The Great Bond Crash of the 1930's

Good Afternoon Everyone!

OK,

Everything is pretty quiet on the news front so I thought today would be a perfect day for a history lesson.

Watching treasuries sell off over the past couple weeks motivated me to take a look back to The Great Depression to see what happened to bonds in the great 1930's bond collapse. I had always known there was a bond crash during this time, but I really had never focused on the timing of it.

I was able to pick up a great chart highlighting what happened:

My Take:

The similarities to today's crisis are eery here folks. As you can see above, there was a huge bond sell off in the late 1920's as the stock market roared to new highs. When the crash of 1929 then ensued, bonds soared as investors flew into the safety of fixed income.

When stocks began to rally after the first leg down in 1929, bonds then began to slightly sell off again as investors started dipping their toes back into stocks.

When the bear market rally died, bonds spiked back up for the final time before the great bond crash.

Whats interesting here is bonds crashed in 1932 at the same time that equities did. The lows in the stock market occurred in 1932. So why didn't we see another flight back to the safety in bonds in 1932 as stocks were crashing?

The reasons were two fold: Liquidity concerns and fears around inflation as a result of massive government stimulus.

Gee, does this sound familiar?

Folks, one of my favorite sayings is "history always repeats itself". I think we are seeing an exact replay in the treasury market today as we saw in 1932. We have seen treasuries rise and fall depending on what the stock market is doing.

However, as we spend ourselves into oblivion, the world is now concerned about our liquidity. They are also concerned about inflation because we are creating trillions of dollars in an attempt to bailout America!

A replay of the 1930's will almost assuredly happen at some point during our Great Depression part 2. Could we see one more rally into bonds if this bear market rally collapses? Perhaps, but this will most likely be the last one.

Folks, there comes a point in which the math no longer works. The Chinese and the ROW are not dopes. They are losing faith in our treasuries because we are running historic deficits at a time in which tax revenues are crashing!

China's main motivation to buy bonds in the first place was done in support of our obsession around consuming. China's manufacturing roared as we spent like drunken sailors. They also bought bonds because they considered it to be the safest place to park their reserves.

When you look at the new world in which we live in, both of these scenarios have now drastically changed. Our consumer is collapsing, and our safe treasuries all of the sudden don't look so safe anymore.

Bottom Line:

I will be increasingly shorting more treasuries in the very near future. I already have a position here but I am hesitant to buy more because I think stocks are about to take another big dump. This could result in one more big push into bonds.

I will be taking a large position in TLT PUTS on any bounce in treasuries following a market sell off.

The game is about over folks. If you wanted a guess as to where I think we are in this process today versus the 1930's chart above, I would say we are in early 1931.

Find a good hard desk to hide under. You are going to need it by the end of the year.

Got Jobs?

The market continued to roar today as the "green shoots" sold to us by Wall St continue to bloom! Meanwhile back here on earth, "Rome" continues to quietly burn in the background.

The latest jobs report came out today and the news was not good but better then expected. The unemployment rate soared up to 8.9% as the economy shredded another half a million jobs.

The stunning rise in unemployment that we are witnessing is breathtaking when you compare it to previous recessions:

My Take:

Uhhhh...Can you say WATERFALL? As you can see above, we are seeing job losses on an unprecedented scale. I am sure Wall St is right though. The recession should be over by the second half of the year. NOT!

Question here:

How does Wall St expect everyone to continue to pay their bills when they have zero dollars coming in the door?

The markets liked the number today because we "only" lost half a million jobs. Folks, this is utter bullshit. You need job growth of +400k in order to see economic growth in this country. The trend on job losses is still firmly downward.

The fact that we slowed down the losses should have been expected. At the rate we were losing jobs the past few months, no one would be working a year from now! The fact that the media and Wall St are spinning this as a green shoot is simply ludicrous!

Market Gone Wild

The financials continued to roar as the S&P 500 closed up 21 points at 929. Bear market rallies tend to be severe and powerful. The more violent this move gets the more I think its just a bear market rally. Bear markets don't end in a straight line higher. especially one of this magnitude.

There is obviously some severe manipulation going on here. The government and Wall St. realize that their lives are on the line.

Here is my best guestimate as to whats going on:

I believe that the trading desks on Wall St all turned desperately bullish after learning about the stress tests.

They all knew that they would be forced to raise equity on their own or die because Congress was done throwing billions of dollars in bailouts to them. The Fed warned them this would be the case while these stress tests were being conducted. The easiest way for the banks to raise cash is by selling new shares of stock. You saw bank after bank repeatedly roll out new offerings last night following the stress test announcement.

Wall St knew that the higher their stock prices were, the easier it would be to raise capital. It would also result in less dilution in their stock price. For example: If you need to raise $5 billion in capital your dilution effect is twice as much if your stock is at $10 versus $20 because you need to sell twice as many shares in order to raise the same amount of capital.

So, as a result, the large banks all had a huge vested interest in taking the market higher.

What made this easier to do was the fact that the banks became buyers at a time in which their liquidity had increased significantly after receiving huge infusions of cash via the Fed. The banks coffers were already a little more full to begin with after severely reigning in their lending.

Further fueling their liquidity positions was the suspension of market to market accounting. This relief allowed them to spend reserves that they had been holding to pay off losses per the FASB accounting guidelines.

When you add this all up you end up with a pack of bank bulls on steroids!

Bottom Line:

I think once these offerings are wrapped up you may see a change in market sentiment.

Trying to fight the banks and the Fed on the short side is a tough tough battle right now. That being said, I will take a shot at them with a few SPY PUTS once we get up over 950. There is some severe resistance in this area as the S&P approaches its 200 day moving average.

Once the banks have ensured their survival via capital raisings you may very well see a pretty solid correction.

Next week should be interesting. Have a great weekend.

Bonds Blow off Ben

UH OH!

Ben Bernanke has a question for everyone: Anyone out there interested in buying a bond?

Ben's got a few trillion to sell this year and he is looking for new buyers after not finding many at today's treasury auction. Take a look at the sell off on the 30 year after today's disastrous auction:

My Take:

Before I start I just wanted to acknowledge that I did read the stress tests results. They are such a joke that I refuse to even discuss them. The results aren't worth the paper their printed on IMO. The fraud rolls on folks.

OK, lets get back to some actual accurate information. Here is the story on the bond auction:

"Investors worried that poor demand for government debt could raise the cost of capital and hamper chances of a U.S. economic recovery.

U.S. debt prices slid, sending the 30-year Treasury bond yield to its highest since November.
"The auction is big news because now it's showing that maybe the Chinese don't want our bonds.

If the cost of capital for the United States becomes more expensive, then the recession is going to take that much longer to get out of," said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.

The $14 billion Treasury bond auction met below-average demand from investors, who bid aggressively to force the government to pay a higher yield as it pushed ahead with plans to help finance its burgeoning budget deficit with more longer-term debt."

Take Continued:

Below average demand is putting it lightly. The Bid to call was 2.14 which was the lowest since last August! Anything underneath a 2 is considered to be a failure! Yields as a result were pushed up dramatically in order to get the bonds all sold.

Folks, I have been warning about this for weeks. Lets see if there is any follow through here in the next few auctions. We have $2 more trillion of this garbage to sell guys. We are doomed if they can't sell all of it. The 10 year yield also moved higher on the news.

Obama: Borrowing comes at a cost!

Our "Messiah" is about to learn a serious lesson on the cost of borrowing money. I find it interesting that this bad auction came as the Federal Budget is being finalized. Perhaps the rest of the world is sending a message?

This all shouldn't be a surprise:

China has been beginning to hoard gold in recent months. They are also making less money on imports off of our increasingly dying consumer. As a result, they don't have the finances that they once did to throw into treasuries.

This ponzi sticksave bailout of the financial system by the government is contingent upon us being able to sell our debt. There will be no bailouts if the government doesn't have the cash to do them.

This new unthinkable reality will come out of nowhere and smack the politicians in DC right upside the head:

THE GOVERNMENT WILL BE FORCED TO DRASTICALLY CUTBACK SPENDING.

Our spoiled brats in Washington will finally have to put the wallet away. Treasury demand is one big thing that Ben can't control. He is absolutely powerless here because he can't force people to buy! Lets just hope he doesn't decide to print. Enjoy that $20 loaf of bread if he does.

My guess is if their spending is cutoff and the game is over, the government would then ring fence itself in order to survive. Everyone outside the fence would be told "sorry" when they come looking for money. This would be a devastating blow to anyone late to the bailout party. Pain will be aplenty in our economy in this scenario.

China and the ROW are not stupid. They realize that we our bankrupting ourselves as we try to bailout a bunch of greedy pigmen. Making matters worse is the fact that the Fed's tax receipts are collapsing. California tax revenue dropped 44% last month versus the previous year.

The rest of the world is beginning to ask themselves: How in the hell is the USA ever going to pay us any of this money back when their revenue base(the taxpayer) is collapsing?

The impact of a massive bond selloff

Lets begin looking at the ramifications of significantly higher yields on bonds:

Higher yields=Higher lending costs. The housing will market explode if we start to see double digit interest rates as a result of higher yields. The home buyer who could qualify for a $500,000 home at 4.75% rates today may only be able to qualify for a $150,000 home with double digit interest rates. Go back to the 1980's and see what houses sold for with borrowers lending at 12%.

The value of those McMansions in the burbs will drop in half or more instantly if the cost of borrowing begins to soar. At this point you need to ask yourself this question:

How many homeowners who bought in at 500k will continue to make their payments when the guy next store pays 150k for the same house? I know I would walk away if I was in this situation.

The resulting collapse in housing prices would then destroy whats left on the banks balance sheet. Trillions of dollars of banking assets would evaporate in a new world of double digit interest rates. The banks are already on their knees as a result of their current losses. Higher lending rates would be the final blow that knocks them down to the canvass.

Imagine how many "performing assets" on the the banks balance sheet would turn into "toxic assets" in an environment of expensive lending. I wonder if they included this scenario when they performed the banking stress tests? HA! We all know that answer!

Bottom Line:

The government will be forced to stop spending if bonds begin to collapse or dislocate. Companies that were able to hide behind government guarantees would then be left naked in public holding a sign reading "HELP!".

Bankrupties would soar as a result. God only knows how bad the market would tank. I can just about guarantee that 666 on the S&P doesn't hold in this new world. The consequenses of all of this are so frightening that I can't think about it for too long because its unimaginable to me in terms of how ugly things could get.

This was only one auction so its early. Let me also note that this situation would take months to play out. However, I personally cannot see how we sell $2 trillion in treasuries without significantly higher rates.

This new world is coming folks. When it does, the reprocussions are going to be breathtaking.

The Rally Roars On!

Stocks continued to soar today as the market cheered the "whisper numbers" that leaked out around the stress tests.

The financials took a rocket shot after sweating out an inaccurate news story around BofA losses that came out of The New York Times last evening. BTW, I am very disappointed with the reporting by the times on the BofA story last night. Make sure you have all the facts before you run your story. Its no wonder they are bankrupt!

The collapses on some of the leveraged ETF's have been remarkable: FAZ(3x short financials) is down to $5! SRS now sits at $20! The rally we are watching here is something that surely will be written about in the history books.

One thing that David Rosenberg noted today in his daily update was that back in the depression, the S&P bottomed in July of 1932 and then proceeded to rally 73% over the following 3 months before once again touching the lows later on.

Is history repeating itself here? I firmly believe so but every bear market is different. However, the only scenario that you can compare this meltdown to is The Great Depression. Its the only other time is history where we saw a debt bubble that was over 300% of GDP.

Therefore, I still believe this is a bear market rally circa 1932. New bull markets don't occur this quickly after what we just went through.

Let me post this reminder of how violent the trading was in The Great Depression as the market found its bottom:





The fundamentals haven't changed folks. The consumer remains weak. Housing is still in the dumps and is continuing to deflate. The economy is still bleeding jobs albeit at a slower pace. The market has been moving higher as the data continues to come in stronger than the previous month/quarter.

Well you know what folks? The last month/quarter was one of the worst ever so thats not saying much. The patient can only bleed so much before it loses its pulse.

This all being said, the Fed is in an all out war against deflation and the banks are now allowed to basically write their own rules. Short term its hard to bet against this combination.

Bottom Line:

The 960 area on the S&P is an interesting area to short because it represents the 200 day moving average. I had said earlier this week that the 950-1000 area on the S&P would be a nice level to place some SMALL bets on the short side. Let me repeat myself: SMALL.

I think we are seeing the same violence on the way up that we saw on the way down when we collapsed last fall. Perhaps we need to rewrite the old saying and change it from "The bigger they are the harder they fall" to "the harder they fall the bigger they get!"

My guess is the next retrace will take us back down with the same violence. This is why caution is a must here.

This market is nothing to mess around with folks. Step to the sidelines for the most part and just watch in awe.

Market Pauses as the Stress Tests Loom

I must admit I did a lot of reading before starting tonight. Things are absolutely crazy out there and its hard to make sense of it all sometimes.

The market traded in a pretty tight range as it awaits the results of the banking stress tests. One thing that was interesting today was the huge volume. There were over 11 billion shares traded on the NYSE.

This action combined with the tight range tells you that the bears and the bulls are in quite a tussle right now as we head into the test results.

There are many rumors out there regarding the stress tests. SNL Financial is claiming that BofA and Citi need $54.8 billion and $71.8 billion of capital respectively. The Treasury supposedly has this figure at around $10 billion for each. Credit analyst Egan Jones reportedly believes that BofA may need $100 billion in new capital! Yikes!

The bottom line here folks is these estimates are a crapshoot. Trying to front run this news is a risky play if you are trading here.

Inflation or Deflation?

I am seeing so many conflicting signals around each of these in the market. I still believe deflation is the biggest risk.

The ISM number for April was much better than expected. However, this increase in demand has done nothing for pricing power:




My Take:

As you can see, prices continue to stay at very depressed levels which of course screams deflation. This is to be expected as the American consumer continues to recover from their massive credit binge.

At the same time, when I look at the markets I see lots of worries around inflation. China continues to buy massive amounts of gold. They now hold the worlds 5th largest stockpile. Could it be they are losing confidence in our treasuries and the US dollar?

I am also beginning to wonder if equities are also becoming a hedge for inflation. Are investors deciding that owning stocks is safer than piling up US dollars? This may turn out to be a wise move if the government continues to pillage our currency by spending like Paris Hilton on a shopping spree after a cocaine binge.

I have not come to any firm conclusions yet. Yale's Robert Shiller(whom I deeply respect) was on Bloomberg TV yesterday telling investors that they need to spread out their risks by buying stocks and real estate! This was an eye opener for me. When the man who helped create the famed Case/Shiller housing index makes this type of call on real estate you need to take notice of it.

BTW, the print article link that I included to Shiller's comments makes him sound much more bullish than his tone was on TV. He is still extremely skeptical about the economy and the market and believes this is just a bear market bounce.

Bottom Line

I guess my point here is the world of investing has dramatically changed. There are serious risks involved with anywhere you put your money in today's crazy world that we live in. This includes even cold hard cash! We are in unprecedented times.

Perhaps diversification into some hard assets with a short on the S&P 500 as a hedge makes some sense here. I am rapidly losing confidence that our government will defend its currency. The bailouts continue to roll and Ben seems hell bent on creating inflation.

The price action in the market recently tells me that everyone including the pro's are confused.

As a result, they are spreading out their risk and diversifying into many different areas. All you need to do is follow the money in the markets to see how this is all developing: At one point today everything was up! Gold, stocks, and treasury sales were all strong! The market is clearly dominated by two emotions right now: FEAR and CONFUSION.

The bottom line here is it might not be a bad idea to spread out some risk. Cash is still king in my book. However, going long a little gold and a few commodities like natural gas makes some sense as we watch the hit video "Government Spending Gone Wild". A small short on the S&P would be a nice way to hedge this bet.

Remember: Cash is king in deflation. Hard assets protect you from inflation. Protect yourself by owning both.

USA's Obsession with Speculation Continues

Whoa!

Another day another bullfest!

Stocks roared higher today as the high octane stock market continued to climb a massive wall of worry. Many of us have been wondering where the next bubble might form. I think we are seeing it right now in plain old equities.

Lets state the obvious here. We all know none of this move higher makes sense given the news. When you think about it over the past few years: When has the market ever made sense? The two biggest rallies(Bear Stearns and the current March rally) have hit at a time when the news was most dire. The one conclusion I can make here is investors continue to be play follow the money and speculate.

The speculative nature of investors in America continues to amaze me because the bubbles that are created as a result of their speculation always collapse. Yet, despite pounding after pounding, they continue to come back for more. It kind of reminds me of an abused wife that constantly continues to reconcile with their ex believing that "He has changed this time!".

Lets take a quick look at some of the bubbles of recent history and see how they all worked out:

- The tech bubble. Need I explain more...NASDAQ 5000 down to 1500
- The housing bubble. Again....No explanation needed. Prices down 30%-50% from the highs.
- The OIL run from $50/barrel up to $147 and then back to $50.
- The speculative explosion in commodities like copper which tripled in price before collapsing.
- The natural gas run up to $21. Today's price? $3 and change.

I could go on and on but you get the point. The one common result here is obvious: Speculation ends in tears!

Welcome to the new world of investing folks. Investors now prefer a "speculate and gamble" investment strategy as opposed to the old school version of "buy and hold" investing.

Speculative investing of course is the fastest way to the poor house because there are no basis or fundamentals that support what or why you are buying. Speculators simply become one of the herd and jump into whatever bubble that is blowing up. They then pray that they aren't the last sucker in who proceeds to get pummeled with an 80% loss as the first ones in begin to sell.

The examples I gave you above all collapsed because of one simple fact: THE FUNDAMENTALS ALWAYS MATTER! The prices were unsustainable because the valuations did not justify the prices. Valuations are completely ignored when bubbles start to form because the investor is too infatuated with the millions he/she is going to make on his/her investment.

Remember Amazon at $300 a share in 1999? $150 oil? How about that one bedroom house in the ghetto that sold for $350,000 back in 2005? You look back today and think about how insane people were for paying such prices. This is the effect that bubbles and greed have on investors. They can make the sane go insane!

I see a lot of similarities when I look at the current 30+% bounce in equities. The fundamentals continue to deteriorate and yet we continue to see the same trend: The bad news continues to get ignored while the good news is amplified.

S&P downgraded many of the banks today and equities didn't even blink following the news.

Bottom Line:

We are seeing a full blown speculative feeding frenzy in the S&P right now. Trying to get in front of this freight train and shorting this move is not a very good idea in my view. The close was pretty bullish. I will be placing a few small short plays if we move into the 950-1000 area.

Cash is still my number one recommendation. Bubbles never end well and they seem to be almost impossible to avoid at this point if you are in the market. Treasuries even look like a bubble today as we try to sell $2.5 trillion worth of them this year to the rest of the world.

Its a pretty sad day when it appears that no investment option is safe.

I am starting to think that the mattress may be the only place left to protect yourself from losses.




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You Better Duck!

Check This out:

This was some video from a recent Fortis shareholder meeting. This is one of the larger banks in Europe that basically was nationalized when the financial system collapsed last year. The stock price now sits under $2.

The sheeple are getting restless across the pond. I wish we had the same spunk over here. Apparently, most of America would rather watch American Idol while their country collapses right in front of them.





A Must Read

I highly recommend that everyone reads this excellent commentary from hedge fund manager Bill Fleckenstein. Bill is one of the smartest guys on the street and was one of the few that accurately predicted the financial collapse last year.

The two paragraphs below from the piece are what caught my eye:

"Though I hesitate to make too much out of one report on the gross domestic product (or government statistics in general), Wednesday's first-quarter GDP data -- which showed a contraction of 6.1%, versus expectations of 4.7% -- make for a wonderful example of what the future holds: essentially a replay of the 1970s, only far worse.

It's not that I find the results terribly surprising or especially alarming. I do not. What's more interesting is that the GDP price index, which measures the prices of goods and services included in GDP calculations, was expected to be 1.8% but registered 2.9%, and that the and that prices of core personal consumption expenditures (a measure of inflation that master of disaster Alan Greenspan particularly focused on) rose 1.5% quarter to quarter, versus expectations of just 1%."

My Take:

There has been a lot of discussion in the news around deflation and inflation over the past few weeks. I strongly continue to believe that we will see massive asset deflation. However, its extremely disturbing to see such a huge spike in price inflation on goods in the GDP report. These numbers are frightening folks.

My worst case scenario for the economy is a combination of asset deflation and price inflation. Many try to argue that we will see either inflation or deflation. In my view you can have both. It won't take long for the torches and pitchforks to come out if wages continue to stay flat or decline while the cost to live rapidly rises as a result of price inflation.

It would make sense to see inflation in areas of the economy right now as we continue to print trillions of dollars in an attempt to keep the debt bubble inflated. However, this phenomenon does not cross over into housing prices.

The deflation in housing and other assets will continue because people can't borrow as much money as they could in the past due to tighter lending standards. Exacerbating this problem is the fact that people are also losing their jobs at an historic pace. The fear that's created by massive unemployment or the fear of getting laid off also lowers the desire for consumers to lend which of course makes the problem even worse! Death spiral anyone?

My question here is how in the hell is the average person going to survive if the cost to live rises rapidly at a time in which everyone is watching their wages stay flat(that is if they had have a job)? Oh wait a second, I have the answer. They have all of that home equity that they can fall back!(Scarcasm off)

I predict you will see consumer confidence plummet if we continue to see price inflation.

I wish I had the answer as to how do get out of this mess folks. I know one thing: Its going to involve a lot of pain.

Raise cash. You are going to need it when a happy meal at McDonald's costs you $15.

One last question:

Anyone have a shoe I can borrow?