Double Dip Recession likely has started

I believe that we are in the midst of a hurricane that will eventually take out the March 2009 lows, perhaps later this year or in 2011.

Since late April, the S&P has dropped about 15% from 1220 to 1030 at the close today. I expect that we will hit 950 by late July, and 850 or lower in August to October.

This started with Greece but is now much bigger than Europe. This is the market pricing in a double dip recession.

I believe that double dip has likely started. Yes, I know that economists have solid growth projected for 2010. I listen to the market, which is speakly very loudly right now. By the time, these bookish economists wake up, the S&P will be at 850.

As the great Bob Hoye has researched, in a post-bubble credit contraction, the economy and stock market often peak at the same time. The high in the 1873 and 1929 stock market was was September, and the respective depressions started in October and August respectively. In 2007, the stock market peaked in October, the recession started in December.

This clear peak in April, if it holds and if the stock market continues to sell off, likely means that a double dip has either started or will start very soon. Recent economic reports have been very bad (retail sales, housing, employment) and lend credence to this likelihood.

I will let John Hussman argue the case based on economic fundamentals:
http://www.hussmanfunds.com/wmc/wmc100628.htm

This double dip is being caused, in my opinion:

1) by the end of the natural cyclical rebound from the 2007-2009 GDP decline
2) the waning impact of a ton of stimulus and printing money
3) A slowing in European and Chinese growth
4) the reemergence of the underlying credit contraction that will take years to complete
5) the end of the US dollar carry trade that I had discussed for months

In 2009, governments were printing and spending money to no end. Now, in 2010, restraint (except in the US) is the name of the game. This restraint is ultimately healthy but will take years to restore government balance sheets. In the meantime, the natural rebound is winding up and the deflationary beast is back.

It is hard to predict how long this double dip will last, but my gut tells me about 12 to 18 months, therefore into late 2011. David Rosenberg has it right when he says that this depression will have a series of recessions. It appears that number 2 has started.

Disclosure: Position in SDS, Euro, US dollar

Black Thursday (1000pt down day)

While there were glitches on Thursday, I don't buy the trader error story to explain why Accenture traded at 1 cent or PG was down 37% intraday.

The Yen was up about 3 Yen vs the USD (and even more vs the Euro) before any crazy trading happened in New York.

There is a lack of liquidity as the huge government bond market seizes up, especially in Europe. In addition, the huge moves out of the Euro (I think bank runs are part of this) and into gold, USD and Yen, is also putting huge pressure on leveraged equity players and hedge funds.

The electronic trading and the few remaining players in the game are also adding to the volatility.

I believe that Black Thurdsday was not a fluke but a warning shot that systemic risk is very much alive. Listen to the market. It is not healthy at all.

This is why I have written about Greece

I haven't had much time to write for my blog due to work and family obligations. However, most of what I've written has been about Greece and the Euro.

Why such emphasis on a country of 11 million (the size of Ontario)?

Greece is the fault line. I have believed that the impending default of Greece, despite a "shock and awe" bailout that I didn't think would happen, is the catalyst for:

1) the end of the tight credit spreads for most insolvent countries. This is consistent with the history of great credit bubbles. This means a Seinfeldesque "no soup for you" to the international bond markets for Greece and the rest of the PIGS. There is too much debt out there, much of it will never be repaid.
2) the end of the Euro as we know it, and a huge dislocation in currency flows
3) A relatively strong US dollar
4) The re-start of the bear market that was interrupted for 13 months.
5) Another banking crisis as all that government debt becomes devalued and countries pull out of the Euro.

It is difficult to predict the future, but I am very worried that a redux of late 2008 is back.

There are still way too many bulls out there who think that this will be contained. I now fear that we have re-entered the September 2008 to March 2009 playbook where volatility rules and anything is possible.

I now believe that a quick 30% from the highs is possible over the next few weeks and months (mid 800s S&P), as things can unravel very quickly if the Euro goes to par in that time, and if multiple countries default, with bank runs and a powerless ECB.

One of my weakness is that I often see things before they happen. I had been worried about a bear market for years (pre-blog). I warned prematurely about a housing bubble bursting in Canada. I have been bearish on the Euro for years. I wrote about a currency crisis in 2008 that didn't fully materialize. I was looking for a huge bear market rally a few months early in 2009 and then I turned bearish too quickly.

This time I fear that I am being too slow in that I have not fully positioned myself for a 30% move that could happen in weeks not months.

I am not predicting this just yet, as the reversal is still new, but one possible doomsday short term scenario over the next 2 months:

Euro to par, maybe in the next few weeks. (Note that we almost hit my 1.15-1.25 range yesterday)
CAD to weaken to 85
S&P to 850
Gold to 1,500
Yen not sure

Risk is very, very high right now.

Disclaimer: I am currently long USD and CAD, short Euro, long gold.

Another month, another Greece bailout

On February 11th:

“In theory, we will help Greece. But they haven’t asked for any money (wink-wink). Go about your business, quit speculating against Greece and let us get back to our bureaucratic plans to form a true European nation ”

Eventually, the market realized that this is just talk.

On March 25th:

OK, OK, we have a mechanism to bail out Greece and the IMF is involved, but we’re not giving you the EU taxpayer any details. And anyway, they haven’t asked for any money. There, that should end the matter!

On April 11th:

Alright then, you leave us no choice. Here are some details. We will sort of gloss over the fact that all EU members must approve this aid, and that it might even be illegal according to the EU charter.

That means that the German, Italian, Irish, Spanish and Dutch parliament (among others) must pass this aid BEFORE it gets disbursed. The IMF could lend without approval (meaning Canadian taxpayers are going to be involved) so perhaps the IMF would do the initial bailout and then the EU would kick in the rest. However, given my admittedly weak knowledge of the history of Germany, I have my doubts as to whether it would pass. What about the Irish parliament? They have taken draconian steps to balance their budget without a cent from the EU. Are their suffering taxpayers going to send money to the notoriously inefficient Greek taxpayer? All it takes is one government to reject the aid (think Meech Lake).

Greece said on April 11th:
The package “sends a clear message that nobody can play with our common currency and our common fate,”

Economic and Monetary Affairs Commissioner Olli Rehn:"There will be no default."

When Greece defaults, what will they say?

At this does is send a clear message that the EU, especially Germany, does not want to set a precedent here by bailing out Greece. It may have to, but it is scared. The IMF can do what it wants.

I believe that Greece will default and get an IMF (not EU) bailout. It needs to restructure its debt and then decide whether it stays in the Euro or goes back to the drachma.

Then the saga moves to Portugal…I am sticking with my 1.15-1.25 2010 target established back in December for the Euro. So far, the US dollar carry tread (negative S&P/USD correlation) has busted in 2010. Let's see if it continues if the Euro continues to sink.

Ironically, if Greece and other Club Med members left the Euro, one day (far, far away though) perhaps the Euro would actually be stronger.

Disclosure: Position in HSD.TO, SDS, EUO, US & Cdn cash

Little March Break

I have not been able to post of late, as I have welcomed a new member to my family, and I have been a little busy (and sleep deprived) of late.

I plan on posting again soon. My big picture view has not changed but I must admit that I am amazed at the resiliency of the bulls. We are yet again at a possible inflection point, where the market can either go up to S&P 1230 or retest the February low/start a new downleg. March is often a key turning point in the markets (2000, 2003, 2008, 2009) as we approach the equinox and the ides of March.

Thanks for all the flattering comments. One generous reader noted that the Tip Jar was busted. I have fixed it now.

All the best....

Dominoes and Euro updated

Euroland crisis: I posted my target for the Euro in 2010 (1.15-1.25) back in December when the Euro was near 1.50. It seemed far fetched.

Now that we are at 1.38 2 months later, it doesn't sound quite so outlandish. Morgan Stanley was correctly bearish at the time, and now dropped their target to $1.24 from $1.32. They feel that the Euro is overvalued by 19%. An overvalued currency in the midst of a crisis. The Euro is currently oversold and could bounce at any time, but I believe we'll see 1.30-1.32 pretty soon. The Euroland crisis was discussed further last month and now, the PIIGS are in freefall and have contaminated risk taking and destroyed the US dollar carry trade.

This is in my investment outlook for 2010 (not posted) and will be part of the unravelling of the USD carry/reflation trade of 2009. Currently, I see the S&P bottoming around 990-1020 over the next few weeks before bouncing a little. The real bear action will likely take place later in spring. I believe S&P 666 is going to fall in the second half of 2010, with new highs in the US dollar index.

What does Greece have to do with the Dow? Nothing per se, but the whole world has too much debt (much of it US dollar denominated) and is long risky assets (emerging markets, commodities, stocks). Greece's coming default/restructuring hurts risk appetites and is hurting the Euro and strengthening the US dollar. Since there are too many people with US debt, the rising value of the US dollar hurts those long risky assets. They sell the assets to pay off debt. Mr. Margin doing his magic after taking 2009 off....

Vancouver the biggest bubble in the world.

A new report on world housing is out....

http://www.demographia.com/dhi.pdf

http://ca.news.yahoo.com/s/capress/100125/national/affordable_housing

Toronto housing severely unaffordable.

Montreal housing seriously unaffordable.

This excellent report uses housing prices to median family income as a measure. Now, I acknowledge that this measure does not take into account different tax policies, interest rates, demographics, weather, etc… However, big picture, this is an excellent tool to use.

In fact, Canada has poor tax policies, already rock bottom interest rates, poor demographics, tons of available space (we have one of the lowest population densities in the world), mediocre demographics, and poor weather in the opinion of most people.

If you adjusted these values to reflect these factors, our rating would be even worse. For example, the US has lower tax rates and a mortgage tax deduction, less available space, better demographics and better weather.

The report also has some unconventional thoughts on high-density versus low-density urban planning. This is beyond my area of expertise, so I will not comment, although I do like unconventional thinking, and moving back to the suburbs from the city, their arguments have a sympathetic ear in this blogger.

I take some issue with the report`s argument that the reason that many markets are unaffordable is land use policy (which roughly corresponds to supply). This is definitely a factor. However, the more important factor is that we are currently in a mammoth housing bubble. This bubble was caused by many factors, and land use policy is likely a minor factor in my view. The bubble was caused by a great credit boom that has spanned generations. Housing was (and still is, in Canada) psychologically deemed to be a safe investment that can not lose money. It is perceived to be the best investment class, despite little long term proof of that hypothesis. Over a decade or two, housing can be a good investment, but from today`s nosebleed levels, housing (or any other nosebleed asset class) is doomed to be a poor performer for years, and more likely, for decades.

By taking a snapshot at any given moment, we can make a determination (as this study does quite well) regarding whether housing is affordable or not. However, without the fullness of time or a full market cycle, it is nearly impossible to make reliable conclusions.

I believe that once the housing bubble in Canada deflates, it will bring housing prices back in line with affordability. In fact, periods of overvaluation are usually followed by periods of undervaluation. This same study done in 2000 or 2020 would yield very different results, and if it does, I doubt it will be because land use policies have changed materially.

I had suspected that Australia and Canada had the two biggest housing bubbles left in the so-called developed world. This report backs up this suspicion. Almost all other countries (UK, US, Spain, Ireland) have seen their bubbles deflate or start to deflate.

What do Australia and Canada have in common? Both are commodity countries.

The commodities and risk trade that reflated in 2009 (partly retracing the 2008 losses), has allowed Australia and Canada:

1. Strong export pricing which has lead to
2. Strong asset inflows and currency appreciation which has lead to
3. Low interest rates (as inflation is not an issue in this deflationary environment) which has lead to
4. “Relatively” mild recessions and relatively low unemployment which has lead to
5. No bursting of the housing markets (unlike the non-commodity housing bubbles)

I missed the call on Canadian housing in 2009, but I believe that both Australia and Canada will play catch-up in the coming years:

Why?

6. The commodity deflation and recession will restart in 2010 which will lead to lower export pricing and lower exports
7. Strong asset outflows and currency depreciation which could lead to
8. Higher long term interest rates as sovereign risk worries kick up (Not 100% sure about this one as the deflationary headwinds are quite strong)
9. “Relatively” severe recessions and relatively increasing unemployment (due to point 6)
10. A bursting of the housing markets as unemployment rises and personal savings increase and the same debt retrenchment that has happened in the US shows up in the Great White North.

The fact that Canada had a sharp recession in 2008/9 without its housing bubble and only a partial deflating of commodity prices is very worrisome for the next leg down.