The View From Main Street
An informed opinion from an outsider perspective.The government has sent in the cavalry. Now that George Walker Bush is here, the markets can rest easy and continue their climb to the heavens.
For months, my girlfriend and I listened incredulously to all the TV talking heads blathering on about "subprime contagion", as if these problems were analogous to an outbreak of the flu and if one bad subprime loan coughed on an auto dealership or a retailer, those parts of the economy could join subprime at the tree of woe (as in "subprime woes"). How ridiculous.
If you want to use a viral analogy, then perhaps the best representation would be the HIV virus. In this case, we don't have to worry about contagion; the economy has already been infected. The only questions now are will the patient develop full-blown AIDS and will he catch a fatal illness after the AIDS onset?
Back to our point, subprime is simply one of these symptomatic illnesses -- it's not the main disease, which is easy debt and loose money leading to overconsumption and mal-investment. Understanding this can help save investors a lot of grief (and money).
I spend way too much time digesting financial media -- Bloomberg, FT, WSJ, Barron's, etc. In fact, I think it's starting to cloud my judgement. It's impossible to listen to a viewpoint repeatedly without being influenced. And with Wall Street and their media outlets, you can find a dizzying array of data, opinions, suggestions, predictions, commentary, so on and so forth. But what you won't find is common sense.
The future is impossible to predict. But it doesn't take much more than common sense to get the lay of the land, see the storm clouds coming over the horizon and decide to head for higher ground. Here's what common sense tells me:
1. The U.S. housing market is in deep doodoo.
Forget the word subprime. It'll only distract you from the main problem. The whole housing market -- subprime, alt-a, prime, all of it -- is overvalued in many parts of the country. The only way to solve the problem is to restore the historical ratio of incomes to housing costs (30% of gross income to mortgage expense), i.e., either raise incomes, drop home prices dramatically and/or drive down long-term interest rates. This means pain. Keep in mind some of the worst-hit places -- states like California, Florida, Arizona, Nevada, etc. -- also account for a disproportionate share of GDP. California is the 7th largest economy of the world and probably the state most affected by the housing crisis. How can this NOT IMPACT THE U.S. ECONOMY?
This leads to what chess vernacular calls a "forced move", a situation where the opponent has only 1 possible move. In this case, the Fed has no choice but to inflate (most likely by cutting rates) due to the housing bust. The Fed has been in this position for some time now and to be frank, Ben Bernanke has done a masterful job jawboning the market off a rate cut that anyone with common sense has seen coming for almost a year now. When treasury yields spiked in June, people predicting pending rate hikes boasted of vindication (funny, don't hear them now). And people called Greenspan the maestro! All hail Maestro Bernanke. I wouldn't be surprised if he continues perpetuating the uncertainty by not cutting rates at the Sept Fed meeting. It's probably the right thing to do in his situation.
Alas, the natural laws of supply and demand pertain even to Mr. Bernanke and our artificial "free markets." The Fed face a market that's now priced in 100% certainty of rate cut(s) and ready to riot if it doesn't get it.
The market wants a rate cut. The market may get what it wants. And it may be sorry for it in the long run.
2. Energy is still where it's at in the long term.
The Artic has been a major news item of late as Russia, Norway, Canada, the U.S and others jockey for position, ostensibly for 25% of the world's remaining oil and gas reserves that are supposed to exist there (that's a story for another day).
It seems to me that you may want to climb Mt. Everest because it's there. But if you're climbing Mt. Everest looking for food, it's because there's no food anywhere else.
Why would anybody in their right mind drill for oil at the North Pole unless they've run out of easier places to drill? The only conclusion you can draw is that the era of cheap oil is over. But thankfully, we still have cheap oil stocks. I'd call it a buying opportunity. But they'll probably get cheaper and call me a cheapskate, but I'm holding out for lower prices still.
My guess is the rate cut will come eventually. Whether recession follows and a bear market with it or instead, a bull market to the heavens (in nominal terms of course), I can't say. Since the beginning, we've positioned our portfolio in energy, materials and precious metals with some diversification in global-oriented S&P companies as a semi-hedge just in case the Fed pulls off a miracle. I think many bears may underestimate the tools at the disposal of the Fed and allies to keep this jig going for a while longer.
The only position more crowded than short mortgage companies is short the US dollar. Even my dead grandmothers (RIP) can see this coming. Forecasting the fundamentals and with human nature being what it is, I can't see anything but inflation coming in the long term. Don't let any talking head convince you that a weak US dollar is good for exports and the economy. We already have a weak dollar. If it gets any weaker, it's going to be a big problem domestically. This is the main reason the Fed has held off cutting rates as long as it has.
For the short term, I'm 25% in cash and waiting for something truly scary to happen. If it does, I'm going to ignore that pit in my stomach and load up on hard asset positions.
09/02/2007 by Davy Bui
Comments, questions or suggestions? Email me
