Saturday, January 5, 2008

Happy New Year!

Happy New Year to all who visited my blog in 2007.

For 2008, I am planning a daily private newsletter to be delivered via user name and password (with some sort of modest subscription fee).

The service will be offered through under the title of The Buttonwood Speculator. I plan to do what I did with the blog -- provide valuable information with a focus on trends impacting the markets (hopefully trends which others have not immediately noticed). From the feedback I received last year, my content alerted many to a variety of very profitable trading opportunities.

The ultimate goal - to continue to stay ahead of the curve!

When I left off last September, I recall stating that the market would retest its previous bear market lows of about 6 years ago in 2008. I still believe we see those lows retested, but certainly with bear trap rallies along the way that shall likely extend the market blood letting into 2009. With 4th quarter earnings/outlook season upon us, the reality is about to set in for many of stock prices being too far above projected earnings growth. And as we move along through 2008, the reality of the depths of counter party risk from derivatives will also be better understood as more disclosures are made thanks to FASB 157.

The President's working committee on financial markets (which many have dubbed the PPT) won't go down without a fight and will do it's best the keep a tourniquet on the stock market outflow through their well known modes of operation. Along with that, more rate cuts by the Fed might provide some support for stocks, but what did the last quarter-point give the bulls? Yep, here we are again, encroaching on the previous lows of 2007 with clear evidence a recession is under way (negative December retail sales when adjusted for inflation, contracting manufacturing, rising unemployment, falling leading indicators, contraction of the monetary base, a yield curve largely under Fed Funds, near moribund housing and auto sectors, unraveling LBOs etc).

Incidentally, most folks have a wrong headed notion that a recession is defined as two consecutive quarters of GDP contraction. That is quite incorrect. NBER, the group that officially sets the start and end dates of recession, states that it looks at a variety of factors to determine if the economy has moved into a recession. GDP contraction is but one factor. Put more subjectively, if it looks like a recession and feel like one - then it is. And with all of the weak economic factors listed above, there's no doubt we're in an era of tough economic times. We don't want to be negative doom and gloom, only honest about assessing the negatives and positives out there.

The problem that the Fed is confronting and even the Administration as a whole as it considers a behind the curve"fiscal stimulus" is an insolvency problem that has entangled the entire financial food chain - from the misfits who took out subprime loans with only consideration for the teaser monthly payment to the outright crooks who pushed those loans (from Countrywide to Citigroup, the Fed, etc). The policy makers who live lives that most Americans can only dream of (eg. no money worries and a Platinum, or Black Amex card with no spending limit) clearly do not understand that we're in a situation that requires far more than throwing money (liquidity) at the problems of the over leveraged financial system - let alone the average tapped out consumer whose housing ATM was shutdown last year.

Housing stands as a stark example of the solvency problem. The 30 year fixed mortgage rate is below 7%, yet with these attractive rates, housing was further beaten down at the end of the year. Lenders are leery of lending as housing prices fall and buyers are leery of buying because housing prices are falling.

Even with extraordinary measures like the Term Auction Facilities by way of the Fed, or the half trillion dollars in 2 week loans from the ECB that were quickly soaked up by the Euro banks in mid December, the ABCP market remain locked up with just a modest contraction in Libor rates.

So with the Fed and other central banks way behind the curve, I am sticking to my outlook for a sagging 2008 stock market. Go back to spring 2007 - what a glorious time. Pick a stock, any stock, and just the whiff of buyout rumor would send it flying. Spring 2007, decent non farm payrolls and a seemingly limitless flow of LBOs, was the widespread justification the bulls used to tell everyone to remain fully invested. Spring 2007 - Bernanke and Paulson were singing the "Containment" song, convincing those who could easily be fooled, and that was most everyone, that the economy was sound and all was well except for that pesky little subprime problem. That's all in the past now. The virtuous cycle of low inflation and firm economic growth is dead. With apologies to perma bull Abbey Cohen, I am just not seeing any reason to be bullish on major indices like the Dow, S&P, Nasdaq, or Russell 2000. Sure, there are plenty of opportunities on an individual stock basis, something to be covered in my newsletter.

As of last September I was bearish on the dollar, and bullish on commodities. I remain bearish on the buck and still hold a bullish bias on crude and gold, with a wary eye on correction risk in both crude and gold.

$1000 gold that the pundits are talking about? That's seems like an fairly easy forecast for this year, though not in a straight line up (can you say black box?). Much of how quickly gold progresses to the upside will depend upon how rapidly the dollar falls, and on demand by investors for a "hard asset" should we see larger scale bankruptcy risk emerge among exposed companies within the Fortune 500. Geopolitical troubles remain a wild card to give gold a further push. My preferred non leveraged vehicle for gold is the GLD ETF. The closer gold gets to $1000 the more resistance and volatility with risk of intraday swings of $50 or more.

A deeper foray into $100 territory, like $115 to $120, for crude? Not impossible even after last year's run. It only takes a refinery outage, or further unrest in an OPEC nation to set off a flurry of buying. Consider too, that in the last two recessions, daily demand for gasoline and diesel did not markedly die off. Recession or not, we're a nation of drivers. The run rate continues to hold at over 9 mln barrels per day for gasoline demand and 4 mln-plus for distillate fuel oil products. In an era of tighter world supply/demand from just 6 years ago and a far larger economy, if consumption dropped by 500k bpd for gasoline, or 200k for diesel, we're still talking about fairly pronounced demand in a "average" recession scenario. That in combination with a weaker dollar stands to keep energy prices firm. Doom and gloom world Depression? Then, of course, all bets are off and energy tanks. For now the trend is your friend and that is stronger energy prices with a floor at the extremes, for now, at about $88 per barrel, which would be an ominous signal for the world economy if we pulled back that far.

There's a lot more to the investment puzzle beyond what I've touched on that I look forward to covering in my online newsletter. The targeted start date will be Feburary 1st.

I will update shortly and hope you will subscribe.

All the best for a Happy and Prosperous New Year,

Jim Kingsland

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