A Distilled Markets and Macroeconomic Letter
The US financial sector has imploded this year and even the mass media is reporting that we may be in a bear market for stocks. While the bounce today (07/16/08) may mark the beginning of a short term rally, my concern is that we may be closer to the beginning of this crisis than we are to the end. We have not seen a crisis in the Credit Default Swap market so far which could be a significant problem.
The housing implosion is propelling the financial implosion, which may further propel the stock markets to fall. I have been reading a new (to me) source on housing, Mr. Mortgage (http://mrmortgage.ml-implode.com/). Here are two key quotes:
...the ‘months supply’ number is calculated using ‘listed’ inventory*and*a very small percentage of bank REO inventory is listed. The amount of ‘non-listed’ bank REO or, shadow inventory, is staggering.
What is most frightening is how quickly values are dropping as a result of the shadow inventory. With as much bank REO inventory selling for as deep of discounts as we are seeing, it is forcing an immediate and swift mark-to-market change in values of entire neighborhoods all over the state [CA]. We have never seen a real estate market in which*one seller (banks) controls so much inventory and*has the ability to sell it for whatever it takes to move it quickly.
While I find this commentary interesting, one should note that Mr. Mortgage is speaking mainly about California in the above comments. I think other states have similar issues.
If this shadow inventory is held from the open market and housing deteriorates further, then the eventual release on the market could make the situation worse.
While writing this letter today, there was an interesting article posted on iTulip about Peak Oil (http://www.itulip.com/forums/showthread.php?p=40976). Some factors that influence the price of oil include:
1. Demand (this may stay relatively high even in a recession)
2. Peak Oil/Peak Cheap Oil (See Eric Janszen’s iTulip articles on Peak Cheap Oil)
3. Devaluation of the US Dollar
4. War/Threat of War (Think Israel/Iran and the Middle East)
Will demand be brought down enough by further economic weakness to significantly lower oil prices? Will the Dollar weaken enough to keep oil prices high? I’m watching this closely. The war issue seems to be much more pressing recently but is more difficult to gauge. From a technical analysis perspective, oil seems to remain firmly in its uptrend, despite what you may hear from the mass media.
Also note: once the economy works through the current crisis (yes, this could take years), we may see much higher oil prices if demand explodes with global growth. This is what I would expect to see with current information and the lack of alternatives.
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Fundamental: In short, I feel that the market is overvalued on a historical basis, though it is less overvalued than in October 2007. If we see higher inflation, the market may move higher in Dollar terms but could well remain challenged in terms of other currencies. (This is still a potential outcome, but I think it is less likely than more market downside).
Technical: The S&P rallied from 1214 to 1245 (07/16/08) today. Next resistance levels may be at 1250, 1275, and 1310.
I’m concerned that longer dated bonds (5 years to 30 years) may fall in value at some point, although this may be a bit further in the future. This concern seems to be rising, though, with further USD weakness.
Gold has moved higher again to $962.70.
Oil is at $134.50 (07/16/08). 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 global 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.
Stocks - Short Term - High Risk
The markets seem to be overstretched on the downside and may bounce up at any time. The Ted Spread has moved back up to 1.41, which is high. The VIX (volatility index or fear gauge) spiked to ~31 intraday yesterday (07/15/08).
Stocks - Medium Term - Elevated Risk
I believe that there is significant risk that 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 seems quite bleak. The credit/insolvency crisis seems to be getting worse.
I’m still concerned about longer dated (5 year and longer) bonds loosing value.
Gold one month futures are at $970 (07/16/08). I’m watching Gold relative to stocks, Fed cuts, the Dollar, and other currencies.
Oil - Staying High
Oil is at $134.50 (07/16/08). Oil has sold off sharply but it seems to still be in a longer term uptrend. Middle East tensions could make oil spike at any time.
The housing/credit/insolvency crisis is still in force. Home prices have fallen in many areas, some quite significantly. I feel that we could see home values have a total drop from the peak of 20 to 30% nationally in 2008 Dollars. The non-inflation adjusted (nominal) numbers may not look as bad.
The Dollar (USD) is at 71.79 (Close - 07/15/08) (stockcharts.com ticker: $USD) and has slipped significantly. I feel that Dollar based assets may be at risk in general, both near and longer term.
Fed Funds are at 2%.
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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