Deflation Straight Ahead?

Hi All

Sorry it's been so quiet around here. Keep checking in because I will post when I get a chance.

Let's get to the markets:

Hmmmm.....Is that the smell of Deflation in the air? The market sure seems to be acting like it.

Let me preface my deflation take by stating that the market is totally manic right now. I expect both inflationary and deflationary panics as the US economy stands on the brink of collapse.

Earlier this year, the Fed turned on the printing press as the economy collapsed hoping that companies and consumers would feel more confident and start spending as things appeared to get back to normal.

As much as we hate it, the Fed must replace the consumer during tough economic times until both the consumer and corporations heal their balance sheets. This usually works very effectively during a mild recession: 1987, 1990, 2001 anyone?

As companies and the consumer recover, the Fed can then yank their liquidity once the economy stabilizes and the private sector is stable enough to stand on it's own.

The problem we have this go around is the economy collapsed in 2008. The Fed has tried to react like it always has and attempted to replace the private sector. What we are slowly learning is that the balance sheets of the consumer this go around are practically beyond repair.

How does an average Joe ever pay off a $600,000 30 year home loan? Answer: He doesn't.

As a result, the Fed is in a real jam with few options. They can't replace the consumer forever because the deficits would eventually destroy the dollar. However, if they pullout, the economythen collapses because the private sector is too damaged to replace them. This would assuredly lead to a deflationary death spiral like we saw in Japan in the '90's and here in the US in the 1930's.

The Bottom Line:

So what will the Fed do? That's the million dollar question. Do they spend spend spend until they create a currency/hyperinflation nightmare?

Or....

Do they fold their hand and let the economy collapse via deflation?

The market appears dazed and confused on this issue. Before this week, the market was screaming inflation as the metals, stocks, and other commodities went on a tear.

This week things changed after the Fed statement. The market began to sell off and both bonds and the dollar started to to rally. What was most noticeable was there was a lot of buying in the long end of the bond market(10/30 year).

This price action screams deflation. The reason I say this is why would anyone buy a 30 year bond at a 4% yield if they expect inflation to rise 10% a year? Answer: They wouldn't because they would be 6% in the hole each year.

So is it deflation or inflation? We have seen panics in both directions in the past few weeks. I don't expect this to change much in the near future.

The future of the dollar and the world economy is very much in the air. This is a time where investors must focus on capital preservation versus yield.

IMO, diversification is a must for both inflation and deflation.

Batten down the hatches folks, there is a nasty storm on the horizon.

Nothingburger!

That's what the Fed gave us today.

This is what happens when your bankroll is dwindling and the economy sits on the brink of collapse. The Fed has just about run out of options.

Their plan of stimulating the economy until the "real" economy can heal itself has failed. How long can they keep this zero interest rate game going without destroying the dollar? My guess is the Fed runs out of money before the economy heals.

The damage has already been done when it comes to the economy. The Fed's "tourniquet" is no longer working. The patient(the economy) is about to bleed out.

I am very tempted to get short right now although I didn't put any positions on today. My spidey sense is telling me that investors are on the brink of realizing that Rome is still burning.

I have seen some horrifying evidence of this anecdotally when I talk to friends involved in banking. Companies are panicking in reaction to this crisis and don't know what to do. They are trying to make 10 workers do the work of 30. Their ability to lend their way through this crisis has dried up.

They have run out of options!

Bill Gross from PIMCO(who I think is a genius) has consistently talked about the new "normal" of our economy which is low to zero growth.

Many businesses are still leveraged up hoping that a gigantic recovery can save them from blowing up.

This ain't happenin folks no matter how bad CNBC wants it too. Welcome to the modern version of The Great Depression.

You think it's bad now? IMO you ain't seen nothing yet.

The dollar, MBS, and the Fed

Hi All!

It's been a long day but thought it was important to discuss a few things tonight. Tomorrow is a big day because we hear from the Fed. The buzz on Wall St is all about the Fed's 80% ownership of MBS and all ears will listening to see if they plan on continuing their purchases of MBS.

Before I explain this let's take a look at the 1 year chart of the dollar because I thought this was the news of the day:

My Take:

That is one ugly chart. We are once again testing the key support level of 76. If this doesn't hold we could easily retest the recent lows of 72. If we break there? Find a desk to hide under because you could potentially see an unwind of the dollar.

Gold was up sharply once again as the dollar dropped. This is a deeply disturbing trend. Gold is now much higher than it was the last time the dollar was down around 72.

This tells me that the world is beginning to question the value of paper dollars as we continue to spend trillions that we don't have. This move in gold isn't an inflation trade IMO.

This is a total fear trade where investors are beginning to question the value of everything whether it be stocks, the dollar, or real estate. They are flocking to things that have historically held value. Gold has done so for thousands of years.

Things are getting pretty chaotic folks. This dollar problem is a very serious situation.

The Fed

Tomorrow's statement by the Fed is critical tomorrow IMO. Word is now out that the Fed now owns 80% of the newly issued MBS market since the market crashed. Essentially this means since the crash that the Fed has financed almost all mortgages wether it be FHA or Freddie.

This news has been floating around the street for a week now but it finally got some attention by the media today.

This is an extremely dangerous situation because the lending that's being done right now in a desperate attempt to keep the housing market alive is still piss poor.

You can qualify for an FHA loan with a credit score of 620 and a down payment of around 3%. To FHA's credit they have risen the minimum credit score up to 620 from 580. However, this type of buyer is hardly a lock to pay a loan back!

If I was a bank I would have no interest in doing a loan with a guy with a 620 credit score, especially with only 3% down!

And their lies the problem folks. The banks have no interest in doing these loans anymore because of the risk involved. So as a result: THE GOVERNMENT ESSENTIALLY NOW HAS TO FINANCE THE WHOLE DAMN HOUSING MARKET BECAUSE THE BANKS HAVE NO INTEREST IN DOING BAD LOANS WITH PEOPLE WHO HAVE 620 CREDIT SCORES!

This is absolute insanity people! What pisses me off about this situation is at least last time we created the housing bubble the banks took the losses.

THIS TIME WHEN THESE LOANS FAIL IT WILL BE THE TAXPAYERS THAT TAKE THE HIT BECAUSE THE FED NOW OWNS ALMOST ALL OF THE MBS MARKET INSTEAD OF WALL ST!

We will be the ones eating the loans of these idiot first time home buyers that bought a house with essentially no money down when you include their 8k tax credit.

Folks, when is this insanity ever going to end? How many times can Uncle Sam repeatedly shove it up the taxpayers behinds? Any future losses will be our problem not the banks because WE THE PEOPLE own these mortgage backed securities via the Fed.

This is what makes tomorrow's Fed announcement interesting. They have already spent over $900 billion of the $1.25 trillion that was targeted for MBS purchases.

They must now announce what their future plans are before this fund gets depleted. If they announce that they plan on winding down this program, you could see one hell of a nasty dump in the markets tomorrow.

Now of course I think we have a better chance of seeing god before we see the Fed pull liquidity so I don't expect them to stop buying the MBS's. They must do so because there will be no home loans without their guarantee.

Why?

Because the banks know most of these loans are garbage and the pigmen have no desire to do the bad loans without a government guarantee. I mean Christ, the delinquency rates on FHA loans is approaching 20%! Why on earth would a bank want any part of this?

The Bottom Line

If the Fed shocks the world tomorrow and ends the purchasing of MBS, you can expect to see strength in the dollar and a collapse of the stock market(especially in the financials).

If the Fed continues it's Ponzi ways and announces more MBS buybacks, expect the dollar to tank and the commodities to continue and rise.

Basically folks, there will be no housing market if the Fed stops buying MBS because the banks won't take on the risk of doing bad loans. The only way you would pull a loan out of them in this scenario is with 20% down and a near perfect credit score with a DTI of less then 36%.

As a result, my bet is on the second scenario where the Fed continues to drop worthless dollars out of helicopters!

The move up in gold and the collapse of the dollar in front of the announcement today only reinforces my thoughts that the Fed has no plans to stop spending. I am sure "the word is out" on the their plans.

As I have said a million times before: This is not going to end well.

Currently Trading? Watch Yourself!

Sorry it's been quiet around here folks.

There really hasn't been much to talk about and things have been very busy at work so I haven't had much time to blog.

I will continue to be here but my posting may be reduced until things settle down at work. Like everyone else right now, the heat is on to produce in the corporate world as we march through this brutal recession/depression. My situation is no different.

Back to the markets:

It's amazing to me that the market can continue to ignore all of the negative news and continue to move higher. The market has truly turned into a casino at this point.

I have thought a lot about why the market is acting so irrationaly rigth now. It has pretty much morphed into nothing more than a bubble blowing/specualtion machine.

I believe one of the key reasons the market is acting this way is the ease in which the retail investor can now go long or short via leverage.

Inverse ETF's can be bought just as easy as any stock. Etrade, Think or Swim, and the other trading platforms have now made buying options a piece of cake.

As a result, the ability to speculate in the stock market has become much more accessible. More importantly, investors can also speculate using much higher leverage than ever before.

This is a very dangerous developement because many of the people using these financial instruments have no idea what in the hell they are doing.

Wall St has taken advantage of the new "leveraged" retail investor IMO.

I mean think about it:

The number of "fish" in the trading pond is now larger(easier access to speculate) plus they are highly leveraged via ETF's and options. This makes the average trader a sitting duck for the wolves on Wall St.

Why?

Because the retail investor becomes much easier to manipulate as a result of being so highly leveraged. This makes it easier to force them out of positions. They don't have the deep pockets to sit on positions especially when they are leveraged up. Don't think Wall St doesn't know this. As a result, it doesn't take much to force them to cover.

The best analogy I can come up with here is poker. The poker pros love when the "fish" take a seat at the table because more times then not the "fish" will be taken to the cleaners. The same goes for Wall St.

Why is Wall St so much better then the retail investor?

A) They know information before you do. How many times has the market moved before a big announcement was made? Is this fraudulent? Of course, but it is what it is and it's a HUGE advatage.

B) This is their profession! They are much more experienced when it comes to the intangibles like trading sentiment.

C) Wall St is filled with math geeks that graduated with 4.0's from MIT. These geeks can use their quants in a market like this to look for inconsistencies in the markets which enables them to find numerous trading opportunities. HFT's anyone? Short covering rallies?

I mean just think of all of the short covering rallies that we have seen recently. Many of these rallies are triggered by the trading desks when they place huge long positions on stocks or ETF's that are too heavily shorted. Commercial Real Estate is the most blatant one that comes to mind.

This one defies belief in my view. There is no rational reason that we have seen many of the REIT's double or even triple from the lows. Defaults continue to soar, most of them can't rollover their debt, and the retail consumer continues to collapse.

Most of these companies would be dead if the mark to market accounting standards hadn't disappeared. The only reason the REIT's are alive is because the government refuses to kill them.

The Bottom Line

Wall St is lining their pockets with the retail investors money.

I believe the reason this rally has been so sharp is because many of the retail(and some professional) traders continually keep getting caught short.
Remember: Calling tops and going short is just about as successful as calling bottoms and going long. Both strategies usually put you in the poor house.

Go surf the net and you will see what I mean when it comes to the leverage being used by the average investor:

Hop on any trading site/investment forum and see what investments they are talking about. It's very rarely a stock. It's almost always the SPY, IYR, SDS,FAZ,SRS etc.

Many are convinced that they are the next "Warren Buffet" of trading. They pull charts and graphs and try to scalp a few points on the S&P. When this collapse is done, I would love to see what the average return is for the average day trader.

Let me also say that there are a small select few that can do this and make money consistently. However, the majority will end up getting toasted for the most part. A 50 year veteran trader in the trading pits once told me "Jeff: Traders die broke". I have always remembered those words.

It's time to get back to fundamental investing folks.

What ever happened to buying and holding a stock that you like? What ever happened to buying treasuries and CD's and focusing on preserving capital when the economy takes a cliff dive? I guess this "old school" type of investing is way too boring in this new greedy ADD world that we live in.

What's sad here is most traders will blow themselves up just like they did after the tech bust. What's scarier this go around is the speculation is 10x worse because we now have highly leveraged ETF's with terrible "slippage" that weren't available during the tech bubble.

I will be the first to admit that I dabble in these trades but it's never more than 10% of my nest egg. My advice is to stay away from trading right now. The fundamentals are non existent, and the market is totally irrational at this point.

China: Don't Believe the Hype?

I am a big Vanguard fan and I thought this was a fascinating look at what is going on in China from the inside economically.

Can China really become the engine of economic growth that the world desperately needs without the US consumer? My thought is no way but you decide: