wellington letter
November 24, 2008 Volume 31: No. 25
THE SERIOUS PAIN STARTS IN 2009
MORE CRISES, MORE BAILOUTS
Late News:
Senator Chuck Schumer (D-NY) said on Sunday that the Congress will be working with the President-Elect to add another $700 billion to the original $700 billion to “stimulate” the economy. Of course, it’s not so much the size but how it will be spent that’s important.
At the same time, Nancy Pelosi said that Congress may give the automakers $75 billion, instead of the $25 billion they asked for. Yes, the politicians have blinked. They don’t have the courage to get the pain behind us. They will do everything they can over the next 10-15 years, prolonging the economic pain just as in the 1930’s. As politicians, they really have no choice. To do otherwise means they would take the blame and not be re-elected. And that means the end of their cushy job, private planes, limousines, etc. That’s unacceptable.
So, the taxpayers, who will struggle to get by, will get the bill. And because of their ignorance of basic economics, the taxpayers will thank the politicians for their “bold” actions.
Russian bombers arrive in Venezuela. Furthermore, Russia and Venezuela will carry out naval exercises very close to the U.S. This is in response to the U.S. installing missile bases in Eastern Europe, surrounding Russia. Washington says these missiles are to protect central Europe from attacks from Iran. Russian isn’t buying the story. Russia’s President Dmitry Medvedev spoke
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with President Bush at last week’s APEC meeting in Peru, and repeated Russia’s demand that the missile bases be closed. That’s what we really need now, another “Cold War.”
The stock of Citigroup has been trading just like Bear Stearns, Lehman, Fannie Mae, Washington Mutual, Wachovia and others just before they either went bankrupt or were taken over. Last week the CEO of Citi said that, “The company is financially sound.” This is the same statement each of the CEO’s of the other companies made just a week before their demise. It’s a bright red warning signal.
Therefore, Citi needed a bailout this weekend. And they got it. Another weekend, another bailout. Citigroup will get a $306 billion governmental guarantee for 90% of the losses of for its underwater derivative portfolio. It will also get $20 billion from the taxpayers, etc. etc. If you have their credit cards, will you get a break on the interest rate? I doubt it. This is a huge guarantee for one firm. It’s now obvious that Bernanke is everything but the kitchen sink at the threatening deflationary collapse. And we can’t blame him. The situation is extremely precarious. To do nothing would be dumb.
The credit card firms have a great window on consumers sales. Master card today reports a huge drop in sales, one of the biggest ever seen. Women and men clothing down 20%. Big ticket electronics down 22%. Large price cuts everywhere. Drops of this size were last seen in the Great Depression.
THE STOCK MARKET
Another bounce, but no bottom
From Election Day to Nov. 19, 11 trading days, the DJI fell 16.9%, the S&P 500 19.8% and the NASDAQ Composite 22.8%. The optimists think that every little bounce in the stock market is the end of the bear market. They are fooling themselves. It’s a matter of hope over experience.
One of the most widely heard phrases this year in the markets is, “stock market bottom.” If you Google “stock market bottom in 2008” you get 2,910,000 results. Yes, all the pundits have been telling investors since the beginning of the year that it was a stock market bottom. Yet, the world’s stock markets have lost over $16 TRILLION this year. So much for “free” advice.
After last Friday’s 498-point rally we are hearing the phrase again. And many investors will fall for that fairy tale. Hope is eternal.
The rally on Friday was predictable. In our SMARTE TRADER service of the prior day, we advised closing out short and bearish positions the next morning as the DJI would drop to
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“approach the 7200-7400 area.” We didn’t think it would hit that area, only “approach” it. That’s usually what happens on the first approach. Then you get a rally. Often that is followed by another decline that breaks the prior low. We had big profits and wanted to cash them in because SMARTE TRADER is a trading service.
But will this be a long-term bottom as so many alleged analysts tell you in the media? Think about it. The S&P 500 already broke through the bear market low of 2000-2002, which was a horrific bear market. That in itself is extremely bearish. That suggests that conditions will get worse than at the bottom in 2002, the depth of a deep technology crash. All the stock that was bought between the low of 2002 and now, that’s 6 years of buying, is now being held at a loss. And much of that stock becomes supply to be potentially sold on any rally in the stock.
Take a premier company, Intel. The company is an industry leader, has billions of dollars of cash, and is unlikely to go out of business. But the stock just broke its bear market low of 2002.
The bulls look at the “cheap” valuations in the stock market, the high dividend yields on some stocks, etc. But those numbers are all history. Look at the Citigroup: the dividend has plunged more than 95% the last two months. The best way to see if the financial situation is worsening or improving is to watch credit spreads, T-bill yields, the spread between the yields on junk bonds and T-bonds, etc. The manipulated Dow Jones Indices won’t tell you.
The yields on Treasury securities, especially short-term T-bills, tell you about stress. When yields are pushed to record lows, as they are now, then you know that money from around the world is fleeing to the safest haven, namely U.S. Treasuries. The yield on 30-year T-bills is now near zero. The two-year T-note yield is below 1%. It’s just like the 17-year deflationary experience in Japan. The flood of money going into Treasuries is pushing the dollar upward. There is another place to look when you think stress is being relieved.
The yield on junk bonds also tells a lot about stress. Currently the yield has soared over 20% on the speculative-grade corporate bonds, surpassing the 20% mark for the first time in at least two decades, according to the Merrill Lynch & Co.’s U.S. High Yield Master II index.
Junk bonds have lost more than $187 billion in market value since August. That’s just three months ago. I remember seeing a number of analysts in the media recommending them because of the high yields. I shuddered each time I heard it. Now the losses are soaring.
One of the foremost junk bond experts is Martin Fridson, CEO of money management firm Fridson Investment Advisors. I had the pleasure of meeting him two years ago. He was quoted by Bloomberg: “Prices are in a virtual freefall.” That’s stress!
Because of stress in the credit markets, we are in a “liquidation bear market” for stocks,
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something seen only rarely. That means that stocks are being sold regardless of value. The only motivation is to raise cash. For short sellers, that’s the best environment. While 99% of investors are using “hope” as their excuse for holding onto stocks, the smart traders, as subscribers to our trading services, are literally making fortunes selling short and buying the bear ETFs.
But short selling goes against human nature. What is the question you hear posed to guests on financial TV about 50 times every day? “What stocks would you buy now?” Do you ever hear someone say, “What stocks would you sell short now?” Of course not. They don’t want to take the chance of losing any advertisers. So how many bears do you see interviewed on financial TV? Very few. Once in a while they invite a “token” bear, but they are usually the ones who were bearish during the entire bull market of the preceding five years and, therefore, have no credibility. Where is the warning label on the screen that says, “This advice may be ruinous to your investment portfolio”?
Since Sept. 15, only 10 stocks on the S&P 500 index are higher. That means 490 stocks of the index are down. Remember this summer when the financial TV analysts were still debating whether or not it was a bear market? Yet almost every guest gave advice on what to buy. Imagine trying to catch the 10 out of 500 stocks that will go up! No one has the guts to say “sell.”
We are in a global financial crisis, but very few believe that it will last long. However, look at the evidence. Billionaires around the world are getting huge margin calls. That’s when financial institutions holding the stock for collateral against loans ask for more money as collateral. In Germany, VEM Vermoegensverwaltung GmbH, the investment unit of the billionaire Merckle family, said it has two weeks to secure bank financing after wrong-way bets on Volkswagen AG shares and the plunging value of HeidelbergCement AG led to a “liquidity shortage”?
In the U.S., Sheldon Adelson of Las Vegas Sands was worth $32 billion a year ago, and soon may be very poor. Kirk Kirkorian of MGM has lost billions, and even Warren Buffett may be down more than $25 billion. Imagine, a $375 subscription to our WELLINGTON LETTER could have saved these gentlemen from those misfortunes. You, our valued subscribers, have done much better than these people with all their overpaid advisors.
Such wealth destruction doesn’t happen because it’s just “a little bear market.” This is a crisis of monumental proportions. Big bank stocks have lost $125 BILLION of market value in the last two weeks, according to Charlie Gasparino of CNBC. Imagine, Bank of America (BAC) losing 22% on one day last week. I believe that BAC and Citi will have to be bailed out by the government buying at least $50 billion of preferred stock in each. They have hundreds of billions in mortgages that can’t be sold, and which are defaulting at an accelerating rate.
I believe that soon we will see bankruptcies in the brokerage business. The first one may be E-trade. Years ago, they threatened to sue us for patent infringement because the name of one of
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our services was “Smart Etrader.” We thought that was a far reach, but the CEO was inflexible. So we changed the name by just moving the “e.” Their former CEO was a jerk, whose pals on the board had given him over $60 million in compensation in one year. That’s $5 million per month, or $30,000 per hour. Then he was ousted.
We are seeing major companies, many of which survived every financial panic of the last 100 years, including a 10-year Great Depression, like Bear Stearns, Lehman Brothers, GM, etc. going out of business. And we are just in the first year of this episode. Even the survivability of the world’s formerly premier companies, such as Citigroup, GE, Ford, JP Morgan and Goldman Sachs, is being questioned.
Until now, we have only seen about one year of financial crisis, and it’s already the worst one the world has ever seen. But this is the easy part. It really hasn’t much affected the average person. In fact, many of my friends, who are smart, educated, business leaders, etc., are still in denial in spite of all the weekly crises in the financial system. The attitude is “they will fix it,” “Wall Street is smart and will get out of this,” etc. I just have to shake my head. Wall Street basically doesn’t exist anymore, except for the asphalt, and they assume everything will turn out fine.
THE NEXT PHASE: Economic Crisis
Now comes the tough part, economic crisis. This is where the real pain starts. In January, there will be an avalanche of corporate bankruptcies. Retailers will still try to capture the Christmas season although they don’t have the credit lines to stock up for Christmas. Therefore, they will deplete inventories. After that, they will have no cash or credit to restock and to pay the bills.
The unemployment rate will skyrocket. Businesses will close, and office buildings will empty out. Positive cash flow will quickly turn negative. Owners of the large office buildings, who financed the purchases with short-term loans over the past several years, will not be able to refinance, and the buildings will go into foreclosure.
Shopping centers will see vacancies soar, and the signs “Closed for Remodeling” will go up in the shopping centers. The REITs specializing in commercial real estate will plunge even further. Banks will have even less incentive to lend as their bad loan portfolios will get much thicker and their write-downs will accelerate. That means all the infusions of capital from the Fed and the Treasury will be used to meet capital reserve requirements, not to make loans.
World trade is already coming to a halt, for two reasons. First, there’s the LOC (Letter of Credit) problem, which we wrote about several months ago. Manufacturers won’t accept them because they don’t have faith in the companies issuing them. Thus the importers have to send cash overseas, say to China, and trust the seller that the goods will be shipped. If they are not, the only
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remedy is to sue in a Chinese court. Good luck! And thus trade stops. Second, consumers have hit the wall. As they start losing jobs, consumer spending will plummet.
Factories in less-developed countries will close by the thousands, and these countries will see a huge outflow of foreign investment money. The term FDI (foreign direct investment) will change to FIO (foreign investment outflows). Their currencies will crash, they will boost interest rates to double-digits in ill-fated efforts to support the currencies and recessions will turn into depression.
When the U.S. unemployment rate hits 10%, the new President will invoke “executive orders” to fix the economy. The natural target will be to tax the “wealthy.” That will be defined as anyone with over $75,000 of income. Labor unions will become very powerful again, which will destroy all opportunity for large firms to fix themselves. Thousands of new taxes and regulations will discourage new formations and entrepreneurs will find retirement more attractive.
Just six months ago, they were talking about the cost of the financial crisis eventually being $280 billion. We said it would be $1-2 TRILLION. Then they kept increasing it. About two months ago, we wrote that it would be $5 TRILLION and eventually perhaps $10 TRILLION. Those projections seemed insane. But the bailout cost is already over $2 TRILLION, and with the new proposal, will soon be at $3 TRILLION. And we are still only in the first year of the crisis.
The foregoing is the unembellished forecast. I wanted to give it to you early, instead of making it the typical year-end forecast. This gives you more time to prepare. And please don’t make the mistake of thinking that this is “too extreme.” In fact, I believe it’s on the optimistic side, as the credit implosion means that any company dependent on getting loans or credit will face extreme stress.
The biotech area is a good example. One expert said: “For the first time in the history of the biotech industry, you’re going to see unprecedented levels of bankruptcies and dissolutions.” The problem is the unavailability of financing. And the merger route, via larger pharma firms, is also closed, as these firms can’t get credit for acquisitions either.
THE CHARTIST’S VIEW
Charts tell the story much better than a thousand words. Going through the charts of several hundred indices, of markets and sectors, the only charts where Friday’s close (after the big rally) was higher than the prior day’s high was the gold related sector. That makes the rally for everything else pretty insignificant, technically speaking. And furthermore, we didn’t see any “weekly” reversals, where the close on Friday was above the close of the prior Friday. Without a
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weekly reversal, you can’t have a meaningful bottom. Therefore, this looks like a relief rally. The holiday week is perfect for that.
Let’s look at the charts. The NASDAQ COMPOSITE (monthly) long-term chart clearly shows
that the index did not even retrace 50% of the 2000-2002 decline during the bull market that
followed. That’s a poor rally. It never got close to the high of 2000 again. This is important. It was my view during the recent bull market that it was merely a cyclical bull market inside of a much longer-term secular bear market. In other words, it was only a rally and the important top was made in 2000. Our work shows that such bear markets last at least 17 years. So if we count 2000 as the beginning, the earliest we can expect a solid bottom is 2017. Of course, there will be rallies in between, even profitable ones for bulls, but they will not lead to new, long-term highs.
NASDAQ COMPOSITE (monthly)
The long-term chart of the DOW JONES TRANSPORTS (monthly) shows the beautiful 1-2-3-point top (next page). As longtime subscribers know, we sell at point three. This is where the indicator below has made the second lower low while the index has made a new high. A good downside target is the 2003 low. That should come early next year.
DOW JONES TRANSPORTS (monthly)
The DJ US UTILITIES (weekly) shows a classic “head and should top” that’s always bearish. We identified that in August. Look at the plunge after the pattern was completed. But Wall Street touts say technical analysis doesn’t work. Let them continue to believe that. The 2002 low was reached, and is major support for now. That suggests that a temporary bottoming phase is ahead.
DJ US UTILITIES (weekly)
The DJ US HEALTHCARE (daily) is one of the sectors recommended by just about every analyst in the media as a “defensive” sector. Well, a 33% decline in 10 weeks is not “defensive.” It’s vastly over-owned. Amazingly, the indicator below is once again negative.
DJ US HEALTHCARE (daily)
The DJ US OIL & GAS (daily) is now back at the October low. This chart still looks bearish. The probability is high that there will be another break to the downside.
DJ US OIL & GAS (daily)
The chart of GOLD (weekly) shows more than a shorter-term chart. Gold is very erratic. Short- term moves often have no follow-through. Our view has been that the deleveraging and dumping of any assets for which there was a market had also been putting pressure on gold. Therefore, an easing of the pressure will be seen in the credit market first. Then you will see it in the dollar, which will decline. And that will confirm a new up move in gold. The rally on Friday was a breakout above a three-week congestion area. This is positive, but it’s only one day. On any pullback, the breakout level must hold. We will watch signals closely. A very good buying opportunity for gold may have emerged.
GOLD (weekly)
The chart of the DJ US GOLD MINING STOCKS (daily) shows a double bottom and a bullish divergence with the indicator below (next page). Now it just has to break out and close above the early November high to
DJ US GOLD MINING STOCKS (daily)
And finally, we have the DOLLAR INDEX (daily), which is a composite of about 13 currencies against the dollar (next page). Note the beautiful rise. But also note that the chart now forms a “rising wedge.” As longtime subscribers know, a rising wedge usually ends in the chart breaking sharply to the downside as the
DOLLAR INDEX (daily)
CONCLUSION
Our downside target for the Dow Jones Industrials Index (DJI) was the 7200-7400 area. In our SMARTE TRADER service last Thursday we advised closing out all short and bearish positions on a decline the next morning as the DJI “approached” the 7400 area. Well, the low was 7449. That’s close enough. However, often the rally starts just shy of such a target. Then the chart declines again and the prior low is penetrated. That often forms a better bottom. In other words, we could be close to a temporary bottom and a bear market rally.
Last time we wrote about gold: A decisive close above $767 would negate the potentially negative formation. On the downside, a move below $714 would be bearish.
Well, we now got the close above $767, which negates the negative formation.
We also wrote: The stock market is now giving us new strong sell signals. We need one-two days to confirm that. But it looks like the major indices will drop back to the October lows, and that implies those lows will eventually be broken and the market will go to new lows.
If that occurs we would have the next downside target of the 7200-7400 area on the DJI.
As we know now, that’s exactly what has happened. Of course, the low was just 49 points shy of our target area. In fact, our area may still be reached. We know that there are people who think we should have known the exact price of the, but we really don’t have a crystal ball.
We also wrote: The only markets rising in that eventuality are the Japanese yen, the U.S. dollar and U.S. Treasury bonds.
As you know, U.S. T-bonds had an astonishing rally, as did the yen.
WHAT TO DO
Last time we recommend that “if the DJI closes below 8130, we would buy some of the ETF’s that are designed to rise in price as the index declines. Here are some to choose from:
PROSHARES SHORT QQQ (PSQ)
PROSHARES SHORT MIDCAP-400 (MYY)
PROSHARES SHORT MSCI EMERGING MARKETS (EUM)
We made phenomenal profits in these bearish ETF’s on Friday when the DJI got top 7449, close to our downside target area of 7200-7400. Anyone who didn’t close these out will probably get another chance to do so. And that’s what we recommend if Friday’s low is approached again. (You have to decide what “approach” means to you.)
WORLD TRADE AT A STANDSTILL
Several months ago we addressed the topic of trade. We had learned from our sources that goods for the holidays were not being shipped by the manufacturers because of the credit squeeze and lack of confidence in the banks. When a retail chain in the U.S. buys goods from China or other places, it gets an “irrevocable letter of credit (LOC). The LOC is issued by a bank, guaranteeing the manufacturer payment for the goods when they are shipped.
The problem now is that the manufacturers don’t trust the banks that issue the LOC. Therefore, they are not shipping. Around the world, ships are standing idle at the ports with nothing to load. As we wrote this summer, at Christmas time the shelves will be empty. But it won’t matter very much, because there won’t be many customers anyway.
A photo of the port of Hong Kong shows a long, long line of freighters. They can’t load cargo because shippers have problems with LOC’s, and other reasons for not shipping. The Baltic Freight index has now collapsed by over 90% since the peak in May. Remember when we showed the chart at that time? It had just made a new, all-time high. We said that would be a
“false upside breakout,” leading to a collapse of 80%. Well, even that outrageously pessimistic forecast was too optimistic. The index crashed from over 11,000 to 800.
BALTIC FREIGHT INDEX
If goods are not being shipped, it’s obvious that there will be terrific shortages on the store shelves next year. Stocking up on necessary staples will be a good idea, especially if they are imported.
Deflation is growing like an out-of-control cancer. The consumer price index dropped 1.0% on a seasonally adjusted basis compared to the previous month, the largest drop since February 1947. That’s 61 years ago!
The LEI (index of leading U.S. economic indicators) fell in October for the third time in four months as stocks and consumer confidence plunged, signaling a deepening recession.
A survey of purchasing managers (ISM) showed today that the manufacturing and service sectors contracted in November at the fastest pace since data were first compiled a decade ago.
Large department stores, such as Saks Fifth Avenue, are having 70%-off sales on everything. The word is that they must raise cash quickly. Obviously, with such discounts they lose money on every item sold. I predict that January will go down in history as a record month for corporate bankruptcy filings.
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But some companies are too big to fail. GM, Citigroup and Bank of America are three of those. Here are the next big sources of troubles in the financial markets:
COLLATERAL LOAN OBLIGATIONS (CLO’S): These are participations in pools of loans backed by credit card receivables, car loans, installment bank loans, etc.
And then we have the CMBS (commercial mortgage backed securities) where commercial buildings are the collateral. The spread between AAA-rated CMBS’s and Treasuries have doubled in the past weeks, indicating growing concerns about the state of the commercial real estate market.
THE CAUSE OF U.S. DOLLAR STRENGTH
What ever happened to all the predictions of the dollar plunging into the abyss, that no one would want it, that it was a great short sale? Well, for new subscribers, and we have a lot, let me point out that our view since this summer has been that it would be one of the strongest currencies, only to be outperformed by the Japanese yen.
Well, last week a well-known economist said that now the U.S. dollar is once again a desirable currency, and is undoubtedly “the reserve currency of the world.” Well, that’s news, but unfortunately it is too late to help all the short sellers who have lost fortunes. They listened to their economists.
One of the greatest economic fictions is that high interest rates cause a strong currency. Apparently economics majors at universities are brainwashed to believe it, because they all say it. Actually, the reverse is closer to reality. The strength of the yen once again confirms what I have preached for the last 30 years, namely that raising interest rates to support a currency is the ultimate folly. For example, the interest rate on the yen is near zero and it’s the strongest currency. The overnight interest rate on the Icelandic krona is 20% and the currency has plunged by 50%. And in the U.S., the Fed funds rate is 1%, the 90-day T-bill is at 0.03% and the dollar is soaring. Moral of the story: Beware of what everyone accepts as the truth, especially when it comes from economists.
So what’s ahead for the dollar? An easing in the credit market crisis will cause a sharp decline in the dollar.
THE SPREADING GLOBAL RECESSION
One huge problem worldwide now is that banks are not lending. They can’t. It’s that simple.
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Of course, if banks don’t make loans, they can’t get more income. But they can’t make new loans because they are close to their capital reserve requirements and have to leave some room for future write-offs of bad assets. In other words, they are in a death spiral. This is why Citigroup is firing another 52,000 people. That’s 88,000 in one year. The only way for them to stay alive is by cutting expenses. It’s like a wolf caught in a trap that bites off its leg to get free. It hurts.
The never-ending cycle of asset write-downs and mounting loan defaults is preventing all the Fed’s monetary injections from spurring new lending. One banking expert believes that U.S. banks will require $350 billion. That can’t be raised in the private markets, so the government will have to step in.
During the Great Depression the value of outstanding bank loans fell by almost half between 1928 and 1935. I expect nothing less this time around.
The Consumer Price Index in the U.S. plunged last month by a hefty 1% compared to the previous month. It was the largest drop in 61 years.
Yes, global DEFLATION, not INFLATION, is the problem. And that’s much worse than inflation. Just a few months ago the Fed was still worried about inflation. Here is another reason why we should not have 12 economists at the Fed trying to “steer” the economy. At critical times they never know where the economy is or where it is going.
Europe is now officially in recession. The 15-nation Euro zone has now entered into the first recession since it adopted a single currency about a decade ago. In the 3rd quarter, GDP declined 0.2% compared to the previous quarter. This followed an equal decline in the second quarter.
My contacts in China and other emerging countries report similar plunges in economic activity. The “virtuous” cycle during the boom, where growth in one area produced growth in another area, is now working in reverse. Contract availability has collapsed worldwide. My Theory of Liquidity, which I first proposed in 1977, says that when availability of money (credit) expands, the economies have to expand, and when it contracts, the economies must contract. There is just no way around that connection. And if the credit contraction is severe, the economic contraction is just as severe. Well, we are having the greatest credit crisis since 1931. Even the largest and best firms, such as GE, can’t get money from the regular channels.
While this is happening, the guests on financial TV continue to advise you to go bargain hunting in stocks, as they will be much higher in five years. Amazing! They never saw this crisis coming, but now they are experts in “knowing” where stocks will be in five years? Well, in five years, these guys will be driving taxis. Do you think they’ll give you your money back?
Apparently there is an endless supply of “analysts” who are ready and willing to make fools of themselves in the media. You don’t see many bears. They are not allowed, with a few exceptions.
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THE EMERGING MARKETS: A GROWING MESS
We have discussed the Iceland financial crisis in the past. Well, instead of being resolved, it’s intensifying. The IMF agreed to lend Iceland $2 billion about three weeks ago. But that came with conditions that haven’t been fulfilled. The IMF wants Iceland to first get twice that amount from other sources. There is no way it can get that.
The central bank of Sweden would give around $620 million after the IMF approves the amount discussed. Other countries such as Holland and Britain are not willing to help until the deposits of its own citizens in one of Iceland’s nationalized banks are returned. In fact, the IMF will not go ahead on the loan until that issue is resolved.
In the meantime, Iceland is teetering on the edge of a hyper-inflationary depression. Goods can’t be imported because the credit mechanism no longer exists. The banking system is gone. You need Letters of Credit in which the seller has confidence to buy goods from abroad. Icelanders are moving out of the country in droves.
This is only one country. Now imagine the other countries that are in trouble having to jump through the same IMF hoops. It’s a long-term mess, which historically has preceded a depression.
THE GLOBAL ECONOMIC CONTRACTION
The U.S. auto industry is not the only one to be in trouble. In Europe the large carmakers are also asking their governments for help. In Germany and Britain alone there are 1.6 million jobs connected to the auto sector. In the U.S. they say it may be as many as 2 million.
Governments can’t risk throwing that many people out of work. They can’t make the reasonable argument that in due time these people will lose their jobs anyway, and they can’t let it happen because the government refused to help.
Car sales in Europe plunged 15% in October. You can bet that “October” will go down into the annals of history as the month that the global recessions got very serious.
According to the Wall Street Journal, Renault and Peugeot-Citroen are slashing production by 25% and 30%, respectively, in the fourth quarter, equivalent to about 370,000 vehicles. Even before this, “excess capacity” was estimated to be around 2.2 million cars in Europe.
Only massive job cuts can restore the sector even to the modest levels of profit many of the region’s manufacturers enjoyed in 2007. European carmakers and auto suppliers would have to shed 26% of their work force, Goldman Sachs estimates. That’s politically unpalatable for politicians in Germany, France and the U.K.
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The European Central Bank President Jean-Claude Trichet has finally seen the light. He said the bank may cut interest rates again in December amid signs Europe’s recession is deepening.
Just 6-8 weeks ago, Trichet wanted to raise interest rates. This is another piece of evidence proving that central bankers should have no authority to set interest rates. They are always far behind market forces and therefore create even greater damage.
THE STATES HAVE HIT A FINANCIAL BRICK WALL
Another big bailout requirement over the next two years will be individual states and cities. They just can’t raise money through the traditional channels. Therefore, how can they meet the payrolls, take care of normal services such as street cleaning, garbage pickup, road repairs, police, etc.?
The federal government will be the only possible source of funds. But it also means that the muni-bond market will be decimated. I have had that conversation with friends over the past year, but they all think they are getting a great deal with the tax-free income. My warnings have fallen on deaf ears for the most part. It’s total denial. They all quote the low default rates over the past 20 years, not recognizing that the current environment is not that of the last 20 years, but that of the years 1930-31.
And as these local governments run out of money, they will increase every tax in sight. Just follow the examples of California over the next 5 years. That will be your road map. Current proposals are for a 5% surcharge on the income tax (currently 9%), and a 1.5% hike in the sales tax.
A good way to invest on that trend is the stock of U-Haul. There will be a long line of people leaving the state.
California employers already have to battle with 72,385 regulations according to CNBC, and the number is growing every day. That’s not a great incentive for companies to stay there.
FEEDING AT THE TROUGH: Everyone wants a piece of the TARP. This was supposed to be a bailout for the banks. Now everyone is standing in line. The Hispanic Chamber of Commerce is promoting Spanish-speaking asset managers for a piece of TARP. The boat dealers are also asking. Who are the winners? As always, the lobbyists. These guys should sell shares in their companies. It would cause a stock market boom.
Chinese sovereign wealth funds are also in line for the TARP. Can you believe it?
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Rewarding failure creates more failures. Rewarding success creates more success.
THE MIDDLE EAST FINANCIAL IMPLOSION
There is an old saying, “What goes up, must come down.” Yes, that’s certainly true in the global stock markets, real estate and the economy. But analysts in the media are still bullish on the oil-rich Middle East. They have no idea what they are talking about.
Last year, we predicted that Dubai would become the greatest real estate disaster in the history of mankind. Now we have the evidence that the implosion of the Middle East bubble is well underway. And as we have been writing for 18 months, once a bubble bursts, it cannot be re-inflated.
In the seven days ending Nov. 15, the Dubai stock index had the biggest decline ever, plunging 32% in basically one week. Qatar’s dropped 25%. The borrowing needs of Dubai real estate developers are now skyrocketing. It’s expensive to build the world’s tallest building, more than half a mile high. Hubris is always expensive.
But the international credit markets have finally realized what we warned over 12 months ago, namely that Dubai is destined to become a fiasco. Now Dubai is trying to borrow from its neighbors, such as Abu Dhabi. But Abu Dhabi has similar uneconomic real estate ventures under construction. If you listen closely, you can almost hear these economies coming to a screeching halt as oil drops below $50.
So far this year, the Dubai stock index is down a hefty 67%, Qatar’s is down 42%, and Oman’s 35%. The Dubai stock index is now trading at 4.7 times earning. I wouldn’t touch it with a 10-foot pole.
The perennial “bargain hunters” on Wall Street will find great bargains over there. Imagine how cheap the empty 40-story office buildings will be. Of course, it will cost a fortune to run the air conditioning during the 125-degree daytime heat, but you’ll have “pride of ownership.”
Dubai Islamic mortgage lender Amlak told Reuters it had suspended new mortgage loans as Dubai’s real estate sector shows further signs of stress. Dubai-based Elysian Real Estate sent out a text message this week to some 40,000 mobile phones, advertising distressed property sales.
This is only the beginning. The Tower of Babel (Burj Babil) was the last huge monument to hubris in the Middle East. Now, over 2600 years later, Dubai will be the monument to hubris gone wild. Currently, they are building the world’s largest building, the Burj Dubai. How appropriate!
Bert Dohmen’s
Wellington LetterTM
Interestingly, there are many other “hubris” projects underway in the world, all trying to be the tallest building in the world. Most are in Asia. One is in Saudi Arabia. And they all will meet the same fate as Dubai.
In an article in the UAE-based Gulfnews, the head of the giant Dubai real estate firm denied that it was having difficulties. He also said the company is not for sale. I don’t think he has to worry about anyone wanting to buy that white elephant.
With regard to DP World’s debts, Bin Sulayem said they were not government debts, but bank loans. “At Dubai World, we have no problem paying off our loans and have refinanced to improve previous loan conditions,” he added. The foreign investments of DP World have not been affected by the current global financial crisis, Bin Sulayem said.
That’s an amazing statement. What planet are they investing on? Apparently they don’t have regulations about disseminating misleading information.
Bin Sulayem said he expected the crisis to recede and the credit market to improve in early 2009. His optimism is misplaced. Dubai World is one of 29 companies listed on the Dubai Stock exchange. The exchange index has plunged over 67% this year, and 32% in a recent week.
More Middle East Problems: Kuwait’s Gulf Bank announced a 375-million-dinar ($1.4 billion) emergency rights issue and a boardroom sweep following the revelation it had lost a similar amount through losing currency trades. They were probably shorting the U.S. dollar.
The hike is the biggest emergency recapitalization move to date in the Gulf. The resignation of the company’s entire board is very unusual.
POTPOURRI
THE NEW ADMINISTRATION Normally, we don’t involve ourselves much with politics. But it’s really important for investors to watch closely where the new administration is heading. The new rulers of our once great nation are now being revealed.
Some commentators have suggested that the President-Elect is a “centrist.” I have a different view. So, we must watch the appointees.
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He’s back! Yes, we were happy when we he was gone. But Tom Daschle, former Senator from South Dakota, will become Health and Human Services secretary. He will head up the effort to revamp the U.S. health-care system. I sure wouldn’t touch a company related to the health care industry with a 10-foot pole now. Philosophically Daschle appears to be to the left of Karl Marx.
Also, for Attorney General we have Eric Holder from the Clinton administration. Same signals!
In fact, there are lots of retreads from the Clinton administration. Is this “the change we can believe in”? The most stunning appointment may be the new Secretary of State, Hillary Clinton. If it happens, it would be a sorry state of affairs. Political strategist Dick Morris writes:
Apart from the breathtaking cynicism of the appointment lies the total lack of foreign-policy experience in the new partnership. Neither Clinton nor Obama has spent five minutes conducting any aspect of foreign policy in the past. Neither has ever negotiated anything or dealt with diplomatic issues. It is the blonde leading the blind.
For me, that’s enough. We now know where the country is heading for the next eight years.
AT LAST: SOME ACTION ON BEHALF OF TAXPAYERS
AIG is a fiasco. They sold over $560 billion of risky derivatives, called CDS (credit default swaps), which guaranteed bonds of many corporations against default. This “insurance” was not just sold to those holding such bonds, but also became a huge vehicle for speculators. Finally, as bond prices plummet because of risk of defaults, the swaps soared in value, which caused AIG to get “margin calls,” i.e., they had to put up more collateral. When the speculators wanted to take profits, AIG had trouble coming up with the cash. So now the taxpayer is paying the speculators.
Remember, just two months ago, the government bailed AIG out with an $85 billion infusion in return for just less than 79% of the common stock. We wrote at the time that this amount would get much bigger. Well, currently it has quietly risen to around $160 billion. Eventually it will hit $250 billion, in our view.
But amazingly, after the bailout the company was still planning to hold its extravagant “retreats” and affairs at five-star resorts, with $20,000 health club bills, etc. And the executives that caused this mess are either retired and celebrating on their yachts, or employed and still expecting their huge severance checks.
Well, it seems that the Attorney General of NY put a stop to that on Oct. 22. Here is what www.investmentnews.com wrote:
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The missive is the latest dispatch from the attorney general, who last week sent a letter to AIG’s board demanding that the company cease covering “extravagant” expenditures and recover unreasonable payments, or face legal action.
Mr. Sullivan’s (CEO) contract calls for some $19 million in payments, plus other benefits, according to the letter.
The company has also agreed that no money will be distributed from the $600 million deferred-compensation and bonus pools in its financial-products subsidiary, the unit that Mr. Cuomo said was “largely responsible for AIG’s collapse.”
He also said that he thinks that Joseph Cassano, the former head of the financial products unit, has a share of $69 million of the funds in that subsidiary. Five other top executives have a combined share of the funds totaling $93 million.
“It is my position that until the taxpayers are repaid with interest the more than $120 billion that has been used in the rescue financing of AIG, no funds should be paid out of these pools to any executives,” Mr. Cuomo wrote in his letter.
Good for Cuomo. It’s nice to see that at least one person considers the interests of the taxpayers.
WHO’S THE SUCKER?
With trillions of dollars being dispensed, who are the suckers who will pay for all this? Of course, you and I. And small business owners who work 6-7 days per week will be hit even harder with tax increases if the President-elect carries out his promises.
In Washington they are talking about appointing an “auto czar” to be in charge of the bailing out the Big Three automakers. Incredible! Earlier this year, Washington was talking about an Energy Czar. This summer, they wanted a “Bailout Czar.” You see, the guys in Washington love Russia, at least those impressive Russian titles.
The CEO’s of the major automakers went to Washington begging for another $25 billion, although just last month they already got another $25 billion. Seeing those three, you could understand why their firms are going under. Heads of the major automakers were in front of the House committee urging the government to give them another handout of $25 billion, without any plan how the money will be used.
Obviously, that’s the same way they have been mismanaging their firms. What a tap dance they did! They implied that profitability is in sight. The fact is that they have incredible legacy costs.
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The average Detroit worker gets about 60% more than his counterpart working in the southern states for the Japanese.
As Congressman Gary Ackerman from NY pointed out, these CEO’s flew into Washington on private jets, with tin cup in hand. Couldn’t they have at least “jet-pooled”?
I have a great friend who is one of the most successful businessmen in Canada, and a member of the Forbes 400 list of billionaires. I remember in the 1980 recession, he sold his jet, and was traveling coach, just to set an example to the presidents of his many companies.
Everyone knows the reasons for the legacy problems of these firms, so we won’t repeat them.
Bankruptcy is a wonderful solution. Going bankrupt doesn’t mean they have to close up. People will still go to work there. And maybe a change in management can find permanent solutions without a handout. Bottom line: Do a pre-packed bankruptcy and don’t burden the taxpayer even more.
My impression of these CEO’s was that they don’t have a clue as to what to do. If these were their own companies, and their own livelihood were at risk, they’d be sweating. But the alternative for them is beautiful, golden parachutes with multi-million-dollar payouts. A business owner gets his best ideas when his back is to the wall. These people don’t have the benefit of that. Their escape routes go through five-star hotels, vacation homes in Aspen, yachts and private planes, hopefully not at the expense of the taxpayer.
Senator Bob Corker (R, TN) asked some very penetrating questions about the labor contracts with the union. And the head of the union said he didn’t know. Bull! Workers who are laid off get 95% of their prior pay. And that’s what you and I will pay for. He also asked the CEO’s, “If we give you the $25 billion, do you promise you will not come back asking for more?” Waggoner of GM answered, “If you guarantee that the economy won’t get worse.” Now they are asking the taxpayers for guarantees on the economy. What arrogance!
They explained the “hardship” of retirees whose health benefits were already cut by 50% through an agreement with the union. But that won’t go into effect till 2010. They let slip out that 40% of the retirees are under the age of 65. I am sure many of our subscribers are older, are still working, and now they may have to pay the retirement and health benefits of 50-year-olds.
Bottom line: The carmakers should go into a prepackaged bankruptcy. They can keep operating just as all the bankrupt airlines have done for years. They couldn’t make profits during the greatest boom in history. They will just keep coming back for more every month if they get this handout.
I am sure that some of our subscribers are asking, “Where is my bailout loan?” Well, you are on the other side of the fence: You’re going to get the bill instead of a loan. And if you don’t pay that in form of taxes, they’ll put you in prison.
Taxpayers are getting very angry. And they don’t even know all the facts that would intensify their anger. Next year there will be more bailouts to get angry about. But how many people actually write their representatives? Very few.
Greetings,
Bert Dohmen
Bert Dohmen’s Wellington Letter, P.O. Box 49-2433, Los Angeles, CA 90049
Phone: (310) 476-6933 Fax (310) 440-2919 Website: www.dohmencapital.com E-mail: client@dohmencapital.com
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