More “Stress Test” Hokum, this Time in Europe

by Mike Larson   07-09-10

Of all the questionable bailout and backstop programs the government rolled out in the wake of the credit crisis, the whole “stress test” episode for the banks stands out the most.

The idea was that the Fed and Treasury would evaluate whether 19 major U.S. banks could survive a recession without a catastrophic erosion of their capital.

The problem: The tests were never stressful enough!

One of the main reasons the whole exercise “worked” — and if by worked you mean it successfully propped up bank stocks — was that the government made clear that any at-risk institution would essentially get bailed out anyway. True “failure” was not an option.

Oh, and at the same time …

• The Fed was pumping hundreds of billions of dollars into the markets by buying mortgage and Treasury securities with newly created cash,
  
• The government was offering tax credits to first-time home buyers to artificially boost the housing market,
  
• And the Obama administration and Congress were showering the economy with almost $800 billion in stimulus funds.

Result: The 10-of-19 banks deemed to be needy had no trouble raising the required $74.6 billion in capital.

Europe’s banking supervisor is conducting stress tests to determine how individual banks would hold up to economic and market shocks.

Hoping to achieve the same results, Europe is now conducting its own stress test exercise. The Committee of European Banking Supervisors (CEBS) is evaluating 91 banks that represent roughly two-thirds of the European Union’s banking industry. The results will be released by July 23.

I don’t think I’m going out on a limb here by saying that just about all the institutions will pass with flying colors. Sure, there’ll probably be a few sacrificial lambs. But all in all, the banks will get rubber-stamped.

There’s just one twist: I don’t think the results will be anything like what we got here in the U.S., and I’ll tell you why …

This Time, It’s Different!

Those are dangerous words to use in the investing world. But they ring true now.

For one thing, we’re not coming OUT of a recession like we were at the time of the previous stress tests. Instead, it looks like we’re sliding IN to a “Double Dip” one! That means credit loss rates aren’t peaking. They’re about to start rising again.

For another thing, the credit crisis has morphed. We were worried about PRIVATE credit risk sinking the banks last time around. This time around, we’re concerned about something much more serious — SOVEREIGN debt defaults!

In other words, it’s not individual mortgage or credit card borrowers that are sliding towards default. It’s actual European countries! That’s a much bigger problem.

Still another difference …

At the time of the U.S. stress test exercise, governments could borrow and spend all they wanted to in order to bail out failing institutions. Now the bond vigilantes are putting their feet down. They’re forcing countries like Greece, Spain, Portugal, and the U.K. to stop throwing money at struggling institutions.

Last but not least, the European stress test assumptions look way too optimistic. That means the markets will likely disregard any rosy results.

Case in point: The CEBS is reportedly going to apply a haircut of just 17 percent on Greek sovereign debt when computing potential bank losses.

By contrast, credit markets were recently suggesting losses on Greek debt could be as high as 60 percent. And a JPMorgan analyst implied that anything less than 25 percent would be unrealistic.

Spanish bonds reportedly will get a paltry 3 percent haircut, compared with a more realistic 15 percent.

And no haircut at all will be applied to bonds issued by the largest European economies, like Germany and France. This despite the fact those countries are putting their own balance sheets at risk in order to bail out their profligate PIIGS neighbors!

Believe in Fairy Tales At Your Own Risk

Washington was able to hoodwink investors, now Europe will try the same shenanigans.

Look, if some investors want to trust the happy talk coming out of European banking regulators and Washington spinmeisters, I can’t stop them. But I sure don’t buy it. I think this is a clear case of “Fool me once, shame on you. Fool me twice, shame on me!”

Bottom line: I find it extremely hard to believe that a bogus European stress test exercise will have the same impact the U.S. stress test exercise had more than a year ago.

So rather than load up the truck with bank stocks in anticipation of another major rally, I’d cut my exposure into any bounce. And I’d continue to batten down the hatches against the increasingly likely scenario of a double-dip recession.

Until next time,

Mike

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Deflation Is Gathering Strength - Quick Checklist

I thought this article was well written and thoughtful. Jim Powell has been for the most part concerned about inflation until recently. It appears that he is now seeing the handwriting on the wall. If you do not feel you understand the implications of deflation, I believe you will enjoy the read.

Subscriber Bulletin
Friday, July 9, 2010. Copyright © 2010
by James B. Powell & Associates, LLC

   

Deflation Is Gathering Strength

I have been warning readers for several months that deflation (the destruction of money) could gain the upper hand over inflation (the creation of money). I now think the tipping point has been reached and deflation is becoming the dominant monetary trend. That is of enormous importance to us because - as I will discuss in a minute - dealing with deflation will require different strategies than we would use with inflation.

The evidence for deflation is overwhelming. Our economy is now hemorrhaging money at a faster rate than the Fed is creating it.

Here are the main engines of deflation that are at work:

• Unemployment is increasing.
• Real wages are falling.
• Household net worth is dropping.
• Real estate sales are off 30%.
• Commodity prices are down sharply.
• Foreclosures and bankruptcies are rising.
• Most asset values are still declining.
• Four U.S. states are effectively bankrupt.
• Several countries in Europe are also close to default.
• The U.S. economy is starting another leg down.
• Bond yields are approaching historic lows.
• At the same time, the Fed's stimulus and bailout programs are ending.

All in all, it's a classic deflationary pattern that is taking billions of dollars out of the economy. The lost dollars are not just going somewhere else, they are disappearing.
Deflation has gained so much momentum that I think it will continue - and probably get worse - for several months. The slide could even last a year, or possibly much longer (see the box).

How Long Will Deflation Last?

Although I don't expect it, there is a chance that deflation will last several years.
That's what happened in Japan after its stock and real estate bubbles collapsed in 1989. For nearly two decades, the Japanese government poured money into the economy almost continuously - just as the U.S Fed is doing now. Interest rates were reduced nearly to zero and key industries received subsidies. Nevertheless, deflation persisted through 2009.
The American economy is far more diverse and resilient than Japan's. Nevertheless, Japan shows how persistent deflation can be if it becomes firmly established.

How long deflation will prevail will depend upon how quickly the Fed steps in to fight the problem, and whether or not the steps will be successful.

If this were any other time in U.S. history, I would have little doubt that the Fed could defeat deflation by flooding the economy with money. But the Fed has been doing just that for 3 years - and it has not been working. Nearly $4 trillion has been spent and deflation has been gaining strength instead of weakening.
Nevertheless, I expect the Fed will seek to introduce another round of record-breaking spending in a last ditch attempt to push deflation aside. However, round two won't be as easy to do as round one. The Fed is already grossly overextended. In addition, the public is strongly opposed to further deficit spending, and Washington is getting the message. That's why Congress defied expectations and just decided not to extend unemployment benefits.

However, because deflation can lead to a depression if it gets out of hand, the Fed may cast public opinion aside and act right away in hopes of stopping it. If so, a blizzard of new money may flow into the economy as soon as this fall. Such a cure may be worse than the disease.

However long deflation lasts, the trillions of dollars the Fed will create to fight it will lead to a period of ruinous inflation.

Because inflation seems unavoidable longer term, I believe the best use of a deflationary period is to acquire precious metals, blue chip stocks, rental residential real estate, and other inflation hedges at bargain prices. When deflation ends, you can either sell the assets and collect your profits, or keep them for even greater gains as inflation starts to rise. If you are prepared to make use of a deflationary period, it can be a windfall instead of a disaster.

A complete list of what to buy can be found in the May 2009 GCOR. For a condensed list of both inflation and deflation investments, see the table on page 6 in the April 2010 issue.

Why Inflation Will Eventually Prevail

Although deflation may be the dominant monetary condition this year, rising inflation is a virtual certainty longer-term. That's because debasing the dollar is the only possible way Washington, the banks, and consumers can possibly "pay" their colossal debts.
Therefore, if you continue to maintain your investment program for a inflationary environment, I'm confident that you will eventually become a very big winner. In the meantime, you must avoid the dangers of deflation and make them work for your benefit.

The Best Deflation Strategy

To profit from a deflationary downturn, it is only necessary to take the familiar rules about inflation and reverse them. Cash will rise in value instead of depreciating. Real assets will go down in price, not up. Interest rates will drop rather than rise. It's all fairly simple. However, it has been so many years since the last deflation occurred, few investors remember what it was like.

Because the ability to make bargain purchases is the key to making a deflationary cycle pay off, you should hold more cash than you would ordinarily wish to have with inflation and a weaker dollar on the horizon.

When I recommend having plenty of cash available I'm referring to actual folding money in addition to funds kept in banks. If a deflationary recession becomes something worse, many already-shaky banks will find themselves in serious trouble. The Fed may declare a bank holiday while it tries to fix the mess. In that event, ATMs, credit card approvals, check verification, online banking, and the accounts themselves will be off line. Of course, safety deposit boxes will also be unavailable. That's when "mattress liquidity" will prove its value.

A Deflation Checklist

• First, being unprepared for inflation (or a possible dollar devaluation) is a much bigger threat to your wealth than missing out on deflation profits. (Please read that again.)
• Therefore, the best way to use this deflationary period is to get ready for the inflation cycle that is on the way. All the inflation/devaluation hedges that I have been discussing in recent months remain attractive. If deflation brings their prices down, all the better. There is nothing I would like more than to see gold drop below $1,000 and for silver to slide into the low teens.
• Remember, during deflation, cash is king. With greenbacks on hand you can pick up bargains, demand discounts, and hire people at attractive rates.
• Apart from your day-to-day needs, I think you should keep some of your cash in a strong commodity currency. I continue to favor the Canadian dollar which is backed by a treasure trove of valuable raw materials (see the April 2010 GCOR). The Australian dollar is also strong for the same reasons. Best of all, an asset-based currency is much more likely than the U.S. dollar to keep pace with inflation. You can open an account in either currency at EverBank World Markets (www.everbank.com).
• You should take steps to keep your cash safe from the turmoil that deflation is likely to cause. Don't be concerned that interest rates are on the floor because deflation will drive up the buying power of your cash. For example, if you earn a miserable 1% on a T-Bill, but the price of what you want to buy (stocks, futures, real-estate, toys) drops 20%, you will make the equivalent of 21% on your money. Choose six or nine month T-Bills and CDs. I would not select fixed income investments that mature beyond that point because inflation may arrive by then, and interest rates will start to climb back up.
• Any collectibles that you have been meaning to sell should go on the block before deflation starts to push their prices down. And when inflation returns, consumers are likely to be in such poor financial shape they won't have money for frills.
• Because cash is becoming increasing valuable, so are dividends paid by high quality blue chip stocks. We have several such companies in our portfolios.
• Likewise, rental housing that generates reliable income looks attractive - provided that you live in a region where prices have stopped falling. If not, wait until they do.
• I would steer clear of all other real estate right now. Home sales dropped a whopping 30% this spring. The commercial real estate market is also in serious trouble. There will be a time when deflation will present you with superb real estate opportunities - but we are not there yet.
• During a deflation it is not wise to take on debt except for anything that generates income. Only borrow money to buy assets that pay for themselves.
• If you are in business, you should pay particular attention to the deflationary conditions that are devastating consumers. Retail sales may hold up for awhile, but a significant rebound is probably many years away. On the other hand, any business that helps people get by for less money should do well. That situation should continue even after inflation begins.

I will continue to keep you up to date about any new economic developments that you should know about. Remaining informed is the key to avoiding big mistakes and making good profits during this difficult time. Please share your knowledge with everyone who is important to you.
You can expect to receive the next issue of GCOR in early August.
Best wishes,

Jim Powell, Editor and Publisher
Global Changes & Opportunities Report

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How Long Will Deflation Last and Then What?

Question:

Real quick, the last time we spoke you mentioned to put our money in cash because of deflation and the banking collapse, but if we hit inflation in a few years would we need to then move it out of cash. I thought I remember us talking about inflation taking place closer the six year mark.

Let me know what you think.


Answer:

When it comes to predicting when scoundrels will be outed and then pull out all the stops to screw everyone regardless of whether it's obvious or not, it becomes a very difficult prediction indeed. There is no substitute for watching and being vigilant. Having said that, my guess would be 2-3 years but perhaps as long as six. The markets should hit bottom in about six years.

In answer to your question, yes at some point it will be appropriate to move out of cash. A likely sign will be that everyone will think you're crazy for doing so because everyone will be in agreement that deflation is the future and that there is no way inflation could re-emerge. Just the opposite of what it is now. Right now everyone knows that inflation is the future and thinks its crazy to be in cash. The only thing consistent about everyone following the crowd is that they always end up being wrong when it comes to investing.

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Double-Dip Recession Warning Signs Everywhere! Batten Down the Hatches!

by Mike Larson   07-02-10

The bright red warning signs of a double-dip recession are flashing everywhere. And I do mean EVERYWHERE.

In just the past few days, we learned that …

• New home sales imploded 33 percent to a seasonally adjusted annual rate of 300,000 units. That’s the lowest ever recorded!

• Durable goods orders tanked 1.1 percent in May, while housing construction skidded 10 percent.

• Consumer confidence plunged to 52.9 in June, according to the Conference Board. That was a huge drop from 62.7 in May and well below the 62.5 that economists were expecting

• The Dallas Fed’s gauge of manufacturing activity dropped to -4 percent from 2.9 percent. The Chicago Fed’s activity index fell to 0.21 from 0.25. The Richmond Fed’s index fell to 23 from 26, while the Philadelphia Fed’s index plunged to 8 from 21.4, the worst reading in 10 months.

The message here? This isn’t some isolated, regional downturn. It’s one that’s spreading to every corner of the United States.

• The Economic Cycle Research Institute’s Weekly Leading Index is falling off a cliff. Its growth rate just fell to NEGATIVE 6.9 percent, the worst reading in a year and far below the high of POSITIVE 28.5 percent in October. The last time this index tanked this much, recession struck within a few months.

Talk about a laundry list of worrisome reports.

If it were just the “official” economic data that was getting worse, you might be inclined to discount it. But it’s not …

Market-Based Signals of Recession Risk 
And Systemic Risk are Going Berserk, Too!

Take European sovereign interest rates. They continue to climb, despite the biggest European Central Bank bailout ever and an explicit pledge by policymakers to buy government debt to prop up prices.

Spanish 2-year note yields have more than doubled to 3.28 percent from 1.51 percent, for instance. Greek 10-year yields just breached the 10 percent level again. Investors have ALREADY lost more than 25 percent on the latest batch of 10s that Greece just sold in early March!

Investors are fleeing the euro for safe havens, like the Swiss franc.

At the same time, investors are dumping the euro hand over fist in favor of the Swiss franc — a typical safe haven currency in times of crisis. And they’re dumping the euro in favor of the Japanese yen, sending that exchange rate to its highest level in eight years.

That’s a market-based signal that global investors are unwinding so-called yen “carry trades” as they frantically slash risk.

More?

Gold prices just exploded to $1,265 an ounce, the highest in history. Volatility gauges like the VIX are climbing fast. And the Standard & Poor’s 500 Index just closed below key technical support in the 1,040 area.

If You’re Not Taking Action, 
I Believe You’re Making a Big Mistake!

These signals are clear and unambiguous.

What they are telling us is that despite the biggest economic stimulus package in U.S. history … despite near-zero percent interest rates from the Federal Reserve … despite the biggest bank bailouts on record and the government takeover of every company from Fannie Mae and Freddie Mac to General Motors and AIG … the economy is sinking yet again.

Even the Federal Reserve, with all its resources, can’t keep the double-dip away.

What was previously merely the RISK of a double-dip recession is fast on its way to becoming REALITY. Worse, it’s happening at the same time as the sovereign debt crisis is gathering steam.

That’s no recipe for a new bull market! Instead, it’s the kind of toxic brew that could send stocks back to the 2009 lows — all the way down to 6,470 on the Dow and 667 on the S&P 500.

Times like these present investors like you with a choice:

You can sit idly by, take the beating the markets are doling out, and lose a boatload of money. That doesn’t sound like a very sound strategy to me.

Or … you can go on the offense. You can turn lemons into lemonade. You can take the bear by his fur, and take aggressive action to protect yourself — and even profit!

How? By taking gains on winning trades and biting the bullet with losing ones. By raising cash across the board. And by purchasing investments that go UP in value when stocks go DOWN, such as inverse ETFs.

These are precisely the steps I’ve been recommending in my Safe Money Report. I’d love to have you on board so you can benefit from my specific instructions; if you’re interested, you can click here and join for only 26 cents a day.

But even if you’re not ready to take that step, I urge you to get more of your money to safety.

The bought-and-paid-for economic recovery is coming to a close. It’s time instead to deal with the very sobering new reality: That a double-dip is here, with all the attendant consequences for stocks, currencies, commodities, and more.

Until next time,

Mike

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This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

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Six Months to Go Until The Largest Tax Hikes in History!

- The 25% bracket rises to 28%
- The 28% bracket rises to 31%
- The 33% bracket rises to 36%
- The 35% bracket rises to 39.6%

Higher taxes on marriage and family. 

The “marriage penalty” (narrower tax brackets for married couples) will return from the first dollar of income. The child tax credit will be cut in half from $1000 to $500 per child. The standard deduction will no longer be doubled for married couples relative to the single level. The dependent care and adoption tax credits will be cut.

Higher tax rates on savers and investors. The capital gains tax will rise from 15 percent this year to 20 percent in 2011. The dividends tax will rise from 15 percent this year to 39.6 percent in 2011. These rates will rise another 3.8 percent in 2013.

Second Wave: Obama Healthcare 
There are over twenty new or higher taxes in Obama Healthcare. Several will first go into effect on January 1, 2011.

They include: 

The “Medicine Cabinet Tax” 

Thanks to Obama Healthcare, Americans will no longer be able to use health savings account (HSA), flexible spending account (FSA), or health reimbursement (HRA) pre-tax dollars to purchase non-prescription, over-the-counter medicines (except insulin).

For more tax increases go to:
http://www.atr.org/files/files/070110pr-jan2011taxes.pdf

Additionally Here are some videos that you might find helpful.

His voice is a bit annoying but the information is worth listening too. :->

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Oh How The Mighty Have Fallen! "Fannie Mae & Freddie Mac"

Andrew Packer
Editor, Credit Crunch Short Report

Fannie Mae and Freddic Mac hold over $6 trillion dollars of American mortgages (combined they have a current market value of only $600,000). Stop and think about that for a second. That’s half a year of America’s GDP!

…A delisting announcement was made yesterday, June 16th, causing shares in each to plummet over 40%…The shares are worthless… 

…Fannie and Freddie have been proverbial “dead men walking” for over a year. How the mighty have fallen! I remember when this was a darling stock of Warren Buffett and Peter Lynch’s largest position for years. In fact, Lynch practically writes a love letter when describing his Fannie investment in his book, Beating the Street.

…But the mighty have fallen!

…You see, while Fannie and Freddie were being delisted, the first post-tax-credit housing numbers came in. They weren’t pretty, even if you Photoshopped some supermodels in the margins. Lumber futures—a leading indicator of housing activity—have fallen 40% since April.

And with Fannie and Freddie out of the way, banks are next in line. They’ll have to foreclose on properties and finally recognize losses. They’ll have to deal with earnings hits. They don’t have the Fed to buy up their toxic debt anymore. It won’t be pretty.

My advice is to spread your wealth around a few different bank accounts—and look for banks with low ratios of defaults. And stay under the maximum FDIC-insured amount in each account... 

Read the full article...

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Proof That We Are Heading Into Deflation - Its all about M3 not M1

Below is a chart of the money supply.

You will note that even M1 is declining which shows the bankruptcy of Keynesian economics. With the trillions added to the national debt to stimulate and bailout the "good old boys" and well connected losers of the two administrations, it has not been enough to repeal the laws of gravity. Although, I suspect the administration will continue to flapp its arms wildly, especially as they get closer to the ground (reality).

* http://www.shadowstats.com/alternate_data/money-supply-charts 

* http://www.shadowstats.com/charts/monetary-base-money-supply

Next, look at the below link:

* http://www.shadowstats.com/charts/monetary-base-money-supply 

Remember that what we use for money today is not just cash (M1), its cash and credit (M3). If you look at the bottom left two charts of M1 and M3 money supply, the shaded area shows the dollar amounts which are listed to the right of the charts. M3 is essentially M1 plus credit. Now compare the amounts. M1 currently stands at about 1.7 trillion while M3 currently stands at about 13.9 trillion (chart is logrithmic) or nearly 10 times M1. In other words M3 is composed of 88% credit and 12% cash. The administration manipulates M1 through its stimulus programs, which has an immediate inflationary effect and which also means that they are trying to avoid deflation by pumping up 12% of the problem while the 88% is currently defaulting and melting down. Deflation accounts for 88% of the final outcome and governmental inflation accounts for only 12%, which one do you think will win?

Helpful Terms

* http://www.investopedia.com/terms/f/fiatmoney.asp

* http://www.investopedia.com/terms/f/fiscalpolicy.asp

Finally, below are two articles well worth reading and understanding: 

* http://www.marketoracle.co.uk/Article19843.html

* http://www.telegraph.co.uk/finance/economics/7769126/US-money-supply-plunges-at-1930s-pace-as-Obama-eyes-fresh-stimulus.html

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