Double Dip Recession 27th May 2009
Dear Fellow Traders
The European economies are now headed into a serious contraction; China is purposely slowing its economy down to try to control a huge real estate bubble; the Fed is slowly withdrawing liquidity from the market ; the U.S. stimulus package has been spent and, despite some pleas for more, there is no more coming.
There is panic in the air and while this news is, all in all, bad for the citizens of the world, it is great news for short-side traders like us
What can we expect in the near term?
More of the down-side action we’ve recently had. The market is now broken, given that the S&P 500 SPX fell through its 200-day moving average. Any trader, technical or not must understand the importance of this trend.
The euro stabilized and then resumed is decline, as did the pound. That means the dollar is rising.
The first austerity measures were proposed in Portugal, Spain and Italy. But we will wait and see what actually comes out of their legislatures as promises are worth nothing until enacted, the public revolt will surely see change of governments and the overwhelming desire of politicians to please their constituents will more than likely see reversal of many of these measures. Modest cuts were also proposed in Britain, and these will get passed.
A Portuguese bond auction went well, but a German government bond auction had the weakest response in two years, which is a strange scenario as Germany has the strongest economy, makes you wonder who was buying the bonds?
The rate banks charge each other on overnight loans (Libor) has skyrocketed, raising their borrowing costs. Libor is a primary indicator of the confidence banks have in each other and this rate change signals that concerns over sovereign debt risk is spreading to private banks.
Bond ratings agencies have lowered the ratings for the sovereign debt of Portugal, Greece and Spain.
THE COMING DOUBLE-DIP RECESSION
For those of you who are new to this service — and there are a number of new subscribers this month, thank you — I have been writing about a double-dip recession for a long time and warned all of my students back in December of 2007 of the impending collapse of the financial industry in 2008/09
This rally in the last 12 months was artificially propped up by printing money.
I’m a bear, that has done the maths that is telling me a double-dip recession is virtually unavoidable.
Watch my webinar I did back in December 2007 I predicted the crash then and it is coming again
The reality of the European fiscal mess is now prompting much greater scrutiny of government debt in the United States — and the political climate is now dead set against adding new debt to stimulate the economy.
And these realities are all on top of the following reality: The United States is not really out of the last recession yet, in real-world terms — that is the world that drives corporate profits and stock prices.
Fact: Unemployment is about 10%.
Fact: The underemployed plus the unemployed equal more than 17%.
Fact: The underemployed plus the unemployed plus the drop outs from the work force equal more than 22%.
Add it up and it means U.S. national income continues to shrink. The consumer, the driver of the economy, is not back in full force. Unemployment, stagnant income, a concern about the future and, most importantly, a $1.5 trillion dollar contraction of consumer credit that will increase after passage of financial reform, are all conspiring to suppress consumer spending.
Now that the government tax credit programs are winding down, housing is once again effectively dead and will remain that way until 2013 or 2014. That’s not just my opinion, but a fair read of the real data. We are only about one-fourth of the way through foreclosures based on current default rates. A number of people are behind on their mortgages or have mortgages greater than the values of their homes and, for the first time in memory, people who can pay a mortgage but are upside down are simply walking away from a house.
Housing inventory is increasing and foreclosures will keep inventories high for another three years, suppressing prices.
Home starts are at an annual rate of 600,000, when one million used to be the low point for the industry. And there is very little private mortgage industry left to service any demand, as more than 97% of all mortgages granted in the United States are now backed by Freddie Mac and Fannie Mae.
Banks are still contracting as the toxic assets, all $1.5 to $2 trillion of them, continue to build pressure on these banks; commercial real estate defaults hit an 18-year high last quarter equally 4.17% of all loans; consumer credit defaults have stabilized but are astronomical by historical standards; there is a very low level of credit activity as banks shrink their balance sheets and that means lower future profitability. On top of it all, financial reform is going to hit remaining profits hard.
Don’t forget that without the major accounting changes made during the past two years, the largest players in the U.S. banking system would be insolvent.
Stimulus spending is ending and the Fed is slowly pulling back even as the money supply continues to shrink. Bernanke has shut down TARP and TALF, and is debating when to start selling off some of the mortgages the Fed bought. It can’t lower interest rates any more than it has, the fiscal stimulus package is mostly done and there is no political will to pass another large package.
And finally, a real-world recession means expectations for corporate profits by year end or early next year are too high, especially for the banks.
The place where the economy and the markets historically meet (again, the banks) drove the market down in 2007 and 2008, and they will almost certainly do so again later this year or early next year.
So what’s next for us? We’ll go back to the basics and find new positions, although for now we have plenty of good choices in our portfolio.
Outside of the euro crisis, banks and homebuilders (two vastly overvalued segments) are bound to disappoint The Street over the next 3-12 months and provide us with ample new opportunities to profit.
The double-dip recession is starting to creep into The Street’s psyche and is causing The Street increasing nervousness, along with day-to-day and intraday volatility. More importantly to us, the two segments to be hit first, banks and home-builders, are technically weak or already rolling over.
The compelling reasons I outlined above about the forth-coming, double-dip recession are going to hand us a bunch of new opportunities to profit on the short side.
If the money we’ve made recently seemed good, just think of that as the appetizer course.
There’s a full-spread banquet of 100%-plus plays that are being laid out on the sideboard for our feasting enjoyment.
The next few months should be a lot of fun and very rewarding for us.
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See you online next Thursday Night
Trader Lyn
