A Distilled Markets and Macroeconomic Letter
A The Whites of the Fed’s Eyes
The Fed seems panicked. The .75% cut was unprecedented and the Fed cut 1.25% in eight days. The key question, in my mind, is will these actions help housing/mortgage lending, bank to bank lending, stock prices, etc? In my opinion, not much. Longer term we may see more damage done to the dollar and only temporary support of stock prices. I don’t think the Fed cuts will make any difference in home values.
Next up is the Bush Administration’s effort to get consumers to continue spending via ~$145 billion tax rebates. Where will this money come from? Debt. Who has to pay off the debt? U.S. taxpayers. These tax rebates, in my opinion, are a band-aid move that will be very temporary and of highly questionable value both long and short term.
Potentially much more important may be credit contraction, insolvency, derivatives, consumer spending, corporate profits, and housing:
1. The banks don’t seem to want to lend to each other because they seem to be concerned about defaults. The write-downs continue and I think they will get worse.
2. Many more mortgages could reset to higher rates causing more foreclosures and CDO/CDS derivative product defaults.
3. Banks may also have serious problems with credit card and auto loan defaults. This could impede consumer spending.
4. Corporate profit margins have been at record highs. I don’t think they will stay there and the market does not seem to be pricing this in. Read Hussman on this here.
5. Housing is now a price/supply issue that can not be fixed by a renegotiation of mortgage terms. It seems clear, in my opinion, that prices need to move down to a point where people will buy. At some point I think there will be a capitulation in prices to much lower levels.
A key article to read is Eric Janszen’s Peak Cheap Oil, Peak Dollar... on iTulip.com. I think Janszen is getting very interesting guests to interview that I’m not seeing elsewhere.
Please send me email if you are reading this on iTulip.com and would like to read Transparency in its PDF version that I email each month.
Fundamentals: In short, I feel that the market is overvalued on a historical basis. If we see higher inflation, the market may move higher in Dollar terms but could well remain challenged in terms of other currencies.
Technical: Please see the SnapShot section below.
I’m concerned that longer dated bonds (5 years to 30 years) may fall in value at some point.
Gold seems to be reacting to the Fed rate cuts and financial/economic weakness.
Reminder: fiat currencies are not tied to anything of tangible value. They are only worth whatever the market, and the public, feels they are worth. As more fiat money is created the value of this paper money should go down. In my opinion, the U.S. is creating too much money and so are China, Japan, and Europe.
Dollar | Currencies
Long-term I’m still negative on the Dollar. The real story is the Dollar as measured against gold and oil etc., where the Dollar has lost a huge amount of value and may lose much more. I am watching the Yen for signs of the “carry trade unwind.”
Oil is at $87.07 (02/06/08). There is significant risk, in my opinion, that it may stay relatively high indefinitely. If oil prices move downward substantially, this may be pricing in a recession. A major concern with oil is the potential for a wider conflict in the Middle East, which could crimp supply. There are many other potential geopolitical risks to oil as well.
I believe that many consumers have less home equity now than before because they have taken money out of their homes and spent those funds. Consumer savings rates are very low or negative. I believe that consumers are being gradually squeezed by high oil prices on one side and rising interest rates on another.
Stocks - Short Term - High Risk
The market bounce from S&P 1270 hit resistance at S&P 1395 and then fell through previous support at ~1380. The VIX (volatility index or fear gauge) is at 28.97 (02/06/08).
Stocks - Medium Term - Elevated Risk
I believe that the risk is the market averages may have quite low returns for some time or potentially flat/negative returns when inflation is taken into account. The fundamental picture is bleak in my opinion. The credit/insolvency crisis seems to be getting worse.
Treasury yields have moved down (again) and seem to be pricing in fear of recession etc. I’m still concerned about longer dated (5 year and longer) bonds loosing value.
Gold one month futures are at $903.80 (02/06/08). I’m watching Gold relative to stocks, Fed cuts, the Dollar, and other currencies.
Oil - Staying High
Oil is at $87.07 (02/06/08). If we have a slowdown or recession, oil might have a relatively steep sell-off. I think there is significant risk that with Fed rate cuts we could continue to see high/relatively high oil prices even with a slowdown/recession.
The housing/credit/insolvency crisis continues to worsen. Home prices have fallen in many areas, some quite significantly. The Fed is worried and seems poised to cut rates further. I don’t think these cuts will have much of a positive impact on the economy.
The USD is at 76.17 (02/06/08) (stockcharts.com ticker: $USD). I feel that Dollar based assets may be at risk in general, both near and longer term.
Fed Funds are at 3.0%. I think the Fed will continue to cut rates if more bad news in the financial sector/economy/stocks/housing comes to light. I, of course, expect to see plenty of bad news.
My concept is to bring you a the most transparent look possible on the economy/markets via a quick read with plain language. This letter is geared toward the busy executive/business owner. If you are really short on time just look at the Snapshot section where I keep everything as brief as possible. In the Detail section I try to give a little more insight into my thinking without delving so deep that I stifle the reader.
When constructing portfolios, I take the client situation into consideration first and then combine that with the current economic/market factors presented in this letter along with well researched asset allocation strategies.
If you have specific questions on where I see things, or would like to discuss your portfolio, please feel free to contact me.
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