IS OUR ECONOMY COLLAPSING?
(Reprinted from the June 2006 Newsletter)

Is our economy heading for recession, or even depression? Yes, I think it is.

Seven months ago American Panthers warned, using the illustration above, that serious economic conditions could send the United States into recession, or even depression. Those warnings are starting to become reality.

The price of real estate is coming down across the country. Pollyanna pundits are calling this the “soft landing” that they were expecting. By “soft landing” they mean a minor and gradual price correction that does not cause economic instability. Unfortunately, that’s not what I think is going to happen. Banks have allowed homeowners to borrow against too large a percent of their home’s value, and to pay temporarily low interest rates on those loans. Interest rates are going up, straining the ability of homeowners to pay their mortgages. At the same time, housing prices are going down, leaving banks with collateral that is below the value of the loan balances. Because of this, 29% of all homes bought in 2005 now have mortgages that are equal to, or greater, than their current value. About 10% of all existing mortgages are in the same boat. You would expect that this would lead to defaults and foreclosures, and you’d be right. The foreclosure rate is up 68% from February 2005 to February 2006. Banks, in turn, do not want to own homes, and when they get a house through foreclosure they sell it below market price if necessary, driving down home prices even further. Continued falling housing prices will lead to bank failures.

With interest rates up, less equity in homes and (hopefully) more caution on the part of lenders, refinances are bound to plunge. Along with that plunge will be the loss of a good part of the discretionary spending that these funds release into the economy.

FINANCIAL TIP OF THE MONTH
THE BEAR MARKET BEGINS`
(Reprinted from the June 2006 Newsletter)

The market began to retreat last month. Especially hard hit were almost all stocks in the emerging markets. The emerging market exchange traded funds that have been previously recommended in this column should be sold by all accounts except those with a long-term outlook. I have sold my personal holdings in those markets and it could be as long as six months before I would recommend reinvestment.

The stock market is coming through a period where good news is bad, and bad news is good. When news of a weakening economy was announced (that’s bad news), investors thought that this would stop the Federal Reserve from raising interest rates because higher rates would further slow the economy. If interest rates remained low, it was believed that would translate into a stronger stock market. And so the market rallied on the bad news.

If the news supported the view that the economy was strong (that’s good news), investors concluded that the Fed would raise interest rates to control the inflation that usually comes with a robust and expanding economy. Rising interest rates are not perceived to be good for stocks. And so the market went down on the good news.

This may seem like strange reasoning but If you want to make money in the stock market you have to follow investor logic and not dispute it.

Changes in stock market direction do not occur at the same time for all groups within it. At a top, the market rolls over a group at a time. This is what has been happening. Homebuilding was one of the first groups to take the hit, most hitting their top last July or August. Healthcare and telecommunications seem to have topped out in March, brokerage stocks in April. The QQQQs had a double top in January and April, with most technologies seeming to hit their top in the March-April timeframe. Also looking like they topped were energy related, chemicals, and consumer cyclicals. Bank stocks seem to be rolling over and may show a clear top next month. Utilities are neutral and may hold until long-term interest rates go up.

This looks like a clear bear market pattern to me. If I’m right, it will be very difficult to find a safe haven in the stock market. High quality fixed income will be the only shelter. I recommend one or two year maturities. Long-term rates may rise due to a weak dollar while near term rates may fall over that period. I haven’t heard anybody say it yet, but the next Fed move may be to cut rates, not raise them. You heard it here first.

THE FEDERAL DEFICIT PUTS AMERICA'S PROSPERITY AT RISK

The ballooning Federal budget deficit is a debt that must be paid back, with interest, by future generations. In addition, the deficit risks the viability of our economic recovery, and will eventually raise the cost of borrowing additional funds. The volume of outstanding U.S. Treasury debt obligations gives foreign debtholders too much control over the American economy and also would make it very difficult to borrow more funds to fight a war that may actually be necessary.

EXCEPT FOR THE MILITARY, OF COURSE

Nothing annoys me more (well, almost nothing) than a Republican starting a discussion about budget cuts by saying: “Everything must be on the table, except for the military, of course”. With that statement, the only part of the budget that can easily be cut is eliminated at the start. Can it possibly be right to keep Social Security, Medicare, education, crime and drugs “on the table”, but not the military budget? Of course not! To make it worse, the area with the most waste and graft is, you guessed it, the military budget. We do not need a war in Iraq, or a star wars missile defense system, or all of those overseas bases. We do not need to pay the salaries of the Baghdad fire department while we are forced to close fire stations in the City of New York.

George Bush's budget proposal contains cuts in education funding, food assistance for pregnant women, environmental protection, AIDS treatment, child-care assistance, food stamps, Medicaid and so on. However, its full speed ahead as far as lucrative contracts for Bush’s corporate pals to “rebuild” Iraq. It now appears as if these deals may have been a part of Bush’s original rationale for going into Iraq in the first place.

War expenses are made more damaging by the administration’s tax cuts for the wealthy, causing a ballooning budget deficit that severely endangers our ephemeral economic recovery. The bill will eventually have to be paid with interest, but this responsibility will fall to future generations of middle income Americans.

LHS