Band Aids and Hope

Unfortunately, this is all that’s holding our fragile economy and financial system together as we enter this most important week of trading. The band aids are the fiscal stimulus programs and government (see taxpayer) funded bailouts of the banking and financial industries. Trillions of our hard-earned tax dollars are being dumped into the economy in an attempt to re-inflate the markets, and it’s clear to anyone even remotely paying attention that this approach is failing miserably. Students of history know how big of a mistake the New Deal was in the 1930’s, and for some bizarre reason the powers that be are not only repeating the exact same mistakes, but they are doing so in the same order. Some would say that the government has no choice…that at this stage of the game they simply have to throw trillions at the problem to stave off another depression. Really? Then why aren’t we seeing even a basic turn-around in the stock market or in the economy? The truth is that the government’s actions are reckless, reactionary and just plain dangerous. If they continue with their present course of action they will send us over a cliff that will take a decade or more to recover from.

Hope. Obama’s best selling book was based on it, yet all we hear from the changeling now is fear and doom. What happened to the optimist that won a land slide election on “change that we can all believe in”? Granted, he’s only been in office a couple of months and while it’s true that he inherited much of this mess, his administrations actions are making things much, much worse. We are buried in debt to the point of being beyond bankrupt….over $60 trillion according to the non-partisan Congressional Budget Office (CBO)…yet his remedy for our systemic debt issue is….you guessed it…more debt! His nearly $4 trillion budget proposal is beyond belief and if allowed to pass will likely be the final nail in this economies coffin.

Remember what got us into this recession that’s quickly becoming a depression? Everyone…the federal government, corporate America, state governments, and individuals…spent like a drunken sailor for close to two decades. At every level we became addicted to living beyond our means, and now it’s time to pay the price. Simply put, it’s time to finish the deleveraging process that started after the Lehman bankruptcy just this past September. And guess what? The good news is that’s exactly what everyone is doing, and at the same time. We’re cutting back on spending, reducing debt and increasing saving. Everyone except for the US government of course, whose spending continues to grow like the party will never stop. Everyone else is cutting back big time. California, New York, Michigan, and 30 other states are slashing their budgets to head off an economic implosion. Corporate America is laying people off at the fastest pace in over 60 years, and we’ll see the worst unemployment number since the 1940’s when the data is released this Friday. The estimates are for 750,000 layoffs in February alone, bringing the total to over well over 4 million in just the last 6 months. Finally, consumers have begun to curtail their spending in a contraction that’s one for the record books. Consumer spending has dropped faster than a lead balloon….I guess that’s what tends to happen when you fear for your job, you have no money saved, and you can’t keep borrowing money the equity in your home, aka our personal ATM’s that have been the primary driver for the US (and global) economy over the last 8 years.

Now for the bad news: The rapid fall off in consumer spending will only hit our consumer based economy that much harder. This is how a classic deleveraging process takes place, and it must be allowed to run its course. These phony government stimulus programs only deepen the fall and slow the recovery.

Buffet Bankruptcy?

Maybe you’ll look back and remember that you heard it here first. If the stock market drops another 50% from current prices, Warren Buffet’s holding company Berkshire Hathaway will likely be insolvent. This is due to Buffets incredibly poor decision to enter the derivatives markets by selling short naked puts over the last two years; this after warning about them in his 2002 letter calling them “weapons of mass financial destruction”. His ill-timed decision to bet on a continuing bull market through the use of derivatives added to his portfolio’s losses, which now total over $40 billion in just the last year. Buffet’s 2009 letter to shareholders was released on Friday and in it he said he was “certain the economy would be in shambles for 2009," and that “2010 would not be much better". He also cautioned there could be "unwelcome aftereffects of the massive stimulus and bailout," such as inflation. He contended the "investment world has gone from underpricing risk to overpricing it," which he said is reflected by investor appetite for Treasury bonds. Future historians will comment on the Internet bubble of the 1990s and the housing bubble of the early 2000s, he said, but "the U.S. Treasury-bond bubble of late 2008 may be regarded as almost equally extraordinary." Just another reason that VRA loves gold and silver!

The Crucial Week Ahead

With the Dow teetering at just over 7000 and with the market reaching 12 year lows, it’s very likely that the next explosive move lower lies just ahead. European banks are reaching the point of no return, Citi and Bank of America are much closer to being nationalized than anyone in the government will admit, and as many as 1000 US banks are a year or less away from becoming insolvent. Add to this the turmoil at AIG, GM, Chrysler, Ford, the insurance industry, and the commercial real estate market, and it’s clearer than ever that the dominoes have begun to fall.

 What we need now is a complete "capitulation" in the stock market. We need a day (preferably a Monday) where the stock market opens down 10% on bad news. This is what typically happens before a massive bear market rally, or possibly even a bear market bottom. One key factor that is preventing a sharp, panicky selling of shares is the piecemeal nature of government attempts to rescue banks and the economy. What we're getting instead is Chinese water torture, and no massive cleanout. Governments and central banks are watching the markets and giving investors small glimmers of hope, not enough to take markets higher, but enough to prevent a huge sell-off. For capitulation to happen markets will have to be hit by a big, negative news event, and for the rebound to be sustainable, the overall environment would have to improve.

We need to see an event that would shock everybody -- a big U.S. bank failure, or a country in Europe going broke. Then we might finally have a sharp sell-off that’s triggered by an event, followed by a huge turnaround as people reversed their short positions and bought into the rally.

I firmly believe that we are weeks, if not days away, from one of the most explosive moves ever in gold and silver. Not only do they represent calm in a sea of fear but they continue to be the only true currency on the planet. Imagine gold at $3000/ounce and then decide how much you want to buy.

Final Note:

The market has figured out that the government is simply trying to stall the speed of the collapse, and I strongly recommend that you use any move higher to sell stocks that you don’t want to own. I’m as sure that the Dow is headed to 5000 as I was when it was at 9000 and I said it was headed to 7000. Long term this is where we are going and I’m afraid that it may not stop there given the governments masochistic behavior.

It’s almost like they want it to happen…but that couldn’t be true, could it?

Kip Herriage

Editor, VRA