
The statement above is false

More Banks
From Ritholtz: “And that’s before we even get to the current issue of systemic risk, or the drag on the overall economy of having two massive Japan-like zombie banks hanging around. Given that we have already spent 300% of their market caps in terms of capital injections, and are on the hook for another 1500% of their valuations in terms of insured paper, these two banks are becoming vast money pits, ginormous black holes into which vast sums of taxpayers wealth disappear, never to be seen again in this universe.”

Even More Banks
From an email joke: “What worries me most about the credit crunch, is that if one of my checks is returned stamped 'insufficient funds' I won't know whether that refers to mine or the bank's.”

Citigroup (It’s no longer a bank)

Citigroup eliminated their dividend on preferred stock last week as the government provided them with more capital and converted their preferred shares. When will this charade end? Citi is basically worthless-the only reason the Fed and Treasury are trying to save them is to prevent the fallout of another Lehman-like collapse. The FDIC guarantees deposits at Cit, it’s about time they stepped in and took over this mess of a company and closed the taxpayer checkbook, which is writing checks which, as we wrote earlier, will “disappear, never to be seen again in this universe.”


The Case Shiller home index pricing dropped 18.5% in December, the biggest drop ever. The index measures prices across 20 cities in US. Highlights were a 34% drop in Phoenix, 33% in Las Vegas, and 31% in San Francisco. I read in today’s Orange County Register that the median home price in the OC has declined from $570K to $360K over the past 18 months.

Existing home sales were below the street forecast, coming in at 4.49 million for January, down almost 9% from last year. According to Seeking Alpha, 45% of those sales involved distressed properties (including foreclosures).

Durable goods orders were down 5.2% vs. consensus of -2.5%, and were down 2.5% ex transportation. That’s the sixth consecutive quarter of declines.

Initial jobless claims were once again worse than anticipated, 667K vs. 625K estimate. Continuing claims topped 5 million (5.1million) for the first time since record keeping began in 1967.

GDP for Q4 came in at -6.2% vs. expectations of -5.4%. The GDP price index was 0.5% vs. expectations of -0.1%. Are we starting to see the early stages of STAGFLATION? I think that stagflation may become the economic status quo given the outlook for government spending over the next four years.

Business investment dropped 21%, and spending on equipment and software dropped 29%.

Personal consumption was -4.3% vs. expectations of -3.7%. That is the first time purchases have dropped more than 3% in consecutive quarters since record-keeping began in 1947.

Due Warning
Robert Prechter of Elliot Wave International, who correctly advised massive shorting against the market in July 2007, is now recommending covering those shorts. “The market is compressed. When it finds a bottom and rallies, it will be sharp and scary for anyone who is short. I would rather be early than late.” Mr. Prechter first achieved notoriety by recommending shorting the market two weeks before Black Monday, 1987.

Health Care

I’ve published a note on the website ( which is titled “Fact Check: Obama Gets it Wrong on Health Care.” This note analyzes the President’s recent comments on health care costs. It’s worth reading.

Mr. Obama proposed his new budget last week, and some of the highlights are discussed here. The new plan proposes a 45% tax rate on estates larger than $7 million, repealing the expiration coming in 2010. The plan also proposes raising taxes on higher earners (those above $250K) by $1 trillion. Texas Rep Jeb Hensarling “You cannot help the job-seeker by punishing the job creator.” Hedge-fund and private equity managers will see their tax burdens triple as their carried interest, now taxed at capital gains rates, will be viewed as ordinary income and taxed at nearly 40% federal. Also, the plan proposes eliminating the more accurate corporate inventory accounting method of LIFO and replacing it with FIFO. The net of this inventory accounting change is to raise corporate tax liabilities during times of inflation, which as I have maintained is coming hard and fast.

I have included a link to Warren Buffet’s annual letter as well as some quotes from the letter, which can be found under the “March” section in the right hand column, entitled “Buffet’s Letter”.

This week’s note is a bit shorter and contains fewer charts than usual. The bulk of the week’s news revolved around the new budget plan, which I think is being analyzed quite adequately by the traditional press, having dubbed it “the Robin Hood budget.” As the House and Senate begin hashing through the plan, I will be providing more useful analysis of the plan. The bottom line on the plan is that it proposes a ton of spending, raises taxes on bigger earners, will result in even more massive deficits, and doesn’t seem to address the problems which we are facing today. In sum, it appears to be a backdoor way to increase government spending while the President has a “free ride” during the honeymoon period of his presidency.

As I write this the Hang Seng and Nikkei are both down almost 4%.

Have a great week.


Ned W. Brines
O (562) 430-3232

No comments:

Post a Comment