The Market Ticker

I thought I'd put together a "5 month review" of my previous "Year In Review" and update anything that needed updating.

Let's start with the predictions from the "Year In Review"

• The US will enter a recession, if it has not already done so. It will be consumer spending driven, with its genesis found in the Housing market. The slowdown will become evident once the “real” holiday sales data is posted, and accelerate into the first quarter. CHECK; real income has been negative every month since October, and real spending has been negative all year thus far.


• Unemployment will increase significantly, rising to north of 5% by the middle of next year. This will of course cascade back into consumer default rates (mortgages, credit cards, auto loans, etc) and cause yet more layoffs. The “virtuous cycle” will turn vicious. Getting there - sitting right on the 5% level.


• Housing will not turn in 2008. The total damage to prices will exceed a cumulative 15% from 2005-2008, and it will not be over. At least one, and probably several, national home builders will be cut to the single digits on their stock price or go bankrupt and be reorganized. Residential Real Estate will NOT be a buy in 2008; you’re still at least one and probably two years too early. CHECK - we have several home builders in single digits and the 15% cumulative decline is pretty much there.


• The story in the housing space in ’08 will be the defaults on “prime” mortgages – which in reality were nothing of the kind (e.g. “Option ARMs”), and on the piggyback seconds and HELOCs behind them. “Jingle Mail” will become common as homeowners that are deeply – 20% or more – underwater simply mail in the keys and say “screw the credit rating.” This will result in a near-total overhaul of the “FICO” system in the next couple of years, as these people will have defaulted on mortgages but nothing else, essentially forcing risk premiums higher for consumer credit and decoupling FICO from actual consumer credit (other than mortgage) behavior. I expect there will emerge a “shadow” FICO system which ignores mortgages but rates everything else. NOT YET; I may be a year early on this one.


• The stupidity in the rest of the consumer lending space (rollovers in auto loans and 0% balance transfer hell for plastic, primarily) will come crashing down on these companies and bring a crushing wave of defaults there as well, along with yet more downgrades in the asset-backed paper market. Starting, but not yet evident to a large degree.


• Recreational sectors (e.g. boats, RVs, etc) will get smashed. If you’re in the market for high-dollar recreational assets and have cash, late ’08 and into ’09 will present some incredible buying opportunities. CHECK - boat and RV makers are in trouble and resale prices are tumbling on both. YOU ARE STILL EARLY if you're shopping - wait!


• Government will, as is usual, try to meddle in the market’s adjustment of risk and price. The depth of this meddling will be the determinant on whether this is a deep but sharp and reasonably-short recession or whether it morphs into something far more serious. With 08 being an election year the temptation to engage in SEVERE tampering will be significant, and if they do, the risks rise materially. There is a serious risk of an all-out deflationary depression, and if we get one, it will almost certainly be the government’s fault. Whoever wins the Presidency may wish they had lost come '09 and '10. $450 billion spent on stupidity and counting; this looks on-track.


• Buffett just announced he is setting up a Municipal Bond insurance company. This will put a stake into the Monolines' hearts, taking all their business away that is profitable, and leaving them with structured finance which has huge embedded – and unrecognized – losses. The announcement, which showed up on the 28th, didn’t send shockwaves through the market – but it should have. Effectively, Warren threw a grenade (minus pin) into the magazine of structured finance. This is the death knell for the few trillion in CDSs that are out there can’t be paid; there is no longer any reason to believe that the companies writing these things will be able to be recapitalized off 'profitable' sides of their business! This is how fortunes are made (for Warren) and lost (for everyone who did imprudent things.) The 'big story' in the financial markets for 2008, and the likely trigger for major turmoil, will be the implosion of the CDS marketplace and how Buffett profited from it. This will stabilize the municipal bond marketplace which has been positively hammered. Kinda. I may be proven wrong on the outcome here in that munis may get positively destroyed due to tax base destruction.


• Equity prices will be choppy in the first couple of months and will experience a peak to trough swing of at least 20% during the year in total. I expect the S&P 500 to at least touch 1220 in 2008 and my current downside target is 1070. Note that should we get a 'parabolic' sort of move in the first quarter, which is possible, the potential for an even louder 'boom' (collapse) goes up dramatically; in that case I would not be surprised to see a three-digit handle on the S&P 500 sometime during the 2008-2010 time period. Check on the "choppy"; targets still open.


• Return OF capital will be far more important in 2008 than return ON capital. Ha! The stupidity of the pump monkeys and the public when it comes to equities is unparalleled. Nobody remembers 2000-03 - but they will.


• I do not expect the central banks to “hyperinflate” anything. Metals, in a protracted, serious deflationary selloff will get smashed. (If you're a "Gold Bug", read below for why I think you're nutty to hold metals - there's a better play if you believe in hyperinflation.) Unresolved. Gold, I note, hit $1,000/oz and has come back in - there are many predicting $1600 "imminently" but they've been doing so since January and so far, are dead flat wrong. We will see.


• Debt will be paid down when possible and when not, defaulted. This, of course, prevents deploying capital towards consumption and production. Expect this to show up in the first quarter in ways that cannot be refuted, and for the market to “get it” some time before the end of the second quarter. Looks like the "get it" has just started. CHECK.


• Commercial Real Estate will collapse. The leverage in these deals has actually exceeded that in residential, if you can believe it. This will prove to have been totally insane and the losses taken there will be immense. It will also put a fork into the “this is contained” thesis, and validate the fact that generally, commercial R/E lags residential by 12-18 months. Guess what – time’s up! Price declines reported for the first time on these; this is starting!


• Business CapEx will slow precipitously and may go negative. This will be “spun” for the first quarter or so, but by the middle of the second quarter it won’t be able to be spun any more, and the truth will have to be faced. That “truth time” will likely mark the start of the second big leg down in the equity markets. CHECK; see Network Appliance (Nasdaq: NTAP) and others. This story is just getting started.


• The Dollar will bounce all over before starting to take off when it becomes apparently that the rest of the world is going to get it worse than we will. Not yet and may be way early; I now think we may see the 60s before this occurs.


• The “market callers” who are (almost to a man!) calling for big moves northward in 2008 will be coming to the public “hat in hand” as we get into the latter part of the year. These people will be roundly discredited and yet another wave of so-called “analysts” will disappear from the scene, along with all the money the chumps who listened to them lost. Dick Bove anyone? Check; first of many.

I count six "Checks", five unresolved, and a couple that look at this point to be clean misses. I'll take it, given where we are. We'll do this again in December as a full recap; it should be fun.

How about these two video segments from CNBC Friday? Argue with these folks at your considerable peril - Mr. Walker is the former Comptroller General of the United States; he resigned earlier this year due to our government's refusal to deal with these issues.

http://www.cnbc.com/id/15840232?video=751583439
http://www.cnbc.com/id/15840232?video=751573252

Now let's take a look at Financial Sense and their article flow this weekend. Virtually every article there is now crowing about how Gold and Silver are going to the moon and complaining about blatant market manipulation of the price. Uh huh. Ok. Tell 'ya what - you buy a futures contract for delivery of either Gold or Silver, hold to expiration, and when the time comes, take delivery.

Come talk to me if the delivery fails. Until then I refuse to entertain this nonsense about how "there is some great cartel suppressing the price."

I'll tell you what's going on - the great "market callers-cum-dealers" were buying with both fists as Gold went to and through $1,000/oz, expecting to see the much-promised $1,600 immediately.

They intended to profit from an engineered squeeze northward as their "news articles" continued to pump the price, then sell that stock to you instead of acting as an intermediary. The spread wasn't good enough - greed got involved just like it did with real estate.

Now that the price has come down suddenly supply has "disappeared" from dealer shelves. But is it really gone?

Or is the truth that having failed in their prognostication and stuck with the inventory, now at a mark-to-market loss, the dealers are trying to provoke a buying panic among retail customers to drive the price back up?

Gee, I wonder.

The Commodities Futures market tells the truth, because it is a regulated entity and fails there get immediate attention. Show me the fails and I'm all ears. Until you do I call horsecrap on the "manipulation" claim.

Oh, and don't bother with the claptrap about the singular nickel failure on the LME a while back. Yes, it happened, but there was a penalty rate impose of 1% per day on the failure to deliver until you made good. I don't know about you, but an annualized return of 365% sounds pretty damn good to me, and those failures resolved essentially immediately because that sort of punitive "fail" rate has a way of making that happen. I'll take a "fail" that results in an annualized 365% return any time you'd like to "impose" it on me.

How about oil? As anyone who hasn't had their head firmly buried under a rock for the last month knows, oil has surged in price over $130/bbl and there are market calls for anywhere from $150-200 over the next months. There are many who claim this is all about speculation and more who claim it is about "peak oil."

Peak oil, by the way, doesn't mean we're running out. It simply means that we have more demand than supply at the current price.

When you have this situation the price shifts to the right on the classic supply/demand curve until either demand is suppressed or supply comes online.

But what if supply can't come online? Then the only equilibrium force is demand destruction, and until it takes hold, prices continue to rise.

Now let's think - does the circumstance exist where supply can't (as in physical impossibility) come online? NO.

We have oil off the coast of Florida, we have oil off the coast of California, we have oil in shale on federal land out west and we have oil in Alaska (and not just in ANWR; there is also a second large field, completely untapped, outside Prudhoe) and we refuse to go get any of it. The cheapest and easiest method to get the shale oil is strip-mining, but we refuse. We can also convert coal to oil but its very expensive.

Back in the early part of 2006 I penned an article at my primary blog of the time called "Musings" in which I talked about the coming oil panics, in which I saw the potential for Iran to cause a rocket shot higher in oil prices. Iran didn't act at that time, but the facts remain. We have, in the interim two years, squandered two years worth of drilling effort, nuke plant construction effort and biomass (specifically, construction of the blue-green algae aquaculture on non-arable lands out west, utilizing that nuclear power to pipe the water, from the sea if necessary) of course.

Note that the path forward advocated requires burying all the "Greenies" that stand in the way.

These very same "Greenies" have not only stood in the way of oil exploration in the United States, they have also blocked all nuclear deployment for the last 30 years, have blocked large-scale reflective solar plants, and have blocked the installation of large-scale wind generation capacity, most notably and recently off Nantucket.

They have also blocked the use of compression-ignition engines until their "ecology standards" were met, and kept moving the goalposts to guarantee that (until this coming model year) they couldn't be in enough states to severely discourage their sale to the public. In the process they also guaranteed that flex-fuel diesels would not be deployed, never mind that the military had them in the 1960s and they would run on nearly any commercial liquid hydrocarbon, including gasoline, diesel fuel, JP9 and Jet-A.

There is no solution to be found in hydrogen or land-crop-based biofuel. Hydrogen is not an energy source, it is a chemical energy storage mechanism and is inferior to hydrocarbons in energy density. Land-crop based biofuels cannot provide more than 5% of our road-based fuel needs; this is a matter of mathematics.

If we are serious about energy independence and security we build breeder reactors until we have 100% of our electricity covered by nuclear power, we electrify our rail system so we can get the diesel engine out of our locomotives (which is being used to generate electricity anyway), we use that electricity to power both extraction of existing hydrocarbons and the production of biofuel from aquaculture and we drill for all the petroleum resources we have to run this nation until the transition can be completed.

As a consequence if you are in the "don't drill/mine/refine/blow/nuke HERE" camp then you have absolutely no right to complain about the current price of gasoline, heating oil and natural gas; YOU EXPLICITLY ADVOCATED FOR EXACTLY THIS OUTCOME AND NOW YOU ARE GETTING IT.

It is time for you to either change your point of view or shut the hell up and enjoy the outcome you advocated for.

Now let's look at home prices.

They have declined. They will decline further until balance is restored. The Home Equity ATM machine is and will remain closed. Consumers have an all-time high in debt service requirements .vs. disposable income.

We have played "ugly American" and "as long as my credit card has room on it I can buy it" for too long. Now the check has to be paid, and its not going to be pretty. There is no escaping this reality, whether we want to or not.

There are no classes of assets that are both unpledged and large enough to support another round of debt bubble creation. The end result is that this debt must either be paid down or default - there is no other outcome possible. At the same time, consumer spending must and will contract as this occurs.

Those who think there will be a "mid-cycle slowdown" are either intentionally spewing falsehoods, delusional, have the brain power of a flea or all of the above.

We are in a recession now and it will be both longer and nastier than is being expected by virtually everyone. This is reality and it is most certainly NOT "priced in."

My expectation is that despite the crooner's call for the "election cycle" to work its magic its too late, just like it was in 2000. We are going to go into that deep and nasty recession as we are coming into the election, and it will lead to tremendous losses for The Republicans in November. The Republicans will get tagged for this irrespective of whether its their fault or not - this is just how politics works.

In the end everyone votes their wallet.

I see no evidence whatsoever that the Republican Party even recognizes this; they are literally whistling past their own graves in the coming election in terms of representation. I fully expect a monstrous Democratic sweep in all three branches of Government, despite the fact that such is inherently contrary to the interests of the American People (you want a divided government to keep them out of our hair to the maximum possible extent!)

Finally, this is a weekend for thanks to those who have put their lives on the line so we are able to maintain the freedoms we enjoy in this nation. Whether you agree with the war or not, the fact remains that without the hundreds of thousands of Americans who have, over the last 225 years, been willing to support our nation in the most personal and final of ways, we would be speaking German or Japanese right now.

Something to think about......