1st Crack in the Goldilocks Dam of Optimism

THE BEAR STERNS HEDGE FUNDS

The first hairline crack in the DAM holding back REALITY has finally appeared but, as usual, nobody is looking and so nobody has noticed it YET. The crack I'm referring to is the CMO pricing debacle associated with the Bear Stern's Hedge Funds. Everybody is comparing it to LTCM, it happened, they fixed it, it didn't spread back then and it won't spread now. The problem is over - witness the tremendous rally in both the bond and especially the stock market that followed as the S&P tempered acknowledgement that there may have to do SOME re-evaluations (re-read my March 4 letter DENIAL).

"You can fool some of the people all the time, But…." The gang of thieves all got together and pulled their offers because they were not satisfied by the 85% of programmed valuations that they received, or so they say. If you believe that, well I guess you will also believe that I am the next coming. The truth of the matter is that there were NO bids. And now everyone is scurrying around re-evaluating their portfolios. But how do you do that against NO BID. Keep in mind that every one of those Hedge Funds playing in the bond playpen, be it CDO'S, CMO'S or the Carry Trade, are leveraged anywhere between 10 to 25 times their equity so that even a 10% downward revaluation wipes out 100% of their Equity. Anyone want to buy a Hedge Fund? I have some that I can sell you real cheap. I just heard the most Bearish yet, real estate expert report on the misinformation channel, assure us that even though there are an estimated (by whom) $500 Billion of ARM's coming due this year, he expects only an 8% drop in prices by the end of 2008 at which time the market will have already started going back up. PHEW I'm so relieved aren't you?

HOPE vs REALITY

Thus far, we have been assured that all those record high defaults and foreclosures have all been restricted to the sub-prime area. Don't you believe it. How many people do you know of that you wondered how they could possibly afford the house that they live in? How many purchased homes that require two incomes and even then as much as 50% of their incomes is needed to maintain them? Any decent financial planner will tell you that you should not spend more than 25% or at most 30% of your income if you want to stay solvent. So far, we have only seen the beginning of the sub-prime disaster, but what about the Alternate A1-A borrowers? Their credit histories are not much better than their sub-prime brethrens. How about those AAA real-estate agents that have purchased multiple properties based on their last year's earnings? What do you think their earnings are going to be this year and next? How about stockbrokers, what will their incomes be once this market breaks? I can go on all the way down the line, but I think you get my point.

The LTCM debacle only involved one group of geniuses working for one company and it nearly bankrupted the system. This time, we have over 8000 funds and who knows how many mavens, with $1.2 Trillion in equity leveraged to over $20 Trillion or almost twice the size of the US Economy. A 10% downward revaluation will wipe out more than 100% of their equity, a 20% revaluation puts them $2+ Trillion in the hole and all that is during a period of Rising Interest Rates. LTCM occurred during a blip up in interest rates but during a general trend of falling rates. Anybody interested in buying any discounted CMO's? By the way, what did you say the bid is?

TAKEOVERS AND BUYOUTS

Don't let this breakout to new all time highs fool you. I have been warning you all for months that this market needs to breakout too new highs, in order to turn the Massive BEARISH Sentiment Bullish before this market is ready to make its final top. The Blackstone deal was probably the final straw and if not, then the coming KKR deal definitely will be. Be very fearful of the misinformation media touting the benefits of Takeovers, Buyouts and Buybacks. If they are so smart, where were they 3 to 5 years ago? How smart is it to buy back your own stock when it's at a 20+ P/E multiple and selling at an all time high? If that is the absolute best use that they can find for their cash, or what's worse borrowed money, then that company is not worth the P/E that it's trading at and their Chairman and CEO should be summarily FIRED. If you care to check, most companies were in their most liquid position in their history the day before the 29 crash.

All those takeovers and buyouts are only taking place because there are oceans of cheap easy to get money floating around, looking for a home and like the sub-prime loans, no scrutiny of the ability to pay back is being taken into account. Besides, it's the DEAL that counts; who cares what happens down the road since everyone involved gets their money up front? History tells us that it is always the banks that will be left holding the bag. However, once the party is over, it always ends up that the Taxpayers who are the ones really left to clean up the mess. Perhaps you have already noticed that the money centered banks, that usually lead rallies, have not participated in this latest rally and have actually been heading lower for quite some time now: What does that mean?

HISTORY REPEATS

Like it or not, History Repeats but never in exactly the same fashion for the majority to recognize it. WHY? For the simple reason that if everyone recognized it, "IT" wouldn't happen. (reread UNCOMMON COMMON SENSE, Why hasn't "IT" Happened Yet Nov. 22, 2006), EVERY bubble is caused and ended for the exact same reason, TOO much money created out of thin air and far TOO much EASY credit. Who is buying those $1,000,000, 800 sq/ft condos and how are they going to pay for them?

In 2005, the average home in Palm Beach County, where I live, was going for $500,000. You have to earn $250,000 a year to afford that plus, who is going to buy up all the overbuilding of those $500,000 homes; the 20 million illegal immigrants? Companies have stopped coming to Florida because the average worker can no longer afford the average home.

For 200 years, Real Estate on average has always just kept up with inflation (averaging 6% per year), but for almost five years, Real Estate appreciated 25% a year and that my friend is just not sustainable. Eventually, everything that gets out of whack always reverts back to the mean, ALWAYS and that includes the STOCK MARKET, BOND MARKET, BUYOUTS, TAKEOVERS , ART and all the way down the line. In order for that to happen, there must be a major financial MELTDOWN and the first crack in the dam of optimism in this Goldilocks economy occurred with the realization that the Hedge Funds are not were wearing any clothes! The lawyers are about to have a field day as everyone tries to asses blame for the approaching tragedy. By the way, what about those $billion Bonuses based on Programmed Valuation which were really just a figment of the imagination but have been taken out in real dollars?

I could go on but if you want more details, you can go to any Bearish website. The Bears whose timing may have been wrong are about to be vindicated. Their facts and analysis were always right, but they overlooked one very important fact - Never fight the FED especially when all the world's Central bankers have been working overtime printing money and what is worse, lending it out freely at 1% or less.

INFLATION

To refresh your memory, INFLATION is always a monetary phenomenon; it is the creation of money at a faster rate than the growth of GDP. Our FED and the rest of the World's central banks have been expanding the World's money supply at an average rate of 7% per year compounded above the rate of growth, for the last 25 years. And all without Inflation, AY? If you believe that then you're not the one paying the bills and you certainly don't know what core inflation is. Like food and energy are not core, neither are movie tickets, cars, vacations, school, medical care and, and .. . And of course, world wide stock and bond prices are not considered inflation either. Why even Zimbabwe's stock market appreciated by 2000% and Bogotá's by 900%. But not to worry, Greenspan, Bernanke and the misinformation media have assured us that core inflation is below 2% which, by the way, after 35 years when you're ready to retire; cuts the purchasing power of All your savings in half. But that's not inflation either, or is it?

GOLD

Is everything all just doom and gloom? NO! Gold is ready to resume its 18 to 20 year BULL MARKET with an Elliot Wave, Wave III Explosion. If you haven't purchased your full position yet, make sure you do so, as it breaks above $675 and you better not be left behind when the Golden Rocket Ship blasts off above $730, with an expected first stop in the $800 area. And all that is expected by the end of this year. As for the future: Well, we will just take it one step at a time.

STOCK MARKETS

To make it Short and Sweet, get out NOW. We have entered that last rally that I have been looking for since February/March. It could last two days, two weeks or two months or it could already be over. The market is now living on borrowed time. My best guess is that the Stock Market will show a choppy upward bias for the next week or so with worsening breath on each rally day. Get out now while you still can. The coming break will set one day record breaks to the downside and you certainly don't want to be around for that. Keep a sharp eye on those Sentiment figure and the advance/decline as well.

BOND MARKET

The Bond Market has already broken and there is nothing but higher rates in sight for the foreseeable future. What will that do to all the refinancing and Bond portfolio revaluations coming due during the balance of this year?

Please don't shoot me, I'm only the messenger and I hope that this time I'm wrong.

GOOD LUCK AND GOD BLESS

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