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Thursday, January 1, 2009

2009: Adapt, Improvise, Overcome

Just finished watching "Heartbreak Ridge" for the umpteenth time.

Gunny Highway's motto came to mind in reading this article, sent by Spartacus, on what financial maven Karl Denninger saw in 2008 and sees in 2009:

Where We Are, Where We're Heading (2009)

Let's score the 2008 edition predictions first:

US will enter a recession: Confirmed by NBER. Check.
Unemployment will rise north of 5%. Check (bigtime)
Housing will not turn in 2008. Major check.
The story in 2008 will be defaults on prime mortgages. Check.
Consumer lending practice stupidity exposed. Check.
Recreational sector (boats, etc) smashed. Check.
Government will meddle. Biggest check of all!
Buffett will win on munis. Miss - a clean miss.
Equity prices will at least touch 1220, target of 1070, no surprise on a three-digit handle for the SPX. Major check.
Return of capital is the dominant theme. Check; 0% IRX anyone?
No "hyperinflation". Check.
Debt to be paid down and/or defaulted. Half a check. The hiding continues, and so far, there's no indication that the end of that rope has been reached.
CRE will collapse. GGP anyone? Check.
Business CapEx will go to hell. Check.
Dollar will strengthen. Check.
Market callers coming to the public "hat in hand". Nope; clean miss. Where's Cramer committing Seppuku on national TV? Oh well; hubris knows no boundaries.

16 predictions, two clean misses and one half-miss, the rest either panned out or were proved tremendously conservative.

That's not bad. Anyone else got a public scorecard? Cramer? Kudlow? How about Dickey Bove? "Generational buy eh? Hmmm....

Let's recap where we are today:

Debt has risen at a faster rate than GDP for the last seven years. This has led to a falsely-stated increase in GDP, in that when debt rises faster than GDP (on a percentage of GDP basis) what you're doing is financing expansion through debt that is not being paid down through production.


Due to the nature of interest, that being the compound nature of it, this constitutes a pseudo-Ponzi Scheme that must fail. It now is failing, yet The Media continues to report falsehoods on exactly what is going on with households (and for that matter, businesses as well.)

The Federal Reserve has continued to pump "liquidity" into the economy, which is their job, but they have also continued to cover up fraud and blatant thievery, which is antithetical to their role as the primary regulator of the banking system. This is what Japan did, but they had savings to cushion the blow of their idiocy. We do not - we only have debt. Note that it did not work in Japan in that they have had below-trend growth for more than 10 years and now are facing a second, disastrous leg downward. Why anyone thinks it will work here with a higher debt-to-GDP ratio defies logic - but this is the altar being prayed at.

As The Federal Reserve and Treasury actions have proved inadequate they have continued to do the same thing but with ever-larger amounts of money that doesn't exist, committing to borrow ever-larger sums. This simply accelerates the first problem.

Neither Treasury or The Fed has a damn clue as to what they're doing. The SEC's Chris Cox and various members of Congress have confirmed this repeatedly, stating clearly that both Bernanke and Paulson have come to them with demands for immediate action backed by outrageous claims of immediate collapse of the entire financial system, martial law or both if they do not acquiesce to their demands, even though less than a month prior (and for the previous year!) these same people were claiming that our economic issues were contained. The only possible explanation for this behavior is that these two men were and are incompetent, insane, panicked and unable to think clearly, concerned that their complicity in this mess is about to be exposed (and it will end very badly for them) or all of the above.

Many of the actions of both Treasury and The Fed are of questionable legality - at best. The worst abuses include claims of "transparency" on the TARP that have simply not been met and The Fed creating over one trillion in new debt against the taxpayer without an authorizing bill in The House - a flatly unconstitutional act that in a true Constitutional Republic would have led to the immediate de-authorization of The Federal Reserve as the nation's monetary authority. More recently Treasury has actually been kiting checks on the TARP (they have committed $10 billion more than authorized thus far); that's a criminal offense if you do it with your checking account.

All of the above have taken what was a 10% correction in GDP that was necessary in 2000 (and which was primarily centered in businesses) and moved it to a nearly-30% correction in GDP that is now necessary. If we continue down this path and actually spend all the so-called "committed" funds in 2009 as would be expected, the net contraction in GDP necessary to bring the system back into balance could reach 50%. This level of contraction would be catastrophic and could easily threaten the political viability of our government, not to mention 30% of American jobs and incomes.

President Obama has "threatened" to spend north of $1 trillion in "stimulus", but in fact the nation doesn't have that $1 trillion. You cannot go further into debt to avoid the consequence that arises from excessive debt in the first place! If President Obama does not realize this fact and change course before he (and Congress) spend this money the odds of that 50% contraction go up precipitously; the $1 trillion expenditure alone will "back load" yet another 5% onto the GDP contraction that must come. This is an act of pure lunacy and yet it appears to be precisely what our government intends to do.

The cockroaches have scurried as their cover is withdrawn (Buffett's "swimming naked" analogy) and this has continued apace all year, with the latest being Madoff. We've developed a quite-impressive list of ignored warnings going back 20 years; subprime, banking "regulation", securities dealers running ponzi schemes and Treasury Secretaries lobbying hard (before becoming Treasury Secretary) for leverage limit removals that prove to be the trigger for the crisis.

Madoff is not what it appears to be. At best Madoff is a 20+ year scam that occurred with not only the intentional blindness of our government but its explicit assistance and cooperation. It is simply not possible for one man to run a Ponzi Scheme of this size, sending out statements every month to hundreds if not thousands of clients and employing a group of people, moving this amount of money around, and have the entire thing be a scam without the cooperation of literally hundreds of accomplices including accomplices inside regulatory agencies and the government itself, along with regulated entities including the banks that lost money. You cannot place that sort of capital as a bank or other regulated entity on nothing more than "trust" - no matter who its being placed with. There is much, much more to this scandal and you can bet the people involved will do their level-best damndest to keep the truth from coming out. Never mind the fact that explicit warnings were transmitted to the SEC.

Job loss has risen and shows no sign of topping. Don't expect it to any time soon. Be aware that unemployment peaks after recovery is already well underway. This makes unemployment a good indicator of misery but a horrible one for where we are in the economic cycle; as such looking for this to "bottom" is a terrible idea if you're an investor.
The number of "bottom callers" have increased dramatically. Don't believe it. The S&P 500's forward earnings for next year is still estimated around $70 (!); that's lunacy. The banking model for earnings is permanently broken and they will return (after washing out) to the "Grandfather's banking" sort of earnings - slow and steady with growth limited to that of GDP. IMHO the S&P 500 will be lucky to post $50 in earnings for 2009. Bear markets frequently bottom with a single digit P/E multiple, which puts the SPX at or under 500 before this is over. We are still 40% overvalued by this metric!

The 20/50W (and 13/34 EMA) timing signals are not only on a SELL from early 2008, they are still getting more divergent toward the sell side. I will simply observe that those who try to be heros in the market often wind up with zeros in their account. Until these timing signals flip the primary trend in the market is down. This doesn't mean you can't make plenty of money trading bear-market rallies, but it does mean that if you're buying here "for the long haul" you are attempting to front-run a trend change that would be years away and another 50% - or more - below us in terms of price. This market is not a falling knife - it is a falling chainsaw.

In short, essentially nothing positive has been done and a lot of damage has been inflicted on everyone in America out of hubris, fraud and avarice.

We now are "discovering" what I have written about for more than a year first-hand - the so-called "growth" over the last seven years has all been a fraud, instead being nothing more than additional debt. Ponzi-finance has taken over every area of our economy, from government to private business, and has run to the natural limit of "the greater sucker", now leaving all of the people beguiled and bedeviled exposed as the naked-swimmers that they are.

There has been zero push for accountability and truth throughout the system. Not among our so-called "leaders", not among the bankers, not among the political or economic elite. All are focused on trying to keep the impossible going.

The truth of all of this is trivially easy for you to demonstrate to yourself. Just ask the following questions:

If you have $100,000 and borrow another $100,000, have you doubled your net worth, or have you actually harmed your economic position, as you will not only have to pay back the $100,000 you borrowed but also interest on that money?

If you do not own a home, do you want that house to be priced high or low?

If you want to buy a car, do you want the price on the car to be $20,000 or $40,000?

If you're buying gasoline do you want it to cost $2 or $5 a gallon?

Are you better off with zero credit card debt, $2,000 in credit card debt or $20,000 in credit card debt?

How did we actually nominate a man for President of the United States (he lost by the way) who declared publicly that he had one half million dollars in credit card debt and couldn't tell a reporter how many houses he owned?

How did we have a bill, the EESA/TARP that obligated citizens to pay $700 billion in taxes that we do not have (that is, to put us all in debt by another $700 billion), that was opposed from 100:1 to 300:1 in calls, faxes and letters to Congress, was passed over those objections with an election less than a month away, and we the people then returned 90% of those who voted "Yes" and stood for re-election to office?

There will be no improvement in the economic condition of our nation until each and every one of us ask ourselves these questions, honestly contemplate our answers, and then put our outrage (or desire) for those economic conditions into firm, no-nonsense peaceful action to force our elected and unelected government officials to act as we direct.

Please realize that if just one third of one percent of the population of America was to get upset enough with the blatant fraud, theft, Racketeering and Ponzi Finance that has literally decimated the economic structure of our nation, American households and our future (not to mention our children) and were to show up in Washington DC in peaceful protest, occupying The Mall, Constitution Avenue and surrounding areas and refused to leave until every one of these charlatans resigned in disgrace or committed seppuku on national TV the protesters would number one million.

Such a mass of people would be literally impossible to refuse to answer to. That we have not yet seen it simply means that the population of this nation either doesn't care that it is being systematically looted, is too full of Prozac to pay attention to the racketeering and theft or is simply not paying attention. (My vote, by the way, goes to the latter - at least for now.)
Further, if we the people were to organize as few as one hundred individuals in each major city we could effectively slow commerce to the point that it would break down entirely, all through peaceful means.

How? Envision your local freeway; you, and three of your friends (four lanes each way, four drivers) line up parallel and then slow to a crawl (if you're in "rush hour" traffic) or to 20mph if not. Traffic would instantaneously snarl behind you and remain that way for hours. Your risk? A traffic ticket. A few hundred dedicated people in each major city could very effectively demand that real reform take place and that all the fraudsters go to jail, refusing to stop their daily protest until it was done. Again - a tiny fraction of one percent of the population of this nation could, through entirely-peaceful actions in protest, force a stop to this nonsense.

It hasn't happened. Why not? Are there not a few hundred unemployed as a consequence of this fraud in every major city across America? Are we really all so neutered as Americans that we will refuse to peacefully protest in an effective manner?

You want to know why the fraudsters - including everyone screaming to be bailed out of their ill-conceived schemes - are winning?

It is because Americans refuse to get off their ass, even though very effective and fully-peaceful means of demonstrating and demanding change - Constitutionally Protected means of expression that would have vast and immediate effect - exist.

Simply put, we are consenting as individuals and a nation to the economic rape being served upon us by the scams and schemes of the few.

Now let's look at first principles when it comes to economics. All of these are not desires, wishes or dreams - they are facts:

Debt when used to "pull forward" future production into current spending can be useful (for example, the farmer who borrows to buy seed or the producer of goods who borrows to buy raw materials that then are made into finished goods.) Debt taken to finance consumption has zero positive long-term impact on the economy. When debt is taken to pay existing debt it has the potential to result in catastrophic economic collapse. The latter is what we have been doing for the last 30 years.

You cannot solve an addiction problem with more of whatever the addict is hooked on, whether it be booze, crack, meth - or debt.

It's not credit, it's debt. Stop listening to the BS handed out on CNBC and in the paper. When someone you talk to says "credit" stop them right there and correct them.

Our monetary system is debt based. The more "liquidity" they pump (and even the more money they "print") the more debt is taken on. Again - have you ever seen an addict cured by giving them more of their favored drug? Is there any possibility that this "medicine" can actually work? Simply put: NO.

Debt is inherently deflationary. The inflationary impact of additional credit creation is temporary; in the longer run debt always has a deflationary impact. This is obvious and inescapable if you use your head; since debt must be repaid with interest, it therefore must deflate (decrease) the monetary base since interest is a non-productive "charge" against income and (thus) earnings. This, by the way, is the fatal flaw in Bernanke's Doctoral Thesis; by refusing to recognize that all modern monetary systems (including ours) are debt-based he also fails to recognize that there are limits to being able to "print" your way out of a deflation since what you are printing is in fact debt and eventually you reach an "inflection point" where the spiral tightens - that is, the more "printing" you do the worse the problem gets!

If debt as a percentage of GDP is increasing then you are paying off debt with more debt and falsely stating GDP. This is obvious to any objective observer; a debt taken to buy a car shows up in "GDP" as the car must be produced but in fact the actual GDP impact of that transaction (over time) is negative as interest must be paid on the debt and the principal must be paid down. In the converse if debt-to-GDP is shrinking then GDP is understated. The true GDP number is only presented when the debt-to-GDP percentage is stable. This is true for all debt-based monetary systems and cannot be changed by waving around magic Federal Reserve wands.

We have been falsely claiming "growth" that did not actually occur for more than 20 years; this is why your wages have been stagnant while everything you need to buy has gone up in price and for most Americans their standard of living has contracted.

The above will not change until the Debt-To-GDP ratio begins to drop.

That cannot happen until The Government stops supporting the bankrupt with more and more bailouts and "stimulus" and instead forces those who can pay down their debt to do so along with forcing those who can't (the broke) into bankruptcy court where their debt is discharged.
The economic pain inherent in such a process cannot be avoided, it can only be delayed and with each delay the total damage that must be absorbed to restore balance to the economy grows.

We keep hearing so-called "pundits" talk about how "we must spend like mad or we will have a Depression." Folks, that die was cast in 2001 when the decision to avoid a recession by pulling forward demand through excessive debt. It is no longer possible to avoid the outcome, we can only choose when the outcome occurs, and the longer we wait to do it the worse it will be as a direct consequence of the fact that in all modern monetary systems money issued by the government is in fact debt and the problem is that we have too much debt already!
FDR has been widely hailed as a hero. He was no such thing. FDR's policies in fact caused a second wave of depression after the original downdraft that originated in 1929. This is not commonly reported but it is in fact true - there was a second, nearly 20% contraction in GDP that occurred as a direct consequence of FDR's policies. Repeating what FDR did to any material degree will not help, and any apparent "relief" will be false.

In short, as pointed out in The Ticker of the 20th - We are all Madoff in one form or another.
Ok, so with that cheery backdrop, here you go with my predictions for 2009.... and I will prefix this by saying this is a list I hope proves to be entirely incorrect. Perhaps there really is a Unicorn that craps skittles even though I've yet to find it - this is one round of predictions I'm willing to take a zero score on come December 09.

The economy will not recover in 2009. Job loss will continue through the year and unemployment will reach 8% in the "headline" statistic by the end of the year. U-6 (broad unemployment, or the closest to "real" unemployment without government "cooking") will top 15%. All the "talking heads" are predicting a turnaround in the second half of 2009. They will be wrong. Look at their records for 2008 - all of them were predicting closes at or above 1500 for the S&P 500. Why does CNBC continue to put people on the air who, if you listened to them, cost you 40% or more of your money?

Deflation, not inflation, will become evident well beyond housing. Other capital goods beyond housing will see real price declines for the first time since the 1930s. Debt is inherently deflationary; the "hyperinflationists" will once again be shown to be wrong (how many years running will it be now?)

Housing prices will continue to decline. I believe we're about halfway done with the price correction. Those who think we will turn this in 2009 are wrong - unless we get an all-on collapse in prices in early 2009, which I do not believe will occur. I've heard several claims we will have positive year-over-year home price changes in 2009. I'll take the other side of that bet.

The Fed's attempt to "pump liquidity" will be shown to be an abject failure. We will see either a Treasury Market selloff or worse, severe instability in the dollar at some point in 2009.
GDP will post a 12-month negative number and there is a decent shot that we will actually see an official depression print before the end of 2009, defined as a 10% decline peak-to-trough.
The Stock Market has not bottomed although you may think it has for a few months. The annual range will be quite extreme; I would not be surprised at all to see 1,000 touched on the SPX in the first part of the year. I believe the SPX will at least touch 500 in the next 12-24 months and the current bottom will not hold. It is possible that we could see a crash to SPX 300 and DOW 3,000 some time this year, probably after the spring (when the "Obama Halo" wears off - if it isn't blown off by economic events first.) Yes, this means I am predicting a fifty percent swing in the SPX in 2009. Lots of money to be made as a trader if you're quick and good, but an absolute minefield if you're a long-term investor.

Precious metals will not be a safe haven. The callers for $1600 and above on gold will be wrong, unless there is a major military conflict. I do not rate that probability as particularly high, but it is an event (along with a major terrorism incident - nuclear or biochemical - that would cause a rocket shot in Gold prices), so I am hedging that call. The risk of this sort of "response" to the economic crisis is, however, real, and will rise significantly going into 2010 and beyond. We'll revisit this one (a major war) next year.

The Dollar will not collapse. This is not because we're in great shape or will truly recover, it is because the rest of the world is in worse shape than we are. Last year pundits were all calling for the dollar to collapse to 40 - it didn't happen. Now they're calling the dollar's strength a "Bear market rally." Nonsense; the simple truth is that while we're in bad shape the rest of the world is literally on the precipice of a full-on collapse. European banks are more-levered and less-transparent than our banks as just one example.

The pound or euro - and perhaps both - will likely be where the FX dislocation initiates if it occurs. I see the potential for the pound and euro to both reach par with the dollar, although I'm not going to go that far out on the tree limb and predict it - yet. Needless to say that would rocket the Dollar Index but it won't be our strength that does it - it will be their weakness.

The US Consumer will go from a negative savings rate to a seriously-positive one. I am predicting 4% in 2009 but it could go as high as 10%. The math on this is simple - the "consumerist legion of more" has run its course and all that's left is debt. It hurts and bad; expecting the American Consumer to cut off his other arm is just plain dumb. By the way this is a good thing in the longer term for America once the excess debt is forced out and defaulted through the system.

Commercial Real Estate will effectively collapse and most commercial Real Estate REITs will be either insolvent or limping on life support. There will be calls for bailouts (which may be attempted; the calls are already starting to be heard) but it won't matter - a failed business is a failed business, bailout or no, and overcapacity must go away before sustainable business conditions can return.

Along with the above, expect 10% of all retail stores to close, and that number could go as high as 20%. That's not going to be fun; there will be hundreds of malls that wind up literally shuttered across America. Stay away from most retailers and property groups as investments. Firms like SPG and VNO are levitating on the strength of their dividends (7-10% yields at present); I believe this is a sucker play; if retailer defaults force dividend cuts (and I believe they will) the commercial REITs will go straight into the toilet.

Several states will get in serious financial trouble and outright default of one or more is possible in 2009. California leads this parade. But even if there is a default on a state basis, the effect will be highly localized, as county and municipal governments vary in their wisdom and budget process. The real pain comes in state-wide social and educational programs. Be very careful if you are in municipal bonds or thinking of getting back into them (I recommended they be dumped in 2007 - look at what has happened to the closed-end funds in 08! Aieeee!) as the default risk is VERY REAL. If you're buying individual issues and do the work to determine not only the risk of default but also the likely recovery if they do default there are some good deals out there - but only if you're doing the work. "Trust me" (as in buying funds, whether mutual funds or closed-end stuff) is very dangerous.

Mortgages are not done. The story last year was "Subprime." This year's will be "ALT-A", "Option ARMs" and so-called "Prime". The Fed and Treasury know this, which is why they are playing games with "agency" debt in a desperate attempt to clear this market before the ticking nuclear devices go off. The amount of debt involved in these "bad deals" is vastly higher than that in the "subprime" space and if they fail to contain it (a near certainty) Round #2 of severe bank instability gets served up on us in the second half of 2009.

If you want to refinance a mortgage you may get one brief shot at it with long rates around 4%.


You're nuts to buy outright unless you intend to die in the home, but if you have a solid reason to be obtaining a mortgage or wish to refinance you will probably get the opportunity. This assumes the "buydown game" gets going before Treasuries dislocate; if you get the opportunity take it as it is likely to be fleeting. The few places in this country where homes wind up selling for 2.5x incomes (on average) and you have an opportunity to finance at 4% and change will be decent buying opportunities - if you're sure you can cash flow the note (e.g. your job and/or income stream is not in any danger of collapsing.)

Those who have said that the corporate bond market is being "unreasonable" in its expectation for defaults will start to look like the jackasses they are. Actual default rates (not projections) on non-investment-grade debt will skyrocket starting in 2009 and there will be no sign of it turning around this year. If you're playing in this area of the market thinking that "the worst is behind us", I hope you like walking around bald as the haircuts handed out to folks like you will be especially severe and delivered with a straight razor.

The calls for "more lending" to consumers and businesses will go exactly nowhere. The problem isn't credit availability - there's plenty of money available to lend if you are credit-worthy.


Those who are being turned down now simply aren't credit-worthy when one looks at what they want to do with the money and what they're backing their repayment capacity with. The more "credit stimulus" is thrown into the economy (and there will be more) the worse the downturn will get.

General Motors and Chrysler will fail to meet their targets and it will be labor that sinks the deal. At least one and probably both will wind up in some form of bankruptcy in 2009. The UAW is insane; Gettlefinger needs to be strung up by his genitals and pelted with rotten tomatoes by his union "brothers", and if they had a lick of sense they'd have already done it. They obviously don't. I give this mess six months tops, with Ford as the only possible survivor. The recent GMAC games show exactly how desperate they are; 0% 5 year loans to people with 620 FICO scores are flat-out insane and the default rates on those loans are going to wind up in economics textbooks five years hence.

Protectionism and currency manipulation will rear their ugly heads in 2009, originating not here but in Asia as their economies go straight into the toilet. China and Japan are at severe risk here.

Commodities will appear to be headed for a new bull market but this will turn out to be a false hope as demand continues to collapse. Attempts to manage oil output to prop up the price will fail. Several oil-producing nations will find themselves in serious economic trouble, with Russia being in the lead but by no means alone.

Sovereign debt defaults will number at least three with many other nations on "watch" for same; we had one last year (Iceland.) Noise about a US "AAA" downgrade will continue. Highest on the list for probables are Russia, which needs oil at roughly double its current price - and stable - to be financially viable. Not going to happen in the near term.

China will have its first large-scale rumbling of civil unrest as a consequence of collapsing export demand and thus employment. They'll manage to tamp it down - this year. Don't take a bet on that holding together longer-term. Those who think China will be "ok" are deluded; they have a horrifying overcapacity problem (debt-financed, of course) and there is no way for them to get out of it. They are truly going to "take it in both holes" down the road, but the worst of it won't be in 2009 - that is still a year or two in the future.

Foreign uptake of Treasuries will be choked off - by necessity. It won't be because they want to screw the US (although they should have a long time ago, given our profligate and unsustainable habits), it will be because they will be forced to redirect their resources inward as their own economies collapse.

"The City" (London to be precise, Britain generally) will be recognized as getting it "worse than we are" (in America.) This will be the first of many validations of my thesis "we're screwed, they're gang-raped."

Things will get "revolting" in a number of nations. Not here in America. Yet. If we're lucky the American Sheep will wake up and stage some of that peaceful protest stuff I outlined above. If we're not so fortunate, 2010 could be really bad.

In terms of recommendations its simple - rallies are to be sold, cash is to be raised and prudence is to be practiced in your own personal financial affairs. Don't get creative in all things finance; get stingy and prudent.

Your personal financial survival could well depend on it.


Now factor in what will happen if the Obamites are foolish enough to pass and sign a new AWB, as is likely.


Remember this if you remember nothing else during the coming year:


They can kill us, but they simply cannot defeat us.


Only we can do that, on an individual-by-individual basis.


Keep the faith.


Adapt.


Improvise.


Overcome.


Steel yourself for what is coming.


Invictus.

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