Tuesday, July 28, 2009

Hussman: Biting a Bullet

One of the funds I utilize is the Hussman Strategic Growth fund, managed by John Hussman, PH.D. His fund is fully hedged and this weeks commentary explains why. Here is the important part:

"That said, I can only describe our investment stance here as “uncomfortably defensive.” That is, the measures that have guided the performance of the Strategic Growth Fund over time are still holding to a defensive stance, which is admittedly uncomfortable with the market pressing strenuous but persistent overbought levels. It's a lot like watching people scale across a tenuously secured rope bridge and get a nice meal at the center. You'd like to climb across and join them, but you know that too many things aren't right with the bridge, and it's not clear that the people who are eating will ultimately survive."

Scott Dauenhauer CFP, MSFP, AIF

Monday, July 27, 2009

Great Housing Numbers or False Optimism

Its becoming annoying how bad the media is at analyzing economic data, almost to the point of ignorance. Either the financial media is stupid and ignorant or they just don't want to report bad news. The housing data that came out today showing new homes sales being up was not good news, to find out why, read the article linked to above. Here is a snippet from the TraderMark blog at SeekingAlpha:

"So the important question in a seasonal number is the year over year percentage change.

Sales of new homes were down 21% versus June 2008.
So despite the handouts and almost multi-generational lows in "cheap money" mortgages - including over half the country now in FHA loans (which many times require only 3.5% down) we still dropped 20%. Praise the green shoots.

What was disconcerting if you are a home builder (but not to worry, homebuilder stocks shot up at 10 AM) was the huge drop in month over month prices. Year over year was bad... but the drop between May and June was almost unheard of: 6%. Don't even try to annualize that.

The median sales price of $206,200, however, was down 12 percent from $234,300 a year earlier and down nearly 6 percent from $219,000 in May."

Scott Dauenhauer CFP, MSFP, AIF

Banks Are Nationalized Already, Just Not Their Profits

Notice how you don't hear about the need to nationalize banks anymore? I believe the reason is that with the accounting rules changes and the explicit and implicit guarantees of the federal government not to let any systemic institution fail we have achieved bank nationalization without actually nationalizing them. What would be different if the government had actually nationalized them? Only one thing, profits. Currently banks can take as much risk as they want, borrow at next to nothing and lend at high rates and produce profits - all because of government programs - any profits are for the shareholders, any losses will be absorbed by the taxpayers....sound familiar? If this sounds like the old Fannie Mae/Freddie Mac scheme, you'd be on to something.

Our banking system, which is effectively insolvent is backstopped by the government in every sense. Other than profits, they've been nationalized.

Scott Dauenhauer CFP, MSFP, AIF

Not a Recession, Okay to Call It a depression

A recession is described in one of two ways, two consecutive quarters of negative GDP growth or whenever the National Bureau of Economic Research says its a recession. But where exactly did the term "recession" come from? The term came out of the Great Depression and it started being used "when the economy collapsed again in 1937, they didn't want to call that a new depression" says Robert S. McElvaine is Elizabeth Chisholm Professor of Arts and Letters and Chair of the Department of History at Millsaps College in Jackson, Mississippi. In other words, we didn't want to spook people into thinking we were having another depression (even though that is what it was and continued to be for many more years) and thus we invented "recession."

So what did we have before we had recessions? We had depressions, many of them actually, even one in 1920-21 that most have never heard about. Depression doesn't have an exact meaning, though many will tell you it is a retreat in GDP of about 10% - but it is really an extended hard-hitting recession. Before the Great Depression there was no such thing as a recession, it was simply called a depression. Most people don't know that America suffered many depressions throughout its history before the Great Depression. We only hear of the Great Depression, but that depression was Great because of how deep it was.

So are we in a depression right now? Well, GDP has not yet shrunk by 10% (though I promise that if the current Cap and Trade bill is passed it will surpass 10% - all politics aside), so technically we are not. In reality, using history before the Great Depression and simply living through this (compared to other recessions) we are now in a depression.

Yes, I said it, we are in a depression. But don't panic, America has been here before and pulled out. The reason I say we are now in a depression rather than a recession is because of a number of factors, Unemployment topping the list. The last time we saw unemployment at these levels was actually in the early 1980's, previous to that - The Great Depression.

Did you know that the current unemployment rate utilizing the most broad measure (BLS U-6) now stands at nearly 17%. This U-6 measure includes those who want to full time work but can't find it and are working part-time and those who have simply stopped looking. In some parts of the country this measure is now over 20%, yes 20% - see New York Times graphic c. In California unemployment is a tad over 20%, in my home state of Oregon it now stands at over 23% (higher than Michigan). The good news, if you can call it that is that the national 16%+ number is only half the same number during the Great Depression (a similar, though not perfect apples-to-apples comparison showed 33% unemployment at the worst stage of the Depression).

So what is my other evidence? The weak and weakening financial sector being led by the Residential and Commercial real estate bust. Recent media reports talk of a turnaround in housing, perhaps a pricing bottom has occured, but if the oncoming wave of foreclosures is not stopped - things could get much worse. Our massive national debt is growing at an unbelievable pace and the present value of our entitlement programs is so large as to make our national debt like chump change (somewhere in the $75 Trillion range over the next 75 years). The national debt problem does not include the massive shortfalls that face our states and municipalities in terms of pension and healthcare shortfalls.

Peter Morici, Professor of Business at University of Maryland in the above linked to Washington Post article says Morici says "a depression is a recession that "does not self-correct" because of fundamental structural problems in the economy, such as broken banks or a huge trade deficit."

If you hadn't noticed we have a broken banking system. Lending is compressing and loans are going bad at a feverish pace, without coordinated action we could have severe problems.

In the meantime savers are subsidizing the recovery by earning next to nothing on their savings while banks lend the money out at big spreads to try and cover the massive loan losses they are being forced to take.

The stock market is up, but that doesn't mean we are on the road to recovery, in fact the stock market climbed even higher after the 1929 crash only to crash again. I am not saying this is 1929 or that we will have another crash, but caution should rule the day.

The last time we had a similar economy was when Ronald Reagan took over the Presidency and our national deficit was only $900 billion (today that is the less than the annual deficit).

We are in a depression currently and history will bear this out. Its okay to call it a depression if you understand the word, its not yet a Great Depression and doesn't have to be. This is not a garden variety recession and we are not yet done, despite what the stock market might be saying. Note, this does not mean that the stock market won't continue to climb.

Okay, its been said, now lets start working our way out of this depression and get back on track for long-term prosperity.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, July 21, 2009

The Panic is Over, The Crisis is Not

With the S & P 500 up nearly 40% from its March lows and volatility way down, it appears the Panic of 08-09 is over (or at least in hibernation), however the crisis is not over and there is no real light at the end of the tunnel - despite what you hear. Don't get me wrong, we very well may have a recovery that appears to be real and solid over the next 18 months, but don't be fooled, the underlying structure is such that it can only be temporary.

I am not pessismistic on America in the long run, but for the short-term I remain uneasy. The basic structure of our system is in peril, though it is masked by government bailouts and more importantly - accounting rules. How a company like Citibank can be allowed to continue operations is beyond comprehension. To be clear, the structural underpinnings I'm referring to are almost all debt-based. Our country as a whole is consumed by debt, from the consumer to the government and unless and until that issue is resolved, we will continue to put our economic future in peril.

Last October the United States was held hostage by Hank Paulson (at Treasury), a gun was put to our head and we were told that if we don't spend a trillion dollars on "toxic assets" the world will fall apart. The Congress and the President acquiesced and gave the Treasury the money, much of which has been spent (yet no one knows quite where) and none of it to buy "toxic assets". Kind of funny that the world didn't fall apart, it did fall off a cliff in October, but perhaps that had something to do with the fear that was instilled in everybody - psychology drives markets.

The funny thing is that Paulson had it right, "toxic assets" were a problem, but buying them was impossible and he had to have known that from the beginning - the only thing that could temporary stop the toxic asset problem was a change in accounting rules (which for some reason didn't come till the end of March). The accounting rules changes finally went through and this has covered up the problems, instead of actually dealing with them. It seems the course of action to be taken with the toxic assets is to simply wait them out and hope banks can "earn their way out" of the crisis. I don't think the financial institutions can earn their way out this (I include the GSE's - Fannie and Freddie) as the potential losses are astronomical.

Banks have written down about $400 billion (see Seeking Alpha story), but they've raised over $300 billion in capital. On the surface, this sounds great, the banks will basically make up their losses by raising more money and earning enough profits to get them out of the mess. This will work for some banks, but not all and not for the financial system (GSE's included) as a whole.

Why am I so sure? I happen to live in one of the hardest hit area code's in the country (Murrieta, 92563) in terms of Real Estate price crashes. My house has an original Tax Assessment base of $521,000 and a similar home two doors down just sold at auction three weeks ago for $190,000. Ignoring the bogus appraisal I got in 2007 for $555,000, my house has dropped in value by about 60% (50% if you solely use tax assessor data). That is a huge and unprecedented drop in value. Neighbors are starting to wonder wether its just best to leave, this is a dangerous psychology.

The next wave of foreclosures is going to be crushing and this represents a major systemic problem to our financial system. Imagine putting 50% down on your home and still being underwater substantially. When good credit and large down payment buyers have substantial incentive to walk away, there is going to be problems. Within a one mile radius of my house (according to RealtyTrac) there are 190 homes in some stage of foreclosure, another 102 that are bank-owned and 34 homes for resale. This doesn't count the people who are now making payments but haven't been placed into the "pre-foreclosure" category yet.
While this may be an extreme, its not uncommon in many parts of California, Nevada, Arizona and Florida - if not dealt with it, it will spread (it already is).

My point, the panic appears to be over (but could easily return), but the crisis is not even close to being over.

Scott Dauenhauer CFP, MSFP, AIF

Monday, July 20, 2009

Equastone Issues - Why I Passed Several Years Ago

(A Wall Street Journal article appeared today that talks about the Atlanta, Georgia Equitable building foreclosure - involving Equastone).

Several years ago I was turned onto a real-estate company in La Jolla (San Diego area) by the name of Equastone. A few people I know invested their client money with the firm and had good things to say about them. I like the idea of investing in commercial real estate directly, if it can be done on a reasonable basis and thought it would add some diversification to client portfolios. So I decided to do some due diligence.

I went down to La Jolla, had a nice lunch with the owners and sales people (my first red flag was that one of the owners would actually have lunch with me, a relatively small advisory firm owner). The pitch was straight-forward, they bought properties that they thought were distressed, but had the potential to be turned around, filled with occupants and then sold. The strategy seemed reasonable, assuming it could be executed correctly.

However, the more I found out the more I decided it wasn't for me, or my clients. A few of the red flags that stood out for me might not have made others list, but here they are:

1.) One of the guys in charge of determining "good" value started bragging about his amazing shoe purchase, he told me that he got these great shoes at an amazing value of just under $300 a pair and decided he'd stock up. For me, $300 doesn't appear to be a great value for shoes (of course I don't put much value in shoes, thus perhaps my problem). However, the guy started using his shoe analogy to demonstrate how great he was at spotting real-estate values.......hmmm, perhaps he suffers from over-confidence. This was a red flag, his value quotient wasn't the same as mine.

2.) Leverage. All the properties were highly leveraged, usually in the 70 -80% range or more (according to them and recent reports). I didn't like the large leverage. I'm fine with a little leverage, but anything over 50% gets me nervous - especially if the financing is short term in nature. Clients can make a ton of money, but they can also quickly lose it all.

3.) The company offered to let my clients in on the current offering at the original offering price, even though they claimed the purchases were already showing profits of 20 - 40%. What this told me was they were willing to throw their current clients under the bus to get new clients. I knew that this meant either that they didn't have the returns they claimed or that my clients would soon be diluted by new investors - or worse, the whole thing was a Ponzi.

4.) I was told that no one who had examined their books had ever failed to invest with them.....being the contrarian that I am I thought this was weird and wanted to NOT invest just to be the first! Having said that, it struck me funny that not a single person ever declined.....that was a red flag.

I decided not to invest with Equastone, perhaps leaving huge upside on the table for my clients. However, time has vindicated that decision as Equastone (according to the linked article and today's Wall Street Journal) is having big problems with their properties. Even the sales guy I spoke with at Equastone has left the company (though I don't know why). Who knows, perhaps the offering that I was to buy for my clients is performing well.......but it just didn't pass the smell test. I think my clients are much better off.

Scott Dauenhauer CFP, MSFP, AIF

Friday, July 17, 2009

Markman: The U.S. China Ponzi Scheme

The picture is of Charles Ponzi,from whom we get the name "Ponzi" scheme. Jon Markman writes a very insightful article linked to above that shows the disturbing linkage between the US and Chinese economy. While this articles attacks a tough subject, it does so in an easy to understand and readable format and shouldn't take you more than five minutes to read - you should read it.

From the article:

"The credit is good only so long as China keeps recycling funds through the Ponzi scheme. But if Beijing leaders ever decide that it's just too risky to own U.S. dollars and debt, then the system is going to come crashing down. Of course, it is not really in China's interest to stop the scheme, even if it wanted to, because its own economy would likewise blow up."

Scott Dauenhauer CFP, MSFP, AIF

Thursday, July 16, 2009

CBO Director: "Federal Budget....Unsustainable"

"Under current law, the federal budget is on an unsustainable path, because federal debt will continue to grow much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the population will cause federal spending to increase rapidly under any plausible scenario for current law. Unless revenues increase just as rapidly, the rise in spending will produce growing budget deficits. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress economic growth in the United States. Over time, accumulating debt would cause substantial harm to the economy."

Evidently the CBO Director didn't get the Biden memo (see: Biden: Spend To Avoid Bankruptcy).

Scott Dauenhauer CFP, MSFP, AIF

Biden: Spend to Avoid Bankruptcy

I can just imagine the flak I'm going to get for this post, but.......come on, how could I resist?

Yes, Biden did say that if we don't spend on health care we will go broke......I guess ignoring the fact that it is medicare and medicaid that are already broke and such large liabilities that they basically make the U.S. insolvent on paper. Never mind the fact that we can't go bankrupt since we have the ability to print money endlessly (ignoring the consequences of that for now).

We have a $10 trillion on-the-book deficit slated to rise to around $20 trillion in a decade and this excludes the costs of medicare, medicaid and social security (okay, not totally, but the vast majority of the present value of the future liability is excluded from this figure). Does it make sense to spend even more money? Isn't that what got us into the financial crisis in the first place?

This type of fiscal irresponsibility is what sinks nations.


Scott Dauenhauer CFP, MSFP, AIF

Wednesday, July 15, 2009

Dykstra: Another Too-Good-To-Be-True Story

Growing up I was a big baseball fan, still am, but to a lesser extent. I collected baseball cards and followed the Major League teams closely. I could tell you the starting lineup of every club, their individual player stats (not just for the year, but their career) and every team a player had played for - it was my passion, before finance. I remember the 1986 world series like it was yesterday - Boston Red Sox versus the New York Mets. It was a great series and my favorite ballplayer at the time, Wade Boggs was about to win his first World Series (Boston)......until the most famous gaffe of all time occurred. In game 6 the Red Sox where one out away from winning the World Series and breaking the Curse of the Bambino, a soft, easy to play ground ball was hit to Golden Glove first baseman Bill Buckner......and it went between his legs (allowing the winning run to score). The Red Sox went on to lose the game, which forced game seven, which they lost.....the curse would continue for another 18 years (they won in 2004). Bill Buckner, a great baseball player by all accounts was hated and villified, his whole life changed after that. At the end of the day though, Buckner went on with his life and most people have forgiven him and can laugh it off. What does this have to do with my headline? Turns out the only real goon on the field that day was not Buckner, but the now infamous, Lenny Dykstra (Nails - for you baseball fans).

The above article will give you a bit of a background on Dykstra in terms of his rise from baseball fame to Investment Manager fame, but I remember about a year or two ago hearing about Dykstra from a buddy (can't remember who). My buddy said something about Dykstra and I said "the ballplayer?" He told me that Dykstra had become a guru of investors and was rich and writing for Jim Cramer (in my Hall of Idiots).......what?

The article will tell you why that surprised me, but suffice it to say I was intrigued, even read a few of his articles and then promptly concluded Dykstra was an idiot. He wasn't doing anything special and would eventually peter out.......instead he went out with a bang. He claims $30 million in liabilities and $50,000 in assets in his recent bankruptcy filing.

Dykstra could help you earn outsize returns so you could live in a big mansion and use private jets.........at least that was the image portrayed. At the end of the day he turned out to be just another of histories fools. Bill Buckner made an error that day back in 1986 (everyone forgets it was Bob Stanley's wild pitch to Mookie Wilson that allowed Mitchell to score, tying the game), but that is part of the game, he was no fraud, he was the real deal who made a big error - Dykstra is a fraud and will forever be known to me as the only Goon to come out of that series.

The real point: If its too good to be true.......well, you know the rest.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, July 14, 2009

Taleb: Time to tackle the real evil: too much debt

Great article that proposes what I am many others have been saying for a long time, Debt must be swapped for Equity.

Scott Dauenhauer CFP, MSFP, AIF

Monday, July 13, 2009

Michael Lewis: The Man Who Crashed the World

An excellent an easy, quite fascinating piece on the unit at the center of the financial crisis and sub-prime meltdown, AIG Financial Products.

The hubris is unbelievable, but what actually happened compared to what the mainstream media has reported is even more interesting. For sure, this is not a full accounting, but its a good account.

Scott Dauenhauer CFP, MSFP, AIF

Time: Revealing Interview with Depression Economist Anna Schwartz

Whether you like, dislike or don't care about Obama, read this Time article with an open mind and consider that its not about Obama, but about the economist who literally lived through the Great Depression and has built a career on it. Anna Schwartz is someone to listen to even if you disagree with her. I pray to God that I have such a spry mind at her age.

Scott Dauenhauer CFP, MSFP, AIF

Siegel Date Called Into Question: Stocks for the Long Run Flawed

The link is to another blog which provides a link to the Jason Zweig Wall Street Journal article about the flawed data Professor Siegel has used in his book Stocks for the Long Run. The book in question had become the bible for most planners (including myself.....but no longer), but the assumptions are being called into question and for good reason - they are highly flawed. You can link to the blog post and article to learn about those flawed assumptions, but suffice to say there isn't much to say. I've quoted and linked to Jeremy Siegel many times in the past and will continue to follow him, however it appears that this professor may be a bubble legend....and this bubble has been popped. The damage however is monstrous as nearly all planners and investment advisors have been schooled in the Stocks for the Long Run methodology. It seems we (yes, I include myself) allowed ourselves to believe what we wanted to believe and instead of trying to design reasonable methods to meet goals, we became cheerleaders for stocks and resorted to almost a religious faith in them as the singular way to meet a clients goal. Things have now changed, its not that Stocks aren't a good invest in the long run or that many of the truths I and others held dear are no longer - its that they may have been misapplied.

More on this to come.

Scott Dauenhauer CFP, MSFP, AIF

NY Times: From Treasury to Banks, an Ultimatum on Mortgage Relief

Interesting article, seems like July 28th may be a day of reckoning for mortgage servicers......but I doubt it. Geithner has summoned them all to D.C. ala Hank Paulson last year to let the servicers know they are doing a poor job. Unfortunately it was Geithner who lobbied for rule changes that allow the servicers and banks to act the way they are (mark-to-market, see previous post). This article does a good job showing that the current round of loan modifications isn't actually happening and when it is, it isn't working. Expectations are for 3.5 million foreclosures over the next year.

The mortgage crisis is worse today then it was a year ago and if smart ideas are employed sooner rather than later it will be worse a year from today.

Having said that, prices have fallen in some places to a point where it makes sense to buy, but that assumes the buyer can withstand a further potential drop in prices. A good example, in my neighborhood I can buy the same home as mine, but with a pool for 55% less than what I paid, its actually now a reasonable purchase.

Scott Dauenhauer CFP, MSFP, AIF

Schiff: New Mark-to-Market Rules: Playing Pretend

This article was written by Peter Schiff in April, but provides an easy to understand reasoning of why the Mark-to-Market rule change (which has since created a rather large stock market rally) are simply stupid and concealing the true bitterness that represents todays bank balance sheets. I was all for a change to Mark-to-Market accounting as a way to help put an end to the crisis, but only if it was coupled with real solutions, it was not and now the distortions continue and get worse.

Scott Dauenhauer CFP, MSFP, AIF

Whitney Tilson: An Overview of the Housing Crisis and Why There is More Pain to Come

T2 July 3

Homeowners - Economic Zombies

The chart provided above via Barron's via Mark Hanson via Hanson Advisors shows the futility of the current program of loan modifications. The Barron's article that this linked to article quotes from is a great editorial with perhaps the best quote I've heard in years, one which correctly pegs the current state of the housing markets:

“Loan mods are designed to keep the unpaid principal balances of the lender’s loans intact while re-levering the borrower. Mortgage modifications turn homeowners into underwater, overlevered renters for life, unable to sell, re-buy, refi, shop or save. They turn homeowners into economic zombies.” Mark Hanson

This quote gets it right on and echoes what I've been saying for over a year now. The loan modifications taking place right now and over the past months have been a ruse. They simply play "kick the can". The goal of the bank is to keep the loan on the books at full value even though the collateral is sometimes worth 50% less than the loan balance (or more). The mortgage services simply tacks on the past due balance, taxes and penalties on to the back end of the loan and lowers the interest rate and/or extends the life of the loan to 40 years. Take for example an individual with a home loan of $500,000 on a property worth $250,000 - they are six months behind on payments or about $35,000 including taxes. The loan mod will give them a new mortgage of $535,000 at a lower interest rate for a longer time period....thereby preserving the lenders balance sheet while increasing the total indebtness of the borrower - who couldn't afford the first loan. This situation makes a redefault highly likely and in fact that is what the numbers show....leading to Mark Hanson's above quote - these homeowners turn into "Economic Zombies".

The problem is not with loan modifications, its how they are being done. The bank balance sheets are the number one priority, not the homeowner, this leads to a situation where the market will take much longer to heal and foreclosures will be much greater and prices will overcorrect. What needs to happen is some government action, but not mass intervention. We need to incentive the servicers and lenders to modify those loans that are economically viable and WRITE DOWN PRINCIPAL and to immediately (following current law of course) foreclose on those where it makes no sense to allow them to stay in the home. In exchange for the balance sheet destruction the government can offer tax incentives and coordinate a national Property Appreciation Rights program that exchanges the debt on the property for equity. This will not fully offset the losses, but it shouldn't. Simply doing this will create a floor under prices in many areas and allow for inventory levels to normalize (some places would continue to fall until they hit equilibrium).

If we keep on the current path we will never be able to build a firm foundation going forward. Of course things have gotten so bad now that fixing housing will no longer fix the economy, but it is a needed first step.

Scott Dauenhauer CFP, MSFP, AIF

Wells Fargo Bank Sues Itself

This story is not a humor break. Wells Fargo actually sued itself during a foreclosure. The holder of the 1st Wells Fargoe sued the holder of the 2nd Wells Fargo. Even better, both sides had their own attorneys. Not only are our banks incompetent and effectively insolvent, they are wasting our and their money on idiot attorneys who can't find a better way to foreclose on a house they fully own than sue each other.....or itself rather. Just another sad tail of the stupidity going on in the unwinding of this massive bubble.

Scott Dauenhauer CFP, MSFP, AIF