Riders on the storm
Into this house were born
Into this world were thrown…
When pressure builds, nature transfers along the path of least resistance from high pressure to low. This is true with electricity, water, the air that creates the wind, and money. When there’s a storm brewing, you do not want to be the path of least resistance, that’s almost never a good thing!
Trying to decide how to protect your assets in the storm that will be 2009? I would submit that if you do not have a clear understanding of the hurricane forces that underlie our economy, then you will continue to donate your wealth to the fiat currency gods, just as most people did in 2008!
The securitization of debt process via derivatives created the largest credit bubble in the history of mankind – estimates are that on a per capita, dollar adjusted basis, that debt levels heading into this storm were 2.5 times a high as they were in the late 1920’s, just prior to the Great Depression. In our current monetary system, which is only 38 years old, credit money is created with the initiation of debt. When that “money” was loaned into existence, it literally was created from nothing – the ether. Now that the parabolic securitization of debt process is unwinding, those same false credit dollars are returning back to the ether from which they came.
There is a powerful psychology that created people’s “buy in” to the bubble while it was being created, and there is a reverse psychology at work as the bubble unwinds. At each stage of the market decline, new bottom callers emerge which helps pull new money into the storm to be destroyed. The vast majority of people still do not see or understand this bubble, nor do they see how far it will unwind or how THEIR dollars will be drawn into the unwinding process.
Thus, my first prediction is that 2009 will be the year of recognition. The fundamental psychology underlying ALL markets will shift from ignorance and hope to recognition that the problems run far deeper and far longer than most had previously believed. This recognition will discredit those who profess to have market and economic knowledge (these false “experts” permeate the financial industry and television), it will discredit the government agencies who manipulate and present false data, and it will remove the “hope” that a new administration has any chance of being more effective than the last at interrupting the unwinding process.
To view how this psychology works, simply review your own perspective about residential real estate since its recent peak (or those of others if you’ve been realistic). A lot of people knew that double digit growth in home prices was not sustainable, yet few took proactive action. The same can be said for equities (stock) and commercial real estate (CRE). The same psychology is at work during all bubbles, so at this point, I think it’s best to review the seven bubble stages Hyman Minsky accurately described (the following excerpt is from my book Flight to Financial Freedom – Fasten Your Finances, written during 2005/2006):
HYMAN MINSKY’S SEVEN BUBBLE STAGES
The late Hyman Minsky, Ph.D., was a famous economist who taught for Washington University’s Economics department for more than 25 years prior to his death in 1996. He studied recurring instability of markets and developed the idea that there are seven stages in any economic bubble:
Stage One – Disturbance:
Every financial bubble begins with a disturbance. It could be the invention of a new technology, such as the Internet. It may be a shift in laws or economic policy. The creation of ERISA or unexpected reductions of interest rates are examples. No matter what the cause, the outlook changes for one sector of the economy.
Stage Two – Expansion/Prices Start to Increase:
Following the disturbance, prices in that sector start to rise. Initially, the increase is barely noticed. Usually, these higher prices reflect some underlying improvement in fundamentals. As the price increases gain momentum, more people start to notice.
Stage Three – Euphoria/Easy Credit:
Increasing prices do not, by themselves, create a bubble. Every financial bubble needs fuel; cheap and easy credit is, in most cases, that fuel. Without it, there can’t be speculation. Without it, the consequences of the disturbance die down and the sector returns to a normal state within the bounds of “historical” ratios or measurements. When a bubble starts, that sector is inundated by outsiders; people who normally would not be there. Without cheap and easy credit, the outsiders can’t participate.
The rise in cheap and easy credit is often associated with financial innovation. Many times, a new way of financing is developed that does not reflect the risk involved. In 1929, stock prices were propelled into the stratosphere with the ability to trade via a margin account. Housing prices today skyrocketed as interest-only, variable rate, and reverse amortization mortgages emerged as a viable means for financing overpriced real estate purchases. The latest financing strategy is 40, or even 50 year mortgages.
Stage Four – Over-trading/Prices Reach a Peak:
As the effects of cheap and easy credit digs deeper, the market begins to accelerate. Overtrading lifts up volumes and spot shortages emerge. Prices start to zoom, and easy profits are made. This brings in more outsiders, and prices run out of control. This is the point that amateurs, the foolish, the greedy, and the desperate enter the market. Just as a fire is fed by more fuel, a financial bubble needs cheap and easy credit and more outsiders.
Stage Five – Market Reversal/Insider Profit Taking:
Some wise voices will stand up and say that the bubble can no longer continue. They argue that long run fundamentals, the ratios and measurements, defy sound economic practices. In the bubble, these arguments disappear within one over-riding fact – the price is still rising. The voices of the wise are ignored by the greedy who justify the now insane prices with the euphoric claim that the world has fundamentally changed and this new world means higher prices. Then along comes the cruelest lie of them all, “There will most likely be a ‘soft’ landing!”
Stage Five is where the real estate industry is today [2005/2006]. This stage can be cruel, as the very people who shouldn’t be buying are. They are the ones who will be hurt the most. The true professionals have found their ‘greater fool’ and are well on their way to the next ‘hot’ sector, like the transition from real estate to commodities now.Those who did not enter the market are caught in a dilemma. They know that they have missed the beginning of the bubble (gold, silver, and oil today [2005/2006]). They are bombarded daily with stories of easy riches and friends who are amassing great wealth. The strong will not enter at stage five and reconcile themselves to the missed opportunity. The ‘fool’ may even realize that prices can’t keep rising forever… however, they just can’t act on their knowledge. Everything appears safe as long as they quit at least one day before the bubble bursts. The weak provide the final fuel for the fire and eventually get burned late in stage six or seven.
Stage Six – Financial Crisis/Panic:
A bubble requires many people who believe in a bright future, and so long as the euphoria continues, the bubble is sustained. Just as the euphoria takes hold of the outsiders, the insiders remember what’s real. They lose their faith and begin to sneak out the exit. They understand their segment, and they recognize that it has all gone too far. The savvy are long gone, while those who understand the possible outcome begin to slowly cash out. Typically, the insiders try to sneak away unnoticed, and sometimes they get away without notice. Whether the outsiders see the insiders leave or not, insider profit taking signals the beginning of the end (remember who has sold their rental properties?).
Stage seven – Revulsion/Lender of Last Resort:
Sometimes, panic of the insiders infects the outsiders. Other times, it is the end of cheap and easy credit or some unanticipated piece of news. But whatever it is, euphoria is replaced with revulsion. The building is on fire and everyone starts to run for the door. Outsiders start to sell, but there are no buyers. Panic sets in, prices start to tumble downwards, credit dries up, and losses start to accumulate.
This is where you may see the “lender of last resort” who is usually the government. The government, although they were talking up a soft landing, are now forced to step in to prevent the crises from spreading to other sectors. Ironically, this is where the savvy investor who profited before, really profits now. With government backing, they are asked to step in and return “normalcy” to a now damaged sector.
The government’s attempt to “put out the fire” usually works. However, the conditions beyond the year 2010 will require oceans of water that the government does not posses. You must be ready!
Right now most people view the recent bubbles separately. They see a Japanese real estate bubble, a Japanese stock market bubble, a NASDAQ bubble, a housing bubble, a commercial real estate bubble, a derivatives/financial services bubble, an oil/commodities bubble, and now a bond market bubble. To most people these bubbles were inflated and the “money” moved from one to produce the next.
That’s not what I see. I see one giant credit bubble that produced all those “sub-bubbles,” and at the root of the credit bubble is a monetary system that promotes never ending growth. Never ending growth is IMPOSSIBLE, thus the system is flawed (there’s a lot to this, my “cut the crap” articles are progressing through it). All this debt accelerated future earnings and it shifted forward in time the earnings of the Baby Boom generation. Now that the Boomers are progressing to the back side of their peak earnings curve (peak earnings occur at the statistical aggregate age 48.5), our population is faced with overall reduced earnings to service now skyrocketing debts.
As this correct view becomes more well understood, recognition that it’s NOT CONTAINED will spread, and here’s how that recognition will develop:
Earnings are the underlying support to stock prices. Earnings are still way overestimated for 2009, just as they were way overestimated for 2008. Soon we will begin to get earnings for the 4th quarter and those earnings will be overall less than estimated. That process will repeat over and over until stock prices go down enough to produce a MONTHLY close beneath the 2002 lows. We’ve already had the S&P produce a daily close beneath those lows – Half Way to Zero, but since we rallied back above and the DOW never did the same, many people falsely believe that we are building THE bottom. Nope, not THE bottom, just A bottom along the way. The move from October 2007, to November 2008 was likely wave ‘A’ of a Grand Supercycle A-B-C correction.
Indeed, this is a significant bottom in that it is most likely wave ‘B’ up/sideways. It is the “eye of the storm.” And it probably marks the half way point, time wise, along the stock market’s Voyage to the Bottom of the 'C'....
As you can see from the following “Four Bad Bears” chart from Doug Short (dshort.com), this bear market is still pacing the markets during the great depression in terms of time and depth (markets lost nearly 90% during the Great Depression):
Once that monthly close beneath the ’02 lows occurs, all market technicians will be hit between the eyes with the indisputable fact that this correction is on a higher corrective level than the 2000 – 2003 timeframe, or even that of the Great Depression. Those who study Elliott Wave already know that the earlier penetration has signaled this. As more and more technicians understand the technical ramifications, the recognition will spread that THE bottom will not occur in the year 2009, just as it did not occur in the year 2008.
Over the past year, a very few TRUE experts have foreseen what has happened and have gotten it mostly right. IT IS CRITICAL THAT YOU KNOW WHO THE TRUE EXPERTS ARE, and that you heed their advice and not the advice of those who are trying to sell you something (most everyone in the financial industry, those on television, and those in the government). Take the wrong advice in 2009, and your wealth will be DESTROYED – you will simply donate your share of fiat money back to the ether from which it came.
I’m really going to praise Karl Denninger here, because he has had the BALLS to say what is happening and to put his predictions in print. His newest set of predictions are now available and can be found here: Karl Denninger - MUST READ PREDICTIONS.
I follow a lot of people in the financial industry and NONE have been as specifically accurate as Karl. Thus, I will not even attempt to outdo his predictions for 2009, I will simply state again that if you choose to ignore his track record and advice then you will simply donate your fiat dollars away. Please do a realistic self-assessment! Did your understanding and predictions for ’08 beat his?
Again, his prediction are MUST READ material. I cannot argue with any of his predictions for ’09, but I can fine tune a little and add to his list:
• The long term logarithmic uptrend lines will likely provide support in 2009, they are currently about the S&P 540ish area and at DOW 4,000ish area. Those are my target lows for ’09. Those lows may be broken in ’09, but if historic time lines hold, they will not be broken until 2010. I am going to largely exit the market entirely once S&P 600 is touched, and I will probably not do anything further with my money and the markets from that point on until I receive new long term buy signals. Why? Because gains from shorting the market will be difficult or impossible after that point, and going long any bounce in a severe bear market is just gambling unless you are playing for the short term bounce, and then you had better be doing good technical work. Another reason I will not try to play THE bottom is that I believe this to be a Grand Supercycle correction with game changing consequences which will play out well beyond 2010. Thus, “buy and hold” will not be a successful strategy for quite some time.
• At least one major homebuilder will file for bankruptcy in 2009 (admittedly I thought this would happen in 2008 – mid-tier companies did, but the largest ones did not). Residential real estate will not find a bottom, and Commercial Real Estate will deteriorate rapidly, descending on the same line as residential, but lagging by 18 months.
• The Federal Government will step in to bail out State governments who in turn will be forced to bail out local governments – or the Federal Government will just directly step in to bail them all out. State and local governments do not have bad derivative debt instruments like the banks to offer in loan program exchanges, thus the money will be added on to our national debt. Many government retirement plans do contain contaminated derivative debt and there is major trouble brewing there too.
• The pain with financial institutions is not over and we will see more failures in the future. The truth is that all the major players are bankrupt if they are forced to mark their losses. Many believe that we have escaped the wrath of derivatives unwinding. That’s not true, we have only managed to hide the situation for now. The AIG bailout was all about hiding the consequences of derivatives, but at some point enough institutions will fail and the numbers will be so large that the government simply cannot bail them out. That may happen in ’09, but it will happen by then end of 2010.
• Our current account deficit will increase by at least $1 trillion in 2009, but the true GAAP deficit will run in the multi-trillions.
• Entitlement spending will not be curtailed and the math will continue to get worse.
• Military spending will be sacrificed to some degree under Obama’s leadership. But, the military industrial complex will find a way to shuffle budget money away from “the military budget.” Base closures will become another topic for the Obama administration and states will have less power to stop them because of their own fiscal problems.
• Obama will be “tested” and will have to respond to some geopolitical “crisis” within 2009 to prove that he is man enough to use our military, and he will. This, of course, will be orchestrated by the people who profit from such activity, as it always has been and will be.
• I would not be surprised by an attempt on Obama’s life in 2009. Any “free thinking” by Obama, that goes against the interests of the central banks, will make this much more likely. This is very low probability, however, as he has surrounded himself with the same old central banker cast (he would not have been elected otherwise).
• The relationship and balance between a healthy economy, a healthy national defense, and FREEDOM/SECURITY will become a topic of debate. You will begin to see this topic discussed more widely and Obama will pick up on it. Study the thinking of Thomas Jefferson for inspiration.
• Infrastructure and alternative energy will be given much money & lip service as part of a “Great New Deal II.” These efforts will be a much better use of money than propping up the financials, BUT they will ultimately fail to turn this crisis by themselves. The math doesn’t work, and spending more money in infrastructure will not change that monetary math equation, it will only make it worse. All money spent will have to be borrowed into existence or it will be outright printed. Both cause the math to work against the people. Also, we cannot afford to maintain the infrastructure we currently have, adding new infrastructure adds to those costs and will shift the number of people who derive their income from the government up, not down which is the direction of a true and sustainable recovery.
• By the end of the year most people will be referring to this crisis as GDII, but the government will most likely NOT acknowledge such until 2010.
• Airline order cancellations will increase despite low oil prices.
• Technology and small caps will under perform during declines and over perform during rebounds – underperforming overall.
• All other reads by Denninger, including those of currencies, bonds, and commodities will prove to be correct or close to correct.
While my outlook is still pessimistic, my overall viewpoint is optimistic in that this storm is a cleansing process. While America and her economy are great, they are certainly not perfect. Change will be painful, but in the long run I hope that it will be the impetus to push our economy and country to the next level up the evolutionary ladder.
In terms of what to do to protect your wealth, again I cannot improve upon the way Denniger closes his forecast – “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.”
Like a dog without a bone
An actor out alone
Riders on the storm…
No need to be an actor out alone or a dog without a bone - if your finances are going to survive the storm then you must be able to determine WHO is handing out the best advice. Not everyone is going to agree, and to those who disagree, well, all I can say is that some “People are Strange!”