by Addison Wiggin & Ian Mathias
- Famous market forecaster says take profits, then “twiddle your thumbs and wait”
- Headline GDP soothes the Street… how the finer details are far more unsettling
- Eric Fry with an important divergence… “not a promising sign” for the S&P
- Doug Casey’s trade for the next decade
- Plus, two fascinating studies: The plight of old white men and the real cause of the housing bust
“We recommend taking some risk units off the table,” Jeremy Grantham begins today. Largely written off as just another alarmist “perma bear,” Grantham has developed this strange habit of being right — quarter after quarter after quarter. In 1999, he said the S&P 500 would return a negative 1.1% over the next 10 years… which was exactly correct. In May 2007, he called for the pop of a “truly global bubble”… right again. Then at the end of the first quarter this year, he told his GMO investors to buy… yet again, nailed it.
This week, he’s telling you to get out.
“A year ago, equities globally — and everything else, for that matter — were very overpriced, particularly if they were risky,” reads his quarterly letter to investors. “A quarter ago, in mid-March, prices everywhere were cheap. Now they have all — or almost all — converged for a few unusual moments at fair value… It’s difficult to be inspired at fair value.
“Given our view that we are in for seven lean years in which the market will be looking for an excuse to be cheap, we recommend taking some risk units off the table, including becoming underweight in equities — between 1,000-1,100 on the S&P, if it gets there this year. Around 880, you should continue to move slowly to fair value, twiddle your thumbs and wait to see what happens. Boring!”
The stock market is just a few hours away from finishing the best July since 1989. The S&P 500 will likely finish the month up over 8%, its best month since April and best July in 20 years. After yesterday’s 1% rally, the index is up to 987. Baring catastrophe today, the S&P will register its fifth consecutive monthly gain.
With data like this? C’mon:
The U.S. economy shrank at 1% annualized rate in the second quarter, the Commerce Department estimates today. Since that’s better than the 1.5% contraction the Street had predicted, we see headlines of “The Pain Is Easing,” and “Recession Easing” left and right. True, the latest GDP number is better than that of previous quarters, but here are some of the stats that really got our attention:
- The U.S. economy has now contracted four quarters in a row, the worst streak since the Great Depression
- GDP has contracted 3.9% in the last year, the worst fall since at least 1947, when the Commerce Department started keeping track
- First quarter GDP was revised down heavily, from a 5.5% to 6.4% — the biggest quarterly GDP drop in almost 30 years
- The Commerce Department revised 2008 down too, from a 0.4% annual contraction to a 1% decline
- Consumer spending, 70% of U.S. GDP, contracted 1.2%. The retrenchment was largely replaced by government spending, up 10.9%
- Employment compensation rose by just 1.8% over the last 12 months, the slowest rate on books that go back to 1982.
But as you’d expect, the market has clung to the expectations-beating, lower-than-usual headline GDP. Thus stocks are currently holding onto yesterday’s gains and hovering around break-even.
“The modest bounce in consumer confidence last spring is fading already,” writes Eric Fry, “and that’s not a good sign for the stock market. As the chart below illustrates, consumer sentiment trends tend to lead stock market trends.
“Throughout 2007, consumer confidence flat-lined while share prices rallied. This divergence between sentiment and share prices became particularly extreme in late 2007, as share prices soared to new highs while consumer confidence plummeted. Just a few months later, share prices were plummeting also.
“The lesson is clear: If consumers lack confidence, so should investors. During the last two months, share prices have diverged once again from consumer confidence readings. This is not a promising sign.
“And yet, despite this warning sign, lots of hopeful investors have persuaded themselves that the mirage of economic rejuvenation is the real thing. We’re not drinking that sand.”
U.S. Treasury prices have now fallen every month since April. Yesterday’s $28 billion 7-year note auction went far smoother than similar sales earlier this week, but for the month, U.S. paper handed investors a 0.3% loss. July marks the fourth consecutive month of falling bond prices and rising bond yields.
“It seems to me that the sure bet is to be short bonds,” says Doug Casey. “Interest rates are going way up. Why? There will be tremendous demand for capital, of which there’s a limited supply. Interest rates are the price of capital. So they’re going up for that reason — and because of the trillions of paper dollars the government is creating, inflation is going to skyrocket. High inflation will itself guarantee high interest rates.
“So the trade of the decade is going to be to short long-term bonds and to go long precious metals (which are the only financial assets that are not also simultaneously someone else’s liability). These are two excellent investment plays, but there are many others…
“However, just as important is political diversification. The main risk you have is your own government. You have to diversify your assets out of the control of your government. This is even more important than picking the right investment today.”
“The American fiscal deficit is directly linked to Australia,” adds Dan Denning from Agora’s Melbourne office. “The more the Chinese are worried about the value of their U.S. dollar assets, the more quickly they will look to diversify those assets or shed them outright.
“That probably means increased Chinese investment in Australia’s resource and energy sector. Australia is part of China’s answer to ‘the resource question.’ Also, the Chinese already realize that making a buck of Aussie borrowing is not a bad investment strategy either. Dow Jones Newswires reports that ‘China’s Bank of Communications will open a Sydney office as its first working branch in Australia.’
“Selling money can be a good business. China is also branching out with its global investment/expansion strategy, trying to diversify its sources of income. The profit margins in finance are probably a lot higher than the profit margins in making air conditioners (or most assembly and manufacturing industries). If you want to increase national income, it’s a good strategy (although it’s not as good for full employment, which is also a big objective of the Chinese State).”
The dollar has resumed its losing ways. Thanks to two days of rising stocks, the dollar index is down almost a full point from Wednesday’s high. As we write, it’s at 78.6.
Commodities are registering another small gain today as stocks rise and the dollar falls. Oil is up almost a buck, to $67 a barrel. Gold added about $6, to $941 an ounce.
The U.S. recession is causing some interesting changes in demographic employment trends. Specifically, older white males are actually suffering more in this recession than in any downturn in the past. The unemployment rate for white men over 55 is now 6.5%, the highest since the Great Depression. The Labor Department cites the decline of union influence and the lousy markets for white male-dominated fields like finance, manufacturing and construction.
That’s particularly interesting compared to other demographics… black men of the same age are 10.5% unemployed — much higher than their white counterparts, but about one percentage point below their peak in 1983. The contrast is even bigger for black women. They currently suffer a 12.2% unemployment rate, but that’s a vast improvement from their 1983 peak of 20%.
The proliferation of refinancing — not a fall in home prices — is the reason most “underwater” homeowners owe more than their home is worth. A California State University study released this week examined the fates of 4,000 foreclosures in Southern California, with a pretty fascinating results. From the WSJ:
“The original loan-to-value ratio for these borrowers stood at a reasonable 84%, but second and third liens left homeowners with a combined loan-to-value ratio of about 150% by the time of the foreclosure sale date.
“Borrowers, meanwhile, took out around $2 billion in equity from their homes, or nearly eight times the $262 million that they put into their homes.”
In other words, the whole premise of government mortgage bailouts is probably bunk. The homeowners in this study, and likely around the country, are not victims of the market — poor souls that simply bought too much home at the peak of the bubble. In fact, the average purchase year in the study was 2002.
Rather, they are just levered-up speculators… hardly different than the ones on Wall Street the government is so quick to demonize.
Last today, the “cash for clunkers” program has already run out of money. The Obama administration planned the ordeal to run until Nov. 1 or until the $1 billion program runs out of money, whichever comes first. Heh, well with $150 million already paid to dealerships and $850 million set aside for pending sales, the program managed to last about a week. Turns out people WILL line up for “free money” when given the chance.
Under the legislation that created the program, Congress could authorize another $3 billion for clunker rebates around the country. Until then, the program is on hold.
“There is a BIG problem with the ‘cash for clunkers’ program!” exclaims a reader. “The only people that are eligible for it are the rich and stupid! Like the idiot that bought a Cadillac or Lincoln with a big V-8 engine. They get 16 miles a gallon, and if they trade it in on the identical car now that gets 20 mpg (The required 4 mpg increase), they save 20% in fuel consumption.
“Now, if this program were to be effective and fair, it should have no limit on the mpg of the clunker, only a percentage of the fuel saved. They should also include the people that drive a sensible car (getting 25 mpg for a compact) that trade in for a fuel-efficient car (Toyota Prius that gets 50 mpg). That trade would reduce fuel use not by 20%, but by 50%.
“It only benefits the IDIOTS that drive gas-guzzlers. It should also benefit the smart people that have smaller cars and save MORE gas.”
“I can’t wait to see,” adds another, “how many of the cars that were bought under this ‘cash for clunkers’ program (with my money) get repossessed for nonpayment. Why else would they be driving those cars?”
“What madness,” writes the last — this one our favorite. “The central planners have established a program in which significant wealth (the cars and trucks, most of which are fully functioning) of a society is junked to stimulate demand for products from a government-owned business. This is reminiscent of some of the silliness that issued from the Cultural Revolution. Oh, did I mention we are borrowing the money to pay for it?”
Have a nice weekend,
Ian Mathias
The 5 Min. Forecast
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