DENIAL IS NOT A RIVER
IN
Denial
is always the first stage that marks the beginning of a Bear Market: There is
no better example than the one that can be seen when observing today’s real estate
market. What else would you call it besides DENIAL when every real estate guru
is calling for a bottoming of the market after only a year and a 5 to 10% (that
is assuming you accept the published numbers) or so price correction of the
biggest real estate bubble in American history? If you want to see what a real correction or
Bear Market looks like, just take a look at Japanese real estate: It topped out
in 1990 and here we are seventeen years later and it’s only now beginning to
see some life.
RAMIFICATIONS
OF A REAL ESTATE BEAR MARKET
Before
going any further, let me point out that 70% of the population owns their own
home (actually the banks own most of them) so although the real estate business
only represents 20% of the economy, it is really much larger than that.
Everything the analysts, media and politicians report as news is really ancient
history, spun to make it look like it’s what’s happening today. But even
yesterday’s news is not news, but really history. Looking in the rear view
mirror will only tell you where you have been; you better look out the front (forward)
window if you want to know where you’re going so you don’t crash into a brick
wall.
Stages of a Bear Market in Real Estate
1st Stage is the almost complete drying up of sales as buyers
refuse to pay up and as the number of real buyers (as
apart from shoppers) dwindles. At the same time sellers, still caught up in the
rising expectation hype, not only refuse to lower their prices but actually
raise them, having gotten used to houses being sold above their asking price.
2nd Stage There is a dramatic increase in the number of foreclosures.
This begins in the last stages of the boom, but dramatically increases as the
homeowners who cannot meet their obligations, can no longer refinance at lower
interest rates while extracting money to meet their obligations. As prices begin to first stabilize and then
turn down, they can no longer sell their home for any price that even remotely approaches
their outstanding mortgages and are left with no other choice but to mail their
keys back to the mortgage holders.
3rd Stage One by one, the sub-prime mortgage brokers shut
their doors and go bankrupt, but that is not the end of it. The brokers and banks that have packaged
these junk mortgages and sold them off to the public and institutions such as insurance
companies and pension funds have also securitized them and thus far, we have
not yet seen the carnage that will occur as $1.3 trillion of junk bonds comes
home to roost. As in every bubble that bursts (as they all must eventually do),
the BANKS are always left holding the bag. At least until the Government (read
Public) bails them out.
The banks are also in denial
as they attempt to cover up $ trillions in bad loans, using financial trickery
such as giving new fixed payment negative amortization loans to defaulted
borrowers in order to avoid realizing the losses while booking refinancing
profits instead. During the last real Bear Market (1973–1974), it was the
Trumps and the Memorex’s that they loaned additional funds to in order to bring
their payments up to date, so that they would not be forced to write off their
huge losses and damage their balance sheets. Here is how it works today: Suppose we take a
$400,000, 6% interest only mortgage, which comes to $2,000 per month, add
another $1000 for taxes and $1,000 for insurance and maintenance, for a total
of $4,000/month. The borrower is 6 months in arrears, so instead of foreclosing
the bank loans an additional $27,500 is loaned to them so that the arrearage
and refinancing charges can be paid, with a # year fixed payment negative
amortization loan costing $2,000/month because that is all the borrower can
pay. The result is that by the end of three years, the outstanding mortgage
stands at $499,500. ($400,000 +$27,500 + $72,000 {3 years at $2,000/mo negative
amortization}): All done in the hope that prices will increase 35% so that both
the bank and individual can get out whole in three years. Wishful
thinking? But in the meantime, the bank books a $3,500 profit instead of
writing off a bad loan of $400,000 but they will most likely write-off $500,000 in 3
years. Federal bank regulators using their Moral Suasion” have asked lenders to
be more cautious when making the high-risk loans and scrutinizing borrower’s ability
to repay them; thus marking the end to undocumented loans. The banks have now
“locked the barn door” after all the horses (read Money) have gone, drastically
tightening up lending standards, making sure that their wishful game plan can’t
possibly materialize. The final nail in
the coffin came last Tuesday when giant Freddie Mac said it will no
longer buy sub-prime home mortgages it deems most vulnerable to default or
foreclosure. Where will all the new buyers come from to support a resumed housing
boom and more importantly, where will they get their financing from?
ON
ANOTHER SCORE- what is the difference between sub-prime and Alt-A lending, some
arbitrary difference in FICO scores? Can we not liken the mortgage bubble to
the dot-com craze in the late 1990s in which most investors ignored the failure
of the smaller Internet companies as a harbinger of things to come. One of the main reasons that real estate prices were
so elevated is at least two-fold. Firstly, a whole class of people came into
the market, who under normal credit terms could not have been homebuyers and
secondly, the degree of speculation became wildly overblown. What is going to
happen to overall demand when you take away the ability of these two sets of people
to buy homes?
4th Stage Layoffs and
drastically reduced earnings and salaries; first due to the sharply reduced
construction followed closely by a reduction in all of the auxiliary industries,
ranging from real estate agents and mortgage brokers to furniture and
landscaping. So far, this stage remains hidden as it is masked by the backward
looking unemployment and economic numbers being reported. I expect that it will
be a shocker when next quarter’s numbers are reported..
5th Stage Economic recession (if we are lucky). By next
quarter, as the economic numbers begin to reveal the truth as to what is really
going on in the economy is the time when we will be facing our greatest danger.
What type of legislation will Congress propose and will the President have the
guts to veto it? There is no question
that Bernanke, like Greenspan before him, will rush to the rescue with the
FED’s liquidity hose, but this time it won’t work. There is already too much
liquidity in the system and the tightened lending standards brings us to another
old truism “you can lead a horse to water but you can’t make him drink.” Especially under conditions of tightened lending standards.
What happens to all that take-over money under the new lending standards?
HISTORY REPEATS
Although history always repeats, it never does
so in an identical fashion, thus it only ends up being recognizable long after
the fact. The current rally that began
in Aug. 2003 in the general equity markets is really only a B Wave of an
Irregular Top of the Bear Market that began in 2000; all of which is based on
record low interest rates, several tax cuts as well as the FED and BOJ flooding
the world with fiat money! Soon the Fed will be forced to continue to
raise interest rates in an attempt to save the dollar and stop inflation from
exploding. The first causality will be to exacerbate the crash of the real estate
market; then comes the imploding of the stock and bond markets, followed
closely by the credit markets as the take-over and privatizing craze comes to
an abrupt end. We are about to witness the Laws of Supply & Demand in
action. Balance of payment deficits of an unprecedented magnitude have resulted
in credit induced economic over heating on a global scale. There is a limit to
how much money created out of thin air can keep the
We
are about to vote on the first NEW DEAL type legislation: Elimination of the Secret
Ballot when it comes to voting for unions. The passing of this bill would
drastically shift the power in favor of the unions; exactly the same thing as what
happened in the 30’s. If this bill passes, we will shortly thereafter find out what
outsourcing is really all about. There
are already 83 Protectionist Bills floating around in Congress, similar in kind
to the Smooth Holly Bill; shades of the 30’s? Start a Trade War and you will
also start the next world wide depression, with a capital “D”.
Another
shot across the bow was last Wednesday’s Letter from Hillary Clinton to both
the President and Secretary Paulson on our country’s financings and its
reliance on foreign loans. Great idea – lets piss-off our bankers; that will
surely solve our problems. One thing for sure is, as the economy slides into
recession, tax revenues will fall and the deficits will explode, just in time
for the tax cuts to expire. In the 30’s,
marginal tax rates were gradually raised to 93% in their attempt to cut the
Federal deficits, turning what should have been no more than a 3-year recession
into a Depression that lasted 17 years. Will we now, 65 years later, once again
turn what should be at most a 2 year recession into a world wide depression and
a
WHAT, IF ANYTHING, CAN WE DO ABOUT IT?
Brings to mind another old axiom, “UNITED WE STAND DIVIDED
WE FALL.” As individuals, there
is not much that we can do besides call our representatives and demand that
they stop their partisan bickering and start working together for the good of
our country OR ELSE we will throw them all out come the next election.
On
a more realistic and personal basis, we can start protecting ourselves and
especially our finances by firstly reducing the risks that we are taking with
our investments. Secondly, reduce our outstanding debt as much as possible and
thirdly start to live BELOW our means, so we will be prepared when the S… hits the fan. And
last but far from least, BUY GOLD.
GOLD
Have
you all been stunned by the recent action in Gold and Silver? Well you shouldn’t
be! If you have been reading my missives since last June, then you should have
noticed that Gold has been behaving, if not exactly, pretty close to what we
have been expecting.
#
1, A 500% five year
#2 An 85 month Bull move requires a minimum of
a 10% or 8 ˝ month time wise consolidation taking us into the end of February –
mid March to complete the “ABCDE” sideways consolidation. Normally this type of
consolidation is in the form of a downward sloping triangle. But with all the
hot money sloshing around the Hedge Funds; in conjunction with the sharpness of
the Market’s Sell-off last week, we got exactly what should have been expected:
Instead of selling out losers and letting profits run, panic sets in and the winners
get sold, fearing that they will turn into losers and naturally hang on to the
losers as the losses worsen. The sharp increase in volatility is providing a
heretofore only dreamed of opportunity. In my last letter, I called for a
downside objective bordering around $600 Gold. Don’t Blow it by “looking a gift
horse in the mouth”
#
3 Has paralysis set in, so that even
though there is a great build up of cash, when it comes time to buy the
bargains, they can’t move because they are frozen by a portfolio full of
losers. By becoming aware of what is happening, you can try to make sure that
this doesn’t happen to you.
#
4 We are now
into the top of my $650 - $550 downside target area. It’s time to start scaling
IN.
TWO RISKLESS INVESTMENTS
#
1 Take your pick either (A) This Goldilocks economy will continue on with no
recession in sight for at least two years and the FED will sooner or later be
forced to raise interest rates OR (B) We are headed for a slow down and the FED
will be forced to lower Interest Rates and pump up the money supply to stave
off inflation. The short answer to either scenario is BUY GOLD.
# 2 The GRAND DADDY of all IRRATIONAL EXUBERANCES is the
credit spread between Junk and Treasury Bonds which, before last week, was standing at an unbelievable 278 basis points,
down from highs above 1500 basis points. Who in their right mind would only
demand 2.75% more to buy a Junk Bond over a Treasury.
That is telling me that the investment community thinks there is absolutely no
risk anywhere in the world: They have had it so good for far too long that I
would bet my last nickel that they are about to get their ass handed to them on
a platter. It is too bad that the Barclay’s Junk Bond ETF is not trading yet or
I would be putting on long treasuries short junk ETF’s spreads until the cows
came home. Since this trade is not available to the average investor, you will
have to ask your broker to check with his research and margin departments to advise on the best way to institute this spread.
CONCLUSION
The best opportunities present themselves during
periods oh high volatility, so do your homework and be prepared to take
advantage of the opportunities as they present themselves. Most importantly,
you must have the courage of your convictions and be prepared to stand alone if
you are to reap the rewards due you.
GOOD LUCK AND GOD
BLESS
Aubie Baltin CFA, CTA, CFP, PhD
561-840-9767