Further Than Most Expect
By Paul Lamont
June 30, 2008
As we forecast last month, the regional banks have quickly brought about the next round of financial troubles. We expect a large decline in the broader stock market to be the next major issue. The Royal Bank of Scotland, Morgan Stanley, Barclays, and even the Bank of International Settlements (the central bank’s central bank) have issued financial storm warnings. We referenced the Bank of International Settlements (BIS) last July in warning of the credit crunch last year. According to the Telegraph, they are now specifically warning of deflation. The BIS states:
"Historians would recall the long recession beginning in 1873, the global downturn that began in the late 1920s, and the Japanese and Asian crises of the early and late 1990s respectively. In each episode, a long period of strong credit growth coincided with an increasingly euphoric upturn in both the real economy and financial markets, followed by an unexpected crisis and extended downturn…The eventual global slowdown could prove to be much greater and longer lasting than would be required to keep inflation under control. This could potentially even lead to deflation, which would evidently be less welcome."
Chief Economist, Bill White, in his departing memo continues:
"It is not impossible that the unwinding of the credit bubble could, after a temporary period of higher inflation, culminate in a deflation that might be hard to manage, all the more so given the high debt levels."
In our last few reports we too have warned of the turn from temporary inflation to deflation. Now evidence of this transition is appearing in the economic data.
Money Supply Growth Slowing
Shortly after the appointment of Chairman Ben Bernanke, ‘expert’ on the Great Depression, the Federal Reserve retired the reporting of M3. M3 is the broadest measurement of the money supply. Conspiracy theorists (usually gold bugs) believe that the Fed hides M3 so that it can ‘print money’ and secretly monetize the debts of the banking system. So John Williams (Shadowstats.com) began keeping track of M3 himself. Recently, money supply observers have been surprised: his measurement of M3 growth is slowing down. Instead of hiding ‘money printing’, the Fed is really covering up the extreme slowing in the growth of money. The velocity of money has slowed. No new real estate loans, no new money. To support this case, the annualized growth in loans and investments held at commercial banks has gone negative as well (chart below).
Chart from Northern Trust’s Daily Commentary by Paul Kasriel and Asha Bangalore
This is precisely what we would
expect at the beginnings of a deflationary bust. No wonder the BIS is
concerned. But the
The Sun or the Fall of Icarus, Merry-Joseph Blondel 1819
As we have stated, we expect this private sector credit tightening to prevail over emergency Fed lending. One main reason is that the credit bubble is global. As a Bear Stearns executive recently described their meltdown:
“It was as though a computer virus had been launched. Where the hell was this coming from? Who started it? We tried, believe me, but we could not track it down. We know lots of big hedge funds were spreading rumors, but how can you pursue that? Only the S.E.C. can, and they’re all over this.”
The central planners may try to
“manage” things, but contagions could result quickly from panics in
Cash and the Inflation Problem
One major excuse that investors
have been given to stay
invested in stocks has been ‘inflation.’ Regardless of what may
occur due to money supply changes, let’s look at what is happening to
Futures Market Forecasts 20% to 40% Housing Price Decline By 2010
Many folks are waiting to
“catch the falling knife” in real estate. As the futures market
currently stands (table below), real estate prices will
continue to plunge until 2010. We think even that is optimistic, especially
after the bond market bubble implodes. Remember in
More Indications of an Oil Top
The discussion at a recent cocktail party recently turned to homemakers buying oil stocks. Black Gold, a reality show on drilling for oil is being shown on TNT. Meanwhile Wall Street hedge funds are increasing their short bets on oil and gas companies. Not much changes in the financial world. The last time we saw a reality show based on an economic trend, it was called ‘Flip This House.’ The homebuilder stocks peaked out that year. We still expect a ‘last hoorah’ from the oil price. It could easily spike into the $160-$190 range. But like in the last recession, oil falls (50% in the last mild downturn) with the real economy.
Return of the Bear Market - Fashion Insanity
We noticed the
recent theme of a male fashion show in
The title track, Aladdin Sane (a
pun on ‘A Lad Insane’), was actually named “Aladdin Sane
(1913-1938-197?).” Dates representing World War 1, World War 2 and what he
thought might mark the start of World War 3 according to wikipedia.
Like the ‘hyperinflationists’ of our day, he got the date right,
just the wrong outcome: In January 1973, Nixon signed the Paris Peace Accords
Last month we quoted Benjamin Graham from his 1949 classic, The Intelligent Investor; “the small investors, who preponderate in terms of numbers, should own as many Series E bonds as they possibly can, even though they buy nothing else.” Let’s look at a few of the reasons Benjamin Graham thought U.S. Savings Bonds were a ‘boon to investors’ and show how U.S. Treasury Bills compare:
“Combined Safety and Yield”
U.S. Treasury Bills like U.S Savings bonds are backed by the full faith and credit of the United States Government. A six-month U.S. Treasury Bill has a current Yield-to-Maturity of 2.0% (roughly). Compared to other asset classes this is quite a return!
“Option To Redeem Before Maturity”
Treasury Bills are extremely liquid, as they are considered ‘interest-bearing cash.” They can be sold with funds available the next day.
U.S. Treasury Bills have the same tax features as U.S. Savings Bonds. They are subject to Federal income tax, but they are exempt from all state and municipal tax.
‘Bottoming’ For The Next 2 Years
The advertising scheme currently emanating from Wall Street is ‘buying the bottom.’ Frankly, most baby boomers are already fully invested. There is no new buying. The drumbeats of ‘buy’ are really just to keep folks from selling. At the bottom, (which we expect in 2010), most will finally give up, fire their stock brokers and will sell. At that point, those who have invested their retirement savings in stocks will receive the lowest possible value. When this final panic occurs, we will recommend equity purchases. In the meantime, we are recommending a smarter alternative to money market funds.
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Copyright ©2008 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at firstname.lastname@example.org, or call (256) 850-4161.