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July 13, 2006 at 7:10 AM #6861July 13, 2006 at 8:04 AM #28232
powayseller
ParticipantI have a friend, who follows indian gurus around the country and world, says they are predicting a very bad time starting in September. I don’t know if this is economic or war related.
What would avert a recession? Another liquidity injection? But that is unlikely. We’ve had a global liquidity glut, and all central banks particpated in that, so all are unwinding and raising their interest rates.
Recessions are a natural cycle of the economy. They are necessary to cleanse excesses, even more necessary in economies no longer backed by gold. The longer we avoid having a recession, the worse the eventual one will be. Oceans have waves. They rise and fall. How can we keep a wave from rising? Our day has light and night. How can we avoid nightfall? It’s just a natural rhythm of things. The question is one of severity, and the severity of the recession is proportionate to the excesses which preceded it. That is why this next one will be huge. We had years of federal funds rate below inflation. Investor buying MBS from mortgages at 100% financing given to high risk borrowers without demanding any kind of risk premium. Crazy stuff. The derivates collapse potential is huge, but it is a thing I do not understand.
The masses think the economy is good because the read the headlines: low unemployment. They listen to Bush trump the success of his tax cuts, and that the budget deficit is less than projected. They think housing will stay flat for a yeaer and start rising again. I don’t know anyone outside this forum who understands what is going on now. Not one person. The masses are clueless. They don’t care about the economy or politics. How many people even care that we could be starting a major war in the middle East over the Israel matter?
We are happily ambivalent because life is still good. The tsunami is coming, but it is calm at the beach, and we are happily playing in the sun. You tell me a tsunami is coming, and I look at you puzzled, because the ocean is smooth and the sun is warm and the sand is soothing under my feet. Life is good.
Use this information to prepare. That puts you ahead of your competitors.
As Bugs said, if everyone rushed out at once, we would have a disorderly decline. I needed a bullish real estate view so I could sell my house and find a rental. I needed people to buy stocks so I could cash out mine. So the early bird wins. I have moral guilt over this, but I am living in a capitalistic society so I play the game.
July 13, 2006 at 8:39 AM #28237privatebanker
ParticipantI think we are headed for a recession without a doubt. When or the degree of it is uncertain but when an economy is heavily dependent on a certain cyclical sector it is very vulnerable. Once that sector pulls back, there either needs to be something else to step in and support the economy (none to my knowledge at this point) or the economy pulls back. The degree of the pull back is debatable. Recessions can be good for the economy in the long run. This one will be dubbed something like the “land rush /credit hangover”.
July 13, 2006 at 9:58 AM #28242lindismith
ParticipantJust paraphrasing, so I can make sure I understand you both so far: a period of exuberance is followed by a pull-back and then other factors can influence to what degree it becomes a full-blown recession, vs a slight dip etc.
So in the dot-com exuberance, that led to a pull-back, which was exacerbated by 9/11. But lowering interest rates by the Federal government allowed money to flow back into the economy?
What was the prior recession due to? (I was just out of college in the early 1990s.)
If the Fed knows all this, then don’t they have an idea of what we’re in for? I mean, don’t they have teams of people running forecasts, and analyzing EVERYTHING, and then controlling whatever factor(s) they need to? I realize we’re in a capitalist market, and not everything can be controlled, but why let interest rates get SO low?
Do you think they have models of possible outcomes?
Do you think there’s a ‘consumer-housing-crash model’?
July 13, 2006 at 10:28 AM #28245ParticipantMarket excesses correct and revert to the mean, sometimes overswinging. The NASDAQ was at 6000, and is today at about 2000. It was wildly overpriced, and is probably at equilibrium today. When will it reach 6000 again? I believe in markets correcting to equilibrium, because that is what history has shown always happens.
The lower interest rates created a liquidity glut, because they were below inflation. Inflation was 3-6%, but interest rates were 1%. Why would anyone save money? Just borrow and spend.
I started working and investing in 1988, so I didn’t follow the 1990 recession. The last recession was a mild one, in 2000-2001. It was due to a decline in capital spending. But consumer spending stayed strong, thus it was a mild recession. Nonetheless, it spooked stock markets around the world, and stocks and commodities sank as capital spending declined.
Why did the Fed let rates go so low? I am not smart enough to know this. There are many guesses. I’ve read to avoid deflation. To avoid a recession after the dot com collapse and the terrorist attacks.
What the Fed knows and what they say are two different things. I spoke with my smart friend this morning (who wants to remain anonymous here), and he said that the reason the Fed is raising interest rates is to stamp out the housing lending bubble. Since the exotic lending was tied to the LIBOR and other short term rates, they needed to raise the short term rate. This is working.
Another problem is that inflation is rising globally. I don’t understand why it is rising now, and not before. I have a question why did it wait so long to rise. But the fact is that many central banks are raising interest rates to reduce inflation caused by rising input prices. In the 70’s our inflation was caused by rising wages. This inflation is caused by high prices in oil, commodities, and rents. What is not showing up in the CPI is contributing even more to inflation: food, health care, housing costs, insurance, tuition. If you put a real basket of consumer goods into the CPI (instead of doing hedonic adjustments and substituting rents for housing prices), you’d see inflation has been closer to 6-9%.
Bernanke talks about the importance of keeping expectations of inflation low. Inflation gets a foothold only if people expect inflation to be a reality. So you have to dampen the perception of it existing. They didn’t care about high inflation, until it showed up in the CPI. Now the Fed must keep raising interest rates until the CPI is in a comfortable range of under 2%, so that we all believe it is low, and act accordingly. So the Fed must keep raising interest rates as long as the CPI is above 2% (Bernanke’s target), and the high commodity and oil prices are feeding through to producer prices, and low unemployment could put upward pressure on wages.
Greenspan talked about froth in the housing market many years ago, but right after that, came out and promoted ARMs. He wanted to be liked. That was his biggest problem. His desire to be popular was bigger than his desire to do the right thing. Volcker was unpopular for raising interest rates in the 1970’s to 19% (?), but Greenspan lacked the will to do the right thing. He was our bubble man.
I have learned all this since coming to piggington in November, and I don’t understand a lot of this stuff. But like you, I started with housing and found that the global economic policy is the basis for understanding it.
July 13, 2006 at 3:26 PM #28273Doofrat
ParticipantA couple of observations, and a question:
If you look at the S&P over the last 5 years you can see that prices have not moved at all. We’re at the same place we were five years ago. Why is this? Well, to me, it seems that P/E ratios have declined, while the prices have stayed the same. With interest rates being low, you’d think there’d be growth in the market, but this has not happened. Earnings have been increasing in this period, so the cause of this 5 year flatness would seem to be lack of confidence in the stock market which has been pushing down the P part of the P/E ratio.
There are two ways to look at this (positively and negatively):
1. It’s still a good time to invest in the stock market because this lack of confidence has pushed the prices of stock to levels where they are a good buy.
2. It’s not a good time to invest in the market when the market has not picked up steam with low rates and increasing earnings, as well as reasonable market prices. You have to wonder, if this is the best the market can do with all these factors that should be helping the market, and all it can do is stay flat, what will happen if rates are higher (both tightening all the free money floating around, and tempting people to pull money from the market and place it in bonds) and or earnings fall from many of the factors discussed on this site?
Personally, I have a very high percentage of my savings in stock. I weathered the dot.com bust with nary a scratch, but the possibility of a recession has me worried.
By following the advice of Benjamin Graham, I shouldn’t try to time the market at all, and just continue to invest on a regular basis (of course keeping enough cash on hand for emergencies). The only other option should I choose to muck with my investment allocation, is to place a percentage of my investments into bonds if I don’t like current market situation. With the relatively high rates out now, and the possibility of even higher rates, I’ve been toying with moving up to 50% into bonds (basically taking that off the table)
The question then is what to do with the other 50% that’s still in stock. Should it be put into commodity stock like oil stock, or gold funds, “recession proof” stocks like RCII, or should I just go along business as usual and pretend there won’t be a recession since placing 50% into bonds to hedge against a recession and or market collapse?
What do you guys think?
July 13, 2006 at 4:17 PM #28275Jim Brubaker
ParticipantDon’t buy bonds, if the interest rate doubles, bonds loose half their cash value unless you wait until the maturity date. The interest rate hasn’t been this low in 40 years, now is the time to sell 30 year bonds.
Plus if the bond holder files for bankruptcy, you’re behind the vendors who are first in line for payment.
A $20,000 thirty year bond paying 5% today, if the interest rate went to 20%, that bond would sell for $5,000, thats a $15,000 haircut. You could wait 30 years and get your principle back.
Short term T-bills are the way to go if you want to protect your assets with a non speculative investment. If the interest rate were to jump to 20% you would buy the 30 year bonds. Then if the interest rate went to 5% the bond price would quadruple in resale value. A $20,000 bond paying 20% interest is the equivilent of a $80,000 bond paying 5%.
The example is not totally correct, but it gives you the general drift. Plus if you take the “Rule of 72,” and divide that by the interest rate, it gives you the approximate time it would take to double your money.
July 13, 2006 at 4:20 PM #28277Anonymous
GuestChris Johnston
There are very good long term cycles to be aware of for a rally in stocks in the fall. I have spoken of this many times in here during the last 6 months. We are going to need to see a rally in bonds first. They have been up 6 consecutive days now which has only happened 40 times since 1988. Maybe this is a start.
I do not know if this rally will stick, but if it does, and the commercials get long the S&P in the fall, a powerful rally could develop. I have written about this in my newsletter as well. We will have to wait and see come fall how things look. However, a sharp selloff down into that time frame would be nice to setup the buy spot.
We could still have a nice stock rally even during a recession in the economy, that has happened many times in the past. I do believe a recession is around the corner as well. I think the catalyst is going to be the housing market selloff, which is supporting the whole economy at the moment. I agree with poway that the reason the fed took rates so low was the deflation scare. They had to inflate an asset class for all the people leaving the stock market to park their money.
If housing only drops 20% I think the recession will be mild. If it drops more, it could be very unpleasant. It is very difficult for me to predict many years into the future. My time frames are about 6 months or less. However, in general with that being stated, I am not as down on the long-term prospects of our economy as some of the financial experts are.
We are going to have a tough period ahead for awhile. I do think the fed will start cutting rates next year, to stop the negative effects of the raising they have done. This will take some time to have an effect. If you look at this strong rally in bonds the last week you can see some very big money is buying them here. Some of it is related to a flight to quality from the stock selloff, but not all of it.
I tried to keep this as simple as I could, just spitting out alot of numbers tends to be a bit confusing.
July 13, 2006 at 5:45 PM #28288ParticipantI went to 95% cash, and have some play money in COP, and waiting for a gold buy position. I subscribe to Chris J’s bond futures trading service. All my economic experts to which I subscribe, including the $350/year Yamamoto Forecast, are recommending 100% stocks.
If you want to keep a stock or commodities position, and are hands-on, you might like Zeal, a commodities research company that is followed by some of the smart people on this forum. Their luck so far is due to their early entry into commodities and oil, and I don’t know how they will do during the commodities sell-off during the recession.
The stock market is overvalued, and that is why it hasn’t moved. It was overpriced A LOT in 2000, and is simply overpriced now. Interesting you mention Graham in the same paragraph with overpriced stocks. Didn’t he teach value investing? Where do you find value today? It’s all overpriced…
I cashed out my Vanguard index funds, my Bill Miller mutual fund, my Rubio stock, etc. Kept BRK.B, bought COP. Like I said, just a little bit. Most of my money is in various CDs and in a money market that I must move to CDs. The money market is not FDIC insured, and when Fannie Mae blows up, the money market can be history too. Writing this reminded me I need to get rid of my Vanguard money market fund.
Cash can be CD, T bills. Why risk losing a big percentage in the stock market when cash pays 5.5%????
July 13, 2006 at 9:05 PM #28306carlislematthew
ParticipantIf the Fed knows all this, then don’t they have an idea of what we’re in for? I mean, don’t they have teams of people running forecasts, and analyzing EVERYTHING, and then controlling whatever factor(s) they need to? I realize we’re in a capitalist market, and not everything can be controlled, but why let interest rates get SO low?
My belief regarding interest rates is that the fed took what they perceived to be the lesser or two evils. They could do one of two things:
1) Lower interest rates massively.
2) Lower interest rates, somewhat, but not so much as to massively stimulate the housing market.I believe that they chose option 1 because in their minds it was the lesser of two evils. They felt that they could reduce the extent of the recession (that would affect EVERYONE) and trade that for a future housing problem that would only affect SOME people. I believe they traded problems and exchanged a short-term issue for all, into a long-term issue for some. Now, it may not be the case that the long-term issue will only affect “some”, but my theory is that they didn’t realize the extent to which people would be so crazy.
The fed are economists, and they’re not stupid. So they must have had an understanding of what lower interest rates would do. Yes, it would save the short term. Yes, Greenspan could go on record as telling everyone to get ARMS and refinance. But the result should hopefully be some time in the future, and only affect some regions (the “frothy” ones”) and only some people in those regions.
In summary, I believe that that Greenspan and his “pals” picked a milder recession and a few bankruptcies, over a stronger recession and a stable housing market.
Just my 2 cents…
July 13, 2006 at 11:04 PM #28315rankandfile
ParticipantPS: is your moneymarket fund through a larger company or a smaller one? I ask because the larger ones tend to have more financial backing and incentive to weather a floundering fund.
Maybe we should have a thread devoted to strategies for investing in cash?
July 14, 2006 at 12:37 AM #28318ParticipantJim,
Thanks for the info on the bonds. What I probably meant to say was a CD. My focus is on stocks, and I kept a good percentage of cash from 2002 to 2004 since there seemed there was no good liquid alternative worth anything back then. I don’t really know about the various alternatives to the markets like bonds, but with rates rising, it’d probably be a good time to learn, I like Rankandfile’s suggestion to have a thread devoted to investing in cash.
So do you think it’d be better to put money in a CD as a safe storage place?Powayseller,
I’d have agreed with you a couple of years back when everything did seem to be overpriced, but I think there are some good values out there now. In fact, my last purchase was COP as well. My only concern is for a deep recession that would affect the E part of the P/E ratio. I think that by going to 95% cash, you’re speculating on a market that can do some weird things, that’s why I only want to take half off the table. To be honest though, I don’t think you’ll be missing out on any major market rally IMHO, but I’m just as afraid of being completely out of the market and missing out on say four years of gains because I tried to predict that the market would tank.Like you, I’m happy with the 5.5% a CD pays right now with what I take off the table.
So it seems that everybody believes there’ll be a recession soon (as Powayseller pointed out, they are a natural part of the market) Any bets on when the recession will start, and how bad it’ll be?
July 14, 2006 at 4:50 AM #28322ParticipantIt is Vanguard Prime Money Market, but is not FDIC insured. Historically, money markets have kept their value at $1/share.
When I called Vanguard, they admitted that the money market includes some GSE short term debt. That is why I want to get out of it. Some places many not tell you, but GSE is the most widely held debt. I believe we will have a GSE collapse, and I am not sure if the government can afford a bailout. It is trillions of dollars.
With FDIC insured CD rates at 5.5%, why risk the money market which pays the same or less interest without the guarantee? You can spread out among several banks if you have more than $200K/couple.
Also consider Tbills. They are backed by the government.
This is really cool: Everbank.com is FDIC insured, and you can make FDIC insured deposits into euros and other currencies. A great way to diversify if you believe the dollar will fall (as I do).
doofrat, the stock market is going. We had a sell-off in May, another yesterday, and there will be big correction due to the recession. When earnings go down, you will see a big sell-off. The leading indicators show the economy is turning into a recession. When the leading indicators show the recovery, then get back into stocks.
The only reason that timing stocks doesn’t work for the general public, is because the general public is kind of stupid: they do momentum investing. They pile in when things get really hot, and get scared and sell when the asset is at its lowest. Selling stocks now is selling high. We’ve covered this at length in other threads, and you can find this if you do a search (hopefully).
July 14, 2006 at 7:07 AM #28325PD
ParticipantI moved most of my money out of stocks and into cash in early May (whew!!!). I decided that the risk of a heavy loss was greater than the possibility of a gain during the next six (or so) months. I think that we will be hearing lots of news about poor Christmas sales as the recession gains steam. My prediciton is that it will officially start about Thanksgiving.
July 14, 2006 at 8:31 AM #28339Participantcnn.com is full of retailer-woe stories. The slowdown is here. I was reminded that retailer ups and downs this time of year mean nothing. Most of their business, I think about 75% of it (???), is done between September and December, the Christmas selling season. This is the time that housing will really tank, and psychology will change. At that time, the lower MEW rate of January wlll have fed through, and new MEW will be harder to get as interest rates are higher and homes are no longer rising in value. So you’ll have a new psychology of worries about the wealth effect, less borrowing, and the retailers will have a very bad year.
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