The Good, the Bad, and the Ugly. (Part 1)

I generally like to think of myself as an optimist.  In fact, I think anyone in business for themselves have to be of the optimistic-type.  The ups and downs of business, the stock market, and the gyrations of life, in general, demand it. 

But I must admit, I am a bit concerned with the potential consequences of the recent economic policies that our leaders have engaged into over the past couple of months.  In a homage to one of my favorite movies, I decided to hit this subject up using "The Good, the Bad, and the Ugly" as the framework of my outlook:

The Good

1.  Equity prices will definitely improve.  And believe me...we will have better trading days over the next six months or so.  I think our bottom from two weeks ago may have been the "real bottom."  And, yes, the sexy thing to do these days is to call market bottoms.  But who has done it successfully the past few months?  Not many.  

Looking back, I wish I had put together a list of all the bottom callers that appeared on CNBC plus their call number.  I personally thought the bottom was 8200 on the DOW.  But, of course, within months of my call we decimated more than another 1000 points.  Nevertheless, I see equity prices heading higher for a number of reasons to include increased commodity consumption and inflationary conditions that are brought about by an increase in the money supply and lower interest rates.   

2.  Consumer confidence will elevate to more normalized levels.  Now this is key factor as it relates to consumption. Have you noticed how recently Americans stopped spending money which, consequently, has led to a meaningful increase in the savings rate?  Well, I predict that will change by the 3rd quarter of this year.  In fact, the change will occur right in time for the Christmas holiday season.  We should see higher sales across retail which should also mean improved earnings for a number of retailers.  But I suspect we will not see a rebound (or reversion) to recent year norms because most consumers are "tapped out" - no cash and very little credit left. 

3.  The "credit monster" will wake up.  From my perch, I think of the credit monster and the policymakers who are trying to revive the system as a bunch crazy doctors working on Frankenstein.  Monetarily, the markets are seeing the LIBOR and other key lending rates improve significantly.  I for one thought that the volatile credit spreads from last year would be the cure to the overly-loose credit writing guidelines. Not so sure that will happen.  

Of course the revival of the credit monster will be good news for firms needing to improve their working capital and individuals looking to buy more goods.  But the downside is that our economy will fail to understand the dangerous perils that await participants (both firms and consumers) when using borrowed money to increase profits or when consumers begin to mistake "having more stuff as being wealthier" all when they still need to pay the bill.

Most people mistakenly interpret "increased consumption" for "greater wealth"...unfortunately, most goods that are consumed are not really owned but in effect borrowed at a high interest rate.  Thus, negative net-worth.

 

The Bad

1.   Mark-to-market modifications are simply an extension of the goverment's denials.  Giving banks the ability to mark assets to "reasonable" values by making this a quasi-subjective matter is a recipe for disaster.  This is not the right way to do it.  I submit you the following question:  shouldn't the value of an asset that frequently trades hands over an active market be valued at the amount you would get from it on the street right now.  I think so.    

The notion that you can value these assets on the basis of pre-bust "real estate bubble" valuations will not work. The bubble has bursted.  Values in high-priced condos, homes along the coasts, and subprime properties will not return to what they once were.  People need to accept that for what it is.   

Interestingly, this reminds me of the tech bubble.  For evidence I submit to you the NASDAQ's bubble pop from earlier this decade. Notice how the market never returns to apex of the bubble. 

The chart above confirms the destiny of speculators in a boom-bust cycle.  Almost ten years later, we never returned to the valuations that were once enjoyed during the late 90s.  I still remember when dot-coms were being picked up "hand over fist" with corresponding pricing models that were based on eyeballs, page views, and a host of other garbage metrics.  Mania prevailed but the ensuing correction washed out the speculators and "smart money."  I am sorry but GroceryWorks.com, Garden.com, and Pets.com were terrible business models.   

With that said, I predict that US real estate will replicate the same NASDAQ demise of early this decade.  Investors kept believing that it would "come back."  And the notion that the growth of personal real estate holdings became the source of "savings" or wealth creation is not a sustainable method of financial prudence. Further, the increased scrutiny of real estate securitization and how it relates to the banking collapse will also hurt the future prospects of this sector.  It cannot come back; it will not come back.

 

The graph below is a "classic boom-bust" scenario.  It shows a bubble acceleration from 2003 to 2006 and begins its downward pop in 2007 which ultimately led to the bust in 2008.

      

After reaching an all time high in the mid $90s range, it now trades in the $20s.  You need almost 250% to get back over the all-time high.  Sorry, but thats not happening anytime soon on an ETF.

In fact, to further illustrate my point I will construct a housing P/E chart in the next several days.  I promise that the results will be eye-opening.  

To be continued.  Part 2 later....