Saturday, December 13, 2008


The past two weeks have felt good. My attitude has improved, I've taken the mental "for sale" sign off my assets, frequented expensive restaurants, and even done some small, deferrable, home improvements. It's amazing how much better you can feel when the DOW retraces 1500 points. 

While I feel better, I'm also a realist. I don't believe we're in the process of moving higher, stimulus or no stimulus. The headwinds are severe and not all baked into the cake as yet. We may move somewhat higher, but we'll be coming right back down. So, as I reported recently, I've written covered calls and lightened some long positions. I've increased my gold ownership and inverse bonds. Both will help further out when inflation starts screaming. The inverse 10 year treasuries may not help as the economy deteriorates further.

So far the Fed, Treasury, and Congress have attempted, ineptly and impossibly, to neutralize the necessary correction on housing, investment banking,commercial banking, and the auto industry. What's still to come? Here's my list of 2009 problems:
  • Emerging market sovereign debt. Developing countries have borrowed huge amounts and, with economies crumbling, cannot repay. We'll need to create old-time Brady Bonds to hide this mess for a few years. The same cast of characters, big investment banks, domestic and foreign, insurance companies, and hedge funds were at work here.
  • Municipal Bond defaults are coming. You've read about California's problems and the other states and cities lining up for handouts in Washington. Their claim is that they have only a liquidity issue. Wrong. They've built empires and now tax revenues are falling and they are not even going to be close to being able to pay their debt service. Tax increases will only compound their problems. Defaults are inevitable with bondholders taking losses in the restructuring. The yields are high for a reason.
  • Leveraged Buy-Outs are toast. They've stayed alive by refinancing when rates were dropping. A weak economy is going to kill their profitability and bankers won't be in a position to restructure creatively. Bankruptcy restructuring will become the LBO norm. Equity and bondholders will both lose, especially the stock ownership.
  • Public Pension Plans and University Endowment Funds will increasingly admit their mistakes. Both were the favorite sales target of all of the go-go financial ideas of the past decade. They will take staggering losses. The bad news is that the public pension plans will come back to cities and states and demand more funding to keep their obligations kosher. That will mean tax increases or program cuts elsewhere. Universities that built bloated structures, all did, based upon higher tuition through endowment help and student loans will find that neither are as plentiful as anticipated and will cry for help from the states.
  • Worst of all, the US Government and Congress, will find that tax revenues are woefully short of expectations. In the face of bailouts of all nature, massive stimulus spending, and Federal Reserve printing of money, the World will see that the U.S. tax receipts are slowing dramatically. Much less capital gains and corporate profits than in the Bush era plus a higher unemployment rate and less personal income tax doesn't fund debt service on tons of new, and old, treasury debt very effectively. That in itself should induce higher interest rates, but it will also lessen the safety trade into treasuries and this will move interest rates upward.
  • And we're still not done with crazy derivatives gone wild. They will be with us for years as they blowup and unwind.
The reasons I've listed above cause me to stay cautious by keeping lots of assets in reserve, albeit at lousy returns, and avoiding future falling knives. I enjoy thinking that I can find an undervalued stock so I'll forget my own warning and buy stock periodically, but I believe that I'll make more money in 2009 on negative bets on the market than I'll earn on my long positions. My bet is that after the euphoria of the Obama stimulus package dies in February, the market will be heading South once again due to the list I presented above. I've convinced myself that the odds of going down are higher than those of having stocks increase in 2009.

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