Musings

Yes, they really do have potential technical targets in that general area.

For instance, this chart:

Or this one.

Or this one.

All show potential "head and shoulders" patterns in process.  None are confirmed, but all will be if we head back toward March's lows.  Note that these are patterns stretching back more than a decade and thus there is no immediate expectation that this is a "tomorrow" thing - rather, it is a longer-term problem.

All target, effectively, zero.

The Nikkei has a very similar pattern on it, as do most of the other major international indices.

What could cause such a preposterous outcome in the global stock markets?

This sort of crap:

Jan. 25 (Bloomberg) -- Bank of Japan policy makers are prepared to consider expanding an emergency-loan program for banks and increasing purchases of government debt should the recovery falter, people with knowledge of the matter said.

Which "emergency" is that?

This one?

When it introduced a quantitative easing policy of pumping cash into the banking system in March 2001, it said the step would stay until prices stopped falling.

This "EMERGENCY" is A DECADE OLD!

Will the global capital markets keep putting up with this?  So far the answer has been "yes."  But there exists some point - somewhere - that such a policy will cause a full-on collapse of the bond market.

Realize that Bernanke has already effectively destroyed the market for Fannie and Freddie securities.  He is the market; there is nobody who will buy Fannie and Freddie paper at anything approaching the price he has paid.

In the Ivory Tower-filled halls of central bankers, there are those who believe they can twist the dials without consequence.  That their acts, however insane, are confined to their own nations and within their own borders.

This is a dangerous, even suicidal fantasy.

Not all nations will be forever tied at the hip to such magical thinking.  Many may not be even now, and as time progresses those who are bent over the table the most by such fantasies (cough-China-cough) will of necessity find ways to decouple from this self-destructive paradigm.

If the nations involved in this fantasy (Japan, the United States and perhaps Britain) do not stop of their own accord they will continue to see deteriorating public finances which, of course, will prompt them to buy even more of their own debt. 

But such an exercise is at best a circle-jerk and at worst it destroys private investment through crowding out.and destruction of the free market's pricing mechanisms.

The "over center" point where one becomes too deeply in the gravity well of the black hole at the center is almost impossible to determine in advance.  Japan may have already crossed beyond it. 

Once that point is reached it becomes quite literally impossible to prevent a full-on collapse of the monetary system involved.  Other nations will be forced to jettison their ties lest they be sucked into the vortex like two ships tied together when the first sinks below the waves.  If those ties cannot be jettisoned in time a coordinated worldwide bond collapse is quite possible.

There is no attention being paid to these risks, yet with Japan's public debt twice GDP it is rapidly sucking private savings into the vortex along with it. 

When, not if, that private savings is exhausted it will be too late.

The United States does not have the luxury Japan has had, as we do not have the reservoir of private savings the Japanese had at the outset of their folly.  Instead, it is a near-certainty that The United States will attempt to cajole and, if that does not work, coerce private citizens to buy Treasury debt as a means of staving off the collapse.  There is several trillion dollars in pensions, 401ks and IRAs that could be effectively forced into such a program, should the government decide to get out its jackboots.

But that has no different outcome than does Japan's mess - as with Japan it simply sucks all the private capital into the vortex along with the government.

If there is one thing we should have learned from Japan's debacle, now well into its second decade, it is that "Quantitative Easing" does not work.  It fails to halt deflationary pressures because the root of the problem is that there is too much debt in the economy relative to productive output. 

Quantitative Easing is an attempt to avoid the inevitable pain of debt deflation and default.  It is nothing other than a sop aimed at preventing those who made bad loans from being forced to eat them, recognizing their insolvency and going out of business.

Since "Quantitative Easing" does not reduce the level of debt in the system it is mathematically impossible for it to succeed in the goal of relieving the debt overhang.  Indeed, it is virtually assured to make such an overhang worse, since by definition such a program will prompt further and more aggressive debt issuance, especially by the government.  It did in Japan and now it has here in The United States as well.

You cannot fix a drinking problem with a case of whiskey, but you sure as hell can get alcohol poisoning and die.

Japan is well on the road, and we are not all that far behind them.

It looks like Google has finally run into the Chinese form of "screw you forward, screw you backward, or just plain old fashioned screw you."

Like many other well-known organizations, we face cyber attacks of varying degrees on a regular basis. In mid-December, we detected a highly sophisticated and targeted attack on our corporate infrastructure originating from China that resulted in the theft of intellectual property from Google. However, it soon became clear that what at first appeared to be solely a security incident--albeit a significant one--was something quite different.

First, this attack was not just on Google. As part of our investigation we have discovered that at least twenty other large companies from a wide range of businesses--including the Internet, finance, technology, media and chemical sectors--have been similarly targeted. We are currently in the process of notifying those companies, and we are also working with the relevant U.S. authorities.

Second, we have evidence to suggest that a primary goal of the attackers was accessing the Gmail accounts of Chinese human rights activists. Based on our investigation to date we believe their attack did not achieve that objective. Only two Gmail accounts appear to have been accessed, and that activity was limited to account information (such as the date the account was created) and subject line, rather than the content of emails themselves.

Third, as part of this investigation but independent of the attack on Google, we have discovered that the accounts of dozens of U.S.-, China- and Europe-based Gmail users who are advocates of human rights in China appear to have been routinely accessed by third parties. These accounts have not been accessed through any security breach at Google, but most likely via phishing scams or malware placed on the users' computers.

First, the US Authorities don't care.  This is almost-certainly state-sponsored (by China) or at least tolerated.

I have been tracking these attacks now for more than five years.  See, I write (among other things) security software, including spam-filtering code.  It is somewhat of a hobby now, but was a major focus when I ran MCSNet - we were the first ISP in the United States to offer customer-configurable spam filters.

A number of years ago I detected a very disturbing pattern.  A huge number of attacks were being fomented from both China and Russia.  They were sophisticated, not the typical "script kiddie" nonsense that everyone sees on a daily basis.  They were aimed both at machines I had direct control over and those of some of my customers, including some who were of a "sensitive" nature.

My current "best practices" recommendation to firms that I work with, along with what I have implemented on my own machines, places an absolute bar on all but external consumer-visible web services against all IP address blocks that are assigned to China, without exception. 

Doing so has cut the incidence of malicious "probes" and attempted penetrations on the machines I have administrative responsibility for by 95%.

To be blunt: Nobody in our government gives a damn about the fact that China is the source for most of this crap. 

This is in fact a form of cyber-warfare, and is not entirely aimed at business interests.  Some is pointed directly at public-safety and government servers.  Our government at all levels knows of this.

If China was lobbing missiles into our nation on a weekly basis we would soon declare war.  At minimum we would stop buying their crap, force all their nationals to leave our soil and bar any of our citizens - or corporations - from spending money there.

But we don't, because we have extended "most-favored nation" status to them as a "trading partner."

Why our corporations tolerate this crap, beyond our government doing so, is entirely beyond comprehension.  You can walk down streets in China - a nation that is essentially a police state, where dissidents are locked up for years for mere speech or even "disappeared", and buy bootlegged copies of literally ANYTHING for pennies.  Chinese companies routinely rip off anything they can get their hands on and duplicate it without fear, patented, copyrighted or not. 

Why does a company like Intel tolerate this?  Why does Microsoft? 

Why do our stock exchanges allow firms to be listed here (BIDU anyone?) that are headquartered and operate within China?

Why does our government put up with this crap?

Then there is the "bend over the table" game that Yahoo got caught playing.  They agreed to turn over data to the Chinese authorities using procedures that would never be legal in the United States. Is Google innocent of this?  I don't know.

What I do know for a fact is that China is a nation that has no respect for what we consider to be basic human rights.  They do not recognize a right to free speech, they do not respect a right to privacy of one's person and they do not respect property rights in any way, shape or form.  They steal intellectual property (and sometimes physical property) at whim, and even allow the sale of stolen property in an open and wanton matter - so long as you're Chinese.

We have prostituted ourselves and our nation to these craven thugs and a government that in many ways is no better than The Third Reich.  Google may be right to bleat, or they may be covering their own butts, having made a deal they thought would be honored and now finding that you cannot deal honorably with someone who considers anyone who is not part of the Chinese government to be inferior and devoid of any rights whatsoever.

If China does not wish to buy our Treasury debt (they have already stopped) so be it.  We can close our borders to their cheap crap - their lead-painted toys and now, we discover, cadmium-laced costume jewelry - again, a poison made in China being sold to our children.  Read that article - it contains wonderful statements by Chinese manufacturers like this gem:

Lead and cadmium are commonly found in metal jewelry sold in China simply because it's cheaper. A ton of high-quality zinc costs about 28,000 yuan ($4,100) while zinc with lead, cadmium or both in it sells for about 16,000 yuan ($2,350), said Frank Zhang, an executive with a jewelry factory in Yiwu that specializes in high-end exports but who did not want his Chinese or company names used.

Industry executives said most of the low-end goods with high amounts of cadmium are sold in China and increasingly sent to Dubai and other markets in the Middle East with less stringent import controls than the U.S. or Europe.

....

Chen Zaiying, manager of the Yiwu SK Jewelry shop in the International Trade City, echoed Devereux's comment, saying many Chinese manufacturers combine hazardous batches with others that comply with regulations in the destination market.

Got it?  They intentionally cheat and ship things they know do not comply with a purchase order's requirements (do you really need to specify "must not be a known poison" for something intended to be given to a kid as a piece of toy jewelry?) and intentionally intermingle poison products simply because it's cheaper for them!

If we poisoned Chinese children with products exported there they would (rightly so) consider us to have committed an open act of war against their population.  Why is it that we continue to permit this sort of outrageous conduct - the intentional endangerment of our youth - to take place all so we can claim to have an "open trade" policy with those who are intentionally shipping poisonous products for consumption by our kids?

I believe we can - and should - go so far as to selectively default the Treasury debt they hold, simply declaring it worthless, as a "fair exchange" for all the intellectual property they have stolen from our nation's firms over the last two decades and the intentional, repeated and wanton poisoning of our nation's youth.

Whatever really happened with Google China's government is long past its "use by" date and our government's continued bouts of kneeling before China's premier, all in the name of $30 DVD players, destruction of our manufacturing capacity, support and financing for Chinese human rights violations and the poisoning of our children, must end here and now.

Now here's an interesting idea....

BRUSSELS, Jan 12 (Reuters) - The European Commission is likely to launch infringement proceedings against Greece for failing to provide reliable statistics on its budget deficit and debt, an EU source with knowledge of the proceedings said on Tuesday.

What, governments lie about economic statistics?

Gee, what have I (and others) been talking about for a few years now?  Or maybe a few decades?

Let's see.... we don't count anything that might show inflation in the inflation statistics, we back $5 trillion+ of Fannie and Freddie debt with the Treasury but don't count that as debt on the balance sheet, and we have some $70 trillion of unfunded liabilities (on a discounted perpetual cash flow model) in Medicare and Social Security but don't count that either!

Oh, and we count debt in GDP, making the (false) claim that our economy (on balance) is benefiting from the use of debt to pull forward demand and finance consumption (or worse, ponzi-style speculation), even though if you go to the bank and take out a $20,000 loan you're not one penny richer than you were five minutes earlier.

The EU has scant room to complain about this.  There's not one nation under their umbrella that holds their government liabilities (that is, the social promises they've made) nor the backstops they've taken for their banking institutions on balance sheet either!

If any private company CEO or auditor pulled this sort of nonsense they'd wind up in prison. 

I find the concept of complaining about accounting "irregularities" particularly odious when it comes from somewhere like the EU, while they're doing the same thing at the same time, exactly as the US and every other major government has and does.

Before one raises such a complaint there should be a requirement that they restate their own balance sheets on a GAAP basis.  Were we to do this, of course, bond buyers would recoil in horror at how the disappearing paint had worn off the elephant that has been standing in the room the whole time.

After all, if you look at the United States alone with its bloated social spending promises you'd find that we have about $100 trillion of liabilities and yet the total tax base on which the government can assess for revenue is about $14 trillion annually (GDP.)  If you assume that the government could, at best, siphon off perhaps 15% of that without completely collapsing final consumer demand (remember that some 30% of GDP IS government spending, so you have to be careful here!) you find that they're trying to finance $100 trillion in debt with $2 trillion in revenue.  Hmmm... how's that going to work out again exactly?

Yeah.

Yes, it's from April...but it's fitting, and matches the mood of the majority of Americans today....

Happy New Year Fall Street... fall out the window, that is.

Maybe this will be the year.....

Let's score the 2009 edition first:

• The economy will NOT recover in 2009:  I'll take this one, although some would argue I only deserve half (I said 8% unemployment U3, we actually got 10%.) 
• Deflation, not inflation, will become evident well beyond housing.  Miss.  Valid if you look at energy, but the "well beyond" includes a meaningful subset of the various things people buy.  Nope.
• Housing prices will continue to decline: Direct hit.
• The Fed's attempt to "pump liquidity" will be shown to be an abject failure: 1/2 a point.  Certainly if you look at stock prices, it's a miss.  If you look at whether credit creation was stabilized and increased, its a horrifying score.  We did get the instability in the dollar, but no bond market crash.  I didn't specify how, so I can't take credit for that which I didn't predict.
• GDP will post a 12-month negative number, Depression print. Clean miss.
• The stock market has not bottomed.  1/2 credit.  It had not bottomed but my SPX 500 @ 500 call was not achieved.  The 50% swing, however, got damn close.  Lots of money to be made if you're quick and good, but an absolute minefield if you're a long-term investor - spot on.
• Precious metals will not be a safe haven: Clean miss.  Gold and silver have both performed well.
• The Dollar will not collapse.  Correct.  It hasn't.  It ended the year of 2008 at 82, it now trades at 78, down 5% or so. 
• The pound or Euro - and perhaps both - will be where the FX dislocation initiates if it occurs.  Early, which means wrong.  Clean miss although the last month sure looks bad for the Euro.
• The US Consumer goes from negative savings to positive:  Direct hit.
• Commercial Real Estate will effectively collapse: Direct hit although the effect has been well-hidden.  Several Tickers have been written on this, including major banks walking off 50% underwater properties.  I can't take full credit as the REIT explosion I expected didn't happen, so I only get half a point.
• Along with the above, expect 10% of retail stores to close.  I don't have accurate numbers on this but it sure looks that way.
• Several states will get in serious financial trouble and the default of one or more may occur.  Point.  While the default didn't happen that wasn't a condition of the test, and the list of states in trouble is long and getting longer.
• Mortgages are not done:  No kidding.  Default/delinquency/foreclosure rates continue to skyrocket.  Point.
• If you want to refinance you may get one brief shot with long rates around 4%.  You got two, but I don't lose for multiple points of impact.  Both of those were good opportunities IF your property isn't severely underwater (in which case there is no such thing as a good deal.)
• Those who have said that the corporate bond market is being "unreasonable" will start to look like the jackasses that they are.  Maybe.  Actual defaults did in fact skyrocket but new issues are coming to market and subscribing - even for crap-grade paper.  I can't take a point on this one as my expectation when I wrote it was that issue would go in the toilet.  Miss.
• The calls for "more lending" will go exactly nowhere.  Bingo.
• GM and Chrysler will go bankrupt.  Bingo.
• Protectionism and currency manipulation: Miss, at least in the way I described it.
• Commodities will appear to be headed for a new bull market (falsely): Hit.  Soy, Wheat, etc - all looked to be going parabolic in June.  Now, not so much.  "Beans in the teens" eh?  NOT!
• Sovereign debt defaults will number at least three:  Clean miss.  Greece and a couple of others are on track but didn't happen this year.  No points for "on track."
• China will have its first large-scale rumbling of civil unrest:  Clean miss.  I have to admire how they prevented it - more capacity building into an overcapacity world.  That won't end well but for now they've stove it off.
• Foreign uptake of Treasuries will be choked off - by necessity: Hit.  Almost missed that one, but China has stopped buying as the trade imbalance disappeared.  They have, as expected, turned resources inward.
• The City will get it worse than we are:  Since the test was relative I get credit for it; they're doing things like imposing 90% taxes on banker bonuses.
• Things will get "revolting" in nations: Nope.  Riots and such in Greece don't count - "revolting" meant what it said.

I count 14 "hits" (including half-points) out of 25, for a score of 56%.  That's not so good, especially compared to last year.

Ok, so where did I go wrong?

That's pretty simple: I dramatically underestimated the willingness and ability of "the criminal class" (that would be those in DC and on Wall Street) to lie, cheat, steal, paper over insolvency and get away with it - at least for a while.

Will this ultimately lead to an actual recovery?  No.  It mathematically can't.  A short-term bounce in various metrics, yes, just like an insolvent person can spend on his credit cards until they get cut off and look like they're improving.

The S&P 500 currently stands at roughly 1120.  Most "market callers" are expecting another 20% increase next year, which would put it at 1350, just 15% off the all-time high of 1576 and fairly close to where it finished 2007 - that is, as if 2008 and 2009 never happened.  Lunacy, says I, unless leverage can return to where it was in 2007.

Can it?

No.

Let's remember what happened in 2005 and 2006 that made those things possible.  Investment and commercial banks were stuffing various sorts of securitized paper with garbage loans they knew could not be paid, then selling them off to "investors" (who would later be shown to be bagholders.)  This allowed for an unprecedented expansion in consumer and financial system credit - and that, in turn, allowed the buying of "stuff", whether it was companies playing LBO or you buying a house to flip with an OptionARM.

That was the legacy of the "expansion" in 2005 through 2007, and it is not coming back.

In short this time it really is different, and the proof is right here:

This is the first time since records began at The Fed that credit outstanding has decreased.  I have taken the liberty of breaking down the periods into 10 year chunks, which makes it easier to see:

Pay attention to this last graph, as it is the important one in terms of the 2003-2007 "recovery" - note that we went from ~32 trillion in outstanding debt to $53 trillion at the peak, an expansion of 66%. 

That's how we "recovered" from the tech bust, and to believe that we will "recover" from this one you must either find a way to expand debt by a similar amount - that is, to nearly $90 trillion all-in - or figure out how you will get $35 trillion in spending in the US economy above and beyond what we're doing now over the next three to four years.  In short, we cheated, and to believe we can do it again you must explain how we can cheat once more - and to that degree.

And by the way, for those keeping score - since our monetary system is debt-based declining credit outstanding is the definition of deflation in the monetary sense!

This is exactly what Bernanke said he could avoid.  He was wrong and there is no further room for argument on that point.

Further, I do not believe for a second that the Bernanke's "pulling back" from the monetary playing field has a thing to do with the "stability" of the markets, especially housing.  Specifically, there is no evidence to be found that housing has stabilized or is improving - quite to the contrary.  Treasury's "modification" programs have been a joke, with banks either not following through with their supposed responsibilities and borrowers unable to provide documentation of income and assets (because they didn't have the documentation required at the time of the original loan, and still don't!)  In short all these "programs" are simply an attempt to paper over the Ponzi in residential housing - with little actual success, but lots of smoke, mirrors and lies. 

Madoff got away with the same game for years - produce some false statements and keep soliciting for that new business.  All is well until the cash flow forces disclosure of the fact that you're broke - then the ugly truth, that there is no money as it's all gone - comes out.

Such is happening now.  Servicers have been passing through the interest payments on MBS but principal isn't there to be repaid.  The journal entries are being ignored - for now - because none of this trash is actually trading.  It's all being held at or near "par" (100 cents on the dollar) when in fact many of these securities will be lucky to recover anything at all.  Even the "credit supported" tranches are in trouble - nobody ever believed, especially in the "prime" space, that defaults could reach beyond 2 or 3% and recoveries be under 80 or so.  But they are.  Worse, the HELOCs and "silent seconds" are in fact worth zero where the house is worth less than the first note due to priority of claims - yet most of those are being carried at or near full value.

A big part of the reason for this deterioration is due to "misclassification" of loans.  That is, loans were claimed to be "prime" when they were not - they were either "ALT-A" or worse, Subprime in fact, but stuffed into MBS as "prime paper" and then resold onward.  Fannie and Freddie have been recently fingered as a major part of this, but unlike the author of the recent WSJ Opinion piece I believe this scam went much further than the two GSEs - and there has yet to be any honest examination (say much less prosecution) for this conduct.

There's a rather complex "prisoner's dilemma" going on at the present time, with none of the banks wanting to liquidate either securities or inventory lest they trigger an avalanche.  Yet each is eying the door, fully-aware that the first one through will be the only one who gets through should anyone bolt.  One of the more-interesting identities for the man yelling "FIRE!" could be a lawsuit - or state prosecution - over the myriad misrepresentation in this space during the bubble years.

Last year (2009) there was almost no net debt issuance between corporates and Treasuries, adjusted for Quantitative Easing.  Indeed, it was only about $200 billion.  That this sort of extreme measure was required to prevent a bond market implosion is rather telling.  But what's worse is what's on the calendar for 2010 - nearly $2 trillion of net issue, duration-adjusted.  A huge part of this is Treasury debt, and there the news is even worse, as there's a serious duration problem in this regard - nearly half (about 40%) has a maturity of one year or less.  This means that Treasury must roll over that debt - about $3 trillion worth - "or else."

Ask the asset-backed commercial paper market and auction-rate securities folks what happened to them when their short-duration paper couldn't be rolled on commercially-reasonable terms.  Then extrapolate that to what happens to Treasury if (or possibly when) they're unable to roll $3 trillion plus issue another $2 trillion on top of it to fund the deficit.  Do you really think that $5 trillion and change of Treasury paper is going to be "all ok" sans "monetization" - or will "they" foment an intentionally-engineered stock market crash to scare people into Treasury debt?  I wish Timmy the best of luck with this - he's going to need it.

Remember, the belief that foreigners will not be there to rescue us this time around is not speculation - it in fact is born out by the latest TIC data, which showed that China had bought a net zero in Treasury issue in October.  Nor did anyone else step to the plate.  In short foreign nations are chock full of their own issues and are either issuing debt themselves or need their capital internally.

The equity market loves "liquidity" no matter how it comes, whether the truth is embedded in reports or not.  Nasdaq 1999 anyone?  Those firms were not making money and never would but that didn't stop their stocks from doubling, tripling, and in some cases skyrocketing to 10x their IPO prices. 

The key point is that most of them eventually collapsed and were worth zero, but if you were quick (or lucky) you made a lot of money.  Of course the other side of that ditty is that if you weren't you lost everything.

There are many who claim that valuations are not "extended" or "bubble-like" and point to the disasters of Q3 and Q4 of 2008 as "drags" on the P/E ratio, claiming that one should ignore negative earnings.  This is kinda of like going to the casino and only counting the winning wagers when determining how well you've done.  It may look impressive when you brag to your friends but it won't change the fact that you go home broke, and ignoring negative earnings is part and parcel of the same sort of disease.

The fact of the matter is that if you look to corporate and personal income taxes they have all but collapsed.  These are of course regressive and governments have been handing out various tax breaks to corporations so this may not be a fair indication of business and consumer activity.

However, sales taxes are, if anything, going up in percentage charged - not down - and yet they are also deep in the red in terms of collections by the states.  Since some "necessities" (specifically food in many states) are not taxed this is particular troublesome since this trend points directly toward a collapse in discretionary spending - exactly what we need to power the economy forward.  Then there's China, which reported on the 27th that toy shipments to the US were down 15% year/over/year from 2008 - but we're told that Christmas sales were down "only" 1%.  Riiiiight.

So much for  "economic recovery."

Productivity has been on a tear - and no wonder.  Watching everyone around you get laid off has a way of providing a hell of an incentive to work harder, lest you follow your friends to the unemployment line.

These trends - letting employees go and demanding that your remaining workers do more for the same pay, does provide a lift to profits.  For a while.  But it also destroys the base of consumers you need to buy those products over time, and thus the lift that you enjoy from such downsizing and squeezes is short-lived.  The hangover from that speedball should be hitting in Q1 or Q2 of the coming year, and I expect it to be quite the doozy.

China, on the other hand, has outdone us.  Burdened with far too much capacity they are, of course, building even more!  That would be great except that there's no chance they can absorb the output internally.  Not that they care in the short term, as their definition of "GDP" is different than ours - they count a product when it is produced, not sold.  Gee, why are there all these products lined up unused, from cars to washing machines to - gasp - literal empty CITIES of townhouses and apartments?  How far does that bubble inflate before it blows up?  Hell if I know - the Chinese are not exactly models of transparency so the degree of game-playing they can get away with before someone yells "FIRE!" and runs for the door is more difficult to discern than it is over here. 

In the last few days the Chinese Premier has said that he won't "bow to pressure" to allow the yuan to appreciate.  This of course is code for a weak currency which China desperately wants for its export trade.  Then again, so does Japan, and so does anyone else who exports.  Competitive devaluation sounds quaint, but you're seeing it, and it is likely to continue as an attempt to play "beggar thy neighbor" in the coming year - and beyond.  Playing with explosives these nations are (including our country!)

In the credit arena few lessons seem to have been learned.  CDOs, CDO^2s and other similar loose-pin grenades aren't back - yet - but an awful lot of questionable deals are, including, believe it or not, a couple of PIK/Toggle issues.  Those, for the uninformed, are bonds that allow payment not in money but in more debt!  This sort of "debt pyramiding" is the epitome of stupidity when done by a person and a fairly reliable sign of impending default.  In the corporate world we call it "reaching for yield."  Uh huh.

Many market commentators believe that last year and through March 09 was a "financial panic" similar to 1987, from which the market recovered quickly.  Really?  Go look up the page a bit at the credit chart for the 1980s.  Do you see any contraction in 1987 and 1988 - anywhere?  Nope.  None.  In fact, credit growth continued unabated even though the stock market crashed.  The same occurred in the 2000-2003 time frame (again, look above) during the Tech Implosion.  That's the differentiating factor: This was not a market panic, it was and is a credit lock-up caused by outstanding debt exceeding servicing capacity for several years, where the premise became not paying debt through current income but rather a Ponzi-style pyramid that permitted refinancing and the appearance of solvency only so long as asset prices rose!

This is an event that last occurred in America in the 1920s and it occurred this time for the same reason it did the last time: lax or utterly absent regulation allowed people to foist off trash on people while claiming that it was "money good", just as happened with Florida Swampland in the 1920s.  The entire premise of the so-called "financial innovation" then, as now, was fraud.

The simple fact of the matter is that greed often comes with stupidity and nearly always is shortly followed by disaster.  "Rescued" by governments the "princes of finance" learned nothing, were forced to disgorge nothing, and still walk free among us instead of being either jailed or worse, strung up from a lamp post. 

So far.

Whether the people of the various nations will put up with another trip down the bailout, Quantitative Easing or "stimulus" road is another matter entirely.  Tim Geithner and others have gone too far in their grandstanding, cheerleading and claims of "Armageddon Avoided" - or if you prefer, "Mission Accomplished."  Such claims make for great sound bites but have a habit of slamming the door on future intervention, especially if the need for it appears shortly after the claimed "success."  Remember well that 2010 contains a midterm election in November, and as things stand our new President has seen his approval rating drop faster than a condemned man does through the floor when the handle is pulled.

Then there's the "HAMP", or "mortgage modification" programs generically (there have been several.)  It was claimed that HAMP in particular would prevent 4 million foreclosures by the end of 2009.  It has actually resulted in about a half-million trial modifications, but fewer than 100,000 permanent changes.  This should not surprise - the reason people got in trouble in the first place as that they bought more house than they could reasonably afford on any rational mortgage plan, using schemes such as 1.5 or 2% negative amortization "OptionARMs."  These were not actual mortgages in intent - they were predicated on ever-rising home "values" so that they could be rolled over in a couple of years and amounted to a perpetual below-market rent payment to a bank, collateralized via the speculative bet that prices would continue to rise.  When home prices stopped going up there was literally no way around the inevitable - foreclosure.

Government refuses to recognize this as all the trash paper is literally everywhere around the globe!  What's worse is that the very same banks that were making these bets along with homeowners then extended HELOC and other second-priority lines behind the first, extending the trash brigade even further.

Never mind Geithner's insanity, as displayed here:

GEITHNER: We were very careful from the beginning—but the qualifications get lost—to say that we are going to focus the bulk of the financial force on bringing interest rates and mortgage rates down to cushion the fall in housing prices and help stabilize home values, which will feed into people's basic sense of financial stability.

The reason we got a bubble in the first place was due to excessively-low rates - that is, a cost of borrowing money that did not reflect the fundamental economic realities of repayment and duration risk.

Insanity defined: Doing the same thing over and over but expecting a different result.

There is much hot air blown about how businesses and consumers have "de-levered."  Hogwash.  Again, back to the top graph - we've taken a whole $21 billion off the net credit exposure.  Oh sure, if you remove FedGov from the picture (and you arguably should) it's more like $850 billion - but let's be real here - we're talking about a fifty-three trillion dollar debt. 

Even a trillion is less than a 2% reduction in net leverage!

That's "de-leveraging"?  Like hell.

There is much, much more to go.  To get back to the leverage levels seen in 2000 - which themselves were overheated - we'd have to drop back some twenty five percent, or roughly $13 trillion dollars.

We're less than 10% of the way there, and we were overheated in 2000.

What's a more reasonable leverage level?  How about the "more reasonable" time period between 1951 and say, 1983?  175% of GDP?  That would require we cut the outstanding debt by close to half!

Will we see policies that accomplish that?  Not voluntarily!

On a more-macro (beyond one year) level, let's look at this last-decade debt chart again:

In the beginning of 2000 the total systemic debt outstanding was approximately $25 trillion.  It is now about $53 trillion, or more than double where it was in 2000. Let's look at where we were in various metrics at that time:

• GDP was at $9.7 trillion.  It is now 40% higher, roughly.  (Gee, did we really produce all that with our hands, or did we borrow the money, spend it, and then count that as "GDP growth?")
  
  
• Aggregate GDP over the 2000-2009 years was about $124 trillion; of that, about 20% (25 trillion) was increase in debt over the same period of time. Our so-called "growth" over these years was in fact a chimera in that more than half of it was not real - and that's assuming ZERO interest expense now and forevermore.  Of course interest expense isn't, in fact, zero......
  
  
• The S&P began the year 2000 at 1469.  It now stands at 1126, and that's before inflation adjustment.  The DOW was at 11,500, again, before inflation adjustment, and the Nasdaq 100 was at 3708 (it currently trades 1870.)  Again, all before inflation.  Take 30% off all of today's numbers to adjust for devaluation of the currency's purchasing power (that is, inflation) over the last decade and you're roughly in the ballpark.  The bottom line: you have lost big - more than half if you were in the S&P 500, about 40% in the Dow and a crushing 70% if you were in the Nasdaq 100 over the last ten years.
  
  
• There was no shelter to be found in Real Estate either.  Home prices are back to 2000 levels in many parts of the nation, but a huge number of homes are "underwater" on the profligacy of debt taken on by Americans: about 25% of all loans are underwater nationally and nearly half in Florida.  In 2000 that number was basically zero.
  
  
• There was no net job creation but we went from 282 million to 307 million people in America.  That means 25 million people are unemployed simply due to population growth.  Ain't that grand?
  
  
• Median household (and per-capita) income has actually declined since 2000 adjusted for inflation.  Of course gasoline is more than twice as expensive ($1.26/gal in January of 2000), eggs are more expensive (double, roughly) and such.  Never mind medical insurance and health care - double-digit escalations every year have been the rule rather than the exception with medical insurance costs being up a literal 200% or more over the last ten years.

This little game of Ponzi (faking "GDP" by taking on more and more debt), by the way, is not new.  I present for your edification the following table:

This is the aggregate GDP (that is, all GDP produced) during each decade from 1960 onward, the "DTi" (or debt increment) during that decade - that is, the additional debt outstanding in all sectors during that decade, and the percentage of "GDP" that in fact was NOT from production, but rather was "created" due to raw borrowing.

What we are facing down today is a fifty year Ponzi scheme.  Drill that into your head folks - for fifty years we have created false output gains, with the last 40 of those years having between 15-20% of each year's supposed "GDP" not created by the work of people, but by BORROWING MORE MONEY which will have to be repaid with interest.

This is why we hit the wall in 2007.

To run an increase in GDP of about 5%, as so many "pundits" are claiming we will going forward, we would have to increase the total debt in the system to roughly $90 trillion dollars from the present $53 trillion over the next ten years.

That debt would, of course, need to be serviced.  And nobody in their right mind can possibly believe that government could take on another $37 trillion - when the current oustanding public debt is just seven trillion (that is, government would have to increase its debt by 500%!)

If you take nothing else away from this Year in Review Ticker, it should be that singular chart above and a decent understanding of what it means:

To come back into equilibrium, assuming we do not decrease debt in the system at all, we would have to shrink GDP by about 20%.  But shrinking GDP means that money available to pay down debt would also decrease which would generate even more defaults. 

This is how deflationary depressions happen - years, even decades of playing Ponzi by layering debt upon debt.  Bernanke and Geithner, along with President Obama, are well-aware of these facts which is why they are all pounding the table demanding that banks "loan more." 

The problem with such a prescription is that the wise person won't borrow, for he knows what's coming.  The unwise has no collateral to pledge, and thus can't borrow.

If the government forces (either by persuasion or legislation) lending to those who can't pay they only extend the Ponzi and in doing so make the inevitable collapse WORSE.

We have made no progress economically in terms of the common weal of the average American but have added debt in dramatic amounts to paper over the deficiency.  That's the bottom line on the 2000s, and despite all the crooning that "the economy is on the mend" one has to look at the reality of the common man on the street to see what's coming around the bend for our economy and ask the following question:

How do we get positive economic growth when by every metric available the disposable personal income available to Americans has gone down, personal wealth has in fact decreased when one subtracts out debt (and you must; nobody in their right mind argues that if you go to the bank and take a cash advance for $20,000 on your credit card that you are "more wealthy" as a consequence of having done so!) and while employment at first blush looks "equal" to 2000 in fact there are 25 million more unemployed due to population growth - people who create drag on the economy due to entitlement spending rather than contributing to productive output?

So with all this said, here's what I believe we're looking at for 2010... ready or not, here it comes!

• No, this is not a new Bull Market; the market will be lower on December 31st than it is on January 4th, quite possibly by a a hell of a lot.  We may not break the March 2009 lows - but I also don't believe for a second we're going back to 1576 on the SPX.  Not without the leverage - and we can't get the leverage.  I believe we will end the year down from where we begin on January 1st.  McHugh calls it "Wave 3 Down"; I call it "aw crap."  Either way "irrational exuberance" is back for now but cash flow always wins in the end.  I'll be a "generational buyer" of stocks when dividend yields are over 5% and P/Es are in single digits.  We didn't get there last year and yet those are the historical metrics that mark true Bear Market bottoms.  With that said, I would not be surprised if we hit 1220 on the SPX some time earlier in the year - but it is by no means a lock, contrary to what virtually everyone in the "pundit community" expects (most of which are looking for 1350 or more!)
  
  
• The Long end of the Bond Curve is going to move higher on yields.  We have completed a long-term (multi-year) inverted Head and Shoulders pattern.  The probability of the targets set by that pattern being achieved is extremely high.  The target?  6.9% on the 30 year "long bond" - a rate that puts 30 year mortgage money at least to 7%.  This prediction assumes that we do not get a panic-style sell-off in the Stock Market - if we do get one (and I think it's 50/50 on that) then I withdraw this prediction.
  
  
• House prices will fall another ~20% - whether as a consequence of the rate back-up or utter destruction in the markets generally.  Sorry folks, the housing mess is not over.  The math on this is simple; a $200,000 principal loan at 4.75% for 30 years produces a P&I of $1039.18.  That same payment with a rate of 7% produces a principal financed of $157,107.95.  If, for whatever reason (engineered or not) the stock market collapses then you get your housing price crash anyway.
  
  
• Banks will "give up" on holding their real estate as rates start to backup and will dump their foreclosure inventories.  Why?  Because the regulators may let them to play games with alleged "values" when people can get mortgages at 4%, but at 7% there's just no way the numbers work and the fraud becomes too difficult to countenance.  There are rumors of major banks dumping hundreds of thousands of homes on the market next year - this is likely the backstory on "why."
  
  
• Credit will not ease for "ordinary people."  All the exhortations about "lending more" have been going on now for more than two years yet have gone nowhere.  The jawboning will continue but the results will not come, simply because there is no more good collateral left against which to lend.  This will in turn lead to.
  
  
• A massive second wave of small business bankruptcies will sweep the nation.  We've seen the first part of it.  The second will be worse - far worse.  With long rates backing up and the 30% credit card sweeping the land those who have relied on credit to operate in the small and mid-sized business world will get relentlessly squeezed.  Many will fall.
  
  
• Unemployment will appear to be stabilizing - for a while - but that will prove illusory.  We finish 2010 over 10% - no material improvement.  If things get real bad we might see 12-14%.  Yes, U-3.  I won't stick my neck out that far as a prediction but I believe ending the year at or above 10% is a lock.
  
  
• The "revolting" call for last year was early - but not wrong.  There will be at least one major coup or other violent overthrow of a government in 2010 tied to economic instability - either directly or via a war it spawns.
  
  
• The states will go to the government well for handouts, they will probably get them, but it won't matter.  They'll get some assistance at least, but in the grand scheme of things it doesn't make any difference in a world where long rates are rising precipitously.  California and Arizona are in the biggest trouble, with Michigan, New Jersey and New York right behind.  The public employee unions will have a kitten but again, it won't matter - that which isn't there isn't there, whether you want it to be or not.
  
  
• A "double dip" will be recognized by the end of the year.  Between taxes and rising rates - or an intentionally-detonated stock market to stop the long end of the bond curve going bananas - you can bet on it.
  
  
• China will lose control of their property and plant bubble - with horrible consequences.  They're good at the game, but that which can't go on forever won't.  I bet it blows up before the end of the year.  If so, Australia's property market better watch out - they're levitating on the strength of China's commodity demand and pricing there is California-style. 
  
  
• The Canadian Real Estate Market will show signs of cracking - especially in places like Vancouver.  They may have another year before it all goes to hell, but the time approaches.  Beware.
  
  
• The Fed's games will "leak" and credibility will be shaken severely.  There's too much pressure.  Something will give, somewhere.  Washington DC is too hostile a place for the "hold hands and head for the cliff together" game to work with an election coming up......
  
  
• The Democrats lose big in the House.  Time is probably too short for a viable third party to emerge for the midterm elections, and I don't expect the Democrats to lose House control.  However, I do expect them to lose their filibuster-proof majority in the Senate, and to lose enough seats in The House to trash their "steamroller" approach to legislation.  This might be bullish for the markets late in the year and into 2011 - maybe (divided government is generally good for the markets.)
  
  
• Congress continues to try to spend its way out of the recession - and runs head on into rising rates.  Watch the TBAC reports.  Those will be your "tell" along with the TIC data.
  
  
• One or more of the PIIGS (Portugal, Ireland, Italy, Greece, Spain) either defaults technically or is forced into austerity by the ECB.  Further, Eastern Europe becomes dangerous destabilized.  There is a real possibility of outright hostilities in that part of the world next year.  Let's hope not.  The ECB has a nasty problem on their hands; I have said for quite some time that the Euro is likely to trade at PAR down the road.  This year is probably not the year for it, but the cracks in the dam that ultimately could destroy the European Union should become very apparent in 2010.
  
  
• Contrary to virtually EVERY "investment pundit" on the street today return OF capital will once again assert itself as the primary consideration.  Sentiment indicators as of 12/31, along with 52-week highs, all are at levels that have been associated with tops on a historical basis.  Treasury has to issue $2.5 trillion this year, while we all cheered when they issued $1.5 trillion last year - and got away with it.  China has housing trading at 80x average incomes, Australia and parts of Canada have housing markets at 10x or more average incomes and the banksters and "investors" alike appear to have learned nothing, with "reaching for yield" coming back in force.  Ponzi ponzi ponzi!  Add to this geopolitical event risk and things get interesting.  That which can't continue forever won't - we merely argue over timing, not outcome.  I'll lay the marker on one or more of these timers reaching zero in 2010.

Note: Subject to minor edits/revisions and perhaps an addition or two until the end of January 1st, as usual.

Edit: 1960s DTi had a misplaced divisor - corrected and paragraph referencing "nutty Ponzi" in that decade removed.