Bubbles, Bubbles, Toil and Troubles

There's the Housing Bubble and the Commercial Office Space Bubble. There's the Bond Market Bubble and its two progenies, the Junk Bond Market Bubble and the emerging Market Debt Bubble. There's the $3.00 a gallon price you see at the pump, which has all the markings of an Oil Bubble. And the premiums being paid for all those corporate mergers and acquisitions are always coincident with the top of a Stock Market Bubble. In fact, nearly every asset market you can think of is showing signs of bubble-like behavior. That is every one except Gold that while breaking out to new 27 year high is being completely ignored. The reasons for this behavior are quite clear: The global economy is awash in excess cash and credit that has been "created out of thin air". There is a tremendous amount of excess liquidity around and it is proving very hard to get rid of it and the possibility of a bursting Liquidity Bubble around the world should be of serious concern, but nobody seems to have noticed or if they have noticed, they don't seem to care. To many analysts, this excess liquidity is exactly what some of them erroneously expect is the savings of the giant baby boom generation as they reach their peak earnings years and begin to save more and more for their retirement. But the truth of the matter is that the average retiree has less than $3,000 in the bank on the day of his retirement. They are all mostly relying upon the government and if they are lucky, their corporate pensions, which hopefully won't be going bankrupt soon, even though they are loaded up with CDOs and CMOs. The Government's "cradle to grave" campaign promises mentality has been bought hook, line and sinker by a "something for nothing" gullible populace. The fact that the Government cannot possibly meet all its promises has been demagogued out of existence. We have neither a Social Security nor any Medicare/Medicaid problem, President Bush is just a liar…. Wish it were so. And if you think Bush and the Republican $ Trillion (over 10 yrs) Drug Plan and the War were big ticket items, just wait until you see what a Clinton, Pelosi, Rangel, Wright Spending and Tax Increase package will look like.

Most assuredly, the major part of the story is the ultra simulative monetary policies of the central banks around the world. Ever since the Asian financial crisis in 1998, the Bank of Japan has been pumping out cheap money in an attempt to revive the Japanese economy in a vain attempt to slay the Deflation Dragon. Isn't 17 years enough time for the world to figure out doing more of what got you into trouble doesn't work. Before you can solve a problem, you must first learn what the problem is. In the United States, the short term interest rates that the FED has engineered have been below the inflation rate for more than ten years; that's ten years of getting paid to borrow money and take excessive risk. Their message is loud and clear, "go forth and borrow to speculate and spend".

The biggest culprit is probably the Central Bank of China which, in its effort to prevent the appreciation of the Chinese currency, has had its printing presses working overtime so that they can buy up all those dollars earned through exports. CHINA IS A COMMUNIST COUNTRY trying to run a Fascist economy of immense proportions with absolutely no experience and without the built in signals that a Free Market Capitalist Economy has. Make no mistake about it, China is NOT a Free Market Capitalist Economy. The unfulfillable promises that their enormous population has grown to expect will come home to roost, a lot sooner than anyone is expecting and the results will not be pretty.

FED maestro, Alan Greenspan, had argued that nobody can really identify a Financial Bubble until after it has popped, which was his reason why the Fed did little to try to stop the Stock Market Bubble from getting out of hand in the latter 1990s. That has now been belied by any number of objective indicators of the widening gap between the economic and market value of various asset classes. Greenspan then, and Bernanke now, are trying to engineer first a slowdown followed by a soft landing in order to try not to have all of the bubbles pop at once. For some reason, they never seem to realize that "the piper must always eventually be paid." So far the experts have only recently begun to admit that the Real Estate Bubble has popped as they all try to convince us that prices will be back to normal by sometime in 2008. Wishful thinking at best or out and out lies at worst. Popped bubbles always turn into CRASHES. We have at least another 10 to 15 years to go before this real estate market can stabilize.

The downtown office building market is still red hot in parts of the country, even though nationally, there has been little or no increase in rents. Most of the price escalation can be explained only by an expectation that price appreciation will continue at its current pace. This is another perfect example of the "Greater Fool Theory" since a normal positive return on capital cannot be achieved through buying and then renting. Wouldn't you know it, another Banking Fiasco just waiting to come on the scene.

THE CREDIT BUBBLE has also popped, but nobody has admitted to that yet. The world's central bankers had to pump in over $1 Trillion, virtually overnight, just to keep the world's financial system from collapsing. One Guru after another keeps talking about how Citicorp and Merrill are becoming good buys now that they took their write offs and fired their respective fall guys. They keep concentrating on their dividend yields and P/E ratios. That's looking in the rear view mirror. They have no earnings, only more write offs coming and there will shortly be no dividends as the worst is yet to come. My friends, "YOU AIN"T SEEN NOTHING YET."

Phil Verleger, an energy expert, brings a similar analysis to the run-up in oil prices, which he said is being driven less by fundamentals than it is by the upward pull of Futures Markets that worries about an Iran invasion. Now that every Hedge Fund, Mutual Fund and College Endowment is invested heavily in the Futures Market betting heavily on higher prices, we have just witnessed what always happens when a speculative bubble is getting ready to burst: The real prices at the pumps are not following and refinery margins are being squeezed, witness their drop in earnings in the face of rising prices. What has happened to all the manipulation and price fixing those big, bad companies were supposed to be doing?

The current Bond Market Bubble is another warning that nobody is heeding. All the experts are seeing only what they want to see; a FED that continues to cut rates even in the face of full employment and a 3.9% growth in GDP. But the Stock Market is not going up and since that is all they care about, they are demanding more and larger cuts. Now we know that every Wall Streeter is always talking about long term investment, but did you ever meet one that could see any further than his next trade? Let the economy be damned, after all in the long term we are all dead.

What they all refuse to see is that the FED has been printing money at a 15% clip for at least 4 years and that is tanking our Dollar, which the " hear no evil see no evil" gurus take as being good for our exports and balance of trade deficits. Another very important reason and one you rarely hear mentioned is the flight to quality by the super rich, who are more interested in protecting their assets than they are in how much more money they can make; especially given today's valuations and risk reward ratios.

The "Carry Trade" is also completely distorting the world's Bond Markets which we no longer hear even being discussed. What everybody seems to have forgotten is that this Bubble, which nobody knows just how large it really is, must eventually be UNWOUND. But what will be the consequences as everyone tries to get through the exit door at the same time?

A similar story is being told by the near record low spreads between Treasuries and Junk Bonds - the interest-rate premium that borrowers have to pay over "risk-free" U.S. Treasury Bonds. In the Junk Bond Market, spreads are still near historic lows. In the market for Emerging Market Bonds, spreads that once peaked at more than 10 percentage points at the time of the Argentine debt crisis in late 2001, have recently fallen to an all time low of 3.3 %. Perhaps worst of all is the fact that the FED has lost control of the money supply since most of the new "out of thin air" money is being created outside the American banking system by the near Banks and the Reserve Banks of Japan and China as well as a host of other countries such as Australia and New Zeeland. The financial experts can't seem to learn the lessons of Japan. Do they really believe that each country has different fundamental Economic Laws?

Is it too much of a stretch to argue that stock prices have again entered bubble territory? Certainly as a multiple of earnings, today's prices are higher than they have ever been except for the years 1999-2000. How strong can earnings be if most of them are coming from massive cost cutting, layoffs and huge share buy-backs (using borrowed money) with zero or even negative top line growth. There is a strong sense of "deja vu" in seeing banks and Wall Street investment houses, up until the Bear Stearns debacle, tripping all over one another to provide gobs of money on easy terms to companies and private equity funds engaged in bidding wars for overvalued companies. Takeovers are a cyclical phenomena and since most never work out as projected, they must be spun-off in massive cost cutting measures in their attempt to regain profitability. However, recently even this market prop has virtually come to an end although the movers and shakers are still refusing to admit that this game is over. POP! THERE GOES ANOTHER MARKET PROP.

INFLATION
Is there anyone out there who still believes that inflation is only 2%? I have recently been cleaning up my files and in throwing out my 1999 Income Tax Files, I started looking through my bills and I noticed that everything had at least doubled. It then wasn't very hard to figure out that is a 10% compounded annual Inflation Rate.

IS EVERYBODY HAPPY ? WHY NOT?
Don't tell me that after three solid years of the best (without a Crystal Ball) market forecasting you're still not listening? The Stock Market and especially Gold have been behaving almost exactly as expected and wouldn't you know it: Prechter is still calling for Gold to crash; lucky for us because as long as he and the rest of Wall Street's Gurus are bearish on Gold, this Gold Bull Market will continue.

THE STOCK MARKETS
I know it's hard to believe that in the face of a crashing dollar, a burst Real Estate Bubble, a Financial Credit and liquidity squeeze, Inflation that is really between 10% and 15%, massive Budget and Trade Deficits and with the Democrats now in control of both Houses with every likelihood of Hilary gaining the White House (all of whom are calling for massive spending and tax increases), and yet the Stock Markets are still within 5% of their all time highs. WHO'D A THUNK IT?

Well, as Bearish as I am and as you all know I have been for some time now, I think we might still have, after a possible test of the October lows, one last fling into new all time high territory. Why? Because Market Sentiment is still much too bearish for the "Top to end all Tops" to have been made. But as I said before, I would rather shoot craps than play this Top from the Long Side. I have been shorting into every rally for more than 6 months; all those stocks that I think are in dire trouble such as the real estate stocks, then the brokers and banks, then the buyers of all those CMO'S such as Insurance companies and lastly, the suppliers of building materials. The short side is a tough game to play and I warned you not to play it if you have never done it before. Stick to buying Gold and sleep well. What good is having a lot of money if you die from a heart attack?

THE MIDAS TOUCH
Those of you who have maintained your Gold positions and have added to them on each decent (5%) pullback know what the MIDAS TOUCH feels like. For all the rest of you that do not have Gold as your major position, I would suggest very strenuously that you go back into my files and read all my missives on RIDING THE GOLDEN BULL and all the others pertaining to Gold. WHY? Because this GOLD BULL is still just beginning its middle stage. The most explosive 5th stage is still 5 or 10 years away. If I still was on the outside looking in, I would be scaling in starting NOW. For the rest of you Gold Bugs, the Big Quality gold stocks have, as I projected, led the parade. The better of the mid-sized companies are following nicely and its now time to start accumulating quality juniors. The biggest risks and naturally the biggest potential rewards are the ones in high risk countries which I personally stay away from, because there is no telling what lengths politicians will go to cut their nose off to spite their faces. But it's your money. You pays your money and you takes your chances. Personally I wouldn't do it.

I could go on, but I think that's enough BS for one today.

GOOD LUCK AND GOOD BLESS

Aubie Baltin CFA, CTA, CFP, Phd. (retired)
Palm Beach Gardens, FL
[email protected]
561-840-9767