The global economy collapsed in the end of 2008 causing the stock markets to plunge nearly 50 per cent. The Chicago Board Options Exchange Volatility Index (better known as VIX or fear-index) plummeted nearly 300 per cent. People were losing confidence in the economic system.
These sentiments changed completely in the last few months. The Dow Jones Index rose 50 per cent since March and the VIX is down to the levels of January 2008 again. Some banks are even showing profit again! The confidence in the banking system has been retrieved, Citigroup rose 320% since March.
But is it this good? Is the recession going to be V-shaped anyways? Are the problems nearly gone or yet to come?
Friday, the Dutch minister of Finance said in an interview on Dutch television that a ‘new dip’ could occur. According to the Dutch minister the new dip would be a cause of higher unemployment rates and less-consuming consumers.
I linked a video in which Elizabeth Warren, the Harvard professor who is the head of the TARP Congressional Oversight Panel, is being interviewed about the current problems in the economy.
When the interviewer asks “Are we out of the wood as far as toxic assets?” Elizabeth’s answer is very straightforward. “No.”She continues: “By and large, the toxic assets that brought us to this point are still on the books of the banks.”
How come that when the toxic assets are still on the books of the banks the confidence is rising and banks are showing profit? Elizabeth says: “Once the folks changed the accounting rules, which is what happened over the last few months… that means that you can carry them on your books at a higher level than the market would treat them… and now the problem is the banks say in effect, ‘Why do I want to sell them, because if I sell them… that means I have to recognize the loss.’”
An interviewer asks: “If an awful lot of these great big banks are underwater; if you price their assets what they’re worth, you could have a second big hit here, couldn’t you?”
Elizabeth answers: “You could have real trouble.”
I couldn’t agree more. Even this weekend the German Real Estate bank said they will need another stimulus to stay alive. They need 26 billion dollar. According to the Federal Deposit Insurance Corporation 416 banks in the USA are listed for having liquidity problems. Last year ‘only’ 117 American banks were listed. The number of American banks in trouble has more than tripled in the last year!
I also added a video featuring John Kanas. His private equity firm bought Bank United of Florida in May. Mr. Kansas is predicting that 1,000 banks will fail in the next two years.
He says: “Unfortunately we’re not seeing any evidence of a recovery in the real estate market.“
Maybe the American consumer can get us out of this?
Consumption counts for 70% of the American economy and since this (still) is the biggest economy in the world the American consumer has a huge influence in the well-being of the world economy.
The only sad thing is that the American consumer is in some serious problems. The household debts doubled in the last 9 years.
Debt to GDP levels increased and personal savings have been decreased. Housing prices are decreasing and therefore the value of the total assets of the American consumers are decreasing too.
Less assets and more debts.
Just below is an overview in the history of housing prices, you will see how insane the increase of housing prices are in the current boom. Just imagine what would happen if the housing prices went back to the levels of 2002. One of the reasons for the major increase in prices was speculation. In 2006 one out of every three houses bought were bought as an investment.
Once the speculation started to slow down the prices went down, starting the problems for the banks. If the housing prices keep decreasing the banks will even be in greater trouble because on a certain point the problems will go beyond the sub-prime loans and start entering the Alt-A loans.( loans to people or businesses with a better creditability than the people or business with sub-prime loans). In the chart you’ll see the decline in the housing prices of the past few months.
How about the Stimulus plans?
The American government has pumped loads of money into the economy to avoid a depression. They printed massive amounts of money and injected thousands of billions of dollars. What are the effects of the quantitative easing?
It certainly boosts the economy, according to Moody’s the influence of the stimulus on the real GDP growth will be like the this:
It will certainly help to make this recession less steep. But what are the negative externalities to quantitative easing?
Warren Buffet stated it like this in his column in the New York times: “ In nature, every action has consequences, a phenomenon called the butterfly effect. These consequences, moreover, are not necessarily proportional. For example, doubling the carbon dioxide we belch into the atmosphere may far more than double the subsequent problems for society. Realizing this, the world properly worries about greenback emissions.” (…) For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself. To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 per cent of the gross domestic product. This fiscal year, though, the deficit will rise to about 13 per cent of the G.D.P., more than twice the non-wartime record. In dollars, that that equates to staggering 1.8 trillion. Fiscally, we are in uncharted territory.”
So no one knows what consequences this giant government deficit will have?!!
Warren Buffet continues. (…) “During this fiscal year, it (the ‘net debt’ of the United states) will increase more than one percentage point per month, climbing to about 56 per cent from 41 per cent. Admittedly, other countries, like Japan and Italy have far higher ratios and no one can know the precise level of net debt to G.D.P. at which the United States will lose it’s reputation for financial integrity. But a few more years like this and we will find out. “
My thesis is simple: This recession will take longer than expected and will certainly not be a V-shaped recession. We are far from out of trouble…
That’s been a lot of bad news, so should we sell all the stocks and buy a loads of puts?
No. Since the market still clearly is in a strong uptrend you shouldn’t sell your stocks or buy puts yet. You shouldn’t heavily invest in a bear-market and you shouldn’t sell your stocks in a bull-market. Martin Zweig, one of world’s most famous investors, stated it like this:
“If you buy aggressively in a bear market or into individual stocks that are performing badly, it is asking to try to catch a falling safe. Investors are sometimes so eager for it’s valuable contents that they will ignore the laws of physics and attempt to snatch the safe from the air as if it were a pop fly. You can get hurt doing this.”
I think the best thing to do is to put travelling stops under your stocks. ( 5-10 % beneath the current price, depends on the volatility of the stock price.) Also, I would only buy put’s when the 4%-indicator gives a sell. (The 4%-indicator is a very reliable indicator Martin Zweig explains in his book ‘Winning on Wall-street’. It looks at week-to-week changes in the value-line index. If this is greater than +4 per cent it will give a buy, if it is smaller than -4 per cent it will give a sell.)
That’s it for now,
Regards.
