Backfire

Quick-Draw McGraw

Michael Panzner (Financial Armageddon, 11 October) comments on (and graphs) the increasingly synchronized movements of some speculative markets, including gold and tech shares. The range between these assets is tightening and may indicate that a turning point is due.

This would gel with other information: Marc Faber has said that he sees bubbles everywhere, including gold. True, it's also been reported recently that he's been buying into gold, but remember that he is something of an investment gunslinger and will have his own view about when to get out, too.

And Frank Veneroso thinks that the gold price rise is at least partly owing to heavy speculative backing from funds that may have to get out in a hurry, if a general market drop forces them to realize assets to settle accounts.

My feeling? We dudes shouldn't try to outdraw seasoned hands.

Michael Panzner agrees with Marc Faber

In Blogging Stocks, September 7:

We're in a rare moment in history where cash is king... My prediction is that the Standard & Poor's 500 could fall at least another 10% from here. I think the economy is weakening and the crisis in the credit markets will worsen from here... this is not the time for a buy-and-hold strategy. But if you must stay in stocks, look at more defensive sectors like food, beverage and healthcare... Gold...

Read the whole item - and see the video - here.

More on Dow stock valuation

Further to the assertion that stocks are reasonably valued, and Marc Faber's answer that we have an "earnings bubble" that is skewing p/e (share price compared to earnings, i.e. dividends) calculations, here is an essay by David Leonhardt in the International Herald Tribune (14 August) on historical p/e ratios.

A couple of extracts:

...the stocks in the Standard & Poor's 500 have an average P/E ratio of about 16.8, which by historical standards is normal. Since World War II, the average ratio has been 16.1. During the bubbles of the 1920s and the 1990s, the ratio shot above 30...

Graham and Dodd argued that P/E ratios should compare stock prices to "not less than five years, preferably seven or ten years" of profits...

Based on average profits over the past 10 years, the P/E ratio has been hovering around 27 recently. That's higher than it has been at any other point during the past 130 years, except for the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off...

In the long term, the stock market will almost certainly continue to be a good investment. But the next few years do seem to depend on a more rickety foundation than Wall Street's soothing words suggest.

A drop from a p/e ratio of 27 down to 16.8 would imply a share price drop of 37%.

Thanks to Michael Panzner for spotting this and putting it onto his Financial Armageddon site.

Bad news update; listen to Grandad

Peter Schiff has been quoted in various sources, e.g. the LA Times, as predicting oil at $100 a barrel.

Michael Panzner refers us to a site called Grandfather Economic Report, which like me is concerned about the impact of bad economics on families and the next generation.

Pessimism overstated?

Seeking Alpha has a useful round-up of stats and news items on the US housing debacle.

I shall try out a contra-contrarian position here.

It's obvious that adjustable-rate mortgages (ARMs) will pose a problem for American borrowers as they emerge into a variable and now-higher interest rate environment. We are approaching a peak in this process around October/November and again, that's known about, so with all the belated hoo-ha in the media now it should be factored-in to the market.

The packaging of mortgages into collateralized debt obligations (CDOs) and their sale to perhaps naive institutional investors, is now better understood and has started a bout of worry that has spread to prime lending, too. So we have a reasonable dose of pessimism in the mixture, with Michael Panzner and Peter Schiff ensuring we're taking the medicine regularly.

One of Michael's posts last week included a detail of a "charming colonial" house in Detroit going for $7,000. Over here in the UK, somebody screwed a 0 to the side of our house prices over recent years, and if I was shown a residential property fund that would snap up streetsful of properties like the one in Detroit and wait for the turnaround, I'd be tempted.

When recession hit the UK in the early 80s, house prices plummeted in Consett, a Northern steelworking town where the local works - the main employer - closed and unemployment rose to 36%. Now the median price is £152,000. This was a working-class town, not a fashionable area, and at that time (1981) the national average house price was £24,188. So even if you'd bought a house in Consett at that price (and because of unemployment and deep pessimism, it would have been far less), you'd have made a 7.3% compound pa capital gain in the 26 years since - plus income from rent, less expenses.

I don't think the housing market runs the economy, it's the other way round. When we have a real economy, our wealth will be more secure. Perhaps the USA needs to wait for a fresh President who can take tough decisions early, in time for the fruits of his/her labours to show and be rewarded with a second term.

It's early days, but the pessimists in my Dow poll (see sidebar) have the upper hand. I still think there may be a small bounce by the end of the year, when we've digested all the bad news and are ready for a sweet. Please cast your vote!

Michael Panzner relays the alarm

Michael Panzner's latest post discusses a warning from David M. Walker, the nation's chief accountant, about America's vulnerability to potentially unfriendly foreign creditors. This confirms me in my feeling that the recent purchases by the UK of US Treasury securities is extremely significant (see recent posts on Bearwatch).

I have attempted to elicit interest in various quarters, including Iain Dale's influential political blog ("Tuesday open thread", 24 July) but so far I seem to be speaking to the profoundly deaf. Today I submitted the following comment to Iain's Diary, but without much hope of a response - as I have said in an email to Michael Panzner today, the Brits add apathy to financial ignorance:

Okay, one last Cassandra-like call and then I'll admit defeat:

Does it really not matter to your sophisticated political readership that the UK (presumably the Treasury under Gordon Brown) has recently purchased an absolutely massive amount of American Treasury securities, most of it in the last nine months, which quite probably will lose us many billions of pounds through currency depreciation? We have gone in one wild leap from 10th largest holder of American debt, to third place.

The potential downside from this crazy investment (I think it has already lost the equivalent of the first year's interest) worry me less than the implication, which is that the US is using its "special relationship" with the UK to defer (for a short time) the end-stage of a US debt-fuelled global inflationary spiral, with the prospect of a deep economic depression and possibly a wealth-destroying hyperinflation. The problems this would give us make the current floods seem a minor inconvenience.

Or is it that everybody here knows already, and is merely filling the time in the rattling tumbrils with political chit-chat and mutual insult? Is it aristocratic insouciance, or financial ignorance? Surely not the latter, when Americans are discussing their economic problems so openly and extensively.

Michael Panzner on financial liquidity and asset prices

Writing in Seeking Alpha yesterday, Michael Panzner (author of Financial Armageddon - my review here) comments on an article by Yale economics professor Robert J Schiller, which discusses the notion and possible consequences of excess "liquidity" in the world economy. For Panzner's own website promoting his very bearish view on the American economy, see here.

Cash still king?

British investment portfolio manager Tim Price gives his reasons for favouring cash in the present economic circumstances. The post is a few weeks old, but echoes similar intimations from Marc Faber. Price has also reviewed Michael Panzner favourably.

Subprime lending in the US housing market rocking the boat

The Bloomberg financial site is following the subprime mortgage story, and quotes Peter Schiff (see my review of his book) as predicting that the majority of such loans will default.

In the US as in the UK, inflation has made house prices rise fast, and in turn this has encouraged lenders to offer mortgages almost recklessly: high loan to valuation (sometimes even more than 100%), borrowers with a less than perfect track record of honouring their commitments.

Also, and unlike in the UK, the US mortgage has traditionally been a long-term, fixed rate deal, but more recently, many homeowners have taken out loans with a short-term, very low initial interest rate, and now they are coming out of the initial period into higher, variable rates. This would be a challenge anyway, but the variable rates are rising as the government seeks to rein in inflation.

You would expect that the lenders have most to worry about, but there has been a trend towards putting blocks of these debts together and selling them on to third parties as income-yielding investments. Since this gets risky debt off the lenders' hands, the lenders don't mind doing more of the same, so there is a temptation to become careless about quality.

But that risk has been transferred to the investment market, so a wave of defaults will hit returns on investments. And the investor isn't always quite aware of the degree of risk involved. The worst-risk packages are known as "equity tranches" and some have been sold to pension funds - see Michael Panzner's submission to Seeking Alpha. Some would see this hawking of bad risk as looking for suckers, and even with knowledge of his fiduciary obligation, the buyer may sometimes be a bit more gullible if it's not his own money he's investing.

Panzner: data opacity - fear of the financial truth?

The Federal Reserve stopped publishing its M3 data (the widest definition of the money supply) from 23 March 2006, and this occasioned much suspicious comment.

Now, in two posts on his Financial Armageddon website (27 and 29 June), Michael Panzner writes about the lack of transparency in the Bear Stearns sub-prime mortgage debacle, and the failure of credit rating agencies to downgrade Bear Stearns bonds.

It always looks bad if the doctor won't tell you how you're doing.

Crisis report from a very credible source

I looked up an important official today, of whom most of us may not have heard. His job is to review on government spending and report to Parliament. His name is Sir John Bourn and his title is the Comptroller and Auditor General, at the National Audit Office.

Now imagine that this person was so worried about the unravelling of the country's finances that he began touring the country, warning the general public and trying to get the issue onto the agenda for the General Election. I think you'd start to worry, too.

This is exactly what's been happening in the USA, as commented on by Michael Panzner in his website. David M Walker, the Comptroller General, has been playing Cassandra for months. To see the 60 Minutes video about this man, click here.

Could someone tell me the situation here in the UK? We don't seem to have such frank and authoritative public discussion as in the US.

UPDATE

In the CBS video, David Walker notes not only the expense of US medical care, but how many people are uninsured, and the rate of medical error. If you'll also read some of my comments in the globalization thread on Cafe Hayek, you'll see I'm of the view that we should start taking better care of ourselves, rather than trust to Dr Kilpatient.

Further concern re derivatives

The Contrarian Investor's Journal continues its series on crash preparation. Part 1 showed how you could lose your shirt on shorts; now part 2 sounds a warning on derivatives - like Peter Schiff, Michael Panzner and Richard Bookstaber.

Michael Panzner: risky lending and expert complacency

Michael Panzner usefully quotes and comments on an article in the Wall Street Journal (the WSJ online edition charges a fee). The piece is by Steven Rattner, a private equity investment manager, and its theme is risky lending. Here are a couple of snippets:

In 2006, a record 20.9% of new high-yield lending was to particularly credit-challenged borrowers, those with at least one rating starting with a "C." So far this year, that figure is at 33%... money is available today in quantities, at prices and on terms never before seen in the 100-plus years since U.S. financial markets reached full flower...

...The surge in junk loans has also been fueled by a worldwide glut of liquidity that has descended more forcefully on lending than on equity investing. Curiously, investors seem quite content these days to receive de minimis compensation for financing edgy companies, while simultaneously fearing equity markets. The price-to-earnings ratio for the S&P 500 index is currently hovering right around its 20-year average of 16.4, leagues below the 29.3 times it reached at the height of the last great equity bubble in 2000.

Some portion of this phenomenon seems to reflect tastes in Asia and elsewhere, where much of the excess liquidity resides: Foreign investors own only about 13% of U.S. equities but 43% of Treasury debt.

I think this tends to support what I suggested yesterday. The tide of money has not risen evenly on all shores - in real terms, equities have failed to keep up. Some bearishness is now already built into the price of shares.

But not, perhaps, sufficient bearishness, so the market is not an accurate measure of the health of the economy. Much investment wealth is in the hands of the over-50s, the golden generation who had good pensions and in many cases got early retirement. They also rode the inflation train on their houses and have paid off their mortgages. At least in my country, many of that generation don't bother to keep a close eye on their investments, because they don't depend on them much. For them, ignorance is bliss.

For institutional investors, ignorance is well-paid. That's putting it a little harshly, but Panzner's piece, and his most recent post, comment on the complacency of analysts and investment managers, suggesting that it may be self-serving (when do they tell you to cash-in?). Besides, many are relatively young, so their optimism is supported by a lack of direct experience of truly dark days, and by the general health and strength of youth. When the market drops, they will look for what they think are support levels and buy-in for the long term. Bad markets often see a transfer of investments from private to institutional investors, I believe; it's a kind of vampirism. The average private investor sells too late, and buys too late.

But institutional support may explain why a major equity descent takes years: it's the jerky learning curve of the naturally upbeat investment manager.

And in any case, the equity market is more often the vic than the perp, to put it in police jargon. The Wall Street Crash was, I understand, the consequence of a banking crisis, itself created by years of monetary inflation, according to Richard Duncan.

So now it's the banks and the money supply we have to watch. And that's why we need to listen to the analysts of the money system, before the investment analysts.

Michael Panzner on bond yields

Michael Panzner commented in Monday's Seeking Alpha on the increased yield of the US Treasury 10-year bond. He sees it as another straw in the wind - "goodbye to the good old days". Ironically, in the ad box next to his article, a message flashed up, promising to double investors' money in the China boom. Fear meets greed.

Naturally, each day that disaster doesn't strike is taken as further confirmation that Panzner is wrong. I shouldn't count on that: exact timing isn't possible, but I haven't seen a refutation of his threat analysis, or a relatively painless solution.

Michael Panzner: government guarantees increase risky behaviour

Michael Panzner returns to one of the four central risks of which he warns, here in Seeking Alpha: the government mortgages the future with potential claims on the taxpayer's money.

Panzner reviews Bookstaber on derivatives

Michael Panzner's view on the dangers of derivatives is confirmed in a new book by Richard Bookstaber, a senior insider in that world. "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation " is available from Amazon here, where you will also find a review and further information about the author.

Panzner's Financial Armageddon site reviews it (under 18 May) here, quoting and commenting on a previous Wall Street Journal piece. He calls the whole system "Ponzi finance" and Bookstaber himself is calling for a reduction in the complexity of these financial instruments. See also my review of Panzner's Financial Armageddon, which considers these and other risks to America's economy.

Peter Schiff interview with MarketWatch

I'm not quite sure how to rate bears - stars don't give the right flavour. Honeypots? Claws? Anyhow, if Michael Panzner merits five of them, Peter Schiff is only a three or four, since he recommends a tailored suit/e of high-yielding, conservative, non-US value stocks as well as gold and mining shares.

For an introduction to his excellent book, "Crash Proof", see this. Click here for audio of Mr Schiff's interview last month on MarketWatch.com, and here for MW's covering note.

Michael Panzner warns again of systemic risk

Michael Panzner continues to warn of a possible financial earthquake. His 17 May article in Seeking Alpha (see my link list) quotes the NY Fed Reserve President as saying "consolidation of global financial firms, increased leverage and increased complacency all have raised the risk of a systemic shock" - what I'd call the BBC syndrome (big, borrowed heavily and complacent about system risk).

Bigness is no guarantee of security, rather the reverse - think of hedge fund Long Term Capital Management, or indeed the Titanic; on borrowing, the bears have warned until they are hoarse; and complacency has been fostered by increases in the money supply.

Perhaps the complacency is the most dangerous part. People like Michael Panzner and Peter Schiff are like the architect in the 1974 movie "Towering Inferno", worried about a potential disaster because of bad wiring; but the warnings are ignored because there's extra profit in trimming security.

It's noteworthy that the Fed Reserve President, Timothy Geithner, was addressing his remarks to a conference on derivatives, which according to Mr Panzner are another source of instability in the world economy. Derivatives use highly complex mathematical tools, but as far as I can make out their purpose is simple: to see how near to disaster you can go without crossing the line. In other words, trimming security.