The Barnard Observer

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Home  Vault  Misc  Contact                                                           c2003-10 Thomas Barnard

Year End 2009

In the Crosscurrents

On the one hand, you have money that was scared into cash now feeling like they would like a higher return, and some of that may go into gold and commodities, and some of that will go into stocks.

On the other hand, a lot of people are still scared.  What if there is a double dip?  Higher unemployment in December and a bad showing by Alcoa yesterday keeps them scared.

Banks in No Shape to Help

Some of the large banks have paid back their TARP funds.  No cause for cheer here, this doesn't mean that banks are ready to loan.  All that means is that they can reinstitute obscene pay.  How else can Goldman pay its huge bonuses?  No patriotic joy here.  And the banks have been making money, after all if you can get Federal Funds at 0%, and buy bonds paying 3%, you're practically minting profits.

This would argue that government needs to think and re-think the matter of incentives.  We need to have all greedy behavior chained to something which helps the society as a whole.  I don't know if the proposed tax on banks is the solution.  I haven't thought it through.  I've long thought a tax on oil would accomplish three or four things:  make green technologies more viable, and tech is good for the USA;  secondly, it would stench the flow of greenbacks to the Middle East; thirdly, it would raise money for the Treasury, reducing the deficit, which in turn, would help strengthen the dollar.

My feeling is rather than a tax on banks, I would just dismantle any bank that requires government help.  It would help to alleviate a bad idea:  Too Big To Fail.

But back on track, aside from paying their upper eschelons huge sums for returning the dough, profits from borrowing at zero and getting 3% will help to fortify bank balance sheets.  And that's another reason there will be no great loan activity.  When the Fed did their stress tests back in May, they expected that as much as $600 billion might have to be written off.  Only a small portion of that has been written down.

J.P. Morgan Chase is writing off $1 billion a quarter on the credit cards, and there is probably widespread credit card disaster lurking in bank financial statements.

The Home Mortgage Situation - Upside Down Cake

The situation in the home mortgage market can be seen most clearly in the percent of loans that are upside down.  (That is, those that now have more debt than equity in their houses).  Even those who are conforming, the best of the lot, have way overpaid for their homes:

                              Q1 2009       Q1 2011 Projected

Conforming             16%            41% have more debt than equity

Prime Jumbo            29%            46%

Alt-A                  49%            66%

Subprime               50%            69%

Option ARM             77%            89%

Total Mortgage Market  26%            48%        

(Refresher, Alt-A loans probably lack loan documentation, lower credit scores, but are better than subprime.  Option ARM loans are loans in which the borrower can pay only interest.)

This chart comes from a Deutsche Bank report, "Drowning in Debt."  My takeaway from this is that we are a long way from any kind of normal housing market.  No one will be moving soon.

It's Japan in the 1990s, expect a 2nd Stimulus Bill in 2010

This economy cannot recover quickly, it simply is not in the cards.  Home prices are propped up by an $8,500 tax credit now ($6,500 for non-new homeowners).  That is scheduled to disappear in April.  Around the same time the Fed will quit its mortgage purchasing program.  A double whammy for housing.

Moreover, it is hard for homeowners to get loans, now that the new underwriting standards (whoops, I mean the old standards) are in place.  But get a load of this:  the government wants the Fannie Mae and Freddie Mac to ignore these standards and start loaning again.  This sounds like nonsense to me.  It's looking for trouble.  The old underwriting standards were there for a reason, they worked.

Given that home building is going nowhere, banks will not be originating much in the way of loans there, and the auto industry is going nowhere, I think it is a safe bet that economy is going nowhere.  Odds are that unemployment which started up again in December, will continue in the coming quarters, and if it persists, another stimulus bill will be in the cards.  Remind you of anything?  Does Japan come to mind?

Harry Dent

Yes, Harry Dent called for 40,000 on the Dow, but he made certain suppositions that didn't pan out, foremost among them was that he thought oil would be $35 per barrel, not $120 per barrel.

Harry Dent, who gives a lot of attention to demographics, is telling us that demographics will not help us.  The baby boom begins to receive Social Security in 2010, and this will continue throughout the next ten years.  This might help create opportunities for kids now entering the workforce.  But there are serious problems which no one in Congress is talking about during all the hullabaloo about national health - Medicare is not properly funded, nor is Social Security.  And increases in taxes here will retard economic growth.

Confessions of a Wayward Investor

Ten years ago I was knee deep in borrowing money to buy stocks.  I was perhaps 130% invested.  If I had only stopped the leverage then, it would have meant that I would have been forced to take profits.  I didn't, and those profits ultimately disappeared. 

And when the market went down in 2002, I was wrong again.  I thought the market would correct from a PE of 40 to single digits.  Instead, the Dow only went to down to 7850 before Alan Greenspan lowered rates to stop the fall.

But was I really wrong?  Subsequently, in the same decade the Dow fell to 6440 (though the PE was still in double digits).  But consider this: in the interim, before the Dow hit a lower low, it went to 14000 to hit a higher high.  Volatility, my friend.  

Even in March I didn't think we had hit the bottom.  I still think we are headed to a PE in the single digits.  The Dow earned something like $660 last year, and $765 is predicted for the coming year.  So, the Dow does not even have to fall below 6440 to end up with a PE of less than 10.  But if volatility remains high, who is to say that the market won't go above 14000 before it sinks back down below 7650 (if the earnings estimates are correct).  Making the whole investing thing more of a crap shoot than ever.

With the Solution Comes the New Bubble

The housing market is dead.  Over-built for now.  But the government wants to stimulate the housing market, and seeks to find demand where there is none.  This spells disaster.

Too Big to Fail.  What does this mean?  If a bank is too big to fail, and the government will rescue them no matter what, does that mean they can take ridiculous risks?  I think it does. 

Still no regulation.  My father put me on to a PBS program about regulation and a woman named Brooksley Born, who was head of the commodities regulation agency.  We still do not have regulation to avoid another AIG debacle.  Some of those derivative products are still unregulated.  And I'm talking about the just plain illegal stuff, like using the same collateral multiple times.  She warned Congress if there was no regulation, you could expect more bubbles and possibly even worse collapses.

Innovation and New Products

I have said it before, but the only thing, aside from a war, that can stir the economy is new products.  There exist opportunities.  We're not quite there yet, but eventually we'll all be able to watch TV over the internet.  There are already Media Center computers, and this trend will just keep continuing.  Televisions will come with computers inside.  Yes, more expensive at first, but really cool.  I wonder how this will effect companies like Comcast.  Will they need to raise rates on broadband to make up for those who defect from the tyranny of just 500 channels to anything they can grab on the internet?  This could happen any time.

Investment Opportunities 2009

Well, I suppose one could try to do the bank thing.  You can't borrow from the Fed at 0% and put it out at 3%.  But you could try to borrow as cheaply as possible and buy preferred's paying 20% or more.

Fannie Mae and Freddie Mac are to be protected by the Fed or Congress for another 3 years.  Something to think about because they are cheap.  The flip side is maybe they need the protection and have a lot to write off.

Bank Preferreds.  A number of people are looking at bank preferreds.  A friend of mine is looking at the PowerShares Financial Preferred (PGF).

There are some companies that have nice backlogs, like Boeing, but they don't represent bargains at current levels.

The Dow is up 50% from the March 2009 lows.  It is going to be harder and harder to find a bargain, and it doesn't feel like an accent point.  52% of investment advisors are bullish, 17% bearish.  If it is an accent point, we're going down.  As I pointed out Value Line doesn't feel there's much juice left.

Probably the best bargains are in the biotechs, which are coming on despite whatever may happen in national healthcare.  They were up spectacularly in the 1990's into 2000, and then they collapsed.  Products were not immediately forthcoming from decoding human DNA.  But stuff is happening, and I want to do a piece on them this year when I can find the time.

The green tech stocks look like they might get some attention.  I think you need to really pay attention.  Long term buyers, look at your portfolio.  Microsoft and Intel have done nothing for 10 years.  Cisco at 24 is down from 80, ten years ago.  Intel at 20, is down from 70. 

What am I doing?  I have not updated my Quicken, so I don't know exactly where I stand (a sign of disappointing returns).  Three tech stocks, one of them a biotech, and some cash.  I found a telecom tech I might buy.  Probably 65%-75% invested, down from 130% ten years ago.  My leverage these days is the new technology that will eat the competition.

Yes, tech.  We all admire Warren Buffett, but his pal Bill Gates made more money, more quickly than Buffett, and by a lot.  Not to forget when you see a $50 billion figure for Gates, that does not include the $30 billion he's already given away.  And he's decades younger than Buffett.

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December 29, 2009 and January 12, 2010