Government Bottoms and Bailouts

All climactic US stock market bottoms have involved government intervention thus far:

Aug 16/07: Fed cuts discount rate, telegraphs rate cuts (follows up with 50 basis pts in Sept)

Jan 22/08: Socgen bottom: Fed cuts emergency 75 & telegraphs more (another 50 next week) S&P 1270

Mar 17//08: Bear Stearns bailout bottom/new lending facilities S&P 1256
July 15/08: Fannie Mae/Freddie Mac announcement of future bailout S&P 1200
Sep 8/08: Fannie Mae/Freddie Mac takeover S&P 1217 (Friday before)

Every major bottom has been in the 1200-1270 range and every rally has ultimately failed (we are still waiting for July and Sept bottoms to be breached however).

This tells me that market is not bottoming naturally (ie prices low/sellers exhausted/buyers bargain hunting). Perhaps one of the signs that a new bull will be here is when the market bottoms naturally.

What happens on the next Bailout Monday, this week (September 15th)? Washington Mutual (WaMu) and Lehman?

Since the Bear Stearns bailout (with the incessant bottom calling...a financial failed, market bottom- that is so 1998) I have been waiting for a period where more than one bank/broker goes under in the same week and then you get some type of climactic bottom that leads to a multi-month bear market rally (similar to September 2001-January 2002).

We had Fannie & Freddie last weekend and it looks like WaMu and Lehman won't make it much longer. That would be 4 in 1/2 weeks. Weirdly, that would qualify but I don't think these 4 will cut it. It may take a few more bankruptcies or bailouts plus weakness in other sectors (retail? as commodities have already crashed) to cause that type of washout.

Here is my list of candidates once LEH and WaMu are done. I have no special insight, just the way that they are trading:

Bear Stearns

Fannie

Freddie

Very Likely and soon?

Lehman

WaMu

National City

MBIA

Ambac

Wachovia

AIG

Eventually? Some type of takeunder/breakup?

Merrill

Citigroup

Morgan Stanley

Full Disclosure: Puts on MER, C, AIG, MBI, SKF and SKF equity

Dow 9,000 as President Obama wins election?

On the hottest day of the Montreal summer (33C on Sept 6th!), I felt a need to update my financial markets "winter outlook" from August 8th:

Markets remain choppy for August into mid September 2nd. Commodities bounce a little mid/late August and sell off again in early September. US and world markets peak in mid August, pull back in late August, rally into mid September 2^nd to test August highs.

Then we plunge into mid November as the credit crunch really takes hold, the US economy plunges and recession is accepted by all. There is a chance that we get a slew of bank failures at the same time and systemic risk becomes a concern.

Canadian, US and European economies in recession or hard landings. I plan on conserving capital and shorting at opportune times.

Basically, the only change is that the markets topped out faster (Tuesday Sept 2nd) and from a slightly lower level than I thought. Thursday was the first 90% downday (technical measure). If a new downleg has started, you will likely get a series of them over the next few weeks/months.

Cash is king here for all but experienced investors (who can short carefully). Stay out of debt. I saw (and still see) a move to about S&P 1078-1090 (Dow 9Kish?) for this downleg which should last into November, around the time that Barack Obama (or John McCain) becomes the new President.

Some may feel that I am a permabear but I believe that I am a realist. The structural issues facing the global economy are deep. The credit cycle has gone on for most of my life (about 25 years- since the early 80s). Look at any long term chart of debt/GDP, debt/annual income, etc... It will take a severe bear market and a severe and lasting recession to correct the excesses of 25 years. This stock market bear thus far has not been severe (20% +/- on the S&P, 10 months in duration). Severe bear markets can last years (the 2000-03 one lasted about 3 years) and usually shave off 30-50%.

We currently have the worst housing recession in the US and many countries since the Great Depression. We have one the worst financial instability since the Great Depression, as the esteemed Paul Volcker stated today. The US consumer (70% of the US economy and 20% of the world economy) is overleveraged and underwater in his/her stocks and houses. Inflation has been high in recent years, thereby preventing further rate cuts in most countries.

All this and we are supposed to have a garden variety bear market of 20% and 10 months? And Canada is supposed to muddle along impervious to the massive hurt going on to our south. Housing will just magically rise by 5% a year.

I believe that we are likely heading for one of the 50% bear markets in the stock market. We haven't even had a real panic. The August 07 panic was minor. Socgen January was minor. Bear Stearns March bottom was minor. July Fannie Mae bottom was minor. Look at the VIX index. It peaked in the upper 30s in all but the July bottom (it only hit 30 in July). In 1997, 1998, 2000-03, we had numbers in the 50s and 60s. In 1987, we hit 180ish I believe. Perhaps there are structural difference in the markets (ultrashort ETFs, etc...) that will prevent a 60 reading, but even using other measures, we have yet to see true panic in the markets yet. I am old enough to remember scarier "corrections" in the 1997 and 1998 bull markets. There were none of the structural issues out there today! I believe that over the next few weeks you will finally get some panic.

The good news is that after this downleg, I believe that we will finally be past the halfway mark in terms of percentage and maybe, just maybe, in time. We even could get a nice 3 to 5 month counter trend bear market rally. If things got really ugly in October/November and we sunk to say 770 S&P with a few bank failures, you could even have the end to the bear in terms of price.

Eventually, there will be a new secular bull market in stocks and homes. It will probably not be like the ones of the 80s and 90s in stocks and 2000s in homes, but it should be good. We will definitely get a cyclical bull (2003-2007) at some point in 2009 or 2010. The BRIC country story may well be true and if the US can do a (much) bigger 1995-97 Canadian style cleanup cleanup of its structural problems, this could eventually make me start a bullish blog. But the "summer outlook" is likely many years away and for now winter has resumed in the financial markets.

Comments on the G&M website

From the G&M comments

FSA LDU from Canada writes:

Adil, a link to your own blog, spouting about the housing downturn is hardly concrete evidence of the same. I think I'll take the analysis of CREA, the BoC and several major economists over the 'dabbling in financial markets' of a renter.

I dabble in the financial markets too, every time I put my ATM card in a bank machine and take out 20 bucks for lunch and a train ticket home. That gives me as much credence to predict the future of housing prices as you.

As for the job market - great to see our economy still moving forward, albeit slowly, despite the global turmoil in the financials, commodities and jobs. Here's Harper gets his majority and we can enjoy four more years of smart economic planning by our federal government, as opposed to four years of economic hell if the Green Shift ever happens.

I thought I would address his many comments:

Go ahead and trust the CREA, BoC and Big Bank analysts! I think they'll lose you money but that's why we have markets. Notice that I didn't say "free" markets, as the manipulation by the US government with all its new facilities, Bear Stearns bailout, Fed cuts and short selling rule changes have discredited that idea.

As for my credentials, I am comfortable that they are sound enough to work for CREA, BoC etc.., I have a professional designation, many years of experience with financial institutions and I have been a markets junkie for 17 years. I am a renter by choice as I believe that housing is overpriced and I will buy when prices are lower, much lower.

I "dabble" in that I am not a full-time trader and I have a day job as a freelance consultant, but I manage my own portfolio and I am up in the bear market.

The gist of FSA LDU's comments are that I am not credible because I don't work for a big institution. That's fine by me. I'll let you the reader be the judge of that, but I have made many predictions on this blog and most of them seem to be coming to fruition. I do plan to change the profile description (thanks to FSA) as it does sound a little hokey.

A 1 year lag

CREA likes to say: “"The Canadian real estate market, while cooling, is still much different than the U.S. market”

Actually, it really isn’t…

Using CREA data in a crude way, it appears that as of June 2008, we are lagging the US by about 1 year and 2 months. This is consistent with the lag of June 2007. In late 2007/early 2008, we were lagging by a little more (1.5 years) due perhaps to the effect of the commodity bubble on the West.

In July 2008, the lag appears to have shrunk once again to 1 year and 2 months as some of the effect of the commodity bubble appears to be coming out of the Alberta market.

I know that this is not apples to apples, since CREA reports average sales price and Case/Schiller reports a number based on the “repeat sales pricing technique”

However, here goes. If we continue to lag the US by about 1 year and 3 months (I have added a month, in case July was a bit of an extreme), this is where we go for the next year or so.

Back of Envelope Calculations

Canadian Date CREA YoY US Similar Date (Case/Schiller) Lag
Jun-07 10.40% Apr-06 1 year, 2 months
Dec-07 8.10% Jun-06 1 year, 6 months
Mar-08 4.00% Sep-06 1 year, 6 months
Jun-08 0.40% Jan-07 1 year, 5 months
Jul-08 -3.60% May-07 1 year, 2 months
Sep-08 -3.90%? Jun-07 1 year, 3 months
Dec-08 -5.50%? Sep-07 1 year, 3 months
Mar-09 -9.70%? Dec-07 1 year, 3 months
Jun-09 -15.30%? Mar-08 1 year, 3 months

This is not a prediction but merely something to watch. However, for the remaining months of 2008, this is probably a decent estimate of where we go. In fact, it could be conservative if the following effects hit the Canadian housing market this fall:

TSX has a sharp selloff this fall (as I expect)
Commodity prices are now in a bear market (as I expect)
Banks will tighten lending this fall, especially once the October 15th deadline passes
Psychology will change as the “boom is over” become accepted by the masses

I suspect that we go to -6% YoY conservatively by December 2008 and perhaps as low as -9% YoY. For 2009, I don’t know about -15.3% by June 2009 as that will depend on how things play out in the economy and financial markets. I wouldn’t rule it out however!

Down 3.6% in July

"The question is no longer will Canadian house prices drop but whether they will sink to levels seen in the United States where some markets have watched home prices crumble by as much as 30% in the last year."

Financial Post, Gary Marr, August 15, 2008. "Alberta leads national drop in home prices"

Well said...Only problem is just a few months ago, we were hearing tales of a slowdown to 5% growth in 2008 (from 11% in 2007). This is the first time that the FP or G&M (to my recollection) has stated unequivocally that Canadian housing prices will fall. The mainstream media just keeps repeating the doggie do-do that the CREA/real estate people and the banks keep spouting.

July 2008: The average sales price declined 3.6% YoY. As bearish as I am on housing, even I didn't expect that bad a number!

CREA is trying to spin away:

In June, it was only 4 of 25 markets going negative (Calgary and Edmonton included) going negative. The number was skewed....

In July, now you can add Vancouver to the list. Toronto is quite close now at 1.5%. Windsor is now negative.

Listen to CREA spin furiously : " Even though average prices continue to post year-over-year gains in most major markets...the decline was the result of fewer sales compared to a year ago in the four most expensive major markets in Canada – Vancouver, Victoria, Calgary and Toronto."

Hmm, the four most expensive major markets in Canada had fewer sales. Yes, mathematically that would skew the average price downward as you lose more higher prices sales in your mix.

BUT...Is it not concerning to see the #1 and #3 cities (Tor/Van) have fewer sales and go negative in inflation adjusted (real) terms. The other 3 rich cities in Canada (Calgary, Edmonton, Victoria) go negative and/or fewer sales.

How many major cities are there in Canada not affected by this housing crash developing.

Let's start from West to East with all cities over 1 million:

1) Vancouver: From BMO "However, the drop in July spread to a few more cities, including the previously untouchable Vancouver market." Vancouver is the Michael Jordan of housing markets. Sales down 44%!!
2) Calgary: Negative (big time)
3) Edmonton: Negative (big time)
4) Toronto: slowly sales/barely up (1.5%)
5) Ottawa: holding up so far
6) Montreal: holding up so far (new high in average price)

I don't know about Ottawa, but I live in Montreal. Everything happens with a lag here. We've been spared some of the worst recently with some provincial income tax cuts and a strong aerospace sector. Plus, culturally we are a little insulated from what goes on in the ROC, but it gets here eventually.

I would expect to see all 6 major Canadian cities negative YoY by year end. I would expect to see Calgary, Edmonton, Vancouver and Toronto all negative by October latest.

What are the hot areas in terms of price increases?

Saskatchewan and Newfoundland/Labrador (ie commodity bubble land). With the upcoming commodity implosion and housing bubbles in those areas, look for them to follow Calgary and Edmonton's lead. Saskatchewan is already having huge drops in sales volume and anecdotal reports report that much of the increase was due to investment buying, much of it from Alberta. Potash stock price is a good proxy for Saskatchewan's economy. I don't have a position in Potash currently but I have shorted it recently and I think it is reminiscent of JDSU back in 2000.


One last spin by CREA's economists: "Based on what happened in the first half of the year, CREA’s market analysis shows a record national average residential MLS® price by the end of 2008, but with a much more modest increase than was recorded in 2007."

Translation: instead of 5% growth for 2008 (down from 11% in 2007), we are now projecting to go to get back to postive (ie +0.1%) by December.

My take:

• Expect to see negative numbers the rest of the year
• Expect Toronto to go negative soon. When the mainstream media (based primarily in Toronto) gets this, expect to see a flood of housing doom articles. While the doom will be correct, it will be about years late.
  
• Expect Ottawa and Montreal to participate in the housing crash by year end
• Expect to see negative numbers worsen with an occasional upward blip (similar to a bear market rally in the stock market- ie nothing goes down in a straight line)
• Expect to see bottom calling on these inevitable blips
• Expect to see a negative 6-9% by year end
  

Double Bubble: Housing and Commodities

In Canada, there was a double bubble: A housing bubble and a commodity bubble.

The commodity bubble was worldwide, started by supply concerns and growing demand, especially in the BRIC countries. The more commodities went higher, the stronger the Canadian economy, particularly out West.

The housing bubble was driven by pent up demand from a relatively weak period (1990s), record low interest rates post 9/11, investor preference for hard assets (after the stock market bubble of 2000).

As with all trends that continue for a long time, these fundamental drivers inevitably drive up prices and then speculation takes over, driving prices even higher.

The mania can last for years and convince even skeptics that they were wrong. The final blowoff usually involves even the bears throwing in the towel. Then the mania finally exhausts itself, and prices come down. At first, it is just a healthy correction and prices can even rebound briefly, but at some point, it becomes clear that the mania is over. The bubble is popped.

Both bubbles drove up asset prices which allowed Canadians to feel richer, spend more and take on more debt than they would have otherwise. Expect the mainstream media to talk about this after the fact (ie in 2009).

I believe that we are now at the point where the double bubble is letting air out. June housing was down year over year (-0.4%). We could get an upward bounce for a month or two, but the trend is now down for the first time in many years.

Oil and most commodities were trashed in July and August (along with the TSX). Many of their long term trends still appear to be upward at this point, but their parabolic charts look broken. I expect a sharp "snapper" rally over the next few days and weeks, but few if any commodities will hit new highs. And then this fall, look for most commodities to break down again, once it is clear to even the bulls that this was more than a healthy correction.

The bursting of the Double Bubble in Canada will trash the Canadian economy in late 2008 into 2009. If we are in recession already, I expect it to get much worse. We had a nice 15 year boom (1992-2007). It is crazy to think that we can just get through this in a few months or a year.

Stormy Summer 2008: What's the Winter Outlook?

For those of us in Quebec and Ontario, the weather this summer has been incredibly stormy with little in the way of real summer weather.

1) The economy has been just as stormy with the news today that the economy "unexpectedly" (you'll keep hearing that a lot) shed 55,000 jobs and even worse, the private sector shed 95,000 jobs. The worst loss since 1991 (hmm, where have we talked about that year before?).

2) May GDP was "unexpectedly" negative.

3) June housing was negative.

4) Today, the Canadian dollar went below 94 cents, it worst week since 1971!

Have I depressed you enough? Unfortunately, the situation is what it is. Better to accept it and plan accordingly, I believe. There will be a recovery and a new bull market one day and I believe that it is better to preserve capital and pay down debt now.

Let me address the four points above, none of which should surprise (the few) readers of this blog:

1 & 2) Despite believing for over a year that Canada was headed to recession (please see my February posting)

The 1990/91 recession and the slow growth that followed were incredibly brutal. Canada had a very rough time and our economy underperformed most of the G7 during that fairly mild US recession. In 1990, we had 10% real interest rates, a housing bubble bursting, a transition to free trade, enormous budget deficits and the introduction of the GST. On a relative basis (to the US), we won't underperform this time. The only problem is that this time, I believe the US is in for a much longer and deeper recession. Overall, I don't think that this one will be as bad as 90/91 but given all the possibilities inherent in the biggest credit crunch in many generations, nothing can be ruled out.

As for unemployment, this report looks like a catch-up for all the positive months thus far this month. Perhaps July's losses were overstated (and earlier months were overstated) but as I said back in April things changed big-time in spring in the job market in my neck of the woods.

The economy is likely in recession in GDP terms. To all this "jibba jabbah" talk that GDP doesn't measure price changes : what happens when commodity prices sink (as they did this week)? The effects of the commodity mini-crash this past month or so have yet to filter through the economy. Unemployment will rise. Don't buy the fact that the unemployment rate went down in July.

3) If 55,000 jobs were eliminated, that could not have helped housing in July. Expect the numbers to worsen on their own. Throw in a recession and plunging commodity prices in the areas that are still hot (Sask, Nfld)...yikes. The only wild card is that demand is likely to pick up ahead of the October 15th deadline for curtailing "overprime" loans.

4) I wrote back on April 1st:

I think that the Canadian dollar will likely fall to 92-94 cents over the coming months...

Now that we are at 93-94, we probably get a short term bounce as the loonie is incredibly oversold. I sold some small US dollar money market holdings back into Canadian today but I think that given how easy the loonie fell this week, the downside needs to be revised lower. Have to do the research on this (I was waiting for this target to be hit, and the speed of the decline this week from 97 did not leave me time for this). Gut feeling is we go still lower (upper 80s to 90) as commodities continue to implode, but first we bounce.

Winter Outlook:

Markets remain choppy for August into mid September. Commodities bounce a little mid/late August and sell off again in early September. US and world markets peak in mid August, pull back in late August, rally into mid September to test August highs.

Then we plunge into mid November as the credit crunch really takes hold, the US economy plunges and recession is accepted by all. There is a chance that we get a slew of bank failures at the same time and systemic risk becomes a concern.

Canadian, US and European economies in recession or hard landings. I plan on conserving capital and shorting at opportune times.