The Second Quarter T.K.O.

Friday morning the big number, the BLS Employment Situation, landed with a thud. The unemployment rate drifted down to 9.5%, private sector jobs increased by 83,000, the non-farm payroll employment loss was 125,000 and the birth/death rate adjustment figure was 144,000. Government jobs shed 90,000 and 652,000 job seekers left the market. Two-hundred twenty-five thousand temporary census workers were let go. The average workweek fell 0.1% to 34.1 hours and the average earnings also fell 0.1%.

Before we pick up our swords and shields in the third quarter to do battle for gains and profits with a rising Euro, a weakening dollar, massive state and local spending cuts, possibly minimum wage wages for California state employees, a chronically ill housing market, fugitive employment and falling consumer confidence, let’s review the barrel we found ourselves spinning in throughout the second quarter.

The second quarter was one of the most brutal trading quarters I have seen in 27 years, in investing. Here are a few second quarter headline stats from the WSJ MarketBeat Blog: for the DJIA - down 1082.61 points, or 9.97% to 9774.02, the worst quarterly performance since 1st Quarter 2009; S&P 500 Index - down 138.72 points, or 11.86% to 1030.71, the worst quarterly performance since 4th Quarter 2008; and NASDAQ - down 288.72 points, or 12.04% to 2109.24, the worst quarterly performance since 4th Quarter 2008.

These loses are comparable to those we experienced when we were in the thick of the meltdown. Unlike the express elevator to hell we were trapped in the last half of 2008 and the first quarter of 2009, this was a Six Flags rollercoaster ride that took our cash, our lunch, and our sanity. Investors should not hold their heads down in shame. Professionals did not trade this quarter well either. If this quarter had been a boxing match they would have stopped it. This was not an investors’ market and the last week in the quarter told the story.

Referees stop fights when fighters can no longer protect themselves in the ring. Boxers cannot block punches, jab, counterpunch, move on their feet, or throw a combination. Their eyes have a glassy stare. They are unaware of their circumstance.

The last week of the month and quarter is for profit taking and window dressing. Markets are purposely traded. This market, this week, responded not at all based on its whereabouts. Compare the first quarter to the second quarter.

In the first quarter, the market rallied from the start of the year until January 19th. It sold off until the first week in February. Then, it counterpunched and fought it way back to new yearly highs to end the quarter. The beginning of April saw the same fight in the market. A rotation in sectors kept the market moving forward. Traditional punches landed but did little damage to the rally.

Before the second quarter bell ranged, on March 29th, the 7-year Greek auction bombed. On April 19th, the yield spread between Greek and German bonds hit 469 basis points. Then, on April 20th, the BP oil spill occurred. These events rocked the market. On May 6th, the flash crash occurred and markets never really recovered. The market staggered for the rest of May. Investors should have exited the market here. Money managers were tightly clenched throughout June by FinReg negotiations in Washington. Markets and investors set themselves up to win the second quarter on points with improving economic data being released this week. The improvement in the economy did not materialize.

A market hurt and running out of gas whose only hope of surviving was avoiding any more blows and to catch a break. Luck turned out not to be a lady, but rather, a loud, nasty, violent drunk. The oil spill worsened with failed attempts to cap the well, accompanied by pictures of gulf coast estuaries being damaged, innocent wildlife being murdered, and the first hurricane to enter the Gulf of Mexico in June in 15 years. Also, actions of austerity around the world by governments – our allies - were counterproductive to the US economy recovery narrative. The Euro’s fall reversed. The unemployment picture did not improve.

The rally from the spring of 2009 was predicated on the assumption that economic recovery would support higher valuations. Without significant improvement going forward, the markets were overvalued. The only market that withstood the shots of international governmental policies, macroeconomic trends, and supply/demand curves was the mellow yellow – Gold. Au – 196.9665, which refused to be knocked out.

One of the most stunning championship fights in history was the 1965 rematch between, then, current Heavyweight Champion Mohammed Ali and former Heavyweight Champion Sonny Liston. For years, boxing fans argued about the “phantom punch” which knocked out Liston in the first round. Today, we’re still debating what caused the May 6th flash crash. The bottom line is that the explanation or truth for either event is moot; history has recorded Sonny Liston’s loss in a small auditorium in Lewiston, Maine and the 1,000 point drop within minutes did grave technical and psychological damage to the markets.

This third quarter market is no longer the same cyclical bull rally that began in the spring of 2009. The bell has rung, the secular bear is advancing across the ring and he is fighting mad.

What Happens to the Market in the Next Leg Down?

This week, the stock market correction began and with it a resumption of the secular bear market. We focus on price and volume, earnings and growth, when we discuss stock valuations and their trend cycles; however, we frequently overlook or conflate the changing ingredients of the economy with market action, which can cause these movements to occur for different reasons. Recognizing the asset's changing environment, through macroeconomics, provides additional context for making correct investment decisions.

The swift collapse of stock prices this week was not supposed to happen – if you listened to the experts. This was earnings season, with many companies beating the consensus estimates, healthcare reform was a win-win for the insurance industry. The Obama / Pelosi / Reid troika of socialist madness was stopped in its tracks following the humiliating loss of the late Ted Kennedy's Senatorial seat in the bluest of blue states – Massachusetts, (I'm convinced JFK and his poltergeist siblings paid BHO a White House visit in his dreams, Wednesday night), to Scott Brown, and green shoots are growing slowly, but surely, everywhere. So, what went wrong?

First, some background information. The two previous secular bear markets, using the S&P 500 Index, occurred from 1929-1949 and 1966-1982, lasting 21 and 17 years, and returning an average 2.34% and 3.64%, respectively. Many technicians believe the current secular bear market began in 2000. If true, an average length of 19 years, plus or minus 4 years, suggests this explains the "lost decade" of 2000 to 2010, and 2015, could be the earliest before the next secular bull market begins, establishing new market highs.

Prior to the secular 1929-1949 bear market, America spent two decades transforming itself into a manufacturing economy and away from an agrarian one. Our entry into World War I gave a terrific boost in accelerating modernization and production, pushing outward this young nation's supply / demand curve. After the war, and for the bulk of the 1920's, vast amounts of European and Latin American bonds were sold to ever growing prosperous Americans. Combine these two factors with a red hot real estate and a stock market requiring 10% margin, when the party ended, it really ended. Bonds defaulted, real estate collapsed, consumption could not absorbed production, and stocks became virtually worthless overnight.

Before the secular bear market, Charles Lindbergh crossed the Atlantic Ocean in a fabric covered, single-seat, single-engine "Ryan NYP" high wing monoplane and silent movies were the latest in cinema entertainment. As the 1950 secular bull market found its legs, the US Air Force was flying combat missions in Lockheed P-80 Shooting Star subsonic jet fighters. Gene Kelly and Frank Sinatra were singing and dancing, in Technicolor, in MGM's musical "On the Town". A generation of people and technology had past between the two bulls.

The 1950s ushered in the suburbs, television, Disneyland (DIS), union jobs, a growing middle class, rock 'n roll and Elvis, interstate highways, the photo copy, air conditioning, transcontinental passenger flights, a litany of consumer products, and a loss of fear of investing in stocks. Urban centers grew; wages rose, the space race developed, the national debt was reduced, and America led the world in education and technology.

The 1960s saw our wealth and prosperity change, challenging our culture and priorities at home and abroad. Expensive domestic programs and an expensive foreign war led to spending beyond our income. The baby boomer explosion required an expansion of the nation's infrastructure, while the world recovered from World War II by building new manufacturing infrastructures.

Resources were more in demand, globally levitating prices. Inexperienced laborers and rising wages reduced productivity. The Dow Jones Industrial Average reached 1,000 in 1966 and traded between 500 and 1,000 until 1982. Abandoning the gold standard, two oil shocks, a falling dollar, and 15% home mortgages created stagflation and inflation and provided the ingredients for the next secular bear market. Forming beneath the surface at this time, however, were advances in aeronautical and metallurgical engineering, miniaturization and solid-state circuitry, and computer science; the foundation of the information-based and digital-based economy we enjoy today, and in large measure, the basis for the previous secular bull market.

Paul Volcker, as the Federal Reserve Board Chairman, at the start of the 1980s, hiked short-term interest rates above 20%, to break the back of inflation. This bitter medicine drove thousands of credit-dependent businesses out of existence and pushed unemployment to 11%. This allowed a 26 year secular bull market in treasury obligations to begin, followed by the 1982 bull market. Ronald Reagan replaced Keynesian economics for Supply-Side economics.

Deregulation became a top industrial priority, unions were broken, marginal tax rates were lowered, and deficit spending was pursued by government. Usury laws were abolished, Defense spending increased, the personal computer was born, and productivity flourished. Wall Street took off, just in time to accommodate the conversion, by businesses; from defined benefit retirement plans to define contribution plans for their workers, and the mutual fund industry smartly induced metamorphosis to grab a share of the young Investment Retirement Account and 401k market.

In 1996, concerns were raised. Irrational exuberance was sounded; however, the dot.com boom overcame caution and prudence in the stock market by investors averaging 15%, annually. Y2K drove sales and purchases, alike, and the cold war was a fading memory. On Friday, March 10, 2000, NASDAQ closed at 5,049. Friday, January 22, 2010, NASDAQ closed at 2,205.

What caused the secular bear market, this time? The short answer is we are valuing 20th century assets in the 21st century. We are servicing and deleveraging 20th century debt levels with 21st century cash flow. Again, our production exceeded our consumption. Stagnant income in a global economy and declining national wealth restricts our ability to manage outstanding liabilities and the interest expense it generates. This bear market shall be with us until these imbalances are cured, that requires time.

But, the better question is; what happens next? Since last March, investors have enjoyed a vacation from investment terror, however, the disease which pushed our financial system to the brink is still inside our economy, and will continue mutating during the next leg down, so that the last cure is rendered ineffective even as we profit from one more cyclical bull market in the future.

How does one manage risk, preserve wealth, and seek alpha returns for the duration of this secular bear? I am advocating gold and precious metals today, commodities and natural resources tomorrow, and later; energy, utilities, and info-communication companies, for long-term investors. I believe we will witness a new phenomenon this decade that will invent the existence of deflation and inflation, side-by-side. Prior to the 1970's stagnation and inflation could not exist simultaneously, or so we thought. Paper assets, and several currencies will wreak havoc on portfolio returns, losing their value and becoming out-of-favor, for all, save the nimblest of traders.

Only time will rectify the excesses accumulated from the last bull market, thus prolonging pockets of deflation, while seeds for inflation are sowed into every corner of our economy, waiting to ignite. But, these seeds are different from the last bout of inflation we experienced; therefore, correctly identifying them becomes the intermediate and long-term investor's test.

That will be covered in the future.

Where Is Gold Headed?

Gold continued to fall on Friday as the rising U.S. dollar reduced its hedge appeal. December gold fell to $1,115.30 per ounce, down $10.40 on the session. Prices fell as low as $1,110.80 earlier in the day. The metal lost $46.50 on the week, falling in four of five sessions. Gold is more than $100 off the record $1,218 reached last week. Yesterday, gold was flat.

Nothing has changed.

The strategy to buy and hold gold now is predicated on the following rational:

Gold should be held for at least three to five years.
We are at the beginning of a new cycle for gold accumulation.
Economic indicators still favors commodities and hard assets.
The long-term trend is still up for the price of gold.
The secular bull market in equities that began in 1982 exhausted itself in 2007. The current bull market in gold started in 2002. The economic data pouring out in November and December has a tremendous amount of “white noise” in it. The fourth quarter of 2008 had such a dramatic collapse that year-over-year comparisons and seasonal adjustments distorts the true economic picture. This will continue another two or three months.

April 15th, the deadline to pay taxes, is 120 days away. This will be the day of reckoning for municipal budgets when shortfalls in tax receipts around the country become apparent. The federal government will be shocked in the drop in taxes collected, also.

People invest for one of two reasons: greed or fear. Over the next two years, investors will buy gold primarily out of fear. There are insufficient funds to service the obscene amounts of outstanding debt that was issued this decade. As more and more defaults occur from real estate, corporations, and governments, trust in domestic and international financial systems alike will diminish. The price of gold will rise.

Historically, it is documented that after periods of hyper-credit, the swift and troublesome reversal of credit causes an economic depression. Unemployment swells, lifestyles and life choices are interrupted, altered, or sometimes ruined. Public anger begins to rise; politics becomes more bitter and partisan, and true solutions are prevented from reaching the surface and being enacted.

When economic systems are broken, to protect their jobs, politicians rely too heavily on monetary and fiscal policies, which have limited impact on the aftermath of busted bubbles. Political discontent ensues, the propensity for violence by all sides’ increases, and a pattern for chaos emerges. This current edition of growing anarchy isn’t my paranoia; I’m borrowing it from several senior Goldman Sachs bankers who applied for gun permits (soon after receiving first dibs on the H1N1 vaccine before city hospitals) in November before their lavish Christmas bonuses were paid. Their CEO, Lloyd Blankfein, also upgraded the security system on his two New York homes.

These types of events occur pushing up the price of gold absent real inflation.

Then inflation begins.

We are leaving the first decade of the 21st century. The second decade will be quite different from the previous one. Ten years ago, the federal government was running huge budget surpluses and paying down the debt. Then Federal Reserve Board Chairman, Alan Greenspan, speculated aloud about the distant problem of the debt market running out of treasury obligations if the US borrowing needs continued to fall. Congress became concerned and decided to study the problem. So, the future can be changed.

As the price of gold continues to rise, fear is replaced by greed as the primary reason to hold gold bullion. This is a recurring theme throughout history which is never discussed in the mainstream media. I don’t work in the mainstream media; I provide economic commentary to preserve wealth and to manage risk for clients. What investment strategies did work this decade is ill-equipped for tomorrow.

Make no mistake about it: near term, wealth is under assault and risk is growing- from all sides.

10 Reasons to Believe That We're in a Depression

As the economy drifts listlessly going into this holiday season, thoughts of sugar-plumbed call options and zombie companies (Fannie Mae (FNM), Freddie Mac (FRE), and Citibank (C)) are dancing in the heads of day traders, fund managers and CNBC.

Hooray, hooray, everything is OK! Well, not quite. While Wall Street is feasting on the greatest secular bear market bounce in history, Main Street is experiencing persistent and formidable economic famine, the likes of which, have not been seen the Great Depression – which recorded the second greatest secular bear market bounce in history.

10. Look at the macroeconomic data.

Tuesday’s retail sales number, up 1.37 %; excluding autos, were up .2%. The year-over-year number was -1.74%! The world ended September 15, 2008, with the demise of Lehman. Financially, October 2008 was the dark side of the moon, yet, October 2009 still lags? The GPD is in a funk.

9. Look at the market’s technical data

On CNBC’s Fast Money last week, a dazed and beaten Louise Yamada pointed out there are “green shoots” of stock distribution appearing in the market; rising volume on falling days and falling volume on rally days. Additionally, the market’s chart pattern still roughly traces 1932-1941 period. We are near the 1938 bounce during the Great Depression. Money was and can be made in a depression.

8. Look at the market’s fundamentals

On November 6, the Wall Street Journal reported that, with 88% of companies reporting earnings, year-over-year was down 15%. However, earnings estimates by analysts were beaten by 80% of the reporting stocks. Sales are down but layoffs and cost cutting are allowing the market to believe in this Immaculate Conception rally. At some point, currency exchange manipulation by international corporations and lower wages, or fewer workers employed, invariably leads to the destination of painful contraction and negative growth.

7. Consumers

Consumers are toast and retailers are beginning to blink for the holidays. The housing index is rolling over; flat in November at 17, revised downward in October from 18 and September recorded its high of 19 since falling down into single digits. Wednesday morning, housing starts showed a drop of 10.6%, on a seasonally adjusted annual rate, to 529,000 units. In 2006, housing starts were closer to 2,000,000 units. Unemployment is 10.2% ( for U-3; for U-6, the unemployment figure is 17.5%), the housing ATM machine is gone, wages are weak (except on Wall Street) and the market rally has helped institutions more than retail. Credit card lines of credit are truncating, loans are for those who don’t need them and many consumers are too gun-shy to use credit if they could.

6. Municipal Governments

John Maudlin latest piece did a brilliant job dissecting the bleak future of state income shortfalls. A jobless recovery with missing sales taxes will create at minimum 10 more California fiscal basket cases in 2010. The first round of stimulus money actually bailed out states – that’s why new job creation was so muted. Municipal defaults will emerge next year to terrorize investors.

5. Federal Government

Washington doesn’t have the stomach to break up banks that are too big to fail and to seriously reregulate the financial industry. The reverse merger of Washington DC by Wall Street in 2008 makes this so. Much of the financial products that the feds have guaranteed, to the tune of $24 trillion, are so complex that they are only understood by their creators - the borrowers. This ensures that we can sweep our current problems under the rug today to inflict more pain tomorrow. Even if we do not bring back mark-to-market anytime soon, at some point the battered dollar will force interest rates to rise and drive the economy down. Also, certain people in high places need to be replaced. Sadly, they will keep their jobs.

4. The global economy

Countries are diversifying away from the dollar and into gold and other hard assets. So should we (SGOL, SIVR, GDX, GDXJ, IAU, and GLD). They recognize that our fiscal and monetary policies are out of whack and no one in the US, either businessmen or politicians, is putting country before profits or reelection. This is the mindset that formed the greatest generation. South America, circa 1980s, here we come. Also, many countries are recovering faster than the US because their actions in the crisis aimed at repairing their economies, not individual companies.

3. Baby Boomers and retirement

Baby boomers who’ve lost jobs in this period realize their chances of finding one last job before retirement, at their last income level, are extremely low. The “severance package” class of unemployed, and the employed but leery worker, will not return to their previous spending habits. Years ago, they were told to save long-term in the stock market through index funds and to dollar-cost average, to buy more real estate than you could afford because both stocks and real estate rise over time, to fund their retirement accounts and buy company stock, to trust municipal bonds, and they would be alright. Unfortunately, as they near retirement, too few baby boomers are alright.

2. Income and wages

Either global competition, or inevitable draconian changes in fiscal policy to address our growing federal debt, or both, will reduce US wages for many years to come. To increase productivity, wages have been flat for the past 10 years. It was masked by the irrational stock and real estate markets. Without America discovering the “next new thing” our previous standard of living will accelerate downward. State and federal governments will desperately tax income sooner rather than later. These factors enhance the chances of the next leg of our depression.

1. The 21st Century

Every champion, eventually, must retire from the ring. The US is no different. And that is the primary reason most professionals have gotten some portion of the last three years wrong. Any data set from the 20th century is obsolete without significant adjustments. Linear extrapolation of historical patterns of growth, revenue, and consumption, without correctly modifying credit, demand and demographics, plus the impact of technology, domestic tariffs and regulations, and Realpolitik, is like placing a compass inside a magnetic field. Good luck.

No one can take away the fact that America owned the 20th century. However, in the 21st century, cheap land, cheap labor and a younger demographic profile, suggests that in 20 years, the reins of power will be in the adolescent hands of a rapidly growing Asia. So, we invest in their currency (CYB, ICN, and BZF), finance their growth (DRF), and sell them the raw materials (DBN) that they will need to build tomorrow.

For now, besides military weaponry, our number one export is entertainment (DIS).

An Alternative to the Trillion Dollar Deficit

Am I the only one who thinks that a trillion dollar deficit, proposed by the President-elect, is financially insane?

True, as we head into the deepest recession since the Great Depression of the 1930's, we may succeed in becoming the Great Depression II. However, before we touch a lit match to a fuse on a trillion dollar budget deficit (not to mention funding for the wars in Iraq and Afghanistan occuring outside the annual budget, which will surely detonate our country in the future), let us try to address the original problem.

We all agree residential real estate began this current economic slide and that residential real estate's recovery is necessary to end this slump. So, let us rethink the solution.

Since a trillion dollars is on the table, why not try the following; The US government enacts a new program to refinance the following mortgages: 1) all sub-prime mortgages that have reset and will reset. 2) Any mortgage that is underwater by more than five percent; 3) mortgages of homes repossessed in the 4th quarter of 2008 and currently unoccupied, if the previous owners are interested in returning.

Once the government has identified these mortgages, borrowers may apply for a new, 30-year, fixed-rate mortgage, issued at one percent over the current 30 year T-bond.

Do not stop reading. Here is how we save residential real estate and America.

All refinanced mortgages are backed by the full faith and credit of the US government. All refinanced mortgages are assumable.

Yes, I said ASSUMABLE.

Catalog the benefits. Currently, a raging debate about mortgage cram-downs by banks is taking place. Both sides have valid points. By refinancing existing mortgages and paying off lenders immediately, investors holding MBSs are "made whole", per the terms of the mortgage, and contract law is preserved.

Is a home more valuable or less valuable with an assumable loan? The current inventory of vacant and unsold homes would quickly reduce while prices stabilized. Ask a real estate agent if a home with a 30-year, fixed rate mortgage, at 4.25%, completely assumable, is marketable.

Banks' capital requirements and their need to raise cash for 2009 is lessened. Banks will also have fewer assets on their books. Retirees living on fixed income investments are starving for yield. T-bills and CDs today only reduce investors' disposable income and subtract purchasing power from the economy.

On a $200,000 mortgage, refinancing a 6%, or 8%, 10% mortgage, down to 4.25% mortgage is like getting a stimulus check, for several hundred dollars, every 30 days. Would a small business owner rather receive a lower tax rate and fewer customers or 10 or 20 homeowners in his neighborhood with additional money in their pockets?

Vacant homes lower property values. Vandalism occurs to individual properties, squatters break in and stay illegally, and crime can increase in the neighborhood.

The government could begin taking applications 30 days after Congress approves such a bill and begin issuing checks within 90 days, for immediate repayment of mortgages to lenders and injecting more disposable income, through lower mortgage payments, throughout the economy. The psychological benefits to the country alone, with such a program, are incalculable.

Mortgages are public records. This program is completely transparent. As the money is spent, its final destination is available for all to see.

Lastly, if the government is going to destroy the dollar by issuing two trillion dollars in obligations this year, why not try this approach first.

It is just as insane as a trillion dollar deficit for years to come.

Macro Economic Trend Outlook: January 2009

Happy New Year, everyone!  This is my first letter in several weeks.  Because the economic data reported in December was just plain awful, I decided to stop delivering the drip, drip, drip, of negative news and allow everyone to enjoy the holidays.

Now, that we are in 2009, I feel comfortable in resuming the transmission of data to describe the current state of affairs.  In a word – ugly – will be the operative word for 2009.  As you know, 2008 was the most brutal year, for virtually all assets classes, except for treasury and municipal debt.  Holding these specific assets, while our financial, banking, and credit systems imploded, not only protected your principal, they increased your account value.  Individual stock portfolios, mutual funds, ETFs, and so forth, meanwhile, experienced declines of 20, 30, 40 percent or more.

Last year’s margin call on global assets played havoc on the global financial structure to the point of its near collapse.  The forecasts and predictions for 2009 are grossly overly optimistic.  Analysts and money managers behave as if 2008 was a routine year.  Nothing could be further from the truth.  This year, the pain will appear from the beneficiary of ongoing de-leveraging; negative GDP growth and rising unemployment.  

Slipping Into Darkness

From October 29, 2008

The Federal Reserve Board today, at 2:15 pm, announced their obligatory 50 basis point cut of the Federal Funds Rate, from 1.5 per cent to 1 per cent. This is the latest action taken to assuage investors’ fears about the hydra-bear market that has engulfed all capitalism. A triple digit rally was quickly vaporized with an erroneous General Electric rumor concerning the company’s 2009 earnings.

What are not mistaken rumors are the disastrous economic data that continues to flow. On Tuesday came the U.S. consumer confidence index, by the Conference Board, reporting an all time low of 38, down from 68 the previous month. That same day, the S&P Case-Shiller home price index fell 1 per cent, in August from July, and 16.6 per cent, from the previous year. The Census Bureau estimates for the 3rd quarter of 2008, of some 130 million housing units, nationwide, 18.6 million stand empty; 13.8 million year-round, 4 million for rent, and 2.2 million for sale.

On Wednesday, Durable Goods Orders were reported a curved up .8 per cent versus an expected decline of 1.8 per cent. For Thursday, the October 25th week Initial Jobless Claims are announced. Expect a drop of 3,000. Why, I’m not sure.

A General Motors -Chrysler shotgun merger is one step closer to happening, according to reports. If completed, it may add an additional 25,000 auto blue and white collar auto workers to the unemployment line of fixed income investment bankers recently cashiered.

Employment is rising, however, in villages and hamlets across the land as Investment Advisors and Money Managers are deploying their minions to hotel banquet rooms and restaurant’s private cubby holes, armed with clever four-color handouts, PowerPoint Presentations, and empty explanations, as to why their propriety indicators and models could not see the greatest bear market since the Great Depression, sneak up behind them.

I have a feeling that the traditional holiday feathered vertebra – turkey; will not be served this Thanksgiving. Instead, investors will be dining, if they can still afford a meal, on black swan; only recently very, very popular fowl of spenders of others-peoples-money. Of course, it’s too late to sale stocks with portfolios down 30 to over 50 per cent. But, if these Money managers are wrong again, keep some Gray Goose handy.

Next Steps

Next Steps

Wow!

I’m speechless. And, I love to talk. The self-destruction of the post World War II global banking and financial system is in full drive. In Washington and New York, ideology has given way to pragmatism. Potomac Socialism is alive.

The ratio of leverage (debt) to assets, a liquidity crisis (falling cash flow or the rising cost of capital), plus declining asset prices (contracting supply/demand curve) is a sure recipe for massive amounts of non-performing assets, a prelude to an avoidable financial Armageddon.

RISING DEBT LEVELS
RISING COST OF CAPITAL
FALLING ASSET PRICES
FALLING CASH FLOW
FALLING DEMAND
CONTRACTING CREDIT
= MARKET CRASH
= ECONOMIC DEPRESSION
K.I.S.S. (KEEP IT SIMPLE STUPID)

If you had allowed me to build your fixed income portfolio since 2003, and you left it intact, you slept well this week. Am I crowing in this email, perhaps? And, you should, too. Look around; there has been tens of billions of dollars in wealth destruction; major financial institutions have been eliminated, executive managerial careers have been extinguished, fear is widespread, credit markets have seized up for a week yet your bond portfolio is untouched, if not up.

Only, yesterday, gold gained $70 in a single day, the 13-week t-bill traded at .02 of one per cent, part of the reason, institutions are liquidating commercial paper, cash and money market fund accounts because Reserve Primary money market mutual fund “broke the buck”. Investors will get .97 cents for every one of their dollars on deposit. Just incredible.

Before we pop champagne corks and celebrate dodging this credit market implosion bullet, there is much work to be done. Now that the world is no longer in denial and has begun addressing this current financial calamity, I want to have a conversation with you very soon about realigning your portfolio to withstand the next phase of capitalism’s meltdown and the probable upcoming economic depression.

Why do I think a depression is probable? The levels of consumer, corporate, and municipal debt will be reversed to pre 2000 levels. Our economy will contract. At some point, investors will only be able to sell quality assets, like, you know, the bonds in your portfolio and treasuries. If the term depression is too provocative, look at things this way; we are experiencing three simultaneously transitions: 1) from an expanding to a slowing economy; 2) from an extreme credit to a moderately credit driven GDP; and 3) from the largest single economy in the world to a much smaller economy.

Understand this; you currently hold a unique bond portfolio. It has an extremely long-term duration and was designed for the unprecedented seismic shift unfolding this moment in time. Your portfolio is at its greatest vitality, now. Without proper and timely adjustments to your portfolio, radical liquidity injections coordinated by central banks around the world is toxic for long-term duration. The total return of your account is vulnerable. When that day comes to take decisive action will you be prepared?

I am preparing proprietary fixed income portfolio models for EVENT STRATEGY INVESTING, which includes Defensive Estate Planning. In this environment, there are certain insurance contract structures, AIG notwithstanding, are worth considering, for certain situations. And, the properly constructed portfolio should incorporate the next five to ten years.

Also, earlier this week, my email to you contained a link to Federal Reserve Bank of NY referencing where they are stashing all the Collateral Debt Obligations (CDOs) bad paper. There could be up to one trillion dollars in assets, on which, the feds have announced that they are prepared to lose several hundred billion dollars.

Eventually, a Resolution Trust Corporation will be established to liquidate these assets. If you know any buy-side fixed income CDO analysts, traders, or operations managers, interested in this prospect, have them email me or send their CV to: Monsoon Wealth Management, PO Box 15521, Scottsdale, AZ 85267, Attn: CCO.

Finally, as a small business, please forward this email to fellow investors or send me referrals of acquaintances envious of your portfolio or who is unhappy with their advisor. I need to grow my business, too. Thanks.

AmEx Misses: The Bear Trap Thickens

Monday evening American Express (AXP) reported a 37% drop in profits for the second quarter, the third consecutive quarter in which profits fell for the supreme credit card issuer. The second course at this summer’s secular bear market feast is now served. Enjoy.

The consensus of $.86 a share was missed – by a lot. The actual number was $.58 a share, a stunning $385 million dollars off, or $.28 cents a share. Furthermore, Bloomberg reported, Kenneth Chenault, Chief Executive Office said on yesterday’s conference call, American Express is “no longer tracking” a prior forecast of 4% and until the U.S. economy improves, the company will not meet longer term targets.

I believe this is significant because American Express exemplifies the best-of-breed of American credit card issuers. If defaults are rising in this luxurious consumer area, then any remaining doubters or non-believers of this crisis' intensity should perform a financial autopsy on one of America’s signature haute cove for the affluent for confirmation.

This secular bear market is moving slowly across the land, destroying all in its path. The insidious part about this grizzly is that it’s part of an even larger menace. We’re now in the throes of a global downturn of unknown dimensions and ramifications. As the federal government rashly insures $5 trillion dollars of mortgages and refusing to raise interest rates, hoping to achieve a soft landing, the rest of the world is hiking short–term rates, while in a knife fight with inflation, hoping to avoid economic ruin.

Our decision to focus on recession, which is a natural part of the business cycle, versus inflation, a more discretionary and destructive economic occurrence, is a less valuable target to annihilate. Fighting recession will make inflation worse. Will we have the strength, wherewithal, and resolve, in 2009 and 2010, to seriously fight hat-size inflation of 7% or 8%?

Fed Chairman Ben Bernanke testified before congress last Tuesday. In his opening remarks, the following passage is most salient and succinct:

“Moreover, the currently high level of inflation, if sustained, might lead the public to revise up its expectations for longer-term inflation. If that were to occur, and those revised expectations were to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual inflation over the longer term. A critical responsibility of monetary policy makers is to prevent that process from taking hold.”

Bloomberg reported that a private survey conducted by the National Association of Business Economics found that more companies will increase prices and limit hiring because of surging raw material costs are reducing profits. Seventy-one percent of the companies responding stated last quarter their costs rose. That was up from 65% of companies reporting experiencing higher costs the previous three months.

Also, the Labor Department last week reported that wages, adjusted for inflation, were down 2.4 percent for the past 12 months ending in June. Wage inflation is the final crucial element missing from current economic data that guarantees full blown inflation. The total number of new jobs created year-to-date in this economy is a negative 600,000 plus, and rising.

The rationale behind the $1.2 trillion in tax cuts, approved by Congress in 2001 for the wealthy, was that they could invest those dollars wisely and create jobs for the economy. Now would be an excellent moment for the upper crust of society to wave their magic wand and produce 200,000 jobs each month.

Our anemic domestic growth rate of 0.6% in the 4th quarter 2007 and 1.0% in the 1st quarter of 2008 faces formidable challenges in the 3rd and 4th quarters of 2008. Economies in Europe, Asia, and Latin America are in the process of reexamining both their monetary and fiscal policies. Going forward, if they are successful in lowering their respective growth rates will exacerbate our weakening economic condition. Likewise, if trade subsides between partners, some of the inflation embedded in the costs of raw materials that’s exported in finished products, before it evaporates in due course, will remain here long enough adding to our higher inflation figures.The bears can’t wait until the third course is served. Bon appetite!