Inflation?

For all the money the Fed is supposedly pouring into the banking system to "prime the pump", we are acting suspiciously like we're in a deflationary period right now. Commodity prices look like they are finally starting to go up again, however. And although I hear conflicting statements about the velocity of money, at the rate the Fed is going I will agree we will see inflation before long.

What is that going to mean? With the unemployment rate dismal and projected to get worse, housing continuing to fall, and taxes going up (I speak here about the next year, not the next few weeks) I don't think inflation will be anything to write home about. Hyperinflation smiply would not happen.
However, if we do see a recovery at the end of this year, then all bets may be off. We will have expended too much in terms of getting the economy going again to risk cooling it down, and we may see saving accounts yielding 10% again, as they did in the early 80s. You wouldn't even WANT to know what foodstuffs and energy prices would be like. Is there a middle ground? I don;t see how we can have cake and eat it too... there are simply too many sins in our past that we need to expiate before our economy can be considered normal again.

I wish I had a better forecast ... depression or severe inflation. It is still worth hedging into oil or gold -- but not yet. Once gold goes down to $825 or lower, I would consider it - GLD is a decent ETF there. Oil ETFs like USL or UOY are probably a buy here, and very much so if oil goes below $42 a barrel again. We will see the usual spike in oil prices over the summer and that may be the last real trading opportunity we see in anything that is based on normal circumstances. I would stay away from bonds ... especially state or municipal bonds as I fear more cities will follow Vallejo into bankruptancy to get out of their pension obligations. Lastly, if mark-to-market is rescinded and banks go nuts, buy puts against the general banking industry ETFs once the frenzy reaches it's heights. There is still a LOT of crap that needs to be written off.

My one note of happiness today is that Dendreon is now less than one month from disclosing final results for Provenge from the IMPACT trial. They have said "by the end of April" and seem to be in over-delivery mode lately. Definitely a buy at $4.30ish.

Regards,
Trond

Ben Bernanke, our savior?

I guess I am not terribly impressed with our Federal Reserve chairman. Here are several questions.

What has he been right on, so far? Every decision he's made in the last three years has not had the effect he has claimed. The sole mention I can find showing his prowess is that he predicted in 2006 the economy would be worse than Wall Street analysts had predicted.

He has written on the Great Depression and what the Fed did wrong. He claims, as had prior monetarists, that it lasted longer than it had to have, because the Fed contracted the money supply and his "new" point is about the private banking system, in that they let banks fail. So his answer to the current recession is to expand the money supply and to prop up the biggest institutions. However, there are a host of factors that are different in this day and age - and more importantly, just because something may not have worked before does NOT necessarily mean that the exact opposite WILL work.
There is evidence that some failures are necessary to allow the necessary pain (to employees, to shareholders, to would-be borrowers) to happen sooner rather than later. A protracted wind-down may not be in our best interest, if even after near continuous bailouts, some institutions still go under.

Here are questions that I would seriously like to have answered:

If the bailouts occur because some companies are "too big to fail", what exactly does that mean? Can the Fed and/or the administration give us a clear, layman's pitch on what they think would happen if they did fail?

If AIG or Citigroup failing would cause "systemic risk", why is the system that allows such risk worth saving?

What exactly are the weak points in this system and how can we adjust it so that systemic risk is no longer an issue?

Too bad there wasn't a White House email address that one could write a question to, that you'd get a reply back in one week with the answer. :-)

Regards,
Trond

Doom and Gloom

This is a bunch of doom and gloom.

I am usually pretty optimistic, but I have to call it the way I see it. (I am indebted to a number of posters on the InvestorVillage website for their views, which are reflected below and I have bought into) There are certain things occurring in the market, economy, and world that I propose are not being taken seriously enough by the pundits and commentators that most people seem to listen to.

In some ways, this is not their fault.

• From a psychological point of view, “the only thing we have to fear, is fear itself”. If a continuing litany of bad news is the only thing that we are fed, then of course we’ll see a self-fulfilling prophecy.
• Too, as I have mentioned previously, some of the media seems to be “captured” (inasmuch as they are spoon-fed articles of interest from major wire services or hedge funds who have agendas).
• Finally, they WANT to believe we are on the road to recovery. They see their own 401(k) balances headed south, and believe the mantra of cyclical bull and bear markets. After all, we’re in the 16th month of a recession and the average only lasts 11 (since WWII) months.

So why do I hang my head and join the bear crowd? (First, let me state that I do not believe in the Armageddon that some folks say is coming. There are always people who say one should buy canned goods, seed crop, and guns. We will get through this! But it will be months and possibly years longer than most people think)

The market is still overvalued. Everything occurs in cycles – we just finished with a massive bubble and need to see much more downside before we come close to an average. Based on earnings or dividend yield, you can make the argument that we will still see the indices go about 20% lower. Good times tend to be better than expected and downsides tend to be worse than expected.

Specifically within the markets, banks are nowhere near to finished in terms of writing off their bad loans. I have heard they've only written off half of the toxic junk still on their books. And this is the famous slippery slope – when more bad news about the banks and loans appear, downgrades will drive them even lower.

Consumer confidence is shot, and yet investors are not yet at the point of “capitulation” that truly marks the bottom of a market. Every article I read and every market-oriented conversation I have is centered around the question, “When are we going to hit the bottom so I can invest the cash I have ready?”
I have news for you – until we are at the point where the masses are truly ready to swear off stocks entirely, we have not hit bottom. Your grandparents, who lived through the Great Depression and only wanted CDs and savings accounts: that is the kind of capitulation I am talking about.

With stock markets in the tank – guess what the next big emergency is going to be? Pension Funds. They have been trundling along, using rosy projections about 10%+ returns, allowing them to underfund their liabilities. Now the piper is awfully close and we have nothing to pay him with. The Chicago Transit Authotity recently had to float $2 BILLION in bonds to cover their pension payouts, and now are underwater not only on the pension payments, but on the debt service as well. California had budget problems this last winter and when state and local public employees realize their pensions are at risk too, we will see some very angry public servants. We'll also see some very angry taxpayers when they are asked to make up these deficits!

We simply have too much debt still on the books – not only as a country but as individuals. The home is not the ATM it has been in the last few years, credit card companies are tightening requirements, raising rates, and lowering limits as we speak. The Fed recently said it will buy $300B of treasury bonds to get some more liquidity in the market: for one thing this will have to be an off-the-books move, as my last post shows – they only have equity of about $44B. The second impact this has is that again the piper will have to be paid at some point – drastic inflation and higher taxes will invariably follow.

Speaking of homes, not only will they not be useful as a method to pull equity from, but it looks like home prices will continue to fall. The historical average of home price to annual salary is 3:1 – we are still at about a 4:1 ratio now. That means home prices will have to fall by another 25% to get back to the historical average. And recall my point about cycles – to get back to an average, we need to go below the average to allow reversion to the mean. Does that mean home prices will fall another 50%?

Unemployment is perhaps the scariest of all the scenarios to talk about. The latest numbers show a rate of 8.1%. Unfortunately, the commonly used measure of unemployment is the U3 rate – which leaves out folks who are either underemployed or have ceded to despair and stopped looking for work. The “real” rate (known as the U6) now stands at 18%. Nearly one out of five people who want to work are unable to.
Here's a very strange and possible additional outcome: governments will decide to reduce prisoner counts to lessen their costs. Inmates are NOT counted in any measure of the unemployment rates. When released, they will start looking for work and thus will INCREASE the unemployment rates. It's estimated that 0.7% of our population is incarcerated – if 10% of those (the non-violent, victimless, and marijuana-related prisoners) are released we may see an extra 1% rise in the unemployment rate!

Chickens will be coming home to roost. The United States has affected the global economy already – commodity prices have dropped, credit markets worldwide have tightened, and worldwide stock markets have dropped. In turn, we will soon be affected by the world. China has been a large buyer of our treasury bonds; do you think they are going to be pleased about the extra $300B just floated? With all the decifit spending Obama is proposing, we are coming to the point where I fear for the world's faith in our currency. And Obama is just too damn honest about things – at some point he will be forced to admit that his ambitious plans (healthcare, energy, education, as well as the stimulus bill AND all the bailouts given under Bush's and now his administration – oh, and wait until he announces that he is all set to fix Medicare and Social Security!) will require additional taxes. Hmmm... do you feel like going back to the consumerist mentality with THAT hanging over your head?

One last note about the rest of the world – foreign banks are about to hear a certain horizontally-challenged lady singing. Western European banks have lent extraordinary sums (*our* banks aren't the only ones who can over-leverage themselves, you know) to Eastern European countries. Austria's national bank, for example, has lent 70% of its GDP to eastern-bloc countries. They may be bankrupt within a year.

Oil traditionally spikes during the summertime. Can you imagine the pain we are going to experience with the 1.3 million additional unemployed folks this coming summer and a return to $4+ gasoline? Food prices will again climb, as it costs more to transport all the raw and finished materials. People buying less of everything except foods and necessities mean that more retailers go out of business. So what follows that? Commercial real estate will start slipping away too. If you see $4 gas, start thinking about selling your commercial REITs that pay such a lovely dividend.

Bernie Madoff not only set a new record for thievery on a global scale, but may have ruined an entire generation of charitable trusts. Several well known and well endowed charities literally had ALL assets placed with dear ol' Bernie and are now defunct. Everything from soup kitchens to rehabilitation clinics have disppeared, overnight. That adds to not only the general misery of the least fortunate, but may increase the crime rate.

It is not a pretty picture. (Even with the foregoing, I personally think we will work our way through this within three to four years) But in this next few years, I urge you to proceed open-eyed. If two years ago (and I was in this camp myself) you did not think it possible to have the world in the situation we find ourselves in now, what are the chances that you are going to be right about what happens in the next two or three years?

• Take steps to protect the cash you have on hand now.
• Dollar-cost average your way into stock indices (if you have dispoable income AFTER assuring yourself an emergency fund).
• Possibly buy some oil ETFs over the next month to time the coming gasoline price spikes in summer.
• We most likely will have a “bear-market rally” in the next two to three months. I do not believe it will have legs.
• Personally I will take the opportunity to sell some of my individual stocks if they do bounce, and hold on to more cash than I am used to (30 - 40% or so).
• I never would have thought it, but I would even be tempted to buy into a gold ETF if gold drops below $800 per oz.
• Longer term? Short ETFs and SPY/QQQQ/DIA puts, IF they get a bounce by summertime. I do not think the market as a whole will recover for at least one more full year – late summer of 2009 is my prediction.

On an individual basis, I still like Dendreon for the next few months. We'll know in less than 40 days now about Provenge! I like the odds – if the final results are statistically significant, we will see an enormous jump – from $4 today to probably around $20. If not, there is still almost NO chance that the results will be worse than the interim 20% reduction in risk of death over placebo we saw at interim, and the company has signaled they will still refile their BLA with the trial as supportative.

Elan may not move for 4 to 6 months. Tysabri is not increasing with the vigor that I assumed, there will be no Alzheimers news for months, and the market is eying their debt nervously. I actually think it will fall a bit from here, and then recover in the fall. If it goes below $3 I'll be buying hand over fist.

Arena may be the quickest short term play. Results for their obesity drug are due at the end of March – I see the price as very volatile next week and from the present-day $4 I think we'll see $5+ -- a one week 20%+ move would be quite welcome right now!

Discovery Labs is a gamble but also should have some very short term volatility – buys anywhere near $1.10 and sells anywhere around $1.50 until mid-April.

Neurocrine Biosciences is just teasing now. Are they ever going to partner? I will sell when we get a partnership agreement and wait for it to settle with the rest of the market before buying back in.

Finally, Sangamo is very attractive now and perhaps the longest wait of all. I honestly think they'll be bought out within two years, probably at a very nice premium.

Regards,
Trond

Funny Money

Does it bother anyone but me that the Fed is buying $300B of treasury bills?

#1. The Federal Reserve has a net worth of about $44B (as-of 3/11/09). Let's see if these numbers change in a few weeks? (see http://en.wikipedia.org/wiki/Federal_reserve#Budget)

#2. This should simply be outrageous to any thinking person. The Treasury issues bonds which are sold to fund government spending. The Fed, an autonomous quasi-private interest, which nevertheless controls money supply, buys those bonds.
A) What money is being used to purchase the t-bonds?
B) The taxpayers then have to pay back principal and interest to pay the bonds back, to the Fed -- and yet we're supposed to believe the money supply will somehow contract later on to absorb the excesses of today's decisions?

Is your head spinning yet?

I am unfortunately seeing too many things that make me in the "bear" camp rather than the bull camp. Make wise decisions about your money, job, and house today, as you will have to live with them for a long time. I will post tomorrow about why bad times are coming.

Regards,
Trond