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The Endgame

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January 19, 2009 – Comments (16)

Here is the Jan 17 article from John Mauldin's 'Thoughts from the Frontline'. I like reading John Mauldin's stuff a lot. Not necessarily because I agree with everything or because he is on the money, but mostly because I don't agree with everything. His stance is usually a bit different than mine, but that is great because it offers a different viewpoint.

His writing also adds more nuance to the inflation / deflation debate. Because the truth is it will never be just one or the other. There are combinations, there are phases of inflation / deflation. In fact there will be times were the market will act in the opposite direction based on economic data (despite the fact that it is supposedly anticipating the economic conditions 6-9 months out).

You should always seek out opinions that run counter to you own. And John Mauldin is one of the most thoughtful analysts out there. So no matter what your particular opinion is, you should read him anyways :)

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The Endgame
January 17, 2009
By John Mauldin

The Endgame
Employment Numbers Are Worse Than Posted
Aye, Captain, I'm Giving Her All I've Got!
Problem #1: Deflation
Problem #2: Pushing on a String
The Muddle Through Middle
Conversations With John

Deflation? Stimulus? Deleveraging? Recession? A soft depression? A return to a bull market? With all that is going on, how does it all end up? When we get to where we are going, where will we be? In chess, the endgame refers to the stage of the game when there are few pieces left on the board. The line between middlegame and endgame is often not clear, and may occur gradually or with the quick exchange of a few pairs of pieces. The endgame, however, tends to have different characteristics from the middlegame, and the players have correspondingly different strategic concerns. And in the current economic endgame, your strategy needs to consist of more than hope for a renewed bull market.

Rather than looking at just one year, in this week's letter we take the really long view and ask what the end result or endgame will look like. There are three possible scenarios (and multiple combinations) that I can think of, we will explore each. Any of them could happen, so we will need to look at some signposts to get an idea of what is actually going to occur. I can make the following prediction that will be absolutely correct: Whatever scenario I lay out here, events and time will change what actually happens. But this will give you an insight into my longer-term biases, and that should be useful. As I tell my kids, put on your thinking caps.

There are a few housekeeping topics I need to cover, but I will do it at the end of the letter. I just did two interviews with Aaron Task and Henry Blodget at Yahoo Tech Ticker, and will provide the links. I also want to talk about the upcoming Strategic Investment Conference, April 2-4 in La Jolla, which is going to sell out. And make sure you get around to subscribing to my new information service, called Conversations with John Mauldin. I will be posting the first conversation very soon, and you don't want to miss it! So, stay with me and let's jump right into this week's letter.

Employment Numbers Are Worse Than Posted

First, I have to address some more government data that can be misleading. We were told Thursday that initial unemployment claims were "only" 524,000. The talking heads immediately said that was proof the economy is simply bad, not falling off a cliff. Again, like last week, that seasonally adjusted number masks the real number, which was 952,151. That is not a typo. There were almost 1 million newly unemployed last week! That is up over 400,000 from the same week in 2008, while the seasonally adjusted number was up only 200,000. Last week the real number was 726,000, so this is a material rise of over 225,000, yet the seasonally adjusted number suggests a rise of only 57,000 from last week.

The continuing claims data leaped over 500,000 to (again, not a typo!) 5,832,746. The length of time people are staying unemployed is also rising rapidly. We are up almost 1.5 million new continuing claims in just the last five weeks. That is a stunning rise of over 30% in unemployment claims in just over a month. The data is truly ugly, but it is what it is.

When you are in periods where there are deep outliers to the data because of very real turning points in the economy (such as we are going through now), the seasonally adjusted numbers can mask the real underlying trends, both up and down.

Aye, Captain, I'm Giving Her All I've Got!

Let me repeat a point I made last week, which is important and necessary for us to grasp if we are to understand where we are headed.

We are in completely uncharted territory in terms of the economic landscape. Like the USS Enterprise in Star Trek, we are boldly going where no man has gone before. But the captains of our fleet are Keynesians to their core (and they don't have any Vulcan advisors). They don't have any historical maps to guide us back to a functioning economy; they only have theory. The North Star they are guiding us by, for good or ill, is John Maynard Keynes, with a slight nod to Milton Friedman.

It is not a question of whether or not there will be massive stimulus. The question is simply how much and for how long. And my wager, as outlined below, is that it will be far larger than anyone would want to admit today. Think of Scotty, aboard the Enterprise, when Captain Kirk demands more power, "But Captain, I'm giving her all she can take. She's ready to explode!" (But he always finds a little bit more.)

Let's set the scene for where we are today. The US likely just experienced a 4th quarter with GDP down over 4%. Some estimates suggest 5%. For all of 2009 we are likely going to be down at least 1-2%, which will make this the longest recession since the Great Depression. Unemployment is headed to at least 9%. Consumer spending will be off by at least 3% this year and again in 2010, as consumers start to find virtue in savings, which should rise in the US to 6% within a few years. Housing prices are going to drop another 10-15%, taking homes back to a level where they may be more affordable.

Corporate earnings are going to be dismal for at least the first two quarters, with forward estimates being lowered again and again. (For a thorough analysis of earnings, look at the January 2, 2009 issue in the archives.) Global trade is falling rapidly, and it is likely that we will see a global recession this year, which will result in further negative feedback on US, European, and Japanese exports.

On a more positive note, oil is below $40, which is more of a stimulus to consumers than anything anticipated by the incoming Obama administration (at least as far as consumers go). With short-term rates at zero, adjustable-rate mortgages are actually not the problem anticipated a year ago, and many homeowners are rushing to refinance their homes at lower rates. Large banks have indicated a willingness to actually cut the principle and interest on troubled mortgages, which might lower the number of defaults.

Conversely, the number of defaults is high and rising -- throughout the developed world. It is likely to be 2011 before the housing market finds a real bottom and housing construction can begin to rise.

The credit markets are still in disarray. While there are some signs that the frozen markets are thawing, the Fed and the US Treasury are having to provide more bailout capital to large US banks. Citigroup is breaking up. Bank of America needs massive amounts of capital to digest Merrill. The hole that is AIG just keeps getting deeper. It is going to take several years for the credit markets to function at anything close to normal, as we simply vaporized a whole credit industry worldwide. To think it will take anything less is simply naive. And in the meantime, the various central banks of the world, along with their governments, are going to step in to fill the need for credit.

Obama has signaled that he needs the remaining $350 billion of Troubled Asset Relief Program money as soon as possible, although his delegated Treasury Secretary, who will run the program, may be in some trouble, as he failed to pay taxes on his income from his stint at the IMF.

(This is not an "Oops, I forgot!" The IMF does not withhold income taxes from its employees. However, he was given a memo about the taxes he owed. And he did pay them for two years when he was audited and caught. He clearly knew the nature of the taxes due the two prior years, yet did not come clean on those years. Dumb move for someone on a fast-track career and who clearly has an impressive intellect. He has got to be kicking himself. Since the Treasury Secretary is in charge of the IRS, this is not good for Obama. Someone on his team should have vetted this more thoroughly. I do think Geithner is otherwise as qualified as anyone else on the short list, but this is a very large cloud hanging over him.)

The auto industry is reeling. Without a lot more government funds, it is unlikely that GM or Chrysler will survive without going through bankruptcy. The industry needs to shed about 20% of capacity. No amount of government funding will change that reality. Beyond autos, industry after industry is on the ropes.

I could go on and on, but you get the picture that is facing the Obama administration and the entire rest of the developed world.

So, how do we get out of this mess? As noted above, the captains of our collective ships are Keynesians. They are going to provide as much stimulus as needed.

Problem #1: Deflation

We got the Consumer Price Index numbers today, and they tell a tale of deflation. On an annualized basis, the CPI for the last three months was a negative -12.7%! Even core CPI, which is without food and energy, was a minus 0.3%. The CPI for 2008 was just 0.1% for the whole year. This was the smallest calendar-year increase since 1954, and it's down from 4.1% for 2007. (To see the whole release and data, you can go to www.bls.gov.)

I outlined the problem of deflation last week in my 2009 Forecast so I will not go into detail, except to note that central bankers are going to fight tooth and nail any tendency for deflation to catch hold in the economic mind of the country. It is simply part of their DNA.

Obama wants an extra $825 billion in his stimulus package, in addition to the $350 billion in TARP monies. The Fed has started to buy mortgage assets, and that could be $500 billion or more. That is in addition to some $300 billion plus and growing in commercial paper, in addition to bank assets, etc.

Let me predict right here that this is merely the first installment. The problems described above are very large. It is one thing to make credit cheap and yet another to make consumers either want to borrow more, or be able to convince a lender that borrowers can repay their debts. On the one hand, the government is providing capital to banks and hoping they will lend it, and on the other hand the regulators are telling them to reduce lending and increase their capital. Their commercial mortgages on a mark-to-market basis are imploding. Consumer credit risk is high and rising. What's a bank to do?

Let's add it up. In the US, we have seen massive wealth destruction on personal balance sheets. At the end of the third quarter the losses totalled $5.6 trillion, between housing and stocks. They could be over $10 trillion at the end of the fourth quarter. (Source: Hoisington) The losses will almost certainly top $12 trillion by the middle of the year as housing continues to deteriorate. Pick any country in the developed world or much of the developing world, and it's the same picture: wealth destruction.

We have seen at least a trillion dollars of capital on financial companies' balance sheets disappear; and given the recent spate of bailouts, it is likely to get worse.

As I have been pounding the table about, a credit crisis and imploding balance sheets, a housing crisis, and a massive earnings shortfall that yields a relentless stock market drop are all independently deflationary. The combined forces are massively so. To think that a mere trillion or so dollars in stimulus will be enough to reflate the US and the world economies is simply not realistic.

Let me offer a simplistic definition of what I mean by reflation: it's when the velocity of money stops falling for at least two quarters and the economy emerges from outright recession.

And much of the proposed stimulus is not really stimulus. Temporary tax cuts, as much as I like them, that are not targeted at getting small businesses recharged (which is where the real growth in jobs will come from) will likely be saved, much in the way that the last stimulus package did little real good for the economy, and simply put us another $177 billion in debt that our kids will have to pay. Helping keep people in their homes when they are already over their heads in debt is not really stimulus, however noble it sounds. Over 50% of mortgages that are reduced and rewritten are delinquent again within 6 months. That does not bode well for future efforts. Better to let the home go at some price to someone who can afford it. Tough love, but realistic.

Giving money to states to allow them to continue to spend beyond their budgets is not stimulus. And why should Texas pay for a profligate California? We have our own problems. The Robin Hood approach to stimulus programs is nonproductive and only encourages bad budgeting habits.

What will work? Infrastructure development, although that takes time, and some real thought should be given as to which projects are undertaken, rather than allocating according to which Senator has the most seniority. Spending on defense equipment, which must all have US content (which will be distasteful to the left), is real stimulus. Upgrading technology in a number of areas qualifies, although past experience suggests governments are not good at spending new tech money wisely.

Spending on green technologies? Creating a million new jobs in clean tech? Get real. How do we go from less than a 100,000 real clean-tech jobs to 1,000,000 in five years, let alone one? And three million new jobs? Really? From where? What government program could do this? In what universe? It makes for nice feel-good talk, but has no bearing on reality.

Don't get me wrong. In the midst of the late 1970s malaise, when the gloom was as thick as it is today, the correct answer to the question, "Where will all the new jobs come from?" was "I don't know, but they will." And it is still the correct answer. The US free market system is still the most dynamic economy in the world, and I truly believe that we will see new industries spring up, which will be a jobs dynamo. But that will take time. It is not a short-term solution, and by short-term I mean 1-2 years.

My bet is that in the third quarter, when earnings reports come out and are terrible, unemployment is over 8% and pushing 9%, and there is no evidence of a recovery, that we will see more stimulus from both the Fed and Congress. Count on it.

The Fed and the Keynesian captains of our economic ship are "all in." If the current plans do not reflate the economy, they are not going to say, "Well, that is too bad. We did what we could. Now we just have to go ahead and let the US economy catch Japanese disease." Not a chance. They will up the ante.

And they will keep trying to "jump start" the economy until it works. Obama told us to expect trillion-dollar deficits for years to come. Give him this: he is being candid and honest.

The Fed, and I think other central banks, are going to step in and be the buyers of last resort for a whole host of debts, both corporate and consumer. There are those who worry about creating inflation, because they actually do have to print money to buy these debts. While I would prefer a world where a central bank does not intervene in the markets, the time to fix the problem of excess leverage was a decade ago. Allowing banks to go to 30:1 leverage based on "value at risk" models and other financial wizardry that clearly neither the banks nor the regulators understood, was simply bad policy, and we are paying for it. As Woody Brock so wisely notes, 30:1 leverage is not three times more risky than 10:1 leverage, it is 25 times more risky. (Trust me, or at least Woody, on the math.) As an aside, many European banks were even more highly leveraged.

(cont.)

16 Comments – Post Your Own

#1) On January 19, 2009 at 2:52 PM, binv271828 (< 20) wrote:

The End Game

The US (and indeed soon the whole world) is in a deep recession. The US is going to try and combat that recession with stimulus on a scale never before tried. It is a grand experiment. On the one hand is the theory that you can allocate stimulus and keep the velocity of money from falling. On the other hand is the theory that once the deleveraging process starts, there is not much you can do about it: it is going to work its way through the economy. We are about to find out which theory is correct.

So, let's look at three possible outcomes, with the best outcome first. The basic optimistic assumption is that, while this recession is deep and the worst in the post-WWII era, it is still just a recession. Free-market economies eventually recover. Recessions do their work of reducing excess capacity, and the businesses which survive enjoy increased market share and potential for profits to rise. And corporations do indeed have on balance stronger than usual balance sheets going into this recession, except for most financial corporations. Another exception is businesses that were bought by private equity firms with large leverage. Many of those will have to be restructured. And those that have too much leverage or were too aggressive with expansion programs? They will go the way of all overleveraged flesh.

Besides, the optimistic scenario holds, the massive amount of stimulus being applied to the US economy is on a scale never seen. It will work, just as an easy monetary policy has always worked. (Except in the '70s, but we won't make that mistake again! We learned our lesson, yes we did! Volker can stay in retirement.)

This scenario assumes that the psyche of US consumers has not actually been seared all that much, and that they will return to their spending habits as soon as they are able. It also assumes this is a normal business-cycle recession. There really is no endgame. It is business as usual. There has been no fundamental altering of the US dynamic. Banks will start lending again, businesses and consumers will start borrowing, and things get back to normal. Deflation is just some bugaboo that a weird coterie of economists and investment writers harp on to scare the children into behaving more rationally. It can't really happen here. And besides, the Fed can print enough money to make deflation go away. The real worry will be if they overshoot and inflation comes roaring back.

Problem # 2: Pushing on a String

The economy clearly let leverage run to an irrational level. You've seen the graphs. US debt to GDP is now over 300% and has risen precipitously in the last ten and especially the last five years. Leverage and debt fueled the growth of the economy, but debt growth hit a wall and now the deleveraging process is the painful result. This brings us to the worst-case scenario: that all the efforts of the Fed will go for naught and that we are in a liquidity trap.

A liquidity trap is a situation in monetary economics in which a country's nominal interest rate has been lowered nearly or equal to zero to avoid a recession, but the liquidity in the market created by these low interest rates does not stimulate the economy. In these situations, borrowers prefer to keep assets in short-term cash bank accounts rather than making long-term investments. This makes a recession even more severe, and can contribute to deflation. (Wikipedia)

And there is no question, at least in my mind, that the economy, if left to its own devices, would fall into a soft deflationary depression, which would take years to climb out of. The contention of those who believe that we are headed for such a state of affairs is that no matter what the Fed does, excesses on the part of consumers and unrestrained government deficit spending is going to create a Perfect Storm. First of deflation and then, because the Fed is going to try to re-inflate the economy by printing money, we will see a resurgence in inflation and a collapse or, at the very least, a serious drop in the value of the dollar. Further, to expect foreign governments to continue to buy depreciating dollars and allow the dollar to continue to be the world's reserve currency is not realistic. And of course, there are those who think we will eventually see hyperinflation as the Fed is forced to monetize the national deficits, with gold going to $3,000 (or higher!). And Obama, with his talk of trillion-dollar deficits for an extended period, certainly adds fuel to that fire.

If, and it is a big but possible if, the Fed is indeed pushing on a string, then we are likely to see 15% unemployment, yet another lost decade for the stock market, and a real calamity in the pension, endowment, and insurance worlds, which are planning on 8% long-term portfolio returns to meet their obligations. And while I think it is a possibility we must be mindful of, it is not the most likely scenario.

The Muddle Through Middle

Now, we come to the third scenario and -- no surprise to long-time readers -- the one I think is most likely. I think that after we climb out of recession, we Muddle Through for an extended period of time. Follow my reasoning, and remember that I am often wrong but seldom in doubt! And please allow me some room to speculate. I can guarantee that I have some (or most) of the particulars wrong. But I think I have the general direction we are heading in.

We are in a serious recession. We have to allow time for both the housing market and the credit markets to heal. This will take at least two years. I think we have permanently seared the psyche of the American consumer. Consumer spending is likely to drop at least 6-7% over the next two years, and maybe more. The combination of all three bubbles (consumer spending, credit, and housing), which were made possible by increasing leverage and poor lending standards, is by definition deflationary. (I know, I keep repeating, but most readers do not really get the rather disturbing implications.)

The US government in general and the Fed in particular will react to the problem. Most of the government stimulus, other than that used to reliquefy the banking system, build useful infrastructure, and encourage small business to expand, will be wasted or have little short-term effect. The Fed (and central banks around the world), on the other hand, do have the potential to succeed with a "shock and awe" type of stimulus program.

The problem is the Velocity of Money. (You can see this explained in my December 5, 2008 letter.) There is just no way of knowing when the Fed programs will really create some traction. Anyone who shows you a model that says such and such an amount of stimulus is needed is from the government, trying to tell you that this time we really do know what we're doing. Any such models are based on assumptions about things we have no way of knowing.

The Fed (and the US government) are going to continue to run deficits and print money until the economy begins to reflate. That is one thing I truly believe. Will it be a total of $2 trillion? Three? Four? More? I don't know. How large will the Fed balance sheet be in a few years? I don't know. And neither does anyone else. There are just too many damn variables.

But I do believe that at some point there will be some inflationary traction. And combined with an economy resetting itself at some new level of consumer spending, and with a basically resilient US free-market system, a recovery will begin.

But here's the problem. Let's assume, and we can, that we find this new set point for the US economy (see the "Economic Blue Screen of Death"). And that the economy begins to grow, but the Fed has injected a lot of liquidity. Now some of that liquidity is "self-liquidating." By that I mean, commercial paper is typically 90 days. The Fed simply has to begin to wind down its commercial paper investments, and it takes away some of the liquidity it created. Those mortgages they bought? Each month, as payments are made, a little liquidity is taken back from the economy.

And if inflation is an issue, they can begin to withdraw that liquidity or raise rates. Of course, that will serve to slow the economy down, but better a slower Muddle Through Economy than a return to the high stagflation of the '70s.

That gets us to 2011-12. The economy is growing, albeit slower than anyone would like, but government deficits are still in the trillion-dollar range, as Obama and the Democratic Congress have increased the entitlement programs, locking in big deficits for a long time. High deficits put the dollar under pressure. The demand from voters is to get the deficit under control. However, the Social Security surpluses are beginning to dwindle. And just like in the early '80s, we have a Social Security crisis. Some combination of higher taxes, reduced benefits for wealthier Americans, later retirement ages, and a different methodology of indexing for inflation will be the order of the day.

But Social Security is the relatively easy problem. Medicare benefits will be at nose-bleed levels and will swamp the ability of the government to fund it and other government programs. Democrats will never allow the programs to be cut back. And getting the 60-plus Republican senators needed for such cuts is just not likely to happen by 2012-2014.

The problem will be dealt with by cuts in some government programs, but mostly by tax hikes on the "rich" and increased contributions by participants. Since many of the rich are the very small business people who we need to create jobs, this is going to be very anti-growth, extending the Muddle Through Economy for yet another few years. And if taxes are raised too much in 2010 when the Bush tax cuts go away, then we could see a relapse back into a recession.

Such an environment of higher taxes and slow growth is not good for corporate earnings. Earnings in the recent years have been at all-time high levels as a percentage of GDP. Earnings as such are mean reverting, and thus are unlikely to rise back to previous levels in terms of percentage of GDP. (Of course, in nominal terms they should rise.) This is going to put a constraint on stock market growth.

Pension plans, endowments, insurance companies, and individual investors who are counting on 8% long-term compound returns from their stock portfolios are as likely to be disappointed in the next five years as they were in the last ten. The environment I am describing is one of compressing price to earnings ratios, much like the period from 1974 to 1982.

This environment is going to force the creation of new investment programs and products based on income generation. And that is one of the forces that will bring about a real recovery in the middle of the next decade. Investment capital will be made available to businesses that can generate low double-digit or high single-digit returns, as well as new technologies with the promise to deliver new paths to profits.

The second major force will be the arrival of new waves of technological change. We will see a biotech revolution beyond our current comprehension. It has the real potential for solving a great deal of the Medicare entitlement program problems. For instance, it is likely we will have a real cure for Alzheimer's within five years. Since that is as much as 7% of US medical costs, that can create a real cost reduction. The same for heart disease, obesity, cancer, and a host of other medical conditions that will start to be dealt with by a new generation of therapies. That is going to create a new, very real bull market in biotech.

I expect to see a new generation of wireless broadband that powers whole new industries. And it will not just be green tech, but entirely new forms of energy generation that drive the cost of energy down and, combined with other new technologies, make electric cars practical. And along about the end of the decade, the nanotech world begins to really get into gear.

And just as the tightly wound, low P/E ratios of the early '80s gave way to a spring-loaded major bull market as new technologies became the driver for a whole new set of public companies, we could (and should!) see a repeat of that performance. There is a new bull market in our future.

The problem is getting from where we are today to that next dawn. The definition of insanity is to keep repeating what you have done in the past and expect a different result. We are in a long-term secular bear market. P/E ratios are going to decline over time to low double digits. Hoping that stocks somehow rebound to new highs and that the economy is going to go back to what we saw in 1982-1999 or 2003-2006 is not a strategy. You need to be proactive and take charge of your portfolio, looking for absolute-return types of investments for the next 4-5 years. Simply using a traditional 60-40 split of stocks and bonds is not going to get you to retirement nirvana. It will lead to retirement hell.

Conversations With John

As we announced a few weeks ago, I am starting a new subscription-only service. While this letter will always be free, we are going to create a way for you to "listen in" on my conversations with some of my friends, many of whom you will recognize and some who you will want to know after you hear our conversations. Basically, I will call one or two friends each month, and just as we do at dinner or at meetings, we will talk about the issues of the day, with back and forth, give and take, and friendly debate. I think you will find it very enlightening and thought-provoking and a real contribution to your education as an investor. You can still subscribe now, before the actual launch of the service (in a week or so), at the holiday rate of 50% off. I will be having the first conversation next week, and it will include a spirited debate about the topics in this letter. Then, at some point in February, when Nouriel Roubini and I can match our schedules and continents, we will have a conversation you can listen in on as well. This is going to be a very fun project, and you won't want to miss one chat.

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To see my interviews on Yahoo with Aaron Task and Henry Blodget, go to:

John Mauldin's 2009 Outlook: Deflation, Recession, New Market LowsTrillions More: Govt. Will Keep Spending Until Economy Reflates, Mauldin Says

Along with my partners Altegris Investments, I will be co-hosting our 6th annual Strategic Investment Conference in La Jolla, California, April 2-4. I have invited some of the top economic minds in the country to come and address us, giving us their views on what seems to be a continuing crisis. It will be a mix of economic theory and practical investment advice. Already committed to speak are Martin Barnes, Woody Brock, Dennis Gartman, Louis Gave, George Friedman (of Stratfor), and Paul McCulley. I anticipate adding another stellar name or two. This is as strong a lineup as we have ever had, and on par with any conference I know of anywhere.

Due to securities regulations, attendance is limited to qualified high-net-worth investors and/or institutional investors. Early registrants will get a discount. Last year we had to close registration, and I anticipate we will run out of room again, so I would not procrastinate. Simply click on the link below, give us your name and email, and you will be sent a form next week to register.

https://hedge-fund-conference.com/2009/interest.aspx?m=t

I should note that most attendees say this conference is the best investment conference they have ever been to. One of the benefits is being with several hundred very nice people in a relaxed setting. We do it up right.

For whatever reason, this letter has kept me up very late. At 4 AM (!), it is time to hit the send button. For those of you who can actually take a three-day weekend, enjoy it! Alas, Tiffani has me working on a tight schedule as our book deadline looms, although I will slip away tomorrow evening to watch the Mavericks. And hit the gym of course.

Have a great week! And seriously, there are lots of opportunities in the world today. Just open your mind to some "out of the box" possibilities.

Your enjoying the ride analyst,


John Mauldin
John@FrontlineThoughts.com Copyright 2009 John Mauldin. All Rights Reserved Report this comment
#2) On January 19, 2009 at 2:59 PM, anchak (99.86) wrote:

Binve.....did you read the piece Mauldin did on Bernanke. Combined with his paper and speeches and actions - I would say Bernanke has been one consistent beacon in his chosen course of action ......and it should be very clear which side he wants to be out of this crisis.

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#3) On January 19, 2009 at 4:29 PM, binve (< 20) wrote:

Hey anchak, yeah there were a few in November and December that talked about Fed rates and Treasury Policy. You are proably referring to 'Leverage is a 8 Letter Word' ? Yeah, I like how John Mauldin really digs into and issue and thinks through it. But I agree, Bernanke's speeches, plans and actions all point the same direction... Long term inflation. The deflationary impulse right now is so strong. The market is trying to purge excesses. But the Fed and Treasury are embarking on ZIRP and Quantitative Easing. They are trying to stimulate borrowing demand by targeting long term rates. But because that is not working (yet ... but maybe it won't no matter how much money they throw at long term treasuries, too early to tell), they are buying up all kings of toxic collateral and are making plans to buy up so much more. M1 is growing like crazy and all of it points to an all-out monentazation blitz of all types of debt. The Fed still has lot of weapons in the arsenal to fight deflation.

What will be really interesting is when China and Japan start cutting back on Treasury purchase when this monetization kicks into, I don't know, 9th gear? (How many are on the Fed tranny anyways). That means the Treasury options for paying for it with debt become reduced and it becomes all out currency devaluation by the Fed. 

Who knows how it will all play out, that is just one possibility.

Which brings up a great point. _Nobody_ knows how this will all play out. Anybody who thinks that they do is delusional, a paid liar or both. That is why nobody should be 100% adamant / married to their postion. You may have strong convictions (and I do) and you may allocate capital based on those convictions, but I think people are better served in thinking of the future as a set of probablities. You may think a event (such as currency devalutation / inflaton) as a 90% probability which has a very high impact, and you may hedge against that with gold and/or commodities. But you should also be willing to entertain the fact that deflation may be a real near term phenomena (or long term one for that matter) and allocate a portion of your capital in cash or relatively short-term liquid investments.

Managing risk/reward of various possibilties and mantaining several possible scenarios in your investing stance is prudent call (in my opinion). You don't have to weight all the possibilites equally, but you shouldn't have all your eggs in one basket either. And I certainly don't mean "diversification" (you know Wall Streets definition: some health care stocks, some industrial stocks, some financial stocks, etc.) in the traditional sense, I mean: gold, commodites, bonds, broad market equities, sector equities, foreign currencies, etc. etc.

Sorry anchak, most of that was a ramble on my part (none of it was at you in particular, more as a 'you' the 'reader'), but I tend to go on a bit when I get started :) Thanks man!

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#4) On January 19, 2009 at 6:12 PM, Tastylunch (29.41) wrote:

Hah uh oh Binv looks like you found one of my sources for my own take. :-)

Indeed he has a great newsletter, i'm an email subscriber.

Like you I always try to get an idea of different opinions on a subkec matter before forming my own.

Right now the Maudlin/Setser/Bittrolhoff/Shedlock crowd seems to make the most sense. I'm probably more Maudlin esque (eventualy the gov't will sucessfully reflate) than Shedlock (all inflaiton efforts are futile and lead to deflation). That being said I have hard time seeing Gold really take off in 2009. Partially because everyone expects it to.I still there's a very good chance of Ka-poom (as itulip calls it). But I'm waiting for hard confirmation.

That's also my problem with treasuries. I admit I got juked in too early into shorting them in CAPS because I saw a big ton supply coming on a couple weeks ago, but then I saw three things that changed my mind. One Barron's ran a cover saying it was time to short treauries (Barron's has been so wrong this last year I took that as a Bulish sighn, check GS751's latest post for a good luck at why) , two japan announced they would buy as much American treasuries as possible to keep the dolalr strong, and three Setser laid out a compelling case for why Chinese demand for treasuries is actually growing not shrinking like we expected

http://blogs.cfr.org/setser/2009/01/18/it-is-the-time-to-worry-about-a-fall-in-chinas-demand-for-the-worlds-goods-not-a-fall-in-chinas-demand-for-treasuries/

I'm a big believer in what i call "the watched pot won't boil" trading strategy. In that if the crowd is looking for it to hape there's a very good chance it won't (Oil 200 Gold 2000 Treasuries collpase) at least not while they are interested.

Evenually though this treasury madness will likely stop , but i might be a very long before it does. :-( Hopefully soon for my small real life TBT holding, Report this comment
#5) On January 19, 2009 at 7:32 PM, binve (< 20) wrote:

Tasty, yep I am on to you, man :)

Yeah, I like reading a variety of sources too. Authors who I like and have a similar opinion to my own are Saville, Rubino and Saxena. And authors that I like to read for a contrarian view are Mauldin and Shedlock. And when I want to read a smart guy who has been around the block for a long time, has seen a lot of things, and will call it like he sees it, I read Bob Hoye :)

I am 100% on board with your "watched pot" theory. I think gold will be very quiet for the first part of the year because so many people are expecting it to pop. Then after 6 months everybody will forget. So I will be interested to see what the crowd mentaility looks like 6 months from now. :) But this period of underperformance will present another buying opportunity for gold (again, just my take) :)

I am definitely on board with treasuries. I have no doubt they are in a bubble. They have been on a bull run for 2 decades, and have been trading in a rising channel. And they have hit the upper part of the channel and gone beyond it. Yields are a record lows. Therefore everybody KNOWS we are in a treasury bubble, which is precisely why it won't pop just yet. I think the Feds manipulation of treasuries will have some success for awhile, longer than many of us expect.

So a potential scenario would be for a dip in prices (which happened last week). Everybody piles in short thinking they are catching it. Then prices will increase again (which they are now). Then prices will increase slightly more when the really bad economic numbers come out and deflation signs are kicked up a notch. Some of the shorts will go long, thinking this bubble talk is hogwash and the US is doomed and in for a permanent recession. At that point the bubble will burst.

I still think going long TBT is a good call here. In binve, I traded it for a 16 point gain. I will get back in once it drops to around 35. Because at the end of the day, how much higher can long term bond prices go?  Yields are already down to 2.5%. Do you think the smart money will be accepting 2.5% for long, when dividend yields in really strong companies are at 4-6% ? (I don't believe the higher dividend yields for a lot of blue chips and think many will be going down, but there are still a lot of strong companies / sectors). And what about corporate bonds? A lot of the junk will collapse in the coming months. But that will leave the stronger ones in stronger position.

So while I agree the Treasury bubble is not quite ready to pop, I think the downterm risk now is relatively small. I am still holding on to my TBT real life, but I will proabably trade it in CAPS a few more times :)

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#6) On January 19, 2009 at 7:53 PM, Tastylunch (29.41) wrote:

good deal buddy

I will say the assumption your thesis might be making is that those dividends are safe number 1 (which you alluded too) and that they higher than they should be number 2. If you know you market history Stock Yields *should* always be higher than bond yields. That was the old norm. Stocks are inherently riskier than bonds (as bankrupticies routinely prove, common gets nothing, preferred get some, bond holders get the most) so in order to reward the investor accordingly they should have higher yields. That was true until the mid 1950's I believe.

oh and btw here is what I just read today that is more supportive of Ka-poom, thought might enjoy this read if you haven't seen it.

http://www.marketoracle.co.uk/Article8320.html

so yeah I'm keeping any eye on it too. Both sides have points which make me uncertain. But I have to agree with you this has gotten extremely hard to predict now that the government's are attempting to actively dictate the economics...

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#7) On January 19, 2009 at 8:46 PM, anchak (99.86) wrote:

OK....So basically maybe Craig/Madcow/Ed/jdgee are the only other standing stinkyfeet members not indoctrinated by Mauldin. Man I read his book over the holidays - It just blew me away! I subscribe to his feed too.

Binve...I have to disagree to a certain extent with you on the TBT trade. Although till now there has been no divergence between TBT and 2x:TLT - the moment this turns around - I believe there's another leg down on this crisis - you may find TLT possibly trade in a closer new high - and that may create some problems ( I think minor , at the end of the day TLT itself is not so volatile).

Also the "Short Bond" - I am on board and if TLT breaches 120+ - I am going to deploy a 3-4x Leveraged strategy along the lines mentioned in the DIY thru forward, medium and LEAP TLT puts. Let me know what you think!

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#8) On January 19, 2009 at 9:08 PM, binve (< 20) wrote:

Hey anchak, thanks. Maybe I wasn't being clear above. I do think TLT will make a new high / TBT will make a new low. It will hitch higher / lower when: "prices (Bond prices, and price of TLT) will increase slightly more when the really bad economic numbers come out and deflation signs are kicked up a notch. Some of the shorts will go long, thinking this bubble talk is hogwash and the US is doomed and in for a permanent recession. At that point the bubble will burst.".

So I am not saying that now is the best entry point to go short TLT / long TBT. But I do think that going long TBT doesn't have very much downside potential. Timewise I don't think you will collect a substantial gain on it for awhile (who knows how long the bond bubble will stay inflated, several months?). But I think the entry point is safe. Me personal I think TBT will easily get back down to $35-$36. I will probably pick it again there for Caps.

Because when the price does rise higher, I think it will be a relatively transient event. Maybe it will be sharp and violent with no good entry point. Or maybe it will be nice and slow with a good entry point. Either way my take on the situation is that TBT won't go much below $35 and (again, just my opinion) so picking it there (near $35) in the near term might be a nice safe entry. 

Referring to you TLT put strategy, that sounds like a very intesting plan. Yeah, 120 for TLT is pretty stratospheric and I can't imagine it sustaining itself above that for very long. I must confess I am not a options trader (I understand all the concepts because that is vital knowledge for any investor. Most stock market movements are driven by the options market), but I must say I like the strategy. Definitely let me know how that works out for you!

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#9) On January 19, 2009 at 9:12 PM, binve (< 20) wrote:

Beginning of the third paragraph should read: "Because when the price of long term treasuries do rise higher (referring to the upside capitulation of the T-Bond shorts), ..."

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#10) On January 19, 2009 at 11:05 PM, anchak (99.86) wrote:

I may be completely off-base ...but a "Rolling Short-Bond" strategy started at sub 700 S&P with TLT at 120+ ( which TBT would do) can be extremely profitable. Infact, in this case due to the non-volatile nature of the instrument - WE SHOULD BUY & HOLD TBT.

However, binve - there's a small problem man - after the initial explosion ( reverse implosion as evident from the chart) - TBT will become range bound vehicle - and will slowly start seeing the divergence decay - INSPITE ( complete conjecture) of long-term rates creeping up gradually.

My feeling is a 130 ( or 135 if you can get) TLT PUTs spread over Near month, 3/6 month out and 1 Year out....bought around the same period and then judiciously rolled ( around expiry) with the same duration - should provide a steady stream investment return - my guess would be 3-5x of TLT short. Any short term setbacks (which would affect TBT - big time and the near term TLT put) can be averaged over by the Longer-term ones if the trend is restored. 

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#11) On January 19, 2009 at 11:22 PM, binve (< 20) wrote:

Ahhh.... Now I see where you are coming from.

I should clarify. I view TLT and TBT like any other 2x/3x leveraged instrument. These are trading vehicles only. Definitely not long term investments. The only reason why I am willing to sit on TBT and wait for the bond implosion (which I believe will happen in a matter of months) is that the daily movement of TBT / TLT is only a couple of percent. And there isn't crazy intraday volatility. It think these two will track eachother inversely well enough during the short term.

That is definitely a different story than FAZ, SKF, SRS, etc.. Right now I believe the market has a good shot at a rally. But over the longer term I think it will eventually go lower. So by the same logic I applied above, should I buy FAZ now, let it go lower temporarily because I believe it will eventually go higher? Absolutely not, and I know you agree with that. It was the whole point of your last blog post. Because of the whole daily rebalancing issues. The only way I play ultrashorts or ultralongs is while it is trending and only for short periods of time.

TBT is my exception to this in that I am willing to hold it a little longer on this plateau because I believe the movements are small enough and the volatility low enough that it won't get creamed like the other ones. 

But just to be clear, at no point will I consider any of these 2x/3x instruments as buy and hold vehicles.

Seriously man, thank you for all your attention to this issue not only on this post, but your blog and all the other blogs as well. Your diligence is definitely making Caps smarter about this issue. Thanks!

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#12) On January 20, 2009 at 12:00 AM, binve (< 20) wrote:

But commenting directly on your rolling put idea... I like it a lot. I really can't see TLT ever getting over 125. Most of the big buy-up in the most recent rally occured with the Fed's quantitative easing announcement. That was the bid-up by the smart money, or the "buy the rumor" phenemenon. The Fed may be able to target long term rates for awhile, but once the house of cards starts to tremble, my belief is the smart money starts exiting. The Fed has a lot of power to support the high prices / low yields (for a while) but I don't think the bond market is going much higher. Just my take. So in essence, I think that is a very good plan, man. :)

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#13) On January 20, 2009 at 2:54 PM, madcowmonkey (< 20) wrote:

I read cat in the hat...homies. I wish I had more time to read articles, but what ends up happening is they sit in my email box. Maybe when I take vacation in february and March I will be able to read a little of Mauldin's articles. I highly doubt it though, a 3 year and a 1 year old on a plane doesn't really help for reading while flying.

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#14) On January 20, 2009 at 3:26 PM, binve (< 20) wrote:

Actually I find much of John Mauldin's work a good allegory for "If I Ran the Circus" ... :)

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#15) On January 20, 2009 at 4:17 PM, anchak (99.86) wrote:

Madcow....I read Disney princess....you just have to sacrifice the possible material harm to a few of the pages ( like multicolor decorations) - that's the only way to get it done!

Incidentally I have both "Just One thing" and "Bulls Eye Investing" and my daughter was able to spell Mauldin and dissociate that Bulls Eye was like "Just One Thing" ( I read the name and she liked it) - since it was Mauldin and published by John Wiley ( the insignia)!

The plane thing I understand - I have to keep her occupied in flight all the time!

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#16) On January 20, 2009 at 5:29 PM, binve (< 20) wrote:

WooHOO! binv271828's score is now > -2000. Time to par-tayy! ... :)

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