WEEKEND THEATER - THE DEPRESSION NEXT DOOR

I'm a bit torn.  I'm very busy and yet I feel the mounting pressure to post my predictions for 2013 and also do a review of 2012.  If you have a moment read my post, CONFIDENCE LOST - 13 for 2012 where I make a few predictions about how the year would turn out.  I will probably come back and do a formal review, but the truth is, it doesn't matter, the year is over.

The score is that I felt like it would be a negative year in markets and that was wrong, but overall I hit about 8 or 9 of the 13, and especially made some good calls that made money.

It is fun to document what I'm thinking, so I will do a brief bullet point list for 2013 this weekend so we can look back and laugh about how good or how silly I've was in the beginning part of the year.

As we bask in the glory of the financial cliff deal and are joyous about how we'll continue to keep deficit spending rolling for a few more months, I thought I'd give you some weekend viewing pleasure that highlights the wonderful experience of some friends across the pond.  The Spanish were truly folks that were completely swallowed up in the housing bubble and they have suffered greatly from its bursting.

The video is a wonderful one as it really highlights how middle class families and unrelated industries get crushed when markets, investors, governments, and regular people suspend their sensibilities and assume that price increases can go on forever and that they are smart enough to exit before the collapse.

THE GREAT SPANISH CRASH





ENJOY AND HAVE A GREAT WEEKEND.

GOATMUG

Goatmug is an investor that cares about you and your family. Goatmug's Blog - Financial Perspectives From The Mountain Top is a collection of thoughts on our economy and how it impacts the lives of investors and average people. While several specific investments are named in many of his posts, these articles are simply invitations for you to do your own research and reference to these securities does not constitute financial advice. Your situation is complex and unique and you should seek professional assistance with your trading and investing. Please visit Goatmug and share your comments athttp://www.goatmug.blogspot.com/

THEY DID IT ON PURPOSE....

EURO DOWN ON THE CANVAS?
George Soros gave a speech on June 2nd that is worth a read.  I will not make any comment to it here, but will make a post shortly about Europe, the Eurozone, the fall, the recovery, and a stronger scarier Unionized Europe.  I'll make a few predictions that will be 100% correct and you'll wonder how I can be so amazingly accurate three to four years out.  Until I make that post in the next week or two, Mr. Soros will keep us entertained.  Yes, this speech is important as I think he is impacting the moves that people make simply by talking about the choices and the appropriate direction.

SOROS SHAPING THE OUTCOME BY TALKING ABOUT THE OUTCOME

George Soros Remarks

Festival of Economics

June 2, 2012

Trento, Italy

Ever since the Crash of 2008 there has been a widespread recognition, both among economists and the general public, that economic theory has failed. But there is no consensus on the causes and the extent of that failure.

I believe that the failure is more profound than generally recognized. It goes back to the foundations of economic theory. Economics tried to model itself on Newtonian physics. It sought to establish universally and timelessly valid laws governing reality. But economics is a social science and there is a fundamental difference between the natural and social sciences. Social phenomena have thinking participants who base their decisions on imperfect knowledge. That is what economic theory has tried to ignore.

Scientific method needs an independent criterion, by which the truth or validity of its theories can be judged. Natural phenomena constitute such a criterion; social phenomena do not. That is because natural phenomena consist of facts that unfold independently of any statements that relate to them. The facts then serve as objective evidence by which the validity of scientific theories can be judged. That has enabled natural science to produce amazing results.

Social events, by contrast, have thinking participants who have a will of their own.  They are not detached observers but engaged decision makers whose decisions greatly influence the course of events. Therefore the events do not constitute an independent criterion by which participants can decide whether their views are valid. In the absence of an independent criterion people have to base their decisions not on knowledge but on an inherently biased and to greater or lesser extent distorted interpretation of reality. Their lack of perfect knowledge or fallibility introduces an element of indeterminacy into the course of events that is absent when the events relate to the behavior of inanimate objects. The resulting uncertainty hinders the social sciences in producing laws similar to Newton’s physics.

Economics, which became the most influential of the social sciences, sought to remove this handicap by taking an axiomatic approach similar to Euclid’s geometry. But Euclid’s axioms closely resembled reality while the theory of rational expectations and the efficient market hypothesis became far removed from it. Up to a point the axiomatic approach worked. For instance, the theory of perfect competition postulated perfect knowledge. But the postulate worked only as long as it was applied to the exchange of physical goods. When it came to production, as distinct from exchange, or to the use of money and credit, the postulate became untenable because the participants’ decisions involved the future and the future cannot be known until it has actually occurred.

I am not well qualified to criticize the theory of rational expectations and the efficient market hypothesis because as a market participant I considered them so unrealistic that I never bothered to study them. That is an indictment in itself but I shall leave a detailed critique of these theories to others.

Instead, I should like to put before you a radically different approach to financial markets. It was inspired by Karl Popper who taught me that people’s interpretation of reality never quite corresponds to reality itself. This led me to study the relationship between the two. I found a two-way connection between the participants’ thinking and the situations in which they participate. On the one hand people seek to understand the situation; that is the cognitive function. On the other, they seek to make an impact on the situation; I call that the causative or manipulative function. The two functions connect the thinking agents and the situations in which they participate in opposite directions. In the cognitive function the situation is supposed to determine the participants’ views; in the causative function the participants’ views are supposed to determine the outcome. When both functions are at work at the same time they interfere with each other. The two functions form a circular relationship or feedback loop. I call that feedback loop reflexivity. In a reflexive situation the participants’ views cannot correspond to reality because reality is not something independently given; it is contingent on the participants’ views and decisions. The decisions, in turn, cannot be based on knowledge alone; they must contain some bias or guess work about the future because the future is contingent on the participants’ decisions.

Fallibility and reflexivity are tied together like Siamese twins. Without fallibility there would be no reflexivity – although the opposite is not the case: people’s understanding would be imperfect even in the absence of reflexivity. Of the two twins, fallibility is the first born. Together, they ensure both a divergence between the participants’ view of reality and the actual state of affairs and a divergence between the participants’ expectations and the actual outcome.

Obviously, I did not discover reflexivity. Others had recognized it before me, often under a different name. Robert Merton wrote about self-fulfilling prophecies and the bandwagon effect, Keynes compared financial markets to a beauty contest where the participants had to guess who would be the most popular choice. But starting from fallibility and reflexivity I focused on a problem area, namely the role of misconceptions and misunderstandings in shaping the course of events that mainstream economics tried to ignore. This has made my interpretation of reality more realistic than the prevailing paradigm.

Among other things, I developed a model of a boom-bust process or bubble which is endogenous to financial markets, not the result of external shocks. According to my theory, financial bubbles are not a purely psychological phenomenon.  They have two components: a trend that prevails in reality and a misinterpretation of that trend. A bubble can develop when the feedback is initially positive in the sense that both the trend and its biased interpretation are mutually reinforced. Eventually the gap between the trend and its biased interpretation grows so wide that it becomes unsustainable. After a twilight period both the bias and the trend are reversed and reinforce each other in the opposite direction. Bubbles are usually asymmetric in shape: booms develop slowly but the bust tends to be sudden and devastating. That is due to the use of leverage: price declines precipitate the forced liquidation of leveraged positions.

Well-formed financial bubbles always follow this pattern but the magnitude and duration of each phase is unpredictable. Moreover the process can be aborted at any stage so that well-formed financial bubbles occur rather infrequently.

At any moment of time there are myriads of feedback loops at work, some of which are positive, others negative. They interact with each other, producing the irregular price patterns that prevail most of the time; but on the rare occasions that bubbles develop to their full potential they tend to overshadow all other influences.

According to my theory financial markets may just as soon produce bubbles as tend toward equilibrium. Since bubbles disrupt financial markets, history has been punctuated by financial crises. Each crisis provoked a regulatory response. That is how central banking and financial regulations have evolved, in step with the markets themselves. Bubbles occur only intermittently but the interplay between markets and regulators is ongoing. Since both market participants and regulators act on the basis of imperfect knowledge the interplay between them is reflexive. Moreover reflexivity and fallibility are not confined to the financial markets; they also characterize other spheres of social life, particularly politics. Indeed, in light of the ongoing interaction between markets and regulators it is quite misleading to study financial markets in isolation. Behind the invisible hand of the market lies the visible hand of politics. Instead of pursuing timeless laws and models we ought to study events in their time bound context.

My interpretation of financial markets differs from the prevailing paradigm in many ways. I emphasize the role of misunderstandings and misconceptions in shaping the course of history. And I treat bubbles as largely unpredictable. The direction and its eventual reversal are predictable; the magnitude and duration of the various phases is not. I contend that taking fallibility as the starting point makes my conceptual framework more realistic. But at a price: the idea that laws or models of universal validity can predict the future must be abandoned.

Until recently, my interpretation of financial markets was either ignored or dismissed by academic economists. All this has changed since the crash of 2008. Reflexivity became recognized but, with the exception of Imperfect Knowledge Economics, the foundations of economic theory have not been subjected to the profound rethinking that I consider necessary. Reflexivity has been accommodated by speaking of multiple equilibria instead of a single one. But that is not enough. The fallibility of market participants, regulators, and economists must also be recognized.  A truly dynamic situation cannot be understood by studying multiple equilibria.  We need to study the process of change.

The euro crisis is particularly instructive in this regard. It demonstrates the role of misconceptions and a lack of understanding in shaping the course of history. The authorities didn’t understand the nature of the euro crisis; they thought it is a fiscal problem while it is more of a banking problem and a problem of competitiveness. And they applied the wrong remedy: you cannot reduce the debt burden by shrinking the economy, only by growing your way out of it. The crisis is still growing because of a failure to understand the dynamics of social change; policy measures that could have worked at one point in time were no longer sufficient by the time they were applied.

Since the euro crisis is currently exerting an overwhelming influence on the global economy I shall devote the rest of my talk to it. I must start with a warning: the discussion will take us beyond the confines of economic theory into politics and the dynamics of social change. But my conceptual framework based on the twin pillars of fallibility and reflexivity still applies. Reflexivity doesn’t always manifest itself in the form of bubbles. The reflexive interplay between imperfect markets and imperfect authorities goes on all the time while bubbles occur only infrequently. This is a rare occasion when the interaction exerts such a large influence that it casts its shadow on the global economy. How could this happen? My answer is that there is a bubble involved, after all, but it is not a financial but a political one. It relates to the political evolution of the European Union and it has led me to the conclusion that the euro crisis threatens to destroy the European Union. Let me explain.

I contend that the European Union itself is like a bubble. In the boom phase the EU was what the psychoanalyst David Tuckett calls a “fantastic object” – unreal but immensely attractive. The EU was the embodiment of an open society –an association of nations founded on the principles of democracy, human rights, and rule of law in which no nation or nationality would have a dominant position.

The process of integration was spearheaded by a small group of far sighted statesmen who practiced what Karl Popper called piecemeal social engineering. They recognized that perfection is unattainable; so they set limited objectives and firm timelines and then mobilized the political will for a small step forward, knowing full well that when they achieved it, its inadequacy would become apparent and require a further step. The process fed on its own success, very much like a financial bubble. That is how the Coal and Steel Community was gradually transformed into the European Union, step by step.

Germany used to be in the forefront of the effort. When the Soviet empire started to disintegrate, Germany’s leaders realized that reunification was possible only in the context of a more united Europe and they were willing to make considerable sacrifices to achieve it.  When it came to bargaining they were willing to contribute a little more and take a little less than the others, thereby facilitating agreement.  At that time, German statesmen used to assert that Germany has no independent foreign policy, only a European one.

The process culminated with the Maastricht Treaty and the introduction of the euro. It was followed by a period of stagnation which, after the crash of 2008, turned into a process of disintegration. The first step was taken by Germany when, after the bankruptcy of Lehman Brothers, Angela Merkel declared that the virtual guarantee extended to other financial institutions should come from each country acting separately, not by Europe acting jointly. It took financial markets more than a year to realize the implication of that declaration, showing that they are not perfect.

The Maastricht Treaty was fundamentally flawed, demonstrating the fallibility of the authorities. Its main weakness was well known to its architects: it established a monetary union without a political union. The architects believed however, that when the need arose the political will could be generated to take the necessary steps towards a political union.

But the euro also had some other defects of which the architects were unaware and which are not fully understood even today. In retrospect it is now clear that the main source of trouble is that the member states of the euro have surrendered to the European Central Bank their rights to create fiat money. They did not realize what that entails – and neither did the European authorities. When the euro was introduced the regulators allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital; and the central bank accepted all government bonds at its discount window on equal terms. Commercial banks found it advantageous to accumulate the bonds of the weaker euro members in order to earn a few extra basis points. That is what caused interest rates to converge which in turn caused competitiveness to diverge. Germany, struggling with the burdens of reunification, undertook structural reforms and became more competitive. Other countries enjoyed housing and consumption booms on the back of cheap credit, making them less competitive. Then came the crash of 2008 which created conditions that were far removed from those prescribed by the Maastricht Treaty. Many governments had to shift bank liabilities on to their own balance sheets and engage in massive deficit spending. These countries found themselves in the position of a third world country that had become heavily indebted in a currency that it did not control. Due to the divergence in economic performance Europe became divided between creditor and debtor countries. This is having far reaching political implications to which I will revert.

It took some time for the financial markets to discover that government bonds which had been considered riskless are subject to speculative attack and may actually default; but when they did, risk premiums rose dramatically. This rendered commercial banks whose balance sheets were loaded with those bonds potentially insolvent. And that constituted the two main components of the problem confronting us today: a sovereign debt crisis and a banking crisis which are closely interlinked.

The eurozone is now repeating what had often happened in the global financial system. There is a close parallel between the euro crisis and the international banking crisis that erupted in 1982. Then the international financial authorities did whatever was necessary to protect the banking system: they inflicted hardship on the periphery in order to protect the center. Now Germany and the other creditor countries are unknowingly playing the same role. The details differ but the idea is the same: the creditors are in effect shifting the burden of adjustment on to the debtor countries and avoiding their own responsibility for the imbalances. Interestingly, the terms “center” and “periphery” have crept into usage almost unnoticed. Just as in the 1980’s all the blame and burden is falling on the “periphery” and the responsibility of the “center” has never been properly acknowledged.  Yet in the euro crisis the responsibility of the center is even greater than it was in 1982. The “center” is responsible for designing a flawed system, enacting flawed treaties, pursuing flawed policies and always doing too little too late. In the 1980’s Latin America suffered a lost decade; a similar fate now awaits Europe. That is the responsibility that Germany and the other creditor countries need to acknowledge. But there is now sign of this happening.

The European authorities had little understanding of what was happening. They were prepared to deal with fiscal problems but only Greece qualified as a fiscal crisis; the rest of Europe suffered from a banking crisis and a divergence in competitiveness which gave rise to a balance of payments crisis. The authorities did not even understand the nature of the problem, let alone see a solution. So they tried to buy time.

Usually that works. Financial panics subside and the authorities realize a profit on their intervention. But not this time because the financial problems were reinforced by a process of political disintegration. While the European Union was being created, the leadership was in the forefront of further integration; but after the outbreak of the financial crisis the authorities became wedded to preserving the status quo. This has forced all those who consider the status quo unsustainable or intolerable into an anti-European posture. That is the political dynamic that makes the disintegration of the European Union just as self-reinforcing as its creation has been.  That is the political bubble I was talking about.

At the onset of the crisis a breakup of the euro was inconceivable: the assets and liabilities denominated in a common currency were so intermingled that a breakup would have led to an uncontrollable meltdown. But as the crisis progressed the financial system has been progressively reordered along national lines. This trend has gathered momentum in recent months. The Long Term Refinancing Operation (LTRO) undertaken by the European Central Bank enabled Spanish and Italian banks to engage in a very profitable and low risk arbitrage by buying the bonds of their own countries. And other investors have been actively divesting themselves of the sovereign debt of the periphery countries.

If this continued for a few more years a break-up of the euro would become possible without a meltdown – the omelet could be unscrambled – but it would leave the central banks of the creditor countries with large claims against the central banks of the debtor countries which would be difficult to collect. This is due to an arcane problem in the euro clearing system called Target2. In contrast to the clearing system of the Federal Reserve, which is settled annually, Target2 accumulates the imbalances. This did not create a problem as long as the interbank system was functioning because the banks settled the imbalances themselves through the interbank market. But the interbank market has not functioned properly since 2007 and the banks relied increasingly on the Target system. And since the summer of 2011 there has been increasing capital flight from the weaker countries. So the imbalances grew exponentially. By the end of March this year the Bundesbank had claims of some 660 billion euros against the central banks of the periphery countries.

The Bundesbank has become aware of the potential danger. It is now engaged in a campaign against the indefinite expansion of the money supply and it has started taking measures to limit the losses it would sustain in case of a breakup. This is creating a self-fulfilling prophecy. Once the Bundesbank starts guarding against a breakup everybody will have to do the same.

This is already happening. Financial institutions are increasingly reordering their European exposure along national lines just in case the region splits apart. Banks give preference to shedding assets outside their national borders and risk managers try to match assets and liabilities within national borders rather than within the eurozone as a whole. The indirect effect of this asset-liability matching is to reinforce the deleveraging process and to reduce the availability of credit, particularly to the small and medium enterprises which are the main source of employment.

So the crisis is getting ever deeper. Tensions in financial markets have risen to new highs as shown by the historic low yield on Bunds. Even more telling is the fact that the yield on British 10 year bonds has never been lower in its 300 year history while the risk premium on Spanish bonds is at a new high.

The real economy of the eurozone is declining while Germany is still booming. This means that the divergence is getting wider. The political and social dynamics are also working toward disintegration. Public opinion as expressed in recent election results is increasingly opposed to austerity and this trend is likely to grow until the policy is reversed. So something has to give.

In my judgment the authorities have a three months’ window during which they could still correct their mistakes and reverse the current trends. By the authorities I mean mainly the German government and the Bundesbank because in a crisis the creditors are in the driver’s seat and nothing can be done without German support.

I expect that the Greek public will be sufficiently frightened by the prospect of expulsion from the European Union that it will give a narrow majority of seats to a coalition that is ready to abide by the current agreement. But no government can meet the conditions so that the Greek crisis is liable to come to a climax in the fall. By that time the German economy will also be weakening so that Chancellor Merkel will find it even more difficult than today to persuade the German public to accept any additional European responsibilities. That is what creates a three months’ window.

Correcting the mistakes and reversing the trend would require some extraordinary policy measures to bring conditions back closer to normal, and bring relief to the financial markets and the banking system. These measures must, however, conform to the existing treaties. The treaties could then be revised in a calmer atmosphere so that the current imbalances will not recur. It is difficult but not impossible to design some extraordinary measures that would meet these tough requirements. They would have to tackle simultaneously the banking problem and the problem of excessive government debt, because these problems are interlinked. Addressing one without the other, as in the past, will not work.

Banks need a European deposit insurance scheme in order to stem the capital flight. They also need direct financing by the European Stability Mechanism (ESM) which has to go hand-in-hand with eurozone-wide supervision and regulation. The heavily indebted countries need relief on their financing costs. There are various ways to provide it but they all need the active support of the Bundesbank and the German government.

That is where the blockage is. The authorities are working feverishly to come up with a set of proposals in time for the European summit at the end of this month. Based on the current newspaper reports the measures they will propose will cover all the bases I mentioned but they will offer only the minimum on which the various parties can agree while what is needed is a convincing commitment to reverse the trend. That means the measures will again offer some temporary relief but the trends will continue. But we are at an inflection point.  After the expiration of the three months’ window the markets will continue to demand more but the authorities will not be able to meet their demands.

It is impossible to predict the eventual outcome. As mentioned before, the gradual reordering of the financial system along national lines could make an orderly breakup of the euro possible in a few years’ time and, if it were not for the social and political dynamics, one could imagine a common market without a common currency. But the trends are clearly non-linear and an earlier breakup is bound to be disorderly. It would almost certainly lead to a collapse of the Schengen Treaty, the common market, and the European Union itself. (It should be remembered that there is an exit mechanism for the European Union but not for the euro.) Unenforceable claims and unsettled grievances would leave Europe worse off than it was at the outset when the project of a united Europe was conceived.

But the likelihood is that the euro will survive because a breakup would be devastating not only for the periphery but also for Germany. It would leave Germany with large unenforceable claims against the periphery countries. The Bundesbank alone will have over a trillion euros of claims arising out of Target2 by the end of this year, in addition to all the intergovernmental obligations. And a return to the Deutschemark would likely price Germany out of its export markets – not to mention the political consequences. So Germany is likely to do what is necessary to preserve the euro – but nothing more. That would result in a eurozone dominated by Germany in which the divergence between the creditor and debtor countries would continue to widen and the periphery would turn into permanently depressed areas in need of constant transfer of payments. That would turn the European Union into something very different from what it was when it was a “fantastic object” that fired peoples imagination. It would be a German empire with the periphery as the hinterland.

I believe most of us would find that objectionable but I have a great deal of sympathy with Germany in its present predicament. The German public cannot understand why a policy of structural reforms and fiscal austerity that worked for Germany a decade ago will not work Europe today. Germany then could enjoy an export led recovery but the eurozone today is caught in a deflationary debt trap. The German public does not see any deflation at home; on the contrary, wages are rising and there are vacancies for skilled jobs which are eagerly snapped up by immigrants from other European countries. Reluctance to invest abroad and the influx of flight capital are fueling a real estate boom. Exports may be slowing but employment is still rising. In these circumstances it would require an extraordinary effort by the German government to convince the German public to embrace the extraordinary measures that would be necessary to reverse the current trend. And they have only a three months’ window in which to do it.

We need to do whatever we can to convince Germany to show leadership and preserve the European Union as the fantastic object that it used to be. The future of Europe depends on it.

GOATMUG

Goatmug is an investor that cares about you and your family. Goatmug's Blog - Financial Perspectives From The Mountain Top is a collection of thoughts on our economy and how it impacts the lives of investors and average people. While several specific investments are named in many of his posts, these articles are simply invitations for you to do your own research and reference to these securities does not constitute financial advice. Your situation is complex and unique and you should seek professional assistance with your trading and investing. Please visit Goatmug and share your comments at http://www.goatmug.blogspot.com/ 

Mid Year Predictions Review & Trading Update

2010 PREDICTIONS REVIEW


Well, we are more than half way through the year.  The market, if you can believe it, is just about even with where we started, and there is only one word to describe the action, volatile.  If you are trading daily and you are lucky, you are probably breaking even.  If you are not lucky, you are being ground up in the daily, unreasoned swings that occur because the high frequency trading computers run the show.  Call them Skynet (Terminator reference) or Hal 9000, they are doing a job on most active traders.  Unfortunately those that are buy and holders aren't doing any better.  Is it any wonder that treasuries and corporate bonds are the best performers this year?

I have been busy on several projects and that has kept me from writing, but I have had this topic on my mind to review where I thought things were going.  I really love looking at this because it provides great information as to how right and wrong one can be at the same time.  It also allows me to tweak my longer term thesis and review if there has been a significant change that has an impact on my outlook.

Let's jump into it shall we?


INTEREST RATES - (-1)

I SAID - 1/3/2010 - Interest Rates will rise, but not at the direction of the Fed. - The market will demand a more just compensation for the risk it has taken in Treasuries. The 30-year will hit 6%. The market is predicting a rise in the Fed Funds rate coming in August, but I think they will delay raising rates overtly until November or December at the earliest. Any slow down in the economy will be another excuse not to raise them at all in 2010.

REALITY - 7/20/2010 - Ok, interest rates on the 30 year are more like 3.95% so we don't look like we are in danger of hitting my more reasonable 6% target.  So why are we not at a reasonable 6%.  I think for two reasons. 
A)  There is still tremendous fear in the market and investors would rather buy certainty (that they get paid back their money) rather than risk it in the markets.
B)  I think that there is actually a level of true Quantitative Easing being done despite the fact that it officially has stopped.  What I saying is that there have been a number of buyers of treasuries that have been buying in size that don't really typically opt for these instruments.  So while other buyers of our debt have reduced their consumption, the United Kingdom somehow has stepped up mightily and has purchase somewhere near $200 Billion in treasuries over the last several months.  These guys are massively mired in debt and running deficits.  Where'd they get the cash to buy our T-Bills? 

Doesn't matter, I've missed it so far, and frankly, I've changed my tune on this one, we won't see those 6% rates till there is a shock where investors absolutely shun the USD and Uncle Ben will do anything to stop the move up in rates, cause he has to.  I expect that we will see a 30 year mortgage at 3.5% by mid 2011, so give me a -1 to start out the 2010 Predictions Mid Year Update.



QUANTITATIVE EASING - (+1)
I SAID - 1/3/2010 - While the Fed stated they will stop Quantitative Easing in March of 2010, they will not be able to stop because losses on their book will be immense.


REALITY - 7/20/2010 - We as you look above, the question really is, did they really stop?  I would bet they haven't, and we'll actually see more public admission that they are going to publicly do it.  Uncle Ben this week in his testimony on the Hill stated that they are committed to extraordinary steps to keep the fragile economy afloat (my words not his, but that was the meaning).


HOUSING - (+1)
I SAID - 1/3/2010 - Housing issues will improve through April at which time the impact of increasing interest rates will force the hands of banks and they will begin to release their inventory of "non-foreclosed homes" on the market pushing the new wave of speculators underwater teaching them that falling knives are tough to catch. Some are pointing to the HAMP requirements that state that banks that had home owners that modified mortgages and failed to keep the terms of the deal (make their payments) must release this inventory and use short sales as the tool to divest themselves of the inventory as another reason for a coming drop in home prices. I don't see it that way, I see the government changing their minds again and lifting this requirement when they figure out that it could hurt the recovery.


REALITY - 7/20/2010 - I think this pretty much was nailed.  Check out today's report by NAR about the surge in predicted annualized sales through April and guess what, it is going in the tank.  Ummm, look at that inventory build there too.  Isn't government stimulus effective?

Annualized Sales Data from NAR - http://www.realtor.org/research/research/ehsdata
MONTH       Annualized Sales    Supply
2009 Dec       5,440,000   7.2 Month Supply


2010 Jan        5,050,000    7.8 Month Supply

2010 Feb       5,010,000    8.5 Month Supply

2010 Mar       5,360,000    8.1 Month Supply

2010 Apr       5,790,000    8.4 Month Supply

2010 May      5,660,000   8.3 Month Supply

2010 Jun       5,370,000    8.9 Month Supply




CURRENCIES (-1)
I SAID - 1/3/2010 - We will see at least 2 currency devaluations in 2010. These will manifest themselves in the form a North Korea style announcement where you will wake up and the currency will be declared -10% less in value or more. These devaluations are necessary to continue each country's desire to sell goods cheaply abroad. The US' motivation of course is simply to reduce the relative amount of the crushing debt that we continue to heap upon ourselves.

REALITY - 7/20/2010  - We haven't seen this yet, but effectively, the rise in the USD has helped prevent this situation.  If we see Geithner and Uncle Ben resume the significant devaluation in the dollar as a measure to inflate and get us out of this mess, we will see these in the back half of the year.  I'm conceding this as a miss.  Note that Argentina is essentially defaulting on debt to bondholders by forcing an exchange, it isn't a currency adjustment, but sure is sucky if you're told to take new bonds (less bonds).

EURO - (+1)
I SAID - 1/3/2010 - The Euro will face continued pressure, the US dollar will rise significantly against the Euro from the 1.432 level it is as of this writing.

REALITY - 7/20/2010 - Problems in the Eurozone will not go away even if they can pull off a US style sham with the bank stress tests.  They still have major issues of spending too much and promising too many benefits in the nanny state.  Need a preview of where our government is taking us?  Look no further than the week Euro, out of control spending, and a detachment from math that is temporary.  Ultimately Europe and the Euro fail.

YEN - (-1) 
I SAID - 1/3/2010 - The dollar will strengthen against the yen.

REALITY - 7/20/2010 - Hasn't happened.  The Fed and Treasury have had been luck keeping rates low and Japan has not been as effectively using QE as I thought relative to the US.  Remember, this is a race to zero and Japan has been in deflation for 20 years.  I will patiently wait for this, but they are clearly worse than the US.

GSEs - (+1)
I SAID - 1/3/2010 - Fannie Mae and Freddie Mac will become the dumping ground for all private mortgages loans made in 2009 and 2010. The banks will avoid taking losses and pass all of them to the US taxpayer. The Christmas present (uh-unlimited losses) that the government gave the US tax-payer on Christmas day is unbelievable. For the next 3 years the loss limits on these two organizations have been lifted and we are backing them with a blank check.

REALITY - 7/20/2010 - Ok, I'm not sure if this was really a stretch in predicting anything.  These companies are toast, and we the US taxpayer are unwillingly footing the bill for complete insanity.

LENDING - (+1)
I SAID - 1/3/2010 - Small business lending and personal credit will continue to decline through 2010.

REALITY - 7/20/2010 -Lending is still extremely tight.  The administration and Congress just past legislation in an attempt to get small business lending going.  While I applaud this, this probably means an abandonment of conservative lending principles and we'll see losses in this area of government generosity as well.



GOLD (No Rating Yet)
I SAID - 1/3/2010 - Gold will actually decline to the $950 area and then move higher later on in the year when it becomes increasingly obvious that Bernanke and Geithner have no intention of pulling liquidity. This will be the opportunity to add more to the position. Gold ends the year in the $1150 to $1200 range. Longer term, gold is still a buy.

REALITY - 7/20/2010 - Gold is still at $1192 as of this update (7/23).  The gold market has not dropped as much as I anticipated, but certainly hasn't ramped up higher.  I am still looking for the move down to the $950 to $1,000 area though after an anticipated ramp up again.  You could potentially buy it and then sell it higher, but you face serious risks in timing it.

EQUITY MARKETS (+1)
I SAID - 1/3/2010 - US equity markets will end the year slightly positive (meaning less than 5%). This year will be volatile and gains should be harvested when they are acquired. This means that there will be periods of gains and you need to take advantage of the ranges in the markets and buy at the low end and sell at the high end. I still maintain that the Fed will support this market directly or indirectly at all costs. As housing reverses, be prepared to see unexplainable increases in equity markets. Bernanke knows the conventional thoughts that the collapse in 1937 occurred because the Fed increased rates too soon, he'll be sure not to repeat that lesson. This is how we'll be sure to over inflate and also create the next collapse in 2011 or 2012.

REALITY - 7/20/2010 - Pretty right on so far, but I would actually look for a move up in markets over the next month or two and then a slide down in the months of October and November.  There will be no rate increases by the Fed.


FOREIGN POLICY - (No Rating)
I SAID - 1/3/2010 - Middle East tensions will boil over. The US will give Israel the green light to defend herself and presumptively attack Iran. Russia and China will condemn the attack and they will choose the side of their trading partner against Israel by selling arms and providing material support.  Upon attacking Iran, Syria and Lebanon will engage Israel on their northern fronts.

REALITY - 7/20/2010 -  Tensions are mounting.  The longer we languish economically I believe we will see an increase in tensions in the Middle East.


OIL - (No Rating)
I SAID - 1/3/2010 - Oil moves to $100 this is based on the continued debasement of our currency through the actions of the Fed and Treasury and also geopolitical tensions.

REALITY - 7/20/2010 - Oil is now back up to $79.  A move to devalue the dollar any will result in meeting my $100 projection.


US POLITICS (No Rating)
I SAID - 1/3/2010 - Republicans sweep away the majority held by the Democrats in the mid-term elections. The third-party movement continues to garner support but is quashed by the two party system.

REALITY - 7/20/2010 - This looks as though it is moving in the direction I thought, however, I am looking at the impact of the Tea Party Movement which is being marginalized by it's inability to speak through the labels that both the Republicans and Democrats are throwing on them.  Unfortunately the Republicans have swept in and made efforts to identify with the Tea Party (and I'm sure some do), but the cost of allowing Republican incumbents to take the Tea Party mantle is that there is no real and lasting change and you continue to have the same political elites in power.  In a sense for me the Tea Party movement is about new leadership and fiscal responsibility, not the same old structure and system with new faces.

SUPREME COURT - (+1)
I SAID - 1/3/2010 - Obama names a replacement for Justice Ginsberg who retires in 2010.
REALITY - 7/20/2010 - Ok, that was an easy one.


HEALTH CARE REFORM - (+1)
I SAID - 1/3/2010 - Obama is able to pass some sort of health reform. He passes the reform knowing that it is unconstitutional. The strategy is to destroy the health care industry as we know it in the next several years. When the high court determines that the legislation cannot stand, a one-payer system (government) medical system will be the only option left to pick up the pieces. The final step will not take place till 2013 or 2014. No matter what, abortion will be a major component of the bill and will not be removed.

REALITY - 7/20/2010 - Yes, this reform was passed.  We do need change, but this is a mess and more importantly, it is a financial mess.  I've written at length that the cost is out of sight and I am not being over the top.  This is a disaster.  Abortion is a component of this bill and despite the "Executive Order" lie that was provided by our president, we are paying for these with tax payer dollars.  I have rethought my notion that the Supreme Court will strike down the legislation.  It will not, this system is here for good.  The losers are the US consumer and tax payer, the winners are big government advocates and big pharma.


NATIONAL SECURITY / PERSONAL RIGHTS (+1)
I SAID - 1/3/2010 - Despite failed terror attempts our personal rights and privacy will continue to be eroded in the name of our safety. Our government will continue to take measures to protect you after each attempt (meaning safety measures that will waste your time and add little to your safety).

REALITY - 7/20/2010 - Little erosions continue.  We have now discovered in the health care bill that all purchases made by businesses over $600 must be recorded and issued a 1099.  This is far reaching and an encroachment of personal privacy.  The impact is also being felt by gold and silver dealers that now must record and issue a 1099 on all purchases of gold or silver in excess of $600.  What is the purpose of this?  Tax revenue generation, but also a deeper view and insight into the personal transactions of the person in the US. 

OK, thats a wrap.  For those of you keeping score at home, the mid-year update has a score of +6 total.  The tally looks more like this.  +9 Correct right now.  -3 are incorrect now.  4 with no rating.  So 9 out of 17 so far.  This isn't about being right or wrong, it really is about making a statement of what I think will happen and why.

TRADING UPDATE
Over the last several months we've seen markets trade within a 200 point S&P500 range (20%).  As of completing this post today, we are waiting on the European stress tests to come out and convince us that all European banks are healthy and the markets should feel really good about the global economy and recovery.  I personally believe that we will rally for the next month or so and then more reality will set in.  I've written a lot about the possibility of a double dip recession and what is interesting is that we've had no formal announcement from NBER that the recession is even over.  I guess this is a way to hedge your bets and state that there is no double dip - you just never get out of the quicksand in the first place.

I've been laying the ground work for a strategy on the next drop in markets that I will employ and I'll share just a few thoughts about it.  US growth is estimated to be a 2% to 3%.  Emerging market growth is obviously predicted to be much higher somewhere in the 8% to 12% range.  These countries would includes Vietnam, Malaysia, China, India, Brazil, and more.
As we look at this, you must ask yourself where you think the best stock market performance is going to be.  Obviously, you would expect many of these countries to outperform. 

How do you put it together?  First, the easy one, you simply buy those countries.  Second, if you want to give yourself some protection, you could take steps out short US and go long these countries in a relative value trade, hoping that the countries go better.  This gives you some downside protection if they all go down, but you will still suffer.  Ultimately, I think very long term, this will be a home run strategy as millions and millions of new world citizens rise to the ranks of the middle class.  This also makes sense on so many levels as it removes our dependency on our government to actually make responsible decisions and somehow navigate us out of the mess we are in.  If, as the Fed and Treasury desire, they are able to devalue the USD, you'll also win on the currency bet side of things as well.  If deflation in the US takes hold, this strategy my hurt you on the currency side of things as the USD rises in value, but you will hopefully also receive rewards from getting out of the US equity markets into ones that actually will grow.

Ok, enough rambling on this post that has taken a few days to write.  I will develop the relative value trade more and put out some charts to examine.  I'll also do something on gold.  I've thought for a long time that our government would do everything in its power to stop the gold increase and I believe the healthcare bill is just one step to crush the move higher in gold long term.

GOATMUG

Outlook from the Moutain Top for 2010

Predictions are interesting because they allow us to really document and work through what we think and feel. We'll revisit these predictions throughout the year to measure how we're doing. No matter how negative I want to be, I still understand that the Fed is spewing its flood of funds at a pace that has not been seen before. The massive liquidity has been the fuel for the ascent back to the 10500 level in the Dow, an amazing almost 4000 point run up in the index. Our government is committed to see assets increase in value no matter the life-style cost in the longer term. Remember, this asset value increase is so important to re-establish confidence in the financial system. If J6P (Joe six-pack) doesn't believe in the integrity of the system a key player has left the table. Much of the moves of the government are meant to get him back in the game.

One last note - don't forget risk. It is really neat to see the huge gains the market posted last year. Don't make the mistake of forgetting that the entire financial system was almost destroyed in the process. The market is still down some 35% from the Oct 2007 highs. Yes, you can go to Vegas and plunk down your entire net worth on red or black and make an easy fortune, the problem is that this is a tremendous risk as well. What significant changes have been made in the market to remove the risk from the system? What would embolden you to take more risk now.

Let me hear from you on the comments section. I'd love to know your perspective.

I will make a new post regarding year-end / month end analysis over the next couple of days to set up trades for the coming month.

2010 PREDICTIONS

ECONOMY

Interest Rates will rise, but not at the direction of the Fed. - The market will demand a more just compensation for the risk it has taken in Treasuries. The 30-year will hit 6%. The market is predicting a rise in the Fed Funds rate coming in August, but I think they will delay raising rates overtly until November or December at the earliest. Any slow down in the economy will be another excuse not to raise them at all in 2010.



While the Fed stated they will stop Quantitative Easing in March of 2010, they will not be able to stop because losses on their book will be immense.



Housing issues will improve through April at which time the impact of increasing interest rates will force the hands of banks and they will begin to release their inventory of "non-foreclosed homes" on the market pushing the new wave of speculators underwater teaching them that falling knives are tough to catch. Some are pointing to the HAMP requirements that state that banks that had home owners that modified mortgages and failed to keep the terms of the deal (make their payments) must release this inventory and use short sales as the tool to divest themselves of the inventory as another reason for a coming drop in home prices. I don't see it that way, I see the government changing their minds again and lifting this requirement when they figure out that it could hurt the recovery.



We will see at least 2 currency devaluations in 2010. These will manifest themselves in the form a North Korea style announcement where you will wake up and the currency will be declared -10% less in value or more. These devaluations are necessary to continue each country's desire to sell goods cheaply abroad. The US' motivation of course is simply to reduce the relative amount of the crushing debt that we continue to heap upon ourselves.



Fannie Mae and Freddie Mac will become the dumping ground for all private mortgages loans made in 2009 and 2010. The banks will avoid taking losses and pass all of them to the US taxpayer. The Christmas present (uh-unlimited losses) that the government gave the US tax-payer on Christmas day is unbelievable. For the next 3 years the loss limits on these two organizations have been lifted and we are backing them with a blank check.



The Euro will face continued pressure, the US dollar will rise significantly against the Euro from the 1.432 level it is as of this writing. The US dollar will actually fall relative to the South Korean won, Australian dollar, and many other commodity based economy currencies. The dollar will strengthen against the yen.



Small business lending and personal credit will continue to decline through 2010.

Gold will actually decline to the $950 area and then move higher later on in the year when it becomes increasingly obvious that Bernanke and Geithner have no intention of pulling liquidity. This will be the opportunity to add more to the position. Gold ends the year in the $1150 to $1200 range. Longer term, gold is still a buy.

US equity markets will end the year slightly positive (meaning less than 5%). This year will be volatile and gains should be harvested when they are acquired. This means that there will be periods of gains and you need to take advantage of the ranges in the markets and buy at the low end and sell at the high end. I still maintain that the Fed will support this market directly or indirectly at all costs. As housing reverses, be prepared to see unexplainable increases in equity markets. Bernanke knows the conventional thoughts that the collapse in 1937 occurred because the Fed increased rates too soon, he'll be sure not to repeat that lesson. This is how we'll be sure to over inflate and also create the next collapse in 2011 or 2012.

FOREIGN POLICY

Middle East tensions will boil over. The US will give Israel the green light to defend herself and presumptively attack Iran. Russia and China will condemn the attack and they will choose the side of their trading partner against Israel by selling arms and providing material support.



Upon attacking Iran, Syria and Lebanon will engage Israel on their northern fronts.



Oil moves to $100 this is based on the continued debasement of our currency through the actions of the Fed and Treasury and also geopolitical tensions.



US POLITICS

Republicans sweep away the majority held by the Democrats in the mid-term elections. The third-party movement continues to garner support but is quashed by the two party system.



Obama names a replacement for Justice Ginsberg who retires in 2010.



Obama is able to pass some sort of health reform. He passes the reform knowing that it is unconstitutional. The strategy is to destroy the health care industry as we know it in the next several years. When the high court determines that the legislation cannot stand, a one-payer system (government) medical system will be the only option left to pick up the pieces. The final step will not take place till 2013 or 2014. No matter what, abortion will be a major component of the bill and will not be removed.



NATIONAL SECURITY / PERSONAL RIGHTS

Despite failed terror attempts our personal rights and privacy will continue to be eroded in the name of our safety. Our government will continue to take measures to protect you after each attempt (meaning safety measures that will waste your time and add little to your safety).



RELIGION
Christians continue to be attacked for their beliefs (read by the secular world as intolerance) and there will be several prosecutions of Christians for their beliefs. This will of course continue in Europe, but will also begin in the United States.

There they are. I reserve the right to add more as I see them, but I'll add them to the bottom and date them so they will be easily identified.