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It seems that my Thursday edition of Wall Street Insights & Indictments was warmly received by the bullish crowd, many of whom reached out to me to thank me for my optimism.
I'm sorry to burst your bubbles, but I am not a raging bull (but thank you for asking).
In fact, I'm still bearish.
There's a big difference between being bullish and playing all stocks (and other asset classes) from the long (that means "buy") side, and judiciously buying select momentum stocks with fat dividend yields, which is what I was recommending on Thursday.
I was talking about taking the path of least resistance, which I identified as "upward," based on equity activity through year-end and so far in 2012. You've heard the old adage "the trend is your friend." Well, that's what I was talking about. The trend has been up.
I'm bearish because I'm afraid of a European meltdown and a "hard landing" in China.
But there's a huge danger in missing what could be the beginning of a real bull market.
So, it makes sense to start putting on solid positions and even speculating here and there. But I am not all in - not yet. However, the time is coming. But, that is also the problem.
I'm fearful that a crash is coming, and maybe soon. If we get one, and everything flushes out and we get a capitulation bottom amidst a global panic sell-off, then I'll be all in, all the way, for the long-term. I'm talking about loading the boat up with stocks and commodities and enjoying a generational ride that will last for maybe 10 years, or more.
What keeps me up at night now, however, is the echo of 2007. I call where we are now 2007.2. If we are facing 2007.2, then 2008.2 will follow with a vengeance.
I'm guessing the breakdown could come in the first or second quarter of this year (although it could also take as long as 18 months to develop, which would only make it 10-times as bad when it does come).
Think about what I'm about to lay out for you, and ask yourself, what if he's right?
In the spring of 2007, U.S. Treasury Secretary Henry Paulson, when addressing problems surfacing in the subprime mortgages arena said things "appear to be contained." Fed Chairman Ben Bernanke said: "We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited."
Comforting words, right?
Then, speaking to members of the Federal Reserve Bank of Chicago in May of 2007, Bernanke said, "Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market."
Comforting words, right?
Even before two Bear Stearns hedge funds imploded in June of 2007, the Fed Chairman was touting the virtues of derivatives and the widespread sale of mortgage-backed securities when he stated, "The key thing to remember is that these losses are not just held by American banks, as the bad loans were in Japan (referring to Japan's lost decade), but they are dispersed."
Comforting words, right?
Then, on August 9, 2007, after one Bear fund was shut down and the other fund temporary propped by an injection of some $3.2 billion from Bear itself, and the seemingly contained fallout from subprime and AAA mortgages hitting "dispersed" banks in Europe, the European Central Bank's (ECB) Website quietly announced that the ECB would provide as much funding as banks might wish to borrow at only 4%.
What was happening was that European banks weren't lending to each other. The commercial paper market was at a standstill, and there was no short-term funding facility open wide enough to finance their longer-term mortgage positions. And they couldn't sell their positions because after the Bear funds imploded, there were no buyers for mortgage bonds, even the super-senior AAA tranches many European banks and all the big American banks were holding.
Two hours later, 49 banks borrowed three-times what they were usually asking to borrow. And by the time trading closed in the United States on that same day, gold had spiked higher, as had safe-haven U.S. treasuries.
Of course, the equity markets were doing their own thing and were rising that summer, nearing new all-time highs (which they would reach in September 2007).
It took another year before we got our "Lehman moment." But, boy did it hurt.
Fast-Forward to Now....
We're being told by the Fed that our banks are in good shape. We're being told by bank CEOs that they are in good shape and their European exposure is limited. We're being told that there won't be any significant hit to our economy from events in Europe. We're being told that there won't be any significant spillover because European debts are dispersed and banks have derivatives hedges.
These are all lies.
Exactly like what happened in 2007, banks in Europe aren't lending to each other. The commercial paper market over here is closed to them. That's why the ECB announced it would effectively execute unlimited three-year term repos at 1%. And, by the way, they are taking just about anything for collateral, really.
Did 49 banks step up like in 2007? No, in 2007.2 (meaning now) some 500 banks stepped up and took $620 billion (489 billion euros) the following day. And they've been adding to that.
What's happening to gold in 2007.2? After selling off as part of the initial risk-on grab for equities a couple of months ago, it's rising again, and fairly quickly.
What about safe-haven bonds? U.S. bonds have been rising rapidly in price as investors clamor for safety. The 10-year closed Friday at a 1.87% yield, only 20 basis points from its all-time low yield, which it saw in September as European woes were strangling global markets.
How panicked is a lot of smart money? Yields on German and U.S. short-duration bills are less than zero. That means investors have bid up the price of these short-term safe government instruments that the premium they are paying is greater than their yield. Put another way, people are paying to place their money in safe government securities.
Comforting, right?
No, it's not.
Talk about concentration build-up. First of all, most U.S. banks and most European banks are still sitting on tons of mortgage-backed securities that they can't unload. And the U.S. housing market isn't getting any better, nor is Spain's, Ireland's, or China's.
Sure, foreclosures are down lately. But that's because of foreclosure moratoriums resulting from lawsuits. There are estimated to be 10 million homes for sale and over 11 million homeowners holding onto upside-down mortgages. What's going to happen when banks get on with foreclosing and start dumping houses again? It's about to happen.
All that nonsense about dispersed risks - don't believe it. There is no dispersion that matters because all the big banks in the U.S. and Europe and plenty of others hold the same asset mixes, the same duration mortgage pools, and the same sovereign debts.
But in the place where things are smoldering and there's kindling everywhere, European banks are buying more of their sovereign's toxic debts to stave off a collapse of the prices of the debts already on their books. It amounts to a crazy leveraging up on the same bet that sovereign debts will pay off 100 cents on the dollar.
And where are they getting the money to buy more of this crap? From the ECB, which is printing it against the backstop of the same countries who need banks to buy their constantly rolled-over debts.
It's musical chairs, and sooner or later the music is going to stop. Greece looks like it will be the first one standing, or in this case, falling down. Portugal could be next, or Spain, or Italy.
Greece has more than $1.26 trillion (1 trillion euros) of public sector debt outstanding. Do you think that a real default isn't going to crush a lot of banks? Wake up. And if you think that Greece defaulting (or even forcing a 50% haircut on private investors, that would be banks, folks) wouldn't spill over into other countries and across the globe... wake up.
Talks in Greece over private investors taking a 50% haircut - meaning they will only get 50 cents on the dollar on the 100 cents they lent out previously and the other 50% they are giving up will be replaced with longer-term bonds yielding less interest - aren't going well. Most analysts and even central bankers believe the haircut needs to be closer to 75% than 50%. Comforting words to be spoken while negotiations are ongoing, right?
Ah, then there's that little downgrade thing that happened on Friday after European markets were closed. Just because the downgrade of the U.S. from AAA to AA+ didn't cause our borrowing costs to rise doesn't mean it isn't going to happen in Euroland.
It will happen. Downgrades will trigger new capital calls as margin requirements will increase to offset the lower quality of collateral, we're talking about the same collateral folks, the same sovereign bonds. It's an increasing pile, make that pyre, and it's going to self-ignite.
We have a big week ahead; we have Citigroup Inc. (NYSE: C), Goldman Sachs Group Inc. (NYSE: GS), and Bank of America (NYSE: BAC) reporting fourth-quarter numbers. We have housing starts (homebuilders are up 60% since their October lows) and new home sales. And Spain and Italy are auctioning off bonds on Thursday.
Our markets have risen nicely. And on Friday, after selling off hard on the S&P downgrade news, they rallied back impressively. I tell you, it's 2007.2.
Stocks are going one way, and credit markets are signaling trouble ahead.
Sovereign debt has replaced subprime as the powder keg. That makes the brewing storm infinitely more powerful than the subprime dust-up was. It's a question of how long before we get the Lehman moment.
We've survived, even thrived, on a series of "liquidity puts," which is what I call all central banks' stimulus and "free and easy" money thrown at banks to keep them afloat. In a politically charged 2012, that could change.
Keep this in mind. If we're facing 2007.2, then 2008.2 is coming right around the corner. It's just a matter of time.
That's why I say play the equity market diligently; we could scrape higher for a while, as we did in 2007. But, when the fat lady sings, it's going to be deafening.
And everyone knows the opera isn't over until the fat lady sings.
News and Related Story Links:
- Money Morning:
Should You Worry About Europe's Back Door Bank Run? - Money Morning:
Those "New" E.U. Fiscal Rules Aren't So New - Money Morning:
Latest Eurozone Debt Crisis Plan "Another Grand Illusion" - Money Morning:
One of These Banks is Europe's Lehman Bros. - And We're Going to Profit From Its Collapse
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.
Just a comment.
If the look at the S&P 500 daily chart for 2007 / 2008 and compare with the current 2011 / 2012 you can almost overlay the formation. Not saying its going to happen but history has a habit of wearing a very similar shirt. Reckon you are spot on for the 3rd quarter of this year.
regards
Still don't know what to do – sell sell and buy back when .. ?
Good news
Well said. Thanks.
People keep talking about how well our markets would perform if "they" would just find a solution in Europe, as if there's a magic wand sitting around that no one's thought to use yet…and as if everything's coming up roses over here. Last time I looked at the US balance sheet, it wasn't exactly pristine.
Ben UNLIMITED CHEAP DOLLAR SWAPS are shoring up the eurobanks which dont feel the need to delever but to overlever..it seems that Ben put the US at risk and the dollar too when things implode….and made things worse…thank you Ben!!!
I enjoyed the flow of your story. Musical chairs and the fat lady sings are a nice change from kick the can. Earthy clear presentation. I post a video of Monty Python in search of the holy grail. Where Greece and Germany play a game of political football. Basicly nothing gets done or correctly. It is so frustrating to see after so many failed corrections three years later the wolf is still at our door and now has brought his friends.
What an excellent analysis and forecast by Shah Gilani!
The article makes sense and is hard to argue with.
But since the world financial problems were caused by political decisions, it is possible that political decisions could solve the problems. Or at least make the problems manageable.
Many other market commentators are predicting a financial disaster similar to Mr. Gilani, so based on my 41 years experience trading the markets, I have to think they might be wrong.
I think you are spot on with your analysis and it conforms to my own conclusions and that of every newsletter writer I have kept reading over the past two dozen years, but you neglect to tell me what is likely to happen to gold, silver, gold and silver mining stocks and commodities in general when the fat lady sings. Can you expand your analysis?
Excellent article; but what should a self funded retiree do who has 80% of investment in shares and the balance in cash which would tide over 8 years' needs? Thanks
Excellent, very meaningful and by arguments supported presentation
Unfortunately, I am convinced this things will hapened, it is just question in what month..
Shah; I just love an optimist at heart ! What I love about you, is that you "call it like you see it",and don't beat around the edges,waffling, or qualifying. If it walks like a duck, quacks like a duck, then;; draw your own conclusions !
Look;if you are convinced that Armaggedon, is at hand,, then give us poor saps a break; lead us to the land of milk and honey, and peace and contentment, so we can enjoy the few years left, before we croak !
May God Bless ! MB
Your presentation is clear and well written, but grossly exaggerated. Just three examples:
"And where are they [European banks] getting the money to buy more of this crap? From the ECB, which is printing it…" False! As EU countries are constantly rolling over their debts, there is no need for new money to buy newly issued government bonds; maturing bonds provide the liquidity.
"Greece has more than $1.26 trillion (1 trillion euros) of public sector debt outstanding." False! Greek public debt amounts to 360 billion euros, which is a lot, but still one third of your figure! And when the private sector bonds' haircut happens (there is still a high probability it will happen), it'll reduce Greek debt by 100 billion euros bringing down it to around 260 bn.
"Ah, then there's that little downgrade thing that happened on Friday". Yes, it did happen. But it was only one notch down (France lost the AAA, but it's still is AA+), largely anticipated by the markets (no real reaction in the stock exchanges) and, most importantly, made by only one of the rating agencies (S & P), the other two maintaining their triple-A ratings.
All in all, things are bad, but not that bad.
"All in all, things are bad, but not that bad." ………. yet.
I just love it when people go on about Europe. Truth is, California and Illinois (to give just 2 examples of states up to their eyeballs in debt) are just as indebted and have a much larger share of the American pie than Greece, Portugal or Ireland have of the European one!
I believe all the hooha about Europe is a red herring to take the heat off of our pristine little United States, whose criminally fraudulent commercial paper caused much of Europe's financial woes in the first place.
Now comes S & P to "downgrade", – that's a real joke since S & P (and Fitch, etc) are responsible for grading the fraudulent derivatives that America sold Europe and others!
Want a prediction, here's one. The massive monetization undertaken by the Fed the last 3 years will come back and bite us all in the butt when three things happen:
1) China diverts purchase of U.S. sovereign paper toward gold
2) Bilateral trade arrangements between major trading partners involving currency swaps will end the reign of the dollar in commodity trading worldwide (think OIL)
3) failure of the U.S. to put its own house in order with increased taxation of the very wealthy and corporations, and failure to enact real banking/financial regulation will ensure the continued increasing penury of the 90% and the continued collapse of the 70% of the American GDP that represents consumer spending, with resulting SEVERE ECONOMIC DEPRESSION.
So, buckle your seat belts, folks. American police departments are not arming themselves with state-of-the-art crowd-control weapons for no good reason!
Oh dear oh dear. How short sighted we all are.
We continue worrying about making money, but overlook what is really happening on a world basis
That there will be a war between Israel/USA vs Siria/Iran. Already aircraft carriers plus are on their way. But wait, did I not read somewhere that Russian war ships are already off the coast of Siria?
What will happen???? Your guess is as good as mine……..BUT……..from brains far more advanced than mine, with more international scope, are already stating that an outright war between the USA and China is virtually a done thing. And guess what, where will our investments stand?
Personally speaking, I am all for buying gold coins and holding them. After all, once the dust settles, there will not be much left..if anything.
OH DEAR OH DEAR, what ever happened to common sense? Or were we so blind, trying to make money in the stock market, that we failed to see what the Pentagon was up to.
Wake up!
Harold
Shah Gilani has similar concerns to myself and I agree with him that they are well-founded.
However, there's a problem far greater than the rise and fall of stock markets and companies and even nations defaulting on their loans and that is this.
In order to allow a free market to operate there has to be three factors in play beside the ability to seize opportunities when they come along: trust, common sense and responsibility. By responsibility I mean we can't just think of making money for ourselves in an irrational world of poverty, immense wealth and a large amount of insecurity and, on occasions, chaos and disorder.
The way events are shaping, policies based on allowing and even encouraging free and open markets is proving to be no longer a viable option for both a stable world order and creating prosperous egalitarian societies as trust, common sense and responsibility are not there in larger enough quantities to sustain us.
Perhaps, Karl Marx and communism as a political ideal have been dismissed too quickly without examining the benefits. We are all familiar with the downside, wide spread government agency corruption and the killing of individual incentive. However, we can now see the results of too much reliance on free market economic theory leads to rather similar results in terms of destabilizing entire organizations, societies and creating the conditions for an anarchic world. We can see that the very rich are able to corrupt any and every government government agency, including the democratic process as well as limit innovations and freedoms that may go against their interests.
By 1989 the weaknesses of following rigid policies purely based on Communism were clearly evident. However, right now it is obvious that getting rid of communism and socialism has not lead to a fairer, most just and stable world. There is no solution in sight for the destabilized Euro and the EU and that President Obama has done and, maybe, cannot do much about creating anything close to full employment in the US. Both the EU and the US are stumbling along a path to nowhere and no major decision maker is really exploring viable alternatives to the very ideologies that contributed to the present malaise.
I am steadily buying gold and have not even come close to where it will go, even if a quarter of this is right, and I believe it is a whole lot more than that