Tao Economics

This is the “other shoe” that a lot of people are waiting to drop. Right now we are caught up in a compressive debt deflation as mortgages stop “performing” and loans of all kinds are welshed on. Since money is loaned into existence, and a great many loans are not being repaid, then a lot [...]

Kathmandu, Nepal

• Rotting infrastructure shackles India’s ambitious progress,
• The final installment of the 2008 Best in Rude Series
• Voice your big idea forecast for the year ahead and plenty more…

Joel Bowman, reporting from a very cold valley in the Himalayas…

It’s a problem most countries face, both developed and developing, but few places on earth suffer from inadequate infrastructure quite like India does.

Your editor recently spent a few weeks wandering the subcontinent, from the touristy beaches of Goa to the financial nerve center of the bustling Mumbai, then up to Delhi, Agra and finally, to the holy city of Benares.

To be sure, there is much to like about the Indian story, not least of all its impressive average growth rate of 8.8% per year for the last half-decade.  The country is also better positioned, theoretically, to whether the global economic slowdown than many other emerging markets. About 22% of its GDP comes from exports, for example, as opposed to 37% in China.

And stocks? Well, stocks are cheap, historically, as they are in most of the rest of the world right now. Bombay’s Sensex Index (BSE) finished the year down by half as foreign direct investment dried up
and emerging market funds in the west sold anything and everything with an Indian stamp to cover losses at home. Solid companies now trade at deep discounts and are beginning to regain some of their former luster.

Even so, the lack of adequate water and power facilities threatens to drag India asunder at every turn. Disturbing statistics are not difficult to come by. Here’s a quick sample:

• Each and every day of the year, 1,000 Indian children die of diarrheal diseases, mostly due to lack of clean drinking water
• Peak power demand outstrips supply by about 15%, making blackouts a constant problem. (The World Bank estimates that 9% of India’s potential production is lost to power cuts.)
• Half the 17 million residents in Mumbai, South Asia’s largest city, live in one of its 2,000 slums. Most don’t have basic sewage systems or electricity.
• Some 700 million Indians do not have a proper toilet and only about 15% of the nation’s sewage is treated

Interested in the water issue, we traveled to Benares (Varanasi) to check out Hinduisms’ holiest river. Alas, we also encountered severe and prolonged power blackouts which, aside from keeping us cold and in
the dark through the night, also prevented us from sending your weekend edition.

So, while we catch up on the news of the world, thanks to Kathmandu’s relatively reliable Internet, we offer today the final installment of the 2008 Best in Rude Series, which was to be your weekend edition. Originally published back in September, guest columnist Robert Fry’s essay on triumph over adversity was one of your editor’s personal favorites. Please enjoy…

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Bad Bailouts, Good Americans
By Robert P. Fry, Jr.

“I used to have my own construction company,” a taxi driver named Bruce explained.  “We built houses here locally in Birmingham.”

“How big was the company,” I asked, “How many houses did you typically build?”

“Anywhere from 10 to 15 or so per year.”

“What happened?”

“We had a project going last year with 15 lots.  We’d put in all the roads and sewers and had about 9 houses built when everything just stopped dead in its tracks…No buyers.  And more than that.  No phone calls, no inquiries, no agents calling, nothing.  The market for new houses simply died.”

“So what did you do?” I asked.

“I’m still not sure that I handled it all correctly,” he began. “Our problem was the debt on the property.  The interest cost was roughly $1,000 per day. So even though we stopped all of our other expenses, there was nothing we could do about that.  But we had some other assets. So we started selling things to make the payments.  Finally, we got so desperate, we sold my son’s Corvette and, after that, the condo in which he was living while attending the University of Alabama.

“I never thought I would have to do something like that,” he continued, “but the corvette was worth $25,000, which meant we could pay the bank for another month. But even after that, we ran out of money.  So we went to the bank and started giving them the unsold houses in lieu of cash every time we got behind on the payments.  When we finally ran out of houses to give them, we had no choice but to give them the remaining land and then file for bankruptcy.”

“That didn’t solve all the problems,” Bruce explained, “since we still needed to put food on the table and had other bills to pay.  So late last year I leased a cab and started driving.  That has worked out pretty well; the cab has really been a blessing.   So I decided to buy this cab just a couple of months ago.”

Bruce, who looks to be about 50-something – with a daughter out of college and a Corvette-less son who’s a sophomore in college – works all night Friday and Saturday, gets up in the afternoon Saturday to
watch a little football and gets up Sunday morning to go to church, then starts making runs to the Birmingham airport around 4:30 Monday morning.  I heard not one word of complaint about his new life, just
the simple statement, “The cab has been a real blessing.”

There were, of course, some good chuckles about that.  With the move from business owner to cab driver, he admits that some of his friends and family haven’t known what to say to him.

“What are you doing these days, Bruce?” my friends ask.

“I’m driving a cab.”

“Oh.  (Long pause.)…What kind of team do you think the Tide will have this year?”

But Bruce doesn’t seem to care much about “what the neighbors say.” He cares about what his family says. When it came to selling the Corvette, Bruce told me, “Taking my son for a drive and telling him that I needed to sell his car was probably the lowest and most difficult moment of my life.”

“We had done everything that we could for our kids and I was worried that I might have raised some sort of runny nosed-kid who needed a Corvette and would never be able to support himself.  In addition to selling his car, we sold the condo where he was living and couldn’t even help him pay the rent on his apartment so he had to get a job while going to school.”

Bruce then told me how his son had gotten a job and was still doing great in school and now calls him regularly just to ask, “How are things going, Dad?”

At which point I said to Bruce, “So was it worth going into bankruptcy, just to learn that you have a son who is actually a stand-up man?”

After a moment’s reflection, Bruce smiled, “Yes it was.”

Bruce and his family and friends – people who get up every day and do what they need to do to provide for their families and to be good members of their communities – represent all that is still good in America.  They are honorable people who spend all that they have to pay their debts, even if, like Bruce, it ultimately leads to bankruptcy.  And when their businesses fail and life must go on, they take whatever job they can find to put food on the table.

How unlike the whiny, self-indulgent, profiteers who guided Wall Street’s leading investment banks onto the shoals of insolvency. These people, who have nearly destroyed America’s banking system, should be acknowledging their failures. Instead, they are demanding ever more of our resources, and of our children’s resources, as the price for not making things even worse.

America would be better served if Hank Paulson were driving a cab in Manhattan, instead of trying to give billions of dollars of other peoples’ money to his friends and colleagues on Wall Street.  As a cab driver, there is some possibility that he would learn the value of a dollar, the importance of community and the inherent dignity of all good work.  At the very least, we would all be $700 billion better off, less tips.

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[Rude Endnote: Now that the ‘08 season is behind us, it’s time to look forward to what the new year will bring. Over the coming days we’ll be asking for your thoughts on the biggest themes of 2009.

Have we found a bottom in the market? Will the dollar hold on to its tenuous grip as the world’s reserve currency? What will happen to gold, energy and the looming debt cloud that rained on last year’s
parade?

Get your thinking caps on and send us your thoughts if you would like to be part of the next Rude Group Research Project.

We’ll return with the first “new Rude” of the year tomorrow.

Until then…

Namaste,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com

by Addison Wiggin & Ian Mathias

• 2008 retrospective… unless you reside in a small African country, your market lost money
• A closer look at the year for American markets… the few winners, and many losers
• Worst year on the books for commodities too… with four notable exceptions
• Crude oil pops 14%… Russia moves another pawn in the coming resource war
• But isn’t there “a lot of oil out there” to share? Byron King explains crude misconception
• Need to recover from 2008 losses? The 5 unveils “Income on Demand” solution

  Tunisia…

Had you known it at this time last year, you would have taken a page out of William S. Burroughs’ book and hidden away from this global crisis with a hookah pipe in your hand. 

You could have wiled away your time studying the remnants of Carthage, reading up on your St. Augustine, dipping your feet in the Mediterranean… and had your money stashed away in the only market on the planet where stocks increased in “value” in 2008. 

As we promised Wednesday, here are the best and worst global markets over the last 12 months. What a disaster:

  Iceland is even worse than it appears. The table above values its stock market in kronur, which thanks to the Icelandic government are… ummm… worthless. Convert what’s left of their market to U.S. dollars, and the crash was closer to 97%.
We’d say Iceland’s year was a valuable lesson in the pitfalls of leverage, debt and central banking… but we doubt many leaders learned much from the tiny nation’s collapse.

  Here in the U.S., we finished the year in the middle of the list of worst performers. The Dow, despite a nice series of up days over the last week, ended 2008 down 33.8%, its heftiest annual loss since 1931. Only two of its 30 components stayed in the black for the year: McDonald’s and Wal-Mart.

Other major indexes fared even worse. The S&P 500 closed the year with a 38.5% loss. All 10 of the S&P 500’s sectors declined… financials the worst, down 58%. Consumer staples fared “best,” falling 18%. Only 31 of its members ended the year in the black. Family Dollar was the S&P 500’s best performer, up 36%.

The Nasdaq ended up the worst of the big three U.S. indexes, plummeting 40.5%. That’s the biggest yearly loss in its 37-year history.

Approximately $7 trillion of investor worth was wiped out. If you’re sitting on some of those losses and waiting for the market to come back, we’ve designed a specific strategy to help you earn Income on Demand. For details on getting details… see the P.S. below.

  In the strange, but popular world of ETF investing, 19 of the top 20 ETFs this year were of the short or ultra short variety. Here’s the cream of the crop:

• ProShares UltraShort Semiconductor (SSG), up 110.9%.
• ProShares UltraShort Technology (REW), 95.3%
• ProShares UltraShort Russell MidCap Growth (SDK), 94.4%
• ProShares UltraShort Russell 1000 Growth (SFK), 80.8%
• ProShares UltraShort QQQ (QID), 77%.

  But in the rough and rugged markets of 2008, commodities were a decent place to hide your money, right? Maybe? No?

Behold, the worst year for commodities since, well, we believe, the Great Depression. The Reuters/Jefferies CRB Index, the most followed gauge of all commodity prices, fell 36%. The index was born in 1956, and this is its worst year on the books.

15 of the 19 raw materials tacked by the CRB fell this year. The biggest losers include:

But all was not lost for commodity investors. The Ivory Coast, the world’s biggest producer of cocoa, had a tough harvest this year. As simple as that, cocoa bucked the biggest commodity trend of our lifetimes, with a few others in tow:

Still, we expect once the year of the Great Government Intervention concludes… that would be 2009, not its predecessor… commodities will once again be a great place for your money.

  Crude oil ended the year with a 14% surge when Russia took another step towards resource wars with Europe. Light sweet crude jumped over $5, to $44 a barrel, after Russian owned energy giant Gazprom announced it was cutting off supplies to Ukraine. Russian officials insist the move was only a result of unpaid bills… but it’s easy to picture ulterior motives.

Europe gets about a fifth of its gas from pipelines that run through Ukraine, and it’s no secret Gazprom (and Russia in general) has been crushed by fall of resource prices. Earlier this year during Russia’s skirmish with Ossetia, we forecast a future of resource-related war. We’ll add this story to that file… and keep an eye on Mother Russia. More on the preposterous ideas coming out of the former Soviet Union in reader mail, below…

  Today, traders have brushed off Gazprom and oil is back down another 8%, to $41 or so. Lousy manufacturing stats from the U.S. and China (more below) prompted traders to return to the popular mantra: Demand is down, supply is ample.

“When people say things like ‘There’s still a lot of oil out there,’” notes Byron King, “they are not necessarily wrong. But they mean that there is a lot of oil out there that is NOT in giant oil fields. (Or if they’re so smart, how come they haven’t found any giant oil fields lately.) It’s oil that you will not drill up with just a relatively small number of high-output wells, like in the big oil fields of Saudi or Russia.

“The ‘lots-of-oil’ crowd is talking about hydrocarbon molecules (not necessarily light, sweet crude, either) in deposits that are more dispersed, further out, in deep water, under more rock or salt layers, with higher temperatures and pressures. Or they are talking about heavy oil, or bitumen in tar sands, or kerogen in oil shales or even some transformation of coal.

“When people use the expression ‘lots of oil,’ they mean the expensive stuff. It’s oil that requires many expensive wells or immense processing facilities, drilled or built with technology that we have just barely invented. And it’s the oil that you will never see if prices stay at $37 per barrel for long.”

   Amazingly, the dollar ended the year stronger than it began. The dollar index reads 81 today, a full 5 points higher than it did 12 months ago. The euro goes for $1.39, about a nickel cheaper than its price at the start of 2008. The pound, at $1.45, is one of the world’s biggest currency losers for the year… its down almost 50 cents for the year versus the greenback.
 
And if the pound was the dollar’s biggest victim, the Japanese yen is surely its biggest rival. The yen strengthened 19% this year versus the dollar, its best year since 1987. One greenback will get you about 90 yen today, compared to 110 at the start of the year.

  Gold buyers celebrated the end of 2008 by installing a bottom on New Year’s Eve, around $860. The spot price has been trending up ever since. You can get an ounce today for around $880.

  In December, Chinese manufacturing activity contracted for the fifth month in a row, their government announced today. China’s purchasing managers’ index scored 41 in December (below 50 signifies contraction), just above the record low set in November.
 

  America’s gauge of manufacturing, the ISM’s monthly report, found a fresh 28-year low in the same month. The ISM reports this morning its measure of factory activity shrank to 32.4, the lowest score since 1980.

  Today’s jobs report was postponed until next Friday. We’re certain the Bureau of Labor Statistics didn’t want to put a damper on anyone’s New Year’s euphoria just yet.

  With the new year comes some big changes in the banking world. Bank of America closed its $19 billion all-stock buyout of Merrill Lynch today, creating the biggest financial services company in the U.S.

Wells Fargo concluded its own $12 billion purchase of Wachovia today, too.

  “If you have heard of the intelligence term ‘PSYOPS,’” writes a reader, “or ‘psychological operations’, then may I suggest that this is what we are dealing with with regard to Mr. Panarin’s comments about a U.S. split into the various parts. Panarin’s comments are merely misinformation and half-truths put out by an ex-KGB intelligence operative to the intended victim: that is, U.S. citizens.
 
“Don’t get me wrong, the parts of his statements dealing with economic, financial and leadership calamities in the U.S. are partly true; however, that is the trick of the propagandist, to insert half-truths into their statements. The fantasy that is the breakup of the country into its regional subcountries is just that, pure fantasy and an ‘off the top of my head’ kind of statement that doesn’t deserve the text space that people are currently writing on it… including my own blurb.”

  “While Panarin’s scenario,” writes another, “seems a bit off-the-wall with regard to the US getting split up and divided among other nations, it is not so far off the mark in being a realistic possibility with regard to our country acknowledging the disadvantages of being such a large nation with a very big pile of eggs in the henhouse.

“An eventual dismantling of the federal government in favor of state sovereignty would be a step in the right direction. It is much easier see progress, however slight, at the local level, where almost all of the good people who call themselves Americans are ready to knuckle down and work harder AND offer helping hands to their living, breathing neighbors (if not bankers) RIGHT HERE at home!”

  “The reader who actually believes,” writes our last reader, responding to Wednesday’s inbox, “that a majority of the population will fight to keep the U.S. a ‘single, sovereign nation’ is the one who is delusional.

“I’m as patriotic (and heavily armed) as the next fellow, but I wouldn’t lift a finger to preserve this bankrupt (morally, politically and fiscally), warmongering shell of an empire. As far as I’m concerned, it (and its subjects) has failed nearly every test given to it since the federal coup of 1779 and it deserves to be dumped unceremoniously onto the scrapheap of history. And good riddance.”

The 5: Welcome, 2009… what calamities await ye?

Addison Wiggin
The 5 Min. Forecast

P.S. If you’re holding onto your losses in the stock market, waiting things out until Mr. Obama gets the economy “back on track” — whatever that means — we’ve got a great way for you to earn income from your existing portfolio… with no extra expenses or fees… just free and easy income. We call it Income on Demand. You can learn all about it in the next installment of the Agora Financial Emergency Retirement Recovery Webinar series. Sign up for free right here.
 
If you’ve signed up for previous Webinars… no need to sign up again. The Webinar will air next week. You’ll get plenty of advance notice. Again, it’s free, no purchase necessary. 2009 promises to be another interesting year in the markets… might as well earn some Income on Demand while you’re waiting for the next bubble to commence. Check it out here.

We’ll turn around early in 2009 and discover that we are a much poorer nation than we thought because from now on credit will be extremely hard to get for anyone for anything. The businesses that survive will have to keep going on the basis of accounts receivable. This is the area where the crash [...]

There are two realities “out there” now competing for verification among those who think about national affairs and make things happen. The dominant one (let’s call it the Status Quo) is that our problems of finance and economy will self-correct and allow the project of a “consumer” economy to resume in “growth” mode. This view [...]

by Addison Wiggin & Ian Mathias

• A fitting end to 2008… an easy money crisis “fixed” with more easy money
• Equity bottom still out of reach… two historic ratios provide ample evidence
• Bill Jenkins on the big currency story of 2009: death of the euro?
• Worldly markets close the books for 2008… The 5 awards “Worst Index of the Year”
• Jobless claims down, but numbers (and media) deceive… Patrick Cox explains some common misconceptions

  How should we celebrate New Year’s Eve? Perhaps with a fitting microcosm for all of 2008: 24 hours after receiving a $6 billion taxpayer handout from the Treasury, GMAC — the financial arm of GM — announced a year-end 0% financing push on five different models.

GMAC, along with other auto lenders, put the kibosh on free loans in October, when the world instantaneously realized, “Hey, maybe credit shouldn’t be so easy!” Today, they’re back. Never mind that GMAC is borrowing money from the Treasury at 8% and lending it out at 0%. Just move those ’08 models off the lot, GM, you don’t have to worry about making bad loans until they’re at least 30 days past due.

If there’s any cure for a crisis begat with too much easy money, damn it, it’s MORE easy money.

Mazel tov!

Prost!

Salud!

(Sounds of cheers, applause and general crowd approval.)

  The Fed also granted GMAC the “bank holding company” pedigree it pleaded for last week… even though GMAC has yet to reveal the results of a capital-raising effort that the Fed deemed necessary for them to be a “legit” bank.

Under their new status, GMAC too will be able to start taking bank deposits from unsuspecting American savers. (Heh. Good thing there aren’t too many of those left.)

  Despite the giant free lunch at GMAC, loan issuance in the U.S. plummeted 55% in 2008. Banks lent “only” $764 billion in the U.S. this year — the lowest amount since 1994.

According to data released today from Reuters Loan Pricing Corp., institutional borrowing and loans for leveraged buyouts saw the biggest cutbacks this year, both decreasing over 80% from last year.

  So if loans are scarce and the market stinks… no surprise that investors are sitting on historically huge piles of cash , right?

According to data from Bloomberg and the Fed, the total value of U.S. cash holdings, bank deposits and money market funds exceeds $8.84 trillion. That amounts to 74% of the entire market cap of U.S. equities — and the highest ratio since 1990.

But it’s possible we haven’t seen the half of it…

“In July of 1982,” explains Dan Denning, “the total cash position was 95% of total market cap. Stocks bottomed at that point, and the S&P 500 rose by 36% over the next six months, according to Bloomberg.

“Then there’s 1974. The total cash position of investors actually exceeded the stock market capitalization by 121%. Then, between October 1974 and March 1975, stocks rallied by 31%. So what does it all mean?

“Well, you have come to a fork in the road. How you see the cash surplus tells you a lot about yourself. The obvious conclusion, based on the examples cited by Bloomberg, is that a surge into cash as a percentage of the total equity market cap precedes a rally in stocks. That’s the good news.

“The bad news is that the current cash-to-market-cap ratio has not reached historical extremes. For it to do that, the cash position would have to rise even more, or stocks fall even further or some combination thereof. And even then, there’s no guarantee investors will return to stocks.”

  Another indicator of the true value of U.S. stocks: The S&P 500/gold price ratio returned to 1 this week for the first time in 17 years. In other words, one ounce of gold hasn’t been able to buy one share of the S&P since 1991.

But again, while this ratio may be near historic averages, there still seems to be plenty of room on the downside for stocks… or upside for gold.

When the ratio of stocks to gold collapsed in 1971, it fell 93% over the next decade, to a low of only 0.17. So far, during this correction, the ratio has fallen only 82%. Leaving plenty of room for stocks to fall more… and/or gold to rise.

  If you’d like to buy some gold today, an ounce goes for just above $860. Since spiking to $885 Monday, it’s been slowly trending back down.

  While gold has been drifting lower, the dollar is still sweet-talking investors. The dollar index is up nearly a full point from yesterday, to 81.6

  “The euro could die in 2009,” forecasts our new currency man Bill Jenkins.

“When the European Union was formed, most supporters saw it as the cat’s pajamas. Strongly growing economies, all banded together, ready to take the economic world by storm. And so long as the party lasted, everybody was happy. Everybody was making money. The wine was flowing in France, and the beer in Germany.

“But now that the flasks and kegs are empty, all the party food has been consumed and it’s time to pay the caterer, all the participants are looking at each other to see who is going to pick up the bill…

“A number of the euro countries are in real trouble… Spain, Italy and Greece, just to name three. At the same time, chief member Germany, which has always been the economic muscle behind the euro (and a model of fiscal reliability) is falling into recession. They will no longer have the "excess" to help bring lagging countries along.

”Add that to the fact that now many of the eurozone countries are crying out to the ECB for ‘stimulus.’

”Who is going to pay for that? Germany, of course! Are they willing to do that? Probably no more than you and I are willing to pay for a bailout for Mexico! Additionally, had Germany not been sharing its wealth with the less-productive nations of the ‘zone,’ they would certainly be in a much better economic position right now…

”Needless to say, if the European Union begins to fragment, the euro will go into the toilet. Where will all the currency chasers turn then? I would suspect right back to the dollar. Now, don’t get me wrong, if this happens, and that is a pretty big if, it is not going to be next week. But we need to keep our eyes open on the big trends to see where there is opportunity to make some money.”

  Further around the world, most Asian markets closed the books on 2008 early today. Thus, we’re ready to present one award for the year… the worst performing major market:

China’s best known index fell a remarkable 65.2% in 2008. That’s nearly $3 trillion in share value. We’d say Chinese investors are way worse off than their American counterparts… but the SSE rose over 300% between 2006-2007.

As we write your 5 Min. this morning, other markets around the world are still rounding down their last day of 2008. Check us out Friday and we’ll kick off the New Year with a full wrap-up of worldly gains and losses. Some of the world’s minor markets will report some dreadful drops (poor Iceland).

  U.S. market makers are trying to end 2008 with a bang. The Dow, S&P 500 and Nasdaq all shot up over 2% yesterday. Traders were curiously emboldened late in the day when GMAC became a bank holding company and hinted it would kick off an aggressive lending program soon.

Today started a bit more cautiously. As we write, the Dow is near break-even.

  Initial jobless claims have fallen to their lowest level in two months, the Labor Dept. reports today. First claims for unemployment fell by 94,000, to 492,000, last week, way below expectations.

But don’t expect an unemployment bottom. This latest reading was skewed by part-time holiday hiring. And really… what kind of jackass fires people during the holidays anyway?

The real employment number? Continuing claims. A total of 4.5 million people are currently collecting unemployment benefits — the most since 1982.

  No shock then that consumer confidence has hit another record low. The Conference Board’s measure sank to 38 in December, from 44 the month before.

The group started this survey in 1967… today’s reading marks the lowest score on the books.

  But we’re starting to get suspicious of that consumer sentiment survey, too. Our Patrick Cox helps to explain why:

“It is important that we understand that the stock market is not the economy. Even people who are not investors tend to make this mistake. It’s easier to make that mistake if you’re personally invested. On the surface, however, it’s obvious that economies don’t change as dramatically as the market does. Paper losses can be painful, but they don’t translate directly into the destruction of real assets.

“I am pointing out the obvious because I’m so sick of mainstream media’s economic coverage. We know, in fact, that our so-called Fourth Estate has the collective IQ of an underachieving adolescent. We know this because the mainstream media utterly failed to cover the oncoming credit crisis. They did so even as rational analysts were screaming that Fannie Mae and Freddie Mac were headed for a cliff. When the media spin current events, remember how wrong the pinheads were until now.”

Patrick goes on to show that unemployment in the Great Depression didn’t soar until after the market crash of 1929.  The worst joblessness of that era began a year later, after the Smoot-Hawley tariffs were passed… then really took off in 1932 when the new administration came in with promises to “fix” everything. Then, unemployment skyrocketed, culminating with one in four Americans out of work by early 1934.

If you’re currently an Agora Financial Reserve member, read the rest of the story — including Cox’s explanation of how and why nuclear will “go green” in 2009 — here. If you’re not currently a member, you still have 48 hours to claim your spot and get AF’s top level of research for life… at a substantial discount.

  “I wonder how,” a reader begins, “the National Retail Federation expects President Obama to help retail sales by reducing sales taxes when President Obama does not run the states. Have they forgotten that states charge, collect and spend those sales taxes?

“A point that doesn’t seem to be made often enough is that the $20 billion in savings is fraudulent. Forgetting for the moment the obvious indirect costs, if the states get $20 billion less, then they will have $20 billion less to spend. The citizens who save $20 billion will then have $20 billion in fewer state services to enjoy. The retailers are losing too. The states in which they are located will be forced to raise fees on retailers to make up for the lost revenue.

“Even if the NRF is able to correctly state the request to an Obama administration, and then somehow get that $20 billion from the federal government, it is still a robbing Peter to pay Paul situation. Now the federal government will have $20 billion less to put into other programs on behalf of its citizenry. And the money doesn’t exist anyway!”

  “Igor Panarin’s prediction,” writes a reader, referring to yesterday’s 5 , “that the United States would proceed into civil war and could conceivably split up into six pieces is the kind of drivel that would come from a former KGB member. He’s either highly delusional, is processing our financial hard times through the lens of Russian political history or is just trying to get some notoriety by trying to come up with something so far-fetched that the bored journalists will run this ‘hot’ story.

“The freedom of speech that our country provides pretty much guarantees that the majority will always hear the whining and complaining from countless minority and special interests. This may give outsiders the impression that this country is divided and morally depraved. Despite our shortcomings, the majority of the U.S. population knows that this is still the best country to live in and will fight to our last breath to keep it a single, sovereign nation.

“Although, I do have to admit that there would be some humor in seeing someone like Nancy Pelosi bow to the directives of Hu Jintao.”

  “Although I tend to agree with Igor Panarin,” writes another, “that the U.S. may undergo a ‘disintegration,’ I believe it will be more economic, with associated food riots, rising crime and other symptoms of a society in decay/distress. What will not happen is a partitioning of the U.S. proper to the wannabe superpowers.

“Why? The U.S. has 270 million firearms, out of a total of 650 million civilian-owned firearms worldwide, approximately 90 small arms per 100 citizens. We who have prepared will certainly insist (over my dead body) against any foreign state assuming control or ‘reversion.’ Besides, these entities have as much, if not bigger problems, than the U.S., except for, maybe, Canada.”

Happy New Year, eh?

Addison Wiggin
The 5 Min. Forecast

P.S. Again, we’re running the best deal of the year for our highest level of investment research and insights. But the offer ends in 48 hours. Don’t delay. Before too long, you’ll have champagne and streamers competing for your attention and you may miss out. Check it out, right now.

All voting is a sort of gaming, like checkers or backgammon, with a slight moral tinge to it, a playing with right and wrong, with moral questions; and betting naturally accompanies it. The character of the voters is not staked. I cast my vote, perchance, as I think right; but I am not vitally concerned [...]

By Chuck Butler. "The Japanese yen, however, is set to book a performance in 2008 that is the best we've seen from yen, in 20 years! WOW! Shoot Rudy, that's longer than I've been writing the Pfennig!"

• Home prices fall… again. The latest record-setting swan dives
• Chris Mayer on how to spot the bottom… and what to buy when it comes
• World’s biggest companies hold shockingly little cash… global market in the hands of Buffett, China
• But can China capitalize? Byron King on how China has “reached its pinnacle”
• Russian professor predicts end of U.S. by 2010… will Houston be taking orders from Mexico City?
• Plus, your prophecies for 2009… and The 5’s editors issue a forecasting challenge

  Like a crackhead kicking a trash can reverberates through your hangover headache, the folks from the S&P/Case-Shiller Home Price Index updated their data this morning:

“Home prices are back to their March, 2004 levels,” reports David Blitzer, one of the index’s stewards. “Both composite indices and 14 of the 20 metro areas are reporting new record rates of decline. As of October 2008, the 10-City Composite is down 25.0% from its mid-2006 peak, and the 20-City Composite is down 23.4%.”

Phoenix, Las Vegas, San Francisco, Miami and LA remain the worst housing markets in the country, in that order. Dallas and Charlotte are the “bright” spots, having fallen only 3-4% annually.

The entire financial world had placed a wild bet that house prices in the U.S. would go up indefinitely. The year 2008 will go down in history as the year that proved them wrong… and then all hell would break loose.

  The reverberations will continue to reach far and wide in 2009. As a sign of things to come, the first post-Christmas retail bankruptcy occurred Monday. “Parent Co.,” an ironically named retailer of children’s products, filed Chapter 11 yesterday. Our bold, out-on-a-limb forecast for the day: They will not be the last.

Parent Co. joins the ranks of well-known bankrupt retailers like Circuit City, Boscov’s, Sharper Image, Mervyn’s, Linens ’n Things, Whitehall Jewellers and Steve & Barry’s

  “If some miracle doesn’t happen,” notes Bill Bonner, “this will go down as the worst year in Wall Street history. Worse than ’29? A lot worse.

“1929 had been a big winner for investors before the crash began in the last quarter. When the champagne was finally poured on New Year’s Eve, investors were less than 10% below where they began the year.

“This year has been all bad. Investors are looking at a loss over 40%. The typical investor in the stock market has probably lost half his money.”

  U.S. indexes showed no indication of a year-end miracle yesterday. The Dow inched down steadily as the day progressed, fueled mostly by Middle Eastern news — Kuwait’s broken deal with Dow Chemical and the war in Gaza.

Without any compelling reasons to buy, most major indexes drifted down about 0.3%.

  History suggests sluggish and lame markets can — and do — last for much longer than most investors believe is possible. Exhibit A: The Japanese stock market closed out 2008 this morning — its worst year ever – long after its equity and real estate bubbles popped in the early ’90s.

Despite the Nikkei 225’s 1.3% rise today, the index fell 42.1% for the year. The closest comparison would be the 39% annual dive in 1990, after the great Japanese stock bubble popped so magnificently. Still, even compared to that incredible fallout, 2008 takes the cake.

The Nikkei closed today at 8.859. Another 10% or so, and the Japanese market will be flirting with a 25-year low. How does one say “ouch” in Japanese? Itai!

  Rather than commit hari-kari… let’s do something unusual and try to think, umn, positive… it is the holidays, after all. How will we know when the bear market is bottoming? And what should we buy when it does?

“Normalized earnings for the S&P 500 could be $60-70,” Agora Financial’s managing editor, Chris Mayer, opined this morning, taking a shot at an answer.

In layman’s terms, that’s a possible low of 600-700 for the S&P 500… 30% lower than it is today.

“The S&P at 600 is entirely possible,” Mayer continues. “So we could have more room to go. But it doesn’t have to go there. Signals to watch — when earnings stop falling quarter to quarter. I actually think we’ll see a big rally early 2009 a la 1930, when the Dow was up 48% from its bottom by April. Big rally coming, and that will be your last chance to dump your weaker holdings.

“If you are going to invest in stocks in 2009,” Mr. Mayer suggests, “stick with hard assets, management teams with proven track records, strong balance sheets and businesses with good disclosures (i.e., no black boxes or funny business). Ag-related stocks will have a good year, I think — fertilizer stocks, in particular. Oil stocks will come back, too, particularly oil field service stocks.

“Natural gas stocks will do even better, particularly the low-cost producers.

“I think now is a good time to pick up India’s blue chips, if you can sit with them for a while. I like emerging markets still. This is a pause, and not the end, of the emerging market growth story. It’s much bigger than most people think. India has less exposure to exports than China, has a lot of savings, little debt, a very young population (half under the age of 25) and some leading companies dirt-cheap…

“Lots of problems, to be sure, as all emerging markets do, but India will come back.”

  Of the 100 biggest companies in the world by market value, only 29 are in a net cash position — more liquid assets than debt.

Here are the top four, as listed by the Financial Times:

Berkshire Hathaway — $106 billion in net cash
Bank of China — $101 billion
Industrial and Commercial Bank of China — $89 billion
China Construction Bank — $82 billion

If this isn’t a sign of the times, we don’t know what is.

  But “the Chinese growth miracle has reached its pinnacle,” opines our Byron King, contrary to the evidence above.

“During the run-up to the Olympics, the Chinese government closed tens of thousands of factories in and around Beijing, just to control the air emissions and help to create blue skies for the Olympiad. It seemed to work as pageantry. By the time the marathon runners were trotting past the Great Hall of the People, Beijing looked like a picture postcard in its splendor.
 
“But how many of those closed factories have not yet reopened? All across China, we now learn, several hundred thousand factories are closed, with numerous millions now unemployed. All across the Middle Kingdom, owners and investors are closing factories faster than they are opening new ones. The export-led model of development has hit the rocks. Exports are down, incomes are falling, labor strife is up. This is bad for social harmony.
 
“It will doubtless get worse in 2009. Yet the larger truth is that China’s problem is part of a global phenomenon. From New York to London to Dubai to Shanghai, trillions of dollars of global capital have vanished — wrecked by deleveraging and associated market losses. The global banking system is in ruins. Trust is ofttimes gone, and scarce in the best of cases. Capital flows are being interrupted by new Chinese Walls the likes of which not even ancient emperors could have dreamed.

“With the export model broken, the mercantilist money machine is also perturbed. This will impact — negatively — Chinese willingness to continue to buy U.S. Treasuries. Which will impact — negatively — the U.S. ability to fund its chronic national deficits and long-term debts.”

  The other hallmark drama for the year continues unabated. The U.S. Treasury piled us all deeper in debt last night when it threw GMAC a $6 billion life preserver.

Turns out the auto loaner couldn’t wait for its “bank holding company” upgrade from the Fed. Thus, Paulson and company were “forced” to pull another $6 billion from the TARP to keep GM’s financial arm afloat. $5 billion will be loaned straight to GMAC, and the government will get an 8% coupon. The other billion goes to GM, which has been ordered to increase its 49% stake in GMAC.
 
The results of GMAC’s huge debt-to-equity exchange Friday are still a mystery. Judging by the Treasury’s sudden injection, it didn’t go so well.

  Unfortunately, the initial phase of Paulson’s bailout plan, the clunkily acronymed TARP, is already out of money. The $6 billion going to GMAC is actually money that’s already been allocated toward the bank recapitalization project.

If Congress does not approve the second half of the TARP bailout, the Treasury will bounce some pretty large checks.

  Following events from a safe distance, a former Russian KGB analyst says the outlook for Americans is dire. And predicts the breakup of the United States by mid-2010.

"There’s a 55-45% chance right now that disintegration will occur," Igor Panarin told The Wall Street Journal this morning. "One could rejoice in that process. But if we’re talking reasonably, it’s not the best scenario — for Russia."

“Mr. Panarin posits,” according to the WSJ, “that mass immigration, economic decline and moral degradation will trigger a civil war next fall and the collapse of the dollar. Around the end of June 2010, or early July, he says, the U.S. will break into six pieces — with Alaska reverting to Russian control.”

But the professor is not necessarily happy about it. “Though Russia would become more powerful on the global stage,” he says, “its economy would suffer because it currently depends heavily on the dollar and on trade with the U.S.”

Hmmn… we’re trying to imagine some cowboy from Bakersfield submitting to Chinese rule. Or a Texan taking his orders from Mexico City. Heh.

  After briefly falling below 80 yesterday, the dollar index has stabilized around 80.6 today.  
The euro and pound are on the verge of parity for the first time ever. The pound, slammed by a large U.K. recession, housing crisis and lower-than-normal rates, has weakened to 98 pence per euro. Year to date, it’s down 25% versus the multination currency.

The approaching parity is reflected in the dollar exchange, as well. A euro today goes for $1.40… the pound a “mere” $1.45.

  Commodity traders are taking profits today after Monday’s rally. Oil jumped as high as $42 a barrel, before retreating to $38.
 
Ditto with gold. It rose as high as $885 yesterday, but goes for just above $870 as we write.

 “I believe oil and gold are the places to start getting well positioned in for 2009,” writes a reader, “if one hasn’t already. Oil especially is being primed for a V-shaped recovery. If investors are paying attention, they understand that the unrealistically low price of oil is just that — unrealistic.

“Many oil and gas exploration and production projects have been shelved due to the financial crisis and falling price. Some major oil exporters have exhausted their reserves, Mexico being one. Oil exploration and production require oil prices to be over $100 to be profitable. OPEC drastically cut production levels, due to falling demand. Problems of shortages and spiking oil prices are looming.

“Gold is also primed for a spike as the bailouts and stimulus package get under way. Great way to make up for the losses in 2008 if you’re ready for the ravages that will come along with this!”

  “I believe 2009,” writes a reader with his own year-end forecast, “is going to be the beginning of a ‘rich get richer’ story that will reach levels never previously even imagined. This is how I see it playing out. There are many solid companies that have more than sufficient cash to get through the upcoming tough times, but are trading at huge discounts to their historic value. At the moment, the real estate- and energy-related sectors seem to have more of these companies than some other industries, but they exist everywhere. As is often the case, Mr. Market has overreacted and taken down the good with the bad.

“I predict that once there is even a hint that the economy is starting to turn around, there will be a flood of leveraged buyouts whereby those with access to cash will be buying the best companies for a fraction of even their future one-three-year value. And the banks will rush in to provide the financing with the cash they got from the Fed and currently have sitting on the sidelines.

“Bottom line is that Joe the Plumber will find out about a year from now that the only companies still in his portfolio are the companies that the buyout companies did not want. For buyout firms like KKR and Carlyle, this is going to better than robbing a bank, since it is legal. I suggest you provide some guidance as to how to share in this upcoming M&A activity.

“Even a master list of companies that are beaten down but still are earning good money and have plenty of cash would be a start.”

The 5: We’re on it.

Regards,

Addison Wiggin
The 5 Min. Forecast

P.S. While we’re at it, we’d like to propose a little contest. Some background: Yesterday, we were in LA recording some last-minute commentary for the bonus features being released with the PBS Home Video edition of the I.O.U.S.A. DVD. In preparation, we had a short conversation with Bob Bixby, executive director of the Concord Coalition and one of the protagonists of the film. He suggested that the projection of a $1 trillion deficit for the federal government in 2009 is extremely “conservative.”

Patrick Creadon, the film’s director, said he thought it would come in at $1.3 trillion. I reminded him that if you include all the bailout funds, stimulus packages and structural imbalances of the federal budget, the feds have already spent over $2 trillion in FY 2008. We were going to arm-wrestle… but then thought of a better idea: Let’s hold a contest among readers of The 5.

Who can guess the deficit in 2009? We’ll have to pick a date for final entries… cook up some ground rules… and establish a nice prize for giving it a shot. But if we’re going to witness the financial destruction of the great American republic, we might as well have some fun doing it. You game?

P.P.S. Don’t forget, you’ve got less than three days to take advantage of our deepest discount of the year. Learn about this massive savings, here.

By Chuck Butler. "Remember those wild swings I talked about yesterday? The wild swings that could be a result of thin volumes in this the second week of Christmas. Well... We witnessed them in earnest yesterday!"

I heartily accept the motto,—”That government is best which governs least”; and I should like to see it acted up to more rapidly and systematically. Carried out, it finally amounts to this, which also I believe—”That government is best which governs not at all”; and when men are prepared for it, that will be the [...]

By Chuck Butler. "The currencies had a split personality while I was gone too... At first, they rallied like there was no tomorrow, but then sold off, and then range traded. So, we'll finish the year on a down note for most of the currencies"

by Addison Wiggin & Ian Mathias

• How to profit in 2009:  Think like a Fed governor
• A “mere” 25 banks failed in 2008… proof that the FDIC expects many more next year
• Retail on the brink… preliminary reports suggest holiday consumption even lower than anticipated
• So who will thrive in 2009? An unsavory list of stocks prime to benefit from a lousy economy
• Middle East moving markets… why news from Kuwait and Gaza is affecting your portfolio today
• Byron King on the $200 billion consumer bailout Congress never passed

  “The key to approaching 2009,” writes Dan Amoss today, kicking off our week of New Year forecasts, “is to view everything form the perspective of the Treasury and the Fed, as distasteful as that may be. Everyone knows that the real economy stinks and we have too much debt. I doubt everyone realizes just how extreme Treasury/Fed will be in using the deficit and the paper money system to stop the Great Depression 2 scenario.

“I expect the inflationary bailout initiatives to start attacking deflationary forces from the ‘flank,’ to use a military term. The banking system destabilized because its collateral — houses and mortgage backed securities — collapsed in 2008. While the authorities may not be able to reinflate old bubbles, I’m betting they can employ cheap Treasury financing to cushion the decline. This involves refinancing homeowners out of toxic mortgages into conventional mortgages. They’ll also find some way to deal with the problem of negative home equity, even if it involves highly inflationary tactics like Treasury assuming losses from principal reductions via Fannie and Freddie, and if foreigners balk at absorbing new Treasuries, the Fed will monetize them. If so, we could see a fast track to the gold and oil bubbles that I predicted last year.

“In markets, it’s far too easy and popular to be bearish on everything but Treasury bonds, so odds favor a sharp rally in early 2009 — a rally in the S&P 500, led by stocks with the most sustainable fundamentals, including energy, commodities and infrastructure. Stocks with weak fundamentals may participate, but quickly roll over as economic reality sets in. Many will go to $0 in bankruptcy.”

  The Fed’s latest bailout target? GMAC, the financial arm of GM. Bernanke and company granted GMAC the mythical status of “bank holding company” late last week. Like Goldman Sachs and American Express, GMAC is set to join the group of about-to-fail financials given last minute access to the Fed’s discount window, and potentially TARP funding.

That’s great news if you’re in GM’s corner. GMAC handled roughly 35% of GM’s retail loans in 2007. Thus, a GMAC failure would be, umm, less than ideal for the doomed automaker. Shares of GM popped 13% Friday on the news.

But GMAC isn’t an official bank holding company yet. Part of the Fed’s deal stipulated that GMAC successfully conduct a complicated debt-for-equity exchange by midnight Friday. Long story short, that deadline came and went, and GMAC spokespeople won’t say if they pulled it off.

  Twenty-five banks went under in 2008. We’re surprised to report the FDIC had a quiet Christmas weekend, without a single last-minute financial failure. And given their propensity for weekend takeovers, we’ll guess that there will be no more bank closures in 2008.

Granted, 25 is the most since the S&L crisis that plagued the ’80s. We set some records in 2008 too, like Washington Mutual, the biggest bank failure ever. But still, just 25 banks… doesn’t that feel a little too easy?

The FDIC thinks so — 171 institutions remain on their “problem list.” They’ve already doubled the budget for 2009, to $2.2 billion. According to American Banker, most of that money is headed to the FDIC’s “resolution and receiverships” division, which plans on hiring another 800 bean counters to help deal with rising bank failures.
 

  We expect a healthy share of retail failures in 2009 too. The latest shred of evidence: From Dec. 1 to Christmas Eve, total retail sales (excluding autos) fell 8% year over year. That’s even worse than November’s 5.5% plunge.

We admit, these MasterCard stats are skewed. If you factor out gasoline, retail sales are down “just” 2.5% in November and 4% in all but the last week of December. But even without gasoline sales… once the final tallies come in, we suspect this Xmas retail activity will be declared the worst on record.

  And if you thought wealthy shoppers and high-end retailers were immune to this holiday funk, you were wrong. Check out this interesting breakdown from today’s WSJ:

  No surprise, the National Retail Federation is the latest group to beg for a government bailout. The country’s laregest retail trade oganzation petitioned Barack Obama last week to add a series of tax-exempt shopping days to his “New New Deal” stimulus package. The NRF wants three 10-day periods of tax-free shopping in 2009, which the group estimates would save consumers up to $20 billion.

As evidenced by our coverage above, consumers failed to open their wallets when retailers offered huge, desperate holiday discounts… why would they rush into stores for a 6% tax break?

  So who will thrive in this retail apocolypse? If you insist on consumer names, the people at breakingviews.com might be on the right track. Behold its “Poor Getting Poorer Index.” As the site describes it, “a basket of 22 equal-weighted stocks that includes the retailers, white-label manufacturers, repossession agencies, dollar stores, pawnshops and other public companies poised to capitalize on rising poverty.”

Over the last 12 months, this motley crew index is up 9%. Considering the S&P 500’s 40% fall over the same period… not too shabby.

  Stocks muddled through last week, ending down just a bit. Low volume and more weak economic news pushed the Dow down 0.7% for the week. The S&P 500 fared worse, down 1.7%, and the tech-heavy Nasdaq kept with its volatile ways, falling 2.1%.

This morning, it’s looking about the same. Stocks are slowly drifting down, led mostly by this bit of news:

  The government of Kuwait backed out of a $17 billion deal with Dow Chemical today. The Kuwaiti Cabinet said they feared the worldwide slowdown could bring “unpredictable consequences to any global firm” and that the deal was just too risky. Now that oil’s under $40 a barrel, we suspect they’ll be spending petrodollars a bit more thoughtfully.

The two groups were planning to establish the world’s largest maker of polyurethane.

  The price of oil soared 8% this morning after Israel’s somewhat-surprise attack in Gaza over the weekend. While Israel and Hamas renew their battle over the holy land, oil traders are a bit worried about Middle Eastern supply chains. Oil was due for a day up anyway… this morning’s rally snapped a nine-session losing streak.

Thus, light sweet crude popped to just over $40 a barrel.

  Gas prices, on the other hand, have found a new credit crisis low. The national average fell for its 10th consecutive day this morning, to $1.61. You’d have to travel back to February 2004 to find gas that cheap… amazing. Prices are down over 60% from July’s record high of $4.11.
 
“The U.S. Energy Dept. statistics state,” writes Byron King, “that the nation burns about 9.4 million barrels of gasoline per day. That’s about 395 million gallons (at 42 gallons in a barrel). Let’s say a gallon of gasoline is $2.75 cheaper than it was back in July, when I was paying $4.40 per gallon. Take 395 million gallons per day times $2.75 savings per gallon. That’s almost $1.1 billion PER DAY that U.S. consumers are saving at the gasoline pumps. That’s over $32 billion per month of savings, or about $200 billion over six months.
 
“$200 billion? As the saying goes, ‘Show me the money.’ In a sense, the world oil industry has given the American people a huge tax cut. Or call it a ‘bailout bill’ for consumers, except that Congress did not borrow the money to fund it. And that $200 billion is not just money coming out of the hides of Big Oil and those betes noires like Exxon Mobil or Chevron. No, this is a $200 billion cheap-oil tax cut paid for by the sheiks of Araby, Mr. Putin of Russia, Generalissimo Chavez of Venezuela and Mr. I’m-a-Dinner-Jacket of Iran. Could not happen to a nicer bunch, eh?

“So American consumers are receiving a benefit that could be worth, say, $200 billion over six months. But there’s no addition to the national debt, and it’s being paid for by people we don’t like very much. Win-win, right? That’s the best kind of tax cut.”
 
Of course, cheap oil and gas have downsides too. For Byron’s full account, read your latest Outstanding Investments alert. 

  The violence in Gaza gave traders another reason to sell the dollar today. As we write, the dollar index is down a full point, barely clinging on to 80.

  The Russian ruble remains the currency headline of late. Last month, the Russian government snipped the trading band between the ruble and a basket of other currencies… considering the crashed prices of oil and gas, the ruble deserves to be taken down a few notches.

The Russian currency has since plummeted to a four-year low versus the dollar and an all-time low compared to the euro. This morning, it’s down another 1.5%

  The sum of today’s entire issue equals a nice day for gold. For all that we’ve mentioned above, the spot price is up $30 from Friday’s close, to $880 an ounce.

  “I think 2009 will be a wall-to-wall year of pain and languor,” writes a reader offering his New Year forecast. “But I can’t imagine how the bottomless bailouts and desperate war against deflation don’t undo the dollar to even greater levels. Gold will come back more than it has by the fall, if not a little earlier, when the Obama "honeymoon of hope" starts to wane.

“It will take longer for oil to rebound, because that needs the economy to look like it’s warming up again. But the Peak il problem is still out there unresolved. And even though this would be the right time to invest in a disciplined way in energy alternatives (when there’s some breathing room in the energy prices), we will face that issue again, and even more bluntly than before. Buy oil now while it’s cheap.

“Likewise, I can’t help but think that as much as the "E" in P/E is going to suffer over 2009, those companies that have the cash and business advantages will rise once again. Buying now might be buying before a further drop. But prices on a lot of stocks are already good. Catching a lot of future upside would be worth, probably, even a little more of the more immediate downside. If you’re buying with your eyes open.”

The 5: Sounds about right.

If you would like to share your 2009 outlook, send it on over, here: 5minforecast@agorafinancial.com

  “So your parent company’s home office,” writes our last reader, referring to last Tuesday’s issue , “is two blocks out from the red-light district… Am I the only one saying, ‘Now that explains a lot’?”

The 5: Heh. Well, it was our first headquarters here in “Charm City.” We’ve since moved to a slightly more comfortable locale. And that same red-light district is about one block from the mayor’s office, most of the city government and courts and police HQ. That should “explain a lot” about Baltimore too.

Thanks for reading,

Ian Mathias
The 5 Min. Forecast

P.S. Don’t forget, today is your last chance to save 50% on our shiny new currency letter, Master FX Options Trader. After midnight tonight, we’ll jack up the price quite a bit. So if you’re interested, now’s the time… details here.

Agra, India

• Fan & Fred: The end of the road for America’s giant mortgage lenders,
• Back when a 237-point fall in the Dow was still considered “ugly,”
• Gold in ’09, the difference between a jiggle and a jaggle and plenty more…

Joel Bowman, reporting from Agra, India…

The two largest mortgage companies in the United States of America will be penny stocks before the end of the year. If someone said that to you on New Year’s Day, 2008, you might have scoffed.

“Sure there are problems out there,” you might concede, “but Fan and Fred enjoy the implicit backing from the U.S. government. They’ll never go under.”

During the peak of the real estate bubble inflation, 2004, shares of Fanny Mae traded hands for about $80. Freddie’s were as high as $73.70. Now the once almighty bastions of debt change hands for about $0.75.

So, what happened?

In today’s installment of the 2008 Best in Rude Series, originally published back on July 10, Eric Fry and Bill Bonner examine the real estate storm before the monsoon. Enjoy…

—————————————–

Eric Fry, reporting from the land of milk and honeys…

As the risk of stating the obvious: It’s getting ugly out there.

The Dow Jones Industrial Average stumbled 237 points yesterday to a new two-year low of 11,147. After yesterday’s carnage, the Dow, the S&P 500 and the Nasdaq Composite all sit more than 20% below their highs of last October.

Buying stocks isn’t as fun as it used to be.

Crude oil, the enfant terrible of the financial markets, can claim no credit for destabilizing shares prices yesterday. The price of crude barely budged all day.

Unfortunately, the shares prices of Fannie Mae and Freddie Mac budged dramatically…to the downside. Fannie dropped 13% while Freddie tumbled 24%. As these two financial bellwethers slumped ever lower, the rest of the stock market followed. Shortly before the closing bell, Freddie dipped below $10 a share – its lowest “print” since 1992.

The proximate cause of this drubbing in the financial sector was the news that Fannie Mae paid a record-high interest rate (relative to Treasury yields) to sell $3 billion of new two-year notes. In bond market parlance, Fannie paid 74 basis points over Treasuries – or triple the spread it paid two years ago. 74 “bps” over Treasuries would not be a newsworthy item, if not for the fact that investors have spent most of the last two decades believing that the bonds issued by Fannie and Freddie were “as good as Treasurys.”

Now that this naïve assumption is eroding away, investors are beginning to fear that Fannie and Freddie might not even be as good as WaMu or Countrywide. Without the U.S. government’s implied backing, Fannie and Freddie scarcely resemble the AAA credits they purport to be. In fact, former St. Louis Federal Reserve President, William Poole, refers to both of these lenders as “insolvent.” As Poole explained yesterday, Freddie owes $5.2 billion more than its assets are worth.

“Congress ought to recognize that these firms are insolvent,” Poole griped, “It is allowing these firms to exist as bastions of privilege, financed by the taxpayer.” Many investors in the private sector seem to agree with Poole’s assessment, as they mark down the value of Fannie’s and Freddie’s shares and mark up the cost of insuring against a bond default by either company.

Fannie and Freddie might not be insolvent, as Poole asserts, but they are certainly in trouble. Since both companies hold trillions of dollars worth of mortgages, balancing assets and liabilities is no small task. One little jiggle here and you’ve got an “adequately capitalized” financial institution. But one little jaggle there and you’re heading to bankruptcy court.

This we know: Fannie and Freddie are both extraordinarily leveraged companies. Both companies live on the razor’s edge between prosperity and disaster. They always have. As long as home prices were rising, extreme leverage posed no problem whatsoever. In fact, it was an attribute. But now that the housing market is imploding, extreme leverage is creating an extreme problem.

A large amount of leverage is almost never a good thing folks, especially not when the asset side of the leverage is losing value rapidly. This simple observation inspired your editor to produce the image below for a 2004 speech he delivered in New Orleans. He did not actually believe that Fannie and Freddie would perish, but neither did he rule it out.

Even now, he doubts that Fannie and Freddie will perish. But he does not doubt at all that they will become two of the newest and largest additions to the Federal budget.

Any rescue mission on behalf of Fannie and Freddie will require some form of “monetary re-liquification,” also known as “dollar printing.” So the closer that these two gargantuan mortgage lenders move toward genuine insolvency the more we investors should want to sell dollars and buy gold…At least that’s our best guess.

—- Bulletin Board Elite – Final Positions —-

The first time, I called it beginner’s luck…

When it happened again, I called it a coincidence…

But after 9 stocks in a “secret” market one ace analyst was screening JUMPED to major exchanges - and major profits - in just a 12-month span, I knew he was hunting in the right place for huge gains.

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The Woes of Fannie and Freddie
By Bill Bonner

Freddie Mac and Fannie Mae are to America’s great empire what the East India Company was to the British Empire in the 19th century…and the Louisiana Company was to France in the 18th. Huge, stupid, and probably fatal.

Freddie and Fannie are huge government-chartered mortgage lenders. In 18th century France, speculators bet on the riches of Louisiana, through the government-chartered Louisiana Company. In the 19th century, they wagered their money on the riches of India, through the government-chartered Eastn India Company. And in the 20th century, they gambled on rising housing prices through Fannie and Freddie.

The immediate problem is that the mortgage lenders are running out of money. They need to raise $75 billion. A few years ago, that would have been no problem.

Everybody was ready to put money into America’s go-go, securitized housing market. But then, housing went.

Yesterday’s news tells us that housing prices are falling in 23 out of 25 U.S. metropolitan areas. That, according to Case/Shiller. Foreclosures are still rising at a faster and faster pace. Etc. Etc.

(We’re sparing you the details…we don’t want to upset you too much, dear investor.)

So now, Freddie and Fannie have a problem. They need to raise money - a lot of it. And now it has become “very difficult,” say the experts, to raise that kind of dough. Investors are slowly putting two and three together. The pair of mortgage lenders needs more cash. Their industry is in full flight. Their capital is disappearing.

Their collateral gets marked down every month: “Hey, maybe we should sell the stock!” The result of these deliberations was a bad day on Wall Street for the twins, bringing total losses into the billions for remaining stockholders, who were too slow or too dull to sell their shares.

And for the faithful and/or delirious masses who continue to cling to their Fannie and Freddie shares, the bad news has not yet abated. The giant mortgage lenders must still raise even more capital to cover their mounting piles of defaulting mortgage debts. Freddie and Fannie still need to raise money…lots more money. And if a report leaked from Bridgewater Associates turns out to be correct, so will a lot of other businesses…and governments. Bridgewater’s confidential memo - which got out to the Swiss press and then made its way to Ambrose Evans-Pritchard at The Telegraph in London - says that losses from the credit crunch could go as high as $1.6 trillion…four times as high as official estimates from the IMF.

And it only gets worse…

One trillion, six hundred billion dollars is a lot of money. If Bridgewater is right, the whole financial sector will be gutted. You’ll remember, dear investor, after manufacturing pulled out of America, the financial industry was left. And retail. Housing. Services. And not much else. The center of economic power shifted from Detroit and Trenton - where they made things - to Manhattan, where they financed them. Mothers ceased wanting their babies to grow up to be CEO of General Motors; they wanted them to go to Wall Street. That’s where the real money was. Finance was the key not only to huge profits itself, but also to the growth of the retail and housing sectors. People bought durable goods and consumer goods on credit. No credit; no purchases. No purchases; no consumer economy.

Well, now GM has lost 75% of its value…and the financial industry is not far behind.

Well, Bridgewater goes on to say that a $1.6 trillion loss in the financial industry will mean a loss of $12 trillion in credit to the economy as a whole. When the lenders don’t have capital, they can’t lend it out. Typically, they lend $10 for every dollar of capital. So if a dollar of capital is wiped off their balance sheets, as much as $10 of credit is erased from the economy.

Here in Europe, we’re used to high prices. One billion? Heck, we spend that much on lunch. But $12 trillion begins to sound like real money. And $12 trillion taken out of the U.S. consumer economy begins to sound like the Great Depression. Like Japan, 1990-2006…only worse. Collapsing asset prices. Rising unemployment. Bankruptcies. Defaults.

Of course, no central bank or government will go into that good night without a fight. The Fed will cut rates…and lower reserve requirements…and probably intervene directly in markets. Banks will be effectively nationalized…The federal government will increase borrowing and spending to try to offset the money disappearing from the markets and the economy.

What about the foreigners? What about Sovereign Wealth Funds? They’ve got a lot of money. Couldn’t they help recapitalize the credit system? Alas, the SWFs have only $3 trillion currently. And the foreigners? Our guess is that when they realize what is happening they will be desperate to get rid of dollars and U.S. paper of all sorts.

Instead, they’ll want real resources, factories, brands, concrete and land. And they will have a great opportunity. As asset prices fall, they will be able to buy more valuable properties in America at bargain prices. Already, Abu Dhabi bought the Empire State Building. A Belgian brewery, run by Brazilians, is buying Budweiser.
More to come…

How’s our “Trade of the Decade” doing? Eight years ago we suggested you sell stocks and buy gold. The bull market on Wall Street was over, we thought. A bull market in gold was just beginning.

As far as we can tell, we were right.

The S&P is down about 20% from its high…which puts U.S. stocks barely lower than they were in 2000. But adjusted for inflation, the loss has been spectacular. Remember, oil has gone from around $10 a barrel to around $140 a barrel. Everything else has gone up too. Even by official CPI numbers, the year 2000 buck is worth only about 80 cents. And the dollar against the euro is down about 40%.

Real bear markets typically last 10-15 years. This one has another few years to go. These should be the most interesting ones. Commentators are already looking for a bottom in the stock market. They may have to wait a long time.

An ounce of gold would buy the whole Dow in 1926…again in the 1930s…and once again in 1980. If gold stays where it is, the Dow would have to drop below 1,000 for the gold/Dow ratio to return to one. More likely, the Dow will drop and gold will rise to meet it. In 1999, gold bottomed out at around $260 an ounce. Since then it is up nearly 5 times. The U.S. money supply, however, has gone up 11 times. So, our guess is that there’s plenty of upside left for the stuff they make dental fillings out of. If it were to equal the increase in M3, its price could rise to $2,700 or so.

This is all guesswork, of course. But the Trade of the Decade still looks good to us. Gold and the Dow will probably come together somewhere north of 3,000….

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[Rude Endnote: Thanks to all the Rude Readers who, over the last few weeks, have written in with helpful tips for your roaming editor.

Thanks especially to Kelly Russell for the helpful Internet recommendation when in Varanasi. Despite India’s deserved international reputation for IT savvy, the homeland infrastructure is still more challenging than dipping into a wi-fi café in the States or Europe.

We’ll check in tomorrow from the holiest of Hindu cities.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com

“Global Demand for Oil to Plummet,” screams a recent Financial Times headline.   Huh?  No it won’t.  Who are they trying to kid? Global oil demand is not going to “plummet.”  And for the FT to say so is just plain silly, if not irresponsible.  OK, I know.  There’s an old saying that they teach in journalism [...]

Zounds! Public sentiment toward the accelerating economic fiasco has shifted, seemingly overnight, from a mood of nauseated amazement to one of panicked grievance as the United States moves closer to an apparent comprehensive collapse — and so ill-timed, wouldn’t you know it, to coincide with the annual rigors of Santa Claus. The tipping point seems [...]

One of the most hotly debated topics among financial talking heads these days is, “Deflation or inflation, what is it going to be?”  There is no question that we are currently experiencing asset price deflation and economic slowing. But we, the editors of The Casey Report, see this as a transitional phase. In our analysis, the [...]

Laguna Beach, California

·      A look back at the ongoing catastrophe that was, is and will most likely be,
·      One spooky-clear forecasts from this year’s Value Investing Conference,
·      Merry Christmas Holidays from Team Rude and plenty more…

Eric Fry, with visions of sugarplums dancing through his head, reports…

Steven Romick called it!…and we were there.

During a May 7th presentation to the Value Investing Congress in Pasadena, California, Romick cited chapter and verse of the bearish case against brokerage stocks…and presented an impassioned and compelling argument for selling them short.

Romick warned about “a potential Financial Armageddon from even a partial unwinding of hundreds of trillions of dollars of off-balance sheet of derivatives,” while also singling out Lehman Bros. as a particularly vulnerable institution.

But your editors did not select this particular “Best of Rude” column just because Romick “told us so,” but rather because Romick’s analysis is a timeless example of the investment skepticism that breeds success, especially in tough markets.

So please enjoy the “Best of” column below. Alternatively, please enjoy the rest of your Christmas Day.

Merry Christmas from the team at the Rude Awakening!

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Eric Fry, reporting from Laguna Beach, California…

Many generations of investors have trusted in Moody’s infallibility. One generation of short-sellers has scoffed at the notion. The financial markets have settled the dispute: Moody’s is fallible.

Throughout the illustrious 99-year history of Moody’s Investor Service, the esteemed rating agency has enjoyed a Pope-like reputation for infallibility. Moody’s dispensed its ratings like so many papal bulls, thereby establishing a sacred canon for generations of fixed-income investors.

“Moody’s said it. We believe it. That settles it,” served as the approximate due diligence process that vetted trillions of dollars worth of bonds throughout the entire 20th century and the first seven years of the 21st.

But this dubious underpinning of the American capital markets began to crumble sometime around mid-2006, when American home prices finally stopped going up, and actually started going down. At that very moment, the benign macro-economic trends that had served Moody’s rating “system” so well began to degrade.

You see, dear investor, during robust economic times, even a CCC credit will perform like a AAA credit. But when times are tough, only a true AAA credit behaves like a AAA credit – all the imposters slide down the rating scale toward mere junk.

Alas, times are tough…very tough. In fact, times are particularly tough for any investor who trusted a AAA rating from Moody’s. Tens of billions of dollars worth of formerly AAA mortgage-backed securities have slipped into the murky depths of “non-investment grade” paper. Moody’s reputation and share price have followed a similar trajectory.

This downward trajectory gained fresh momentum Wednesday when Moody’s disclosed that a “computer glitch” may have caused the company to award AAA ratings to as much as $4 billion worth of securities that deserved much lower ratings.

Oops!

This revelation begs a follow-up question: “What sort of glitch cause Moody’s to award AAA ratings to hundreds of billions of dollars worth of mortgage-backed securities that deserved much lower ratings?”

News of the ratings snafu at Moody’s produced a stampede of would-be litigants, hoping to tear a bit of flesh from Moody’s hide. Shortly thereafter, Moody’s main competitor, Standard & Poor’s, downgraded Moody’s credit rating. Moody’s might survive these slings and arrows and atomic bombs of outrageous fortune. It might not.

Either way, weep not for Moody’s. It has lived a rich and prosperous corporate life. Weep, instead, for the innocents who trusted in Moody’s and who failed to recognize the hubris of awarding a AAA rating to a collection of junk credits, just because a computer-generated risk calculation assigns a low probability of disaster. A low probability, we now understand, is not the same thing as impossible. And being right a lot of the time, we now understand, is not the same thing as being infallible.

The analysts at Moody’s, despite their advanced degrees and high-powered computers, were never any more capable of predicting next year’s default rate on a AAA subprime CDO than a monkey with an abacus.

We do not fault Moody’s for trying to know the unknowable; we merely wince at the idea that highly complex, utterly unknowable, financial creations could ever garner a AAA rating.

Shun complexity, dear investor, and crave simplicity.

And if you’d like to get a better feel for the sort of complexity you might like to shun, please read the second and final portion of Steven Romick’s May 7th speech to the Value Investing Congress. Steven Romick, Senior Vice-President of First Pacific Advisors, Inc., is the portfolio manager of FPA Crescent Fund, FPA Hawkeye Fund, FPA Multi-Advisor Fund, and various separate accounts. He was previously Chairman of Crescent Management. http://www.fpafunds.com/mutualfundinvestors.asp

For those of you who may have missed the first half of Romick’s speech, please click on the following link: http://www.agorafinancial.com/afrude/2008/05/22/the-raw-deal/

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The Raw Deal, Part II
By Steven Romick

We expect that the market will likely show us a number of head fakes as 2008 continues. Beachgoers have seen a Great White Shark and they aren’t going to enter the water until they’re sure that it’s safe to swim. Their confidence level will increase commensurate with the time that has passed since the sighting; however, just because a dorsal fin has not been seen for a period of time, that does not mean the shark has left the area. We believe that this shark will be trolling our local beaches for some time to come.

Commercial and investment banks, insurance companies and other mortgage lenders and investors have taken cumulative write-downs in excess of $300 billion, to date. We do not believe that all such companies have come clean and, until then, we will neither hit bottom, nor have the capability to fully assess the damage to our financial system, and its economic impact. The International Monetary Fund estimates that the total worldwide losses in the financial sector will be just shy of $1 trillion, but that’s with subprime losses at $45 billion –and we’ve certainly surpassed that. The Sovereign Wealth Funds have been kind enough to inject tens of billions of dollars in equity in order to keep the wheels on the bus, but we can’t count on them. And, if they continue to “befriend” us, we accelerate the transfer of our national wealth to our children’s detriment.

The markets applauded JPMorgan Chase’s recent acquisition of Bear Stearns. We can only agree, as letting Bear fail could easily have led to a daisy chain of negative consequences to our currently fragi