Weekly Recap - Markets, Housing, SubSlime

It was quite an interesting market we had this week.

There wasn't much economic data that came out. Earnings started to trickle out, and they were neither great or horrible. As is usually the case, people focused on the headline number rather than looking beneath - that can and will eventually do severe damage to your portfolio, but of course in the short term if you "follow the herd" everything looks great.

As the weeks go on the flags get hoisted up higher and higher. This week has done nothing to take the edge off my concern in terms of the markets in general - indeed, it has served to instead boost my caution level.

I had several stops taken out this week on short-term long positions; they were set quite tight, but the result of this is that I am now sitting approximately 25% in cash. That's a very large number for me - far more than normal.

This week I added a light call position on the VIX. I'm not one of the "big" players on that, but it does provide tremendous leverage if we see a big plunge. If the VIX runs down a bit I may add a bit more, but I'm not going to commit big money here to this one - at this time.

You keep hearing "the economy is still growing", but the truth isn't quite that simple. The PPI "core" number was reported as flat, but February was revised up and more disturbingly, the "crude goods" component of the PPI - the part consisting of raw commodities (metals, etc) that go into products was up big - a seven percent increase. Energy was also up materially.

Add to this the continued de-evolution of the dollar's value to seriously ugly levels; to wit:



That's fugly, and is now below the December levels. In December, we came back from the precipice and rallied hard, up from 82.6ish to over 85.

As expected the 10 year bond has gone up, and now stands at 4.76%.

There are real issues ahead if this trend continues. As the dollar weakens people who have US denominated assets but live elsewhere see real deflation of the value of their holdings. This is an extremely serious problem because at some point foreigners will divest themselves of these assets rather than suffer further losses! To put this in perspective from the December highs if you had 10 year Treasury Bills you are now underwater for the year, including the interest that's paid! That's obviously not a good thing if you happen to be living in Europe somewhere and are invested in US Treasuries.

It also makes importing products more expensive; if you build something in a foreign country and then import it, you bought your materials in that other nation but import it here; this is, effectively, a tax. The other side of this is that if you sell something in another nation and bring the money here, you get a benefit. But - we're a net exporter.

There is much speculation as to exactly where the "tipping point" is for foreign investors. A commonly-accepted point is somewhere around "80" on the dollar index - which would put it within reach during the next couple of months. Let's hope we don't get there.

Now let's look at earnings, as reported so far.

The headline again on Alcoa was pretty good. In fact, some would go so far as to say "its a blowout." But was it? For them! But did it show solid American growth? No. American demand was flat.

RIMM reported as well, and was promptly taken to the woodshed. Why? Well, how about "too much goods chasing too few customers" for starters. And it doesn't help when you trade at 60 times earnings (are we really back in 1999 again?!)

So the scorecard thus far was pretty much "nothing special". There were other reports, but nothing that moved me in a serious fashion. MERCK was up big today on both a nice forecast and also dismissal of the latest VIOXX lawsuit - a millstone around their neck that doesn't look to be going away any time soon. Nonetheless, the street bid up the shares over 8% today. Ok. Not impressed on the reasons for this here.

Of course next week it gets important - a whole litany of reports comes in all week long.

On a technical basis I see nothing to like here of materiality. There is certainly a bid under the market but raising real interest rates (10yr bond), weakening dollars and what could be called a "collapsing" housing market do not inspire confidence.

Subjectively, the market "feels" like the early part of 2000. There's a bid under the market, but nobody really seems to know why. Its called out as "lots of M&A interest" or "lots of liquidity", but nobody comes out and says "earnings are strong and getting stronger, the economy is hitting on all cylinders, we're going higher baby!" - because we're not.

I see so many different ways that the economy and the market can roll over on top of us I'm not sure how we get beyond them without having at least one go "bang."

Its kinda like sitting in a room full of explosives, while smoking. As long as you sit still, the risk is reasonably low. As soon as you stand up to go get a beer one hot ash that goes flying around blows you straight to Hell.

Adding to this significantly you still have the permabulls out there banging the "buy buy buy!" button. Blowhards like Kudlow are on CNBC every day completely ignoring the data - like souring consumer sentiment - that is a very good leading indicator of consumer spending going in the tank. Everyone likes to say "the subprime problem is contained", but the truth is that median home prices are still five times median income in California and over 2.5x virtually everywhere, and there's no possible way for that to be fixed other than for the prices to come down. Real wage growth is non-existent and real inflation (including food and energy - do you know anyone who doesn't eat or use energy?) is above wage growth. In other words, the net amount of money to buy "things" is going down.

We've spent the last four years managing this problem - real inflation in excess of income - through equity withdrawals from our homes. Now the "home" ATM has a big "closed" sign on it.

As evidence of how this is starting to hurt, look at Brunwswick. Everyone thinks "bowling", right? Well, ok, but what a lot of people don't know is that Brunswick is actually boating! They've been taken to the woodshed the last two days on little news, but lots of expectation that their boating-related results are, to be blunt, going to suck. Well, boats are discretionary purchases and they're expensive. From personal experience - the boat business around here has sucked for the last year, and it doesn't look to be improving - quite the opposite.

How do we keep the "engine" of our economy - the consumer - running when it starts to be starved for fuel?

There are Ostrichs on some of the message boards saying that California's housing market, for example, remains "healthy" for homes. Uh huh. Ok. Then perhaps you can explain this blog which lists the haircuts that flippers have taken, Countrywide's Forclosure listings (which are exploding upward), the 56 lenders who have folded and are listed here (as of today; the number keeps going up!) and more. No? How come?

Then there's this little ditty, which spends a lot more digital ink saying what I've said quite simply - "The House-based ATM machine is now empty, and is not going to be refilled. Americans have been pulling money out at an incredible rate using it since 2001, with the last two years being particularly frightening."

The real problem is that there is basically no way for the street to "deal with this" that works. Its not like you can just take one sector to the woodshed and beat until bloody. If you try, you find that you wind up beating up the entire market, because all these companies are linked into other pieces of the economy.

You say "how's that?" Well, how do you make your car payment - or buy a new car - if you just got thrown out of your house! And how do you go to work when that happens? How do you buy a boat when you can't hit the home equity line of credit any more?

The easy path forward for the street is to stick its head in the sand and go "la-la-la-la-la-everything-is-great." Of course its not, just like it wasn't when we saw the first cracks in the dam in 2000......

How long does the bid stay under the market? That's impossible to determine. But one really big test of that bid is going to come starting next week, when these lenders, builders, and big discretionary purchase companies begin to report first quarter earnings. Everyone expects earnings in the home and mortgage space to suck - the key is what the guidance - if any - is going forward.

We've also got options expiration on Friday, which is going to lead to some pretty heavy volatility. A lot of money has been bet on the short side of a lot of the lenders - WM, CFC and NDE for openers, along with many more. There's a lot of base short interest out there too. Upside surprises could be particularly nasty, but so could disappointments. AHM "disappointed" with a "Good Friday" press release and promptly got slaughtered Monday morning. They have since recovered some with even more volatility, and that was just an earnings warning - we haven't seen the actual numbers yet!

If you're long or short and have profits, this is probably a good time to be playing very tight stops. Markets that are in this sort of jittery condition have a way of breaking down with extreme violence, and the usual pattern with a breakdown like we saw last month is for there to be a second leg - worse than the first - and it usually comes on fast and hard. The other side of this is that a short without protection, just like a long without a stop, is dangerous in this environment, because surprises can hit you from either side. Always remember - while it may suck to pay capital gains taxes (I dislike it as much as anyone else does), what sucks worse is not to have the gains any more at all! An investment position closed out at a profit is cash that's yours - one still in the market is subject to whatever the market does.

Be prepared and be careful. There are profit opportunities on both sides of this market, but it must be traded with care because you're trading sentiment - and with a jittery market, sentiment can blow up - in either direction - with little or no warning.

If you have debt you can get rid of, especially anything with an adjustable interest rate, DO IT NOW. But - do not swap it into your mortgage under any circumstances. Cut up your credit cards if you have to. I'm serious about this - adjustable-rate debt is likely to get very expensive in the not-distant fugure. The Fed is going to get backed into a corner here eventually and may have to raise rates - perhaps dramatically - to keep the dollar from collapsing, irrespective of what it does to the economy.

We are likely living in very interesting times.