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End-of-the-year summary



January 01, 2009 – Comments (4)

2008 was a year when the economy seemed to be at the crossroads. As early as by the end of 2005 it was clear that the government had only two choices: 1.) Inflate the housing bubble still farther, reinflate it again, reinflate again, and so on, ad infinitum... or 2) Deflate the housing bubble and move on. Keeping things as they were was not clearly an option: existing mortgage debt could not paid without refinancing followed by another refinancing followed by another refinancing... It seemed clear that the Fed would have to either start a major hyperinflationary spiral or let the banking system go kaboom. So it's natural that people expected a binary outcome: a deflationary market crash (a la Japan in the 90s) or the beginning of an endless credit-driven speculative bubble (a la Japan in the 80s). The main surprise of the year was that the Fed chose to treat us with both. The result was a stomach-churning volatility that could have made Paulson's bosses trillionnaires if this were premiditated. The irony is that it was not, and that most of the policy choices were a result of sheer stupidity. Now that 2008 belongs to the past, it's easy to see how it all happened, even though it was not obvious to us back then.

We can see in hindsight that the Bush administration had gradually come to believe its own Goebbelsian lies about "affordable" housing. There is no need for complex explanation when the stupidity assumption covers all the facts. It's hard for most of us to believe that the modern financial alchemy knows the way to compensate for non-existant incomes, but for someone who is in the habit of talking to god, perhaps, it's not really that hard. And so an unthinkable thing happened: the crooks who were running a Ponzi scheme did not think of themselves as crooks, did not in fact understand what a Ponzi is and how it works. They did not double the money supply to trigger hyperinflation, which alone could save their Ponzi scheme from crash. The commodity bulls, housing bulls, and stock market bulls were caught completely by surprise. They couldn't expect this kind of irrationality any more than you would expect a burglar to burglarize his own house.  

When the Fed kept interest rates around 5% (extremely low by historical standards, but not low enough to support a Ponzi that's driven by free credit), it was easy to conclude from that that maybe, upon a second thought, the government had actually decided to abandon the bubble to its fate. After all, the bubble had not yet reached a terminal stage. It was not too late yet to deflate the bubble gradually, over the period of 5-6 years. Could it be conceivable that the Bush administration had chosen not to cross the line, as the Japanese government had chosen in a similar situation some 15 years ago? That realization gave rise to a strong bear camp. And this is where the bulls had gone wrong again. They still believed stocks would retain their traditional valuations (which common sense suggested might in fact be undervalued considering the anticipated zimbabwezation of the economy), without realizing that a deflationary panic had already set in. The selloff that followed triggered enough margin calls to cause a near-total wipeout of every leveraged account, even though the experience of the past 50 years indicated that limited leverage was the right way to play the stock-market game. All of a sudden we had a liquidity crisis even as the Fed was already printing new liquidity as if its chairman's name were Mugabe. 

This time, it was the bears' turn to be wiped out. With all this Fed action, it was now clear that there was no way the government would let its bubble go. On the contrary, the new monetary emission was excessive even for the purpose of taking the Ponzi game to the next round. Bernanke had simply panicked and overloaded his helicopter with more cash than he had to. As the shorting bubble burst, the leveraged bear market ETFs were decimated.


Cash will lose its darling status in 2009. As more and more people realize that this is going to be a stagflationary recession and not a stag-deflationary one, the old "cash is trash" paradigm will come back with vengeance. By the end of the year, the Dow will be back at 14000, maybe higher.

Some of you may say I'm contradicting myself. I am not. There are plenty of things that are wrong with the US economy, and all these things will become even wronger. The parasitic nature of the HELOC bubble will continue unabated, real jobs will continue to be lost, manufacturing and construction will shrink further, and whatever new job creation is there will be confined to the financial fraud sector. CDOs, CLOs, and other scary abbreviations will be re-branded and will come back under different names. All of this does not matter. What matters is this: a) The market is down on deflationary expectations that are really harebrained. b) With a larger monetary base comes releveraging of the financial system fueled by the inflationary expectations. I am not saying that there is any real purpose in what the Fed is doing or that it will make us richer, younger, happier, or whatever. I am not even saying that stocks are now cheap. Most of them are prohibitively expensive for my taste. All I'm saying is that you must be crazy to short the market in 2009. If America were a normal country run by a normal government, it would be different. I'm sorry, but I don't have another Federal Reserve for you. You will have to make do with the Federal Reserve we now have. 

By the way, those of you housing bears who think a house is a poor investment but continue to put money in the stock market, you're must be really crazy. Stocks are fairly valued relative to RE when the total market cap is 1/4 of the real estate values. Right now we are at 60%. If you think stocks are cheap now, you should sell all your stocks and put all your proceeds in RE. Or if you think RE is expensive, you must be shorting stocks right now (good luck with that!).

One more thing. Don't assume that foreign markets like China will be doing very well once we start our fraudulent "recovery". The Chinese have lost 2 trillion dollars supporting our consumption except they don't know it yet. Nominally they still have this money in Treasury bonds, but these bonds are only as good as the willingness of the issuing government to keep a lid on monetary expansion. When you read in the news that China has sold its 2 trillion of treasuries at par value or close to par to put it to work on the domestic market, then log into your account, pick any 10 Chinese stocksat random and buy, buy, buy. Otherwise, don't even think of it. I see major trouble coming if they mishandle this T-bond problem, and what I see convinces me that they are going to mishandle it. If you feel you must invest abroad, pick some medium-sized country without direct exposure to US consumers or US Treasury with a friendly puppet government, promising domestic market, and no overreliance on oil. Poland would be an ideal candidate, as well as Ukraine, Lithuania, maybe Kazakhstan. Brazil comes close as long as Lula is the president. But please do yourself a favor and stay away from broken export models like Chinese, Japanese, Taiwanese, etc, where they give money to America (or Europe for that matter) to push their products and effectively lose money on every sale they make, but make up for it in volume. Asset prices in these countries will get better next year, only trouble is, they will just keep getting better and better. 

And of course, don't bet on oil making a comeback. There are plenty of cheap commodities out there. Grid parity or not, we will still need copper, zinc, platinum, and timber. These commodities are Obama-proof, and you should definitely pay up for the chance not to think about the Illinois demagogue while looking at your brokerage statement.

Happy new year, evereyone. 



4 Comments – Post Your Own

#1) On January 01, 2009 at 2:43 AM, DaretothREdux (49.28) wrote:

Thoughtful and provactive as always. I disagree on oil though. We are still way too dependant (as is the rest of the world) and oil will rebound before it's all said and done. Of course, I think all those metals and other natural resources are good investment as well at current market prices.

Happy new year!

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#2) On January 01, 2009 at 2:44 AM, DaretothREdux (49.28) wrote:

Thoughtful and provactive as always. I disagree on oil though. We are still way too dependant (as is the rest of the world) and oil will rebound before it's all said and done. Of course, I think all those metals and other natural resources are good investment as well at current market prices.

Happy new year!

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#3) On January 01, 2009 at 11:45 PM, ISIStrategies (< 20) wrote:

What part does the cost of energy (both near term and long) have to do with your analysis of where we are, going into 2009?  A little surprised that it was not mentioned, given its wild gyration in 2008 and its fundamental role in the economy.  Thanks and Happy New Year.

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#4) On January 12, 2009 at 11:28 PM, biofest (64.46) wrote:

Big mistake to regard stocks in general when investing. It is the specifics that matter. As usual the devil is in the details.

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