View Full Version : Why Hasn't “IT” Happened Yet? - Aubie Baltin

09-24-06, 03:34 PM
Why Hasn't “IT” Happened Yet?

by Aubie Baltin

September 24, 2006

To listen to the Bears over the past few years, you would have thought we would all be in bread lines and soup kitchens by now. So far, all of the ranting about doom and gloom sounds more like the boy who cried wolf than accurate forecasting. But I do believe that when “It” happens, things are going to get much worse than anyone can imagine. Even though the markets, at their lows in March of 2003 had lost over $6 trillion of value. But that was not “It.”

What is “It”? Why hasn't “It” happened and when will “It” happen?

“It” is a major financial melt down followed by an economic contraction. “It” is sudden and sharp downward spiral that takes everything down with it. “It” will be started by a catalyst, a spark that will get everybody's attention. But “It” is already built into the system, like a bunch of oily rags, all in a pile just waiting for internal combustion or a match or a spark to ignite “It.”

Some of the candidates for the catalyst include the following:
Crash of the Dollar
Stock Market Crash
Derivative meltdown at a major bank
Nuclear, Biological or Chemical terrorist attack on the US
Major Corporate Debt Default
Major Municipal or State Default
Secession or even Sale of US Treasuries by Foreign buyersThese are the matches. Alone, each of these can be easily weathered. But when combined with the poor underlying fundamentals of the economy and stock market, such as $800 billion trade and $600 billion budget deficits, sitting on top a mountain of unfunded pension and medical liabilities; then “It” can turn into an inferno.

Below are some of the oily rags just waiting to ignite:
Massive amounts of derivatives ($90 + trillion in notional value)
Over valuation of the US dollar
Overvalued stock market (19 times last 12 months “earnings”)
Massive private and public sector debt build up
Record low percentage of cash levels in mutual funds
Massive build up of personal debt
Under funded pensions–government and private)
Housing bubble
Deflation or Inflation
Municipal and State deficitsBut one thing for sure, “It” will not happen as every body expects. Some are waiting to see the writing on the wall. Most need to see the fire before they will believe there is danger. Things haven’t really changed that much over the past 3 years. Investor attitudes are much too complacent. They see nothing to worry about. Yet liabilities have been outpacing income for six years; since 2000, household income growth has slowed while expenses have continued to accelerate.

So why hasn’t “It” happened yet? Thus far the Fed has succeeded in playing Fire Chief and kept pouring liquidity into the system. But the Fed cannot keep the money and credit spigots wide open indefinitely. After all, is that not the definition of inflation? All they are doing is delaying the inevitable, not curing it. Adding liquidity is only making our future economic problems worse. It’s the same as adding tons of kindling in time of drought. Excessive liquidity was the main cause of the 90’s stock market bubble in the first place and for that matter, every other bubble throughout history.

The Crash in 1987 came as a shocker. But Fire Chief Greenspan and his liquidity hose were on the phone to the banks and brokers offering unlimited credit to any institution that needed it. He saved a melt down with five minuets to spare. The downturn in 1997 was again saved by Alan and his liquidity hose. In 1998, the Long Term Capital Management debacle caught everyone flat-footed. Once again along came the Fed to the rescue. Then came Y2K and the Fed just turned on the printing presses just in case, to prevent any problems. All of these problems had similar characteristics-they were sudden and solved by the Fed with increased liquidity.

Along comes 9/11 and Greenspan once again took out his liquidity hose and drove interest rates down to 1%. But this time liquidity was not enough, it required two G.W. income tax cuts to halt the recession and get the economy rolling again. Only this time the 1% interest rates fueled the biggest real estate boom in history. This chart below, although not fully up to date, shows that the fabled liquidity that Wall Street crows about doesn't exist. This chart is a comparison of M2 (liquid money) to the NYSE capitalization. (If the NASDAQ’s capitalization were included the chart would look even worse.) Liquidity bottomed out in the 1st quarter of Year 2000. It is only slightly higher today, but not enough to make a case for a long lasting bull run based on liquidity.

In fact, the Fed’s solutions have once again driven stock prices to levels of irrational exuberance,. Too much liquidity has destroyed the allocation function of interest rates. Corporations and individuals have taken on unmanageable debt loads. Excessive liquidity drove the housing bubble. Too much liquidity must eventually weaken the US dollar, forcing the Fed to raise interest rates much higher. Adding more liquidity won’t solve any of these problems; it will exacerbate them by delaying the inevitable, and quite possibly will make matters worse. It is taking ever-increasing amounts of money and credit just to hold on to where we are.

When will “It” happen?

“IT” is in fact beginning to happen all around us.

The “oily rags” are there for everybody to see. Debt continues to pile up. The market is still over valued. The US dollar is just barely holding on. No, these aren’t things that have “always been going on” as some pyromaniacs on Wall Street would have you believe. No, they haven’t ignited yet, but we are getting close.

The potential for a stock market crash is always there with a market so overextended. The amount of derivatives outstanding are growing ever larger, now totaling more than $95 trillion, according to the Comptroller of Currency. The total of derivatives is 8 times bigger than the entire US GDP. How risky is that?

What are the odds of any one of the catalysts for “It” happening? I don’t know. The risk varies. I put the odds of nuclear war very low, but rising. I imagine the North Koreans or Iran might think differently. The odds of a derivative meltdown taking down a major bank are much higher. Barings Bank’s failure and Long Term Capital’s failure have shown us that derivatives can cause a financial disaster over night. The top banks are playing with matches, big matches, and there is almost no Federal regulation on derivatives.

Warren Buffett referred to derivatives as financial time bombs. The odds are that the catalyst will come from the credit markets. Maybe one foreign bank will start to dump US bonds. Which would cause US long term interest rates to spike up and the US dollar to crash Could this happen? Could this have a domino effect? Japan with its 40% savings rate, has been the biggest buyer of our bonds both public and private, now looks like it’s finally starting to come out of its 14 year recession. If it hasn’t, it will, sooner rather than later, and then they will need some if not most of their savings to invest in their own economy. Their stock market is deeply undervalued compared to the US stock market. It’s a matter of when not if they stop buying or even start selling its massive holdings of US treasuries.

Any one of the above could lead to a market decline or crash. Long term rates look like they may start climbing again should inflation numbers force the Fed to resume increasing rates. And the stock market is once again attempting to climb a wall of worry and break out to new all time highs. Could that be the trigger; the Big Hook that I have been looking for, for almost two years? Yet each time the market looked like it was ready to break out it sold off.

Irrational Exuberance

If there is any doubt that the world’s investment community is suffering from irrational exuberance, just look at the German and French Stock Markets. In the face of 12% unemployment rates and less than 1% growth rates to look forward to, which they consider to be good, unemployment rates can only get worse and yet their stock markets were making new five year highs, in spite of political instabilities as indicated by two weeks of Muslim rioting in Paris.

There is certainly enough smoke to know there are still problems with stock and bond markets all over the world. Anyone who is tired of hearing all of the dire predictions from the bears should be doubly careful since some of the most die-hard bears have finally tossed in the towel and turned bullish; when the last bear turns bullish or neutral, watch out below.

Anyone that is waiting for “It” to arrive before they act is playing a dangerous game. Now is the time to act to protect your assets. If you wait for IT to be obvious, it will be too late as you get trampled in the mad rush for the exits.

The Last Remaining Bull Market

For those of you who do not know how to handle the coming bear markets and insist on always being fully invested rest easy. There is still one ongoing bull market that is still in its infancy and yet most bulls are ready to throw in the towel: gold. My opinions are always forward looking, usually projecting three to six months out. So if you have heeded my past musings you have been selling your stocks and bonds into rallies and you have cashed in your speculative real estate over the last year or so. At the same time you should have established a program of scaling into gold and silver with your ever increasing cash reserves. Buying gold and silver bullion and gold and silver stocks or what might be even better, buying any one of the well known Precious Metals Funds that are out there, and stop worrying. It’s my estimation that you will more than double your money at a minimum, somewhere over the next two to five years.

Gold: Where to now?

For all those that have now been gripped by fear that gold has by breaking below 600/oz entered a new bear market of its own, stay calm. I have been warning you that when ever you have an Elliott wave extension and that extension occurs as part of a fifth wave blow off–which is exactly what happened–that extension is always doubly retraced, pulling back to the beginning of the extension which according to my interpretation of Elliott wave is $540. Now if the bullish sentiment percentage drops to below 15% as gold approaches $540 in my opinion it would then be time to back up the truck and load up with gold and gold stocks.

Now $540/oz is not a written in stone magic number. My down side support and thus the area of accumulation should be a $50 range bracketing $540 or $515 to $565. This is a typical Fibonacci, Elliott Wave 50 to 62% retrenchment of the 2001 to 2006 first wave of the bull market. So start scaling into gold as we approach that range. As far as silver is concerned, there is a strong probability that silver will out-perform gold.

Personally I prefer gold because apart from all the fundamentals it is the only real money and I’m willing to pay a small premium for the insurance. But take your pick. Real profits occur to those who at crucial times have the courage to stand alone.


Aubie Baltin CFA, CTA. CFP. Phd.

Palm Beach Gardens, FL.

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09-25-06, 07:24 PM
Aubin Baltin beliefs run a little counter to Itulip? Have I read his analysis correctly?

Deflation in all Financial Assets - and Gold/Silver/precious metals will inflate?

Aren't we like to have big inflation in some industries as the Central Banks try to get out of this rough batch with lots liquidity? Inflation in oil, health care, and food?

Its a bit too much of an immediate doomsday scenario for my - but, I wrong about things on a regular basis.

09-27-06, 07:10 PM
I'll admit the "technical" part of the discussion reminds me of numerology and other voodoo, but the collapse of financial system is not a matter of if, but when. I hold a lot of bullion, and yes it will rank up there with ammo, rice and gasoline come the Apocalypse, but you also need to hedge. In the actual sense, not as in hedge fund.

I try to keep my assets in two fairly equal parts, one run with conventional wisdom (well, contrarian centrist) and the other sort of bull goose loony from the gut feelings. The first fares moderately well and is boring (thank god) but I've had fairly spectacular (though only occassional) wins on the loony side.

Overall they seem to balance out and let me indulge wild stuff yet have a backup.

Diversify, diversify, diversify.