This has been a tough quarter for companies. Compared to last year’s second quarter, profit is down roughly 31 percent and revenue is down even more. Wall Street thought it was going to be even worse. So in one of the worst quarters ever, the market has rallied.

Investors learn all the wrong lessons from a rally like this. Nothing about it makes sense. The smallest companies are outgunning the biggest one. The most heavily shorted stocks are doing better than the least shorted stocks. The companies with the worst analyst ratings are outshining the ones with the best ratings. Everything about this rally is backwards.

Over the past 37 years – from 1972 to 2009 – these “best of breed” companies have made shareholders 2.3 times more money than the stock market as a whole. For every $100 you made from the stock market, you would have made $230 from these “best of breed” companies.

That’s not just slightly outperforming the market. That’s lapping the market and then some. And it’s even more impressive when you take into account everything this period covered. It’s been an eventful 37 years of embargoes, stagflation, a savings & loan crisis, an Asian economic crisis, a Russian national debt default, a near collapse of the Mexican peso, 9/11, two gulf wars, the bankruptcy of the Long-Term Capital Management hedge fund, the dotcom rise and fall, a bursting of the housing bubble, credit bubble and spending bubble. Forgive me if I’ve left some “minor stuff” out like the fall of the “Iron Curtain” and the rise of China.

Through all this, these companies gave their shareholders a steady and rising stream of revenue and a return that, as I’ve said, was more than 2.3 times what the markets gave. Who wouldn’t want that?

Everybody would. And that’s a big problem for all those mutual funds which don’t touch these companies … and for the hyper-active Wall Street press which makes a fuss over a dozen things every day but somehow misses the biggest story of all…

The existence of a class of companies which know how to put ever-increasing amounts of cash into the pockets of their shareholders, year in and year out, decade in and decade out.

Almost as bizarre as our junk rally are dividend-paying companies that can do no wrong. The ones strong enough and confident enough to raise dividends are going up in price. And the ones that are cutting dividends? Many of them are going up too.

Shareholders have recently been accepting smaller checks without protest and without selling their shares. They are evidently willing to take the hit today so the company can grow profits tomorrow. It’s easier to do when investors think that some kind of recovery is around the corner. If that recovery doesn’t materialize, these shareholders will be showing much less forgiveness to dividend cutters. I don’t want to own these companies when that happens.

If I were an investor in any of those companies, I’d sell my shares right away. The whole point of investing in the “best of breed” companies is that you get paid no matter what.

Everybody is cutting costs, the strong and weak companies alike. But not all dividend companies are cutting their dividends. Just slightly more than half are these days. It pays to invest in the dividend hikers, not so with the cutters. Let other investors be forced to rely on a recovery to reverse their portfolio losses.

You should be and can be making money even if the economy remains weak. As long as there are “best of breed” companies still raising their dividends, there’s no reason why you should sacrifice your pay “for the good of the company.”

The scary thing (for us and the Fed) is that low-interest rates aren’t speeding up the recovery. People aren’t willing to borrow. And banks aren’t willing to lend. The amount of money floating around the economy is pretty stagnant. The Fed should be pretty discouraged. They have $2 trillion on their balance sheet. And all they have to show for it are some banks which should have gone under but are instead giving its employees million-dollar bonuses.

Dividend companies are getting a little respect again. They may even have become the “new fad” according to the UK’s Telegraph. Here’s the money quote…

Few professional investors are banking on a return to the super-charged capital gains we have seen from equities in the past. Rather, the new fad is for companies capable of delivering reliable sources of income. Historically, dividends have been responsible for more than half the return on equities. In the more risk-averse environment which is the new norm it may be rather more than that.

But why be satisfied with just a “reliable source of income” when you could get income which is both reliable and growing. Perhaps the Telegraph doesn’t realize that with “best of breed” companies, you can have your cake and eat it too. But the Telegraph isn’t the only newspaper or media outlet that doesn’t “get it.”

Nobody is talking about these companies providing reliable revenue to shareholders for decades (yes, I said decades) and increasing their dividends at rates of 25-40 percent every year. Yes, I said 25-40 percent every year.

Do the math. A company raising its cash payments to you by 25 percent every year will double the money it pays you every three years! If you’re getting $10,000 in cash every year from a company now, in six years you’ll be getting $40,000.

These aren’t junk bonds. They’re not risky derivatives. They don’t depend on a bull market. These payments come from some of the safest and strongest companies in the market. When companies provide rising cash payments for decades and generate plenty of cash with above average profit margins, they qualify for “best of breed” status.

Actually, some people out there do “get it.” One of them is Hersh Cohen. He has managed the Legg Mason Partners Appreciation fund for the past 30 years. Over these three decades, his fund has done better than the S&P 500, the dividend-company benchmark index and the average return for large-capitalization stock funds. Cohen, who holds a doctorate in psychology, says he focuses on companies with “superior balance sheets and rising dividends.”

Cohen says his academic training helps him when the market goes to extremes. During such times he likes to go against the flow, cutting back when the market is euphoric and increasing his bets when others panic “and stuff is being given away.”

I’m not a fan of mutual funds. I think they’re terrible instruments, trapping investors into very narrow styles of investment long past the time when those styles made a buck. And I don’t think mutual fund managers are the sharpest tools in the investment shed. So when I see an exception, I try to point him out. Cohen is an exception.

If you’re interested in doubling your money every three years with very little risk, there’s only one way to do it. Invest in “best of breed” companies.

To your investing success,
Andrew

Source: Why ‘Best of Breed’ Investing Is No Passing Fad

REITs are still in the early stages of a huge deleveraging cycle that will last for years, which means that the REITs that concentrate on commercial real estate may be a deceptively dangerous asset class.

Our story begins with the massive credit bubble – and related housing bubble – of the last several years. These twin bubbles powered a dramatic rise in consumer spending. Some significant portion of commercial real estate sprouted up to serve and satisfy this artificial demand. From the top to bottom of the U.S. economy, easy access to credit during the last several years powered excess consumption – and a frenzy of knock-on commercial ventures.

Accordingly, shopping boutiques popped up everywhere, along with restaurants, real estate offices, home-furnishing stores, art galleries, etc. All of these enterprises unwittingly relied on credit-fueled demand, and believed that this demand was “normal.”

But now that credit has disappeared from the U.S. economy, thousands of businesses are discovering that they cannot survive the new normal – the one that relies on actual paychecks and savings, NOT credit. And so, one by one, business doors are closing and the empty commercial spaces are piling up.

“The severity of the recession is turning some malls that were once viewed as viable into potential casualties,” the Wall Street Journal recently observed. “‘Any mall that’s sitting on life support is probably going to get its plug pulled as the economy stalls,’ says Michael Glimcher, chairman and CEO of Glimcher Realty Trust, which owns 23 U.S. properties, including Eastland Mall in Charlotte.”

The distress in the commercial real estate market would be serious, even if credit were still flowing freely. But credit is contracting, which means that commercial real estate is in especially dire circumstances. Refinancing commercial properties has become an extremely difficult task. Without the ability to refinance – or to sell at a profitable level – properties will continue to stumble into foreclosure and liquidation, which will put continuous pressure on property values.

Owners of underwater properties will have to either default and hand the title over to the lender, or they’ll have to inject an impractically large amount of new equity into the property to qualify for refinancing. And in these cases, we are talking about face-to-face negotiations between borrowers and lenders. In the modern “securitized” economy, face-to-face negotiations have become as rare and quaint a concept as the corner malt shop. In the modern economy, most mortgages are sliced and diced into unrecognizable portions of various mortgage-backed securities (MBS).

Think of securitization this way: Image your pet pig ran away from home and stumbled into a sausage factory. If you searched for your pig at the end of the sausage production line, you probably couldn’t find him. He’d be there alright, but not in a form you would recognize. He is there; but he is now everywhere. So is your mortgage.

Securitization is, therefore, a very toxic aspect of this particular commercial real estate bust. Simply stated, securitized mortgage structures are not designed to function in our current environment — one with falling collateral values and soaring defaults. Let me highlight the loan restructuring challenge ahead for troubled commercial property owners and their lenders.

Take just one example of evaporating equity in commercial properties. It shows why stressed property owners cannot easily renegotiate terms with their lenders. A few weeks ago, Sunstone Hotel Investors Inc. defaulted on its mortgage on W San Diego hotel. Sunstone bought the W for $96 million in 2006. The transaction was financed by a $65 million mortgage that was sliced, diced, and sold into the commercial mortgage-backed security (CMBS) market. The W’s value is now below the face amount of the mortgage, so Sunstone will likely write its equity down to zero and turn the deed for the W (i.e., the mortgage collateral) over to creditors in order to eliminate its mortgage obligation.

Sunstone defaulted when it skipped its June 1 payment on the W hotel’s mortgage. Thus, Sunstone basically invited its servicer, Centerline Servicing, to foreclose on the hotel. Centerline represents the interests of the lenders, who are spread throughout the ownership structure of CMBS. Without the chance to renegotiate, the only real option is for lenders to foreclose and auction off collateral. Even worse, if Centerline were to approach the lenders about restructuring the mortgage, the lenders would have different objectives — some would want to liquidate collateral to get paid, while others would prefer to renegotiate and hope for a rebound in collateral value. This is known in the securitization business as “tranche warfare.”

From a legal standpoint, borrowers are too far away from ultimate lenders. The complex legal structure of CMBS practically guarantees that sensible loan restructurings, including debt-for-equity swaps, are very difficult.

Now apply this situation to hundreds of other properties around the U.S., and you can see how securitization (CMBS) practically eliminates the potential for property owners to meet with their creditors and renegotiate. Private sector creditors who want to participate in fire sales and in very attractive loans are waiting for property to fall to more reasonable levels first. Banks are not going to refinance commercial mortgages coming due on properties that are down 50% from peak values, and no equity is left. This means that the foreclosure market will dominate the overall market, pushing values for every comparable property down even more.

There will not be any legitimate bottom in the REIT market until there is a bottom in the prices of commercial real estate mortgages. The smart institutional money will initiate its investment in real estate by buying the distressed mortgages of attractive properties, NOT by buying REIT shares. These investors will want to buy claims on commercial property market that are high up in the capital structure, not gamble on equity in properties, which may be worth a fraction of peak values — or zero. That’s why I’m monitoring transactions in the commercial real estate debt markets, looking for signs of a true bottom.

The “bottom” we saw in early March was almost entirely due to the Fed’s extraordinary commitment to print money in an attempt to prop up old bubbles. This caused a temporary rally in CMBS and REITs. The most stressed REITs used this as an opportunity to de-lever their balance sheets just a smidge by flooding the market with new shares. With the window for REIT secondary offerings closing, by fall we should see another leg down in the Dow Jones U.S. Real Estate Index.

The real buyers for CMBS and commercial property are professional investors – not the Fed or taxpayers. By and large, these professionals are waiting for bargains, with bids far below the current market.

So should you.

Source: Sell REITs

The Fed wants you to believe hyperinflation is looming. Or at least, it shouldwant that, if doubling its balance-sheet – purchasing and lending against investment junk – is going to work the wonders that modern central-bank theory says it can. And the Fed certainly wants you to believe it will stop at nothing to avoid deflation (”whatever means necessary” as the chairman put it back in 2002).

So anyone touting the hyperinflation risk in public is playing the shill, a decoy – seemingly unconnected – proclaiming the miracle powers of Dr.Ben Bernanke’s snake oil to CNBC anchors at every chance.

In fact, they’re doing the Fed’s work better than the Federal Reserve itself. Really.

“The major danger with a zero lower bound for the interest rate,” said Swedish policy-wonk Lars Svensson(also a Princeton colleague of the Fed chief and his credit-bubble associate Paul Krugman) in a speech earlier this year, “is that inflation expectations will be too low and even negative, and that the real interest rate will thus become too high.”

With it so far? Slashing interest rates to the very minimum of 0% suggests inflation has vanished, at least in the central bank’s eyes. But that, in turn, reduces the rate of inflation expected by consumers, investors and business. Central banks are credible forecasters, you see. At least in central-bank eyes. So in Svensson’s philosophy, the zero-rate solution to falling inflation proves self-fulfilling as people hoard cash and sit tight in bonds.

“It is thus necessary to…to counteract expectations of falling inflation, and preferably to create expectations of higher inflation,” Svensson went on. But “as Paul Krugman put it” says the Riksbank’s deputy governor, “How will the central bank ‘credibly promise to be irresponsible’…?

Heaven knows the Fed’s trying. (So’s Krugman, to no one’s surprise.) But while it’s embraced credible recklessness, the Fed’s stop short of French kissing it.

Why so coy…?

“We have a very serious recession, we have a 9.4% unemployment rate,” said San Fran Fed governor Janet Yellen in a speech in California on Tuesday. “If we were not at zero, we would be lowering the funds rate…We should want to do more.”

Just how much further would the Fed go – all the way to hyperinflation perhaps? Racing to first base, “The vigorous policy actions of the Fed and other central banks, combined with sizable fiscal stimulus here and abroad, have sent a clear message that deflation won’t be tolerated,” Yellen said.

“Based on measures of inflation expectations,” she went on, an apparently reading straight from Svensson, “the public appears confident that the Fed will adopt policies that will maintain a low, positive rate of inflation. Evidently, the credibility that the Fed and other central banks have built over the past few decades in bringing inflation down has spilled over into a belief that we won’t allow inflation to get too low either.”

Steady on, cheeky! Second base next, and “A glance at history shows that many countries with massive structural deficits and without an independent central bank turned to the printing press to pay off their debts,” Yellen continued.

Straight to third then, and “That’s a recipe for high inflation and, in some cases, hyperinflation.”

Gulp, almost home! But then, somewhere between third and fourth base, the Fed’s gone shy and rebuttoned its blouse. Because “I don’t believe the United States faces that threat,” Yellen said, showing the come-on to be just one big tease.

“Looking back in history, runaway fiscal deficits have often been accompanied by high inflation,” she explained in Tuesday’s speech in the bankrupt state of California. “But, since World War II, such a relationship has only held in developing countries. In countries with advanced financial systems and histories of low inflation, no such connection is found.”

Oh man, what a let down! Who’s gonna put out hyperinflation if not the Fed…?

“In order to make up for the collapse of credit, we are effectively creating money,” said George Soros, the legendary if only occasionally accurate hedge funder, at a Washington forum in March. “If and when credit is restarted, you would then have an incredibly swollen monetary base, which, if it were leveraged, you would have an explosion of inflation.”

The trouble comes, as Lars Svensson guessed back in January, with that “if and when”. Because it opens the door to the idea that a central bank might opt instead to withdraw all this new money after the deflation panic has ended. And that in itself is enough to make creating it useless. Pointing to Japan’s five-year experiment with ‘Quantitative Easing’ between March 2001 and March 2006, said Svensson, boosting the monetary base by some 70% failed to “noticeably affect expectations of inflation and the future price level.

“For example, the Yen did not depreciate as it should otherwise have done. Firms and households clearly believed that the expansion of the monetary base was temporary and not permanent, which subsequently proved to be true. The monetary base fell back to normal levels when the interest rate was later raised to above zero.”

Sure, the Bank of Japan’s trillions did triple Japanese Gold Prices. But even with gold refusing to drop back against the Dollar right now, eagle-eyed readers will note that, quite apart from the urgent debate in Europe, the US authorities are at pains to deny they need an ‘exit plan’ any time soon. White House advisor Christina Romer made that much plain in last week’s Economist magazine, blaming the double-dip depression of 1937 on “an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy.” Yellen said it again Tuesday.

So Team Bernanke have got the right idea – at least on Planet Svensson – if not the right level of irresponsibility just yet. Slip a little vodka into their juice though, and they might start talking up inflation like Alan Greenspan, Bernanke’s predecessor and the Maestro himself, writing last week in the Financial Times. He tried to spook everyone out of cash and into the stores by warning of a decade of inflation ahead!

“A pending avalanche of government debt is about to be unloaded on world financial markets,” Sir Alan of Greenspan warned sagely, almost visibly winking from behind those enormous spectacles. “The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt.”

Or given enough sauce to get really loose, the Fed might even get crazy like Asia-based doomster Dr.Marc Faber. (He’s been known to enjoy the odd cocktail or two.) Stop warning on hyperinflation. Just come out and say it instead.

“I am 100% sure that the US will go into hyperinflation,” as Faber told Bloomberg in late May, and again onJune 29th. “The US central bank has structured and introduced policies without considering exponential credit growth and its consequences,” added the Gloom, Boom & Doom author in an interview with the Korea Timeson Wednesday.

See what I mean about being a shill? It’s like he’s on the payroll…

“The United States will not raise interest rates for many years to come because it needs to pay off its huge debts,” he went on, recommending inflation-friendly assets such as equities and Gold Bullion. “In turn, too much money in the economy will raise costs of everything, including healthcare and education, giving rise to hyperinflation.”

There, now that’s the way to do it! Greenspan and Faber on song, while the Bernanke Fed tip-toes around stating its aim:

Spark inflation and leave it to burn. Because putting it out worsened both the Great Depression and Japan’s “lost decade” – the one that started two decades ago and hasn’t yet ended. Everyone who’s anyone in monetary theory knows that.

And if they claim otherwise, maybe they’re the ones kidding.

Source:  Faber and Greenspan: Shills for Fed Snake Oil

Said Bernanke: “This disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt.”

In other words, credit is the lifeblood of our economy, and the continued operation of credit providers is actually an issue of national security.

In truth, not all economies run on credit. But over the last decade, the United States became a bubble economy that needed unlimited credit to keep from collapsing. In a legitimate economy, it is not credit that fuels spending and investment, but simply income and savings. It’s too bad our Fed chairman does not understand the difference.

That American families now routinely rely on credit to make every-day purchases is a habit that needs to be broken – not encouraged. What we need in America is more restraint and less indulgence.

For example, Americans in the current economy should not go into debt to buy new cars. Given the level of debt that weighs down the typical family, Americans should defer such purchases until they have paid down existing debt, or have replenished their savings to the point where they can afford to pay cash. Until that time, Americans should continue driving their old cars. In the meantime, the untapped savings could be made available to local businesses that would use it to finance badly needed capital investments.

But such a drastic reversal in financial culture represents the kind of change that no one in the outgoing or incoming White House administrations appears willing to consider. By providing perpetual support to lenders that have bankrupted themselves through bad loans, the government merely guarantees that bad economic behavior will continue.

Credit is indeed vital to an economy, but it does not constitute an economy within itself. The important thing to remember is that credit is scarce, and is limited by the stock of savings. Obviously, savings loaned to one individual is not available to be loaned to another until it the outstanding debt is repaid. If it is never repaid, the savings are lost.

Loans to consumers not only crowd out more productive loans that might have been made to business, they have a far greater likelihood of ending in default. In addition, while business loans increase our capital stock and lead to greater productivity, loans made to consumers are merely spent, and do not create conditions that will make repayment easier.

When businesses borrow to fund capital investments, the extra cash flows that result are used to repay the loans. When individuals borrow to spend, loans can only be repaid out of reduced future consumption.

One of the reasons we are in such dire straits is that consumers have already borrowed and spent too much. Many did so based on the false belief that ever-appreciating real estate would ultimately provide the means to repay their debts and finance their lifestyles. Now that reality has finally set in, why should the spending spree continue?

The fact that our gross domestic product (GDP) – 70% of which is consumption-driven – is currently contracting should not surprise anyone. In fact, such a contraction is long overdue and the government should not do anything to interfere.

In trying to perpetuate the illusion, the government wants to revive the spending spree that has led us to this disaster. But how can such actions possibly help? How will more debt improve the economy? Wouldn’t our circumstances be vastly improved if we paid off some of our debts and replenished our savings? Wouldn’t we be in better shape if instead of buying more stuff we concentrated on producing it?

The unpleasant reality is that years of bad monetary and fiscal policy have encumbered our economy with debt and undermined our industrial capacity. The sooner we can begin to repair the damages, the sooner we can right the ship. If instead we merely administer more of the same, the ship will sink in a sea of inflation.

Source:  Is the U.S. Bailout Perpetuating the Credit Bubble?

“Economists see longest recession since WWII,” is a headline at Reuters. Economists are always the last to know what is going on. If they see a long recession coming, maybe the recession is already over? But, no… this time, we think even the economists have it right.

“This is worse than the 1980s savings and loans crisis,” said our old friend Jim Rogers a year ago. “This is the first time – this is the worst credit bubble we’ve ever had in American history. No – never in American history have people been able to buy a house with no money down, never. That’s never happened anytime in the world. So, we have the worst credit bubble. It’s going to take a long time to work its way out. You don’t cure a bubble in five or six months… It takes five or six years.”

The world economy is clearly ailing. But what’s really wrong with it?

In 1945, the war economy was suddenly out of business. Orders for tanks, guns, and C-rations stopped coming. The economy felt a little ill. Economists feared the US would sink back into a ‘30s-style depression. And investors sold off stocks in anticipation.

Instead, the soldiers came home and got married. Women gave up their jobs building airplanes and began to build families. Then, the new families started spending the money they had saved up during the war years. In came the orders for refrigerators, houses, and automobiles… and the illness passed!

Once again, the economy is feeling like it has a touch of the flu. And once again, the cause can be traced to a change in the weather. After so many years of living beyond their means, Americans are reluctantly beginning to live beneath their means. Instead of spending every nickel they earn, plus a few they didn’t, they’re finally beginning to save. Not that they want to; but they have to. The easy credit is gone.

And so the orders for new cars, new granite-topped kitchen counters, and new televisions have stopped coming in.

But now there are no soldiers coming home – or not enough to make much of a difference. And there are no women giving up their jobs at the aircraft factories to start new families. And no kindling to light a fire under a new consumer spending boom – people have soggy debt, not savings.

This is not just a problem for the US; it’s a problem for much of the world. Americans were the world’s consumers. They could be counted on to spend money – even when they didn’t have any money to spend. They bought the gadgets made by the Chinese, the wine made the Chileans, and the automobiles made by the Japanese. They were the chumps of last resort for the entire planet. Now that American consumers are coming to their senses, the whole world economy is feeling a little ill.

Left to their own devices, people would adapt. Chinese factories would gradually switch from making gee-gaws for people in Minnesota to making things for people in the middle kingdom. Displaced Japanese autoworkers could open noodle stands. One way or another, things work out… the malady would pass.

But the quacks threaten to make it much worse.

Of course, they’re delivering the standard elixirs – in massive doses.

As to the ‘fiscal stimulus,’ the president elect says he will change the TARP program so that it corrupts more taxpayers – rather than just a few big ones on Wall Street. He says he aims to create 4.1 million new jobs. Already, the US deficit for 2009 is expected to come in at $1.18 trillion – BEFORE Obama’s new stimulus program is added in.

As to ‘monetary stimulus,’ there’s nothing left to cut in the Fed’s key lending rate. If they want to ease rates further, they’re going to have to pay borrowers to take the money.

But the new super drug at the Fed is its policy of “quantitative easing.” What is ‘quantitative easing,’ you may want to know? It describes the Fed’s latest ploy, in which it buys toxic assets from banks. The banks thus increase their reserves. If they were to maintain the same loan-to-reserve ratio, they would have to lend out more money. But when the Fed buys assets from the banks, it does not borrow the money; it creates it ‘out of thin air.’ In other words, between ‘quantitative easing’ and ‘printing money’ there is not enough space to wedge a subway ticket.
So far, this new treatment has produced no signs of recovery. But don’t worry; the quacks won’t give up. They’ll give larger and larger doses – until the patient dies.

More news:

“A 314-year low in UK interest rates and the pound is rising,” notes Theo Casey in our London office. “Surprising? Yes. Cause for concern? No.”

You’ll recall that Theo and his team at The Fleet Street Letter have been bearish on the pound. They showed their readers how to protect themselves against a sterling collapse back in August last year. Since then, the advice has done more than protect them – it’s made them some 17% on their money. That compares to an -18% fall in the stock market.

Theo believes there’s plenty more to come in this sterling down move.

“The pound’s recovery is unlikely to last. The negative economic data coming from UK businesses is relentless. Most recently, Nissan is to reduce the workforce at its iconic plant in Sunderland by nearly 30% (the plant is the UK’s biggest car producer). This is just the latest in a mounting pile of jobless news and is a good reason to expect jobless data to come in at record lows this month. The negative flow of data should break the pound’s suspicious bounce, which itself came in a December to January window where very little economic news was released.

“What will soon become clear is that further action from UK policy makers is on the cards and is likely to come soon. There is talk that it could come in the form of quantitative easing – economist speak for printing money. However, Alistair Darling is playing coy on how close the UK is to starting up the printing presses:

“[On quantitative easing] There’s a debate to be had about what you do to support the economy as interest rates approach zero, as they are in the US. But for us that is an entirely hypothetical debate.”

“Tough talk but the Government and the Bank of England are running out of ammo to prop up the UK economy and, as the FT notes, the availability of credit to both households and businesses has tightened further. They are desperate to increase the flow of lending. And there are few options left apart from printing money.”

[Editor’s note: Theo believes that the recent impressive rally in the pound against the euro is a great opportunity for investors to put on a position which will profit when sterling once more starts to slide. To discover how to place this position, click here.]

And more thoughts:

*** Our old friend Jim Davidson, founder of the National Taxpayers Union, sends this note:

“Obama has confirmed he will take rapid action to cut taxes for 95% of Americans. At first blush, cutting taxes for 95% sounds like a grand idea. However, look closer. The top 5% of income earners already pay 60% of all income tax, up from the top 36.64% in 1980. The corollary to Obama’s tax reduction, which will go mainly to people who don’t pay income taxes, is that a large increase is scheduled for the high earners.

“A hint of the magnitude of the coming burden was offered by The Washington Post on January 2, when it published its assessment of the cost of the bailout as already announced.

“According to Post, if equally apportioned over the 139 million tax returns filed last year, the toll of the bailout would be $61,871 per taxpayer. But taxes are manifestly not apportioned equally. Even before Obama’s tax hikes take effect, 60% of the tax burden falls on 5% of earners – roughly speaking, those who earn $250,000 or more annually.

“If you are one of them, your share of the bailout cost will be about $750,000. Pencil that into your balance sheet.”

*** A dear reader writes:

“I hear people telling me that things are heading up again, that the market reached the bottom in December, blah, blah, blah. Consider this:

• My wife and I were in an excellent sea food restaurant on route 1 in Saugus – an extremely heavily traveled commercial strip north of Boston – back in mid-November. We were there from 12:45 to 2:00. There was one couple there when we arrived, and two more came whilst we were there.
• Traveling over the Mystic River Bridge into Boston, the parking lot below the bridge where imported cars are parked before being shipped to dealers was full to overflowing. A news item along about that time reported that they were trying to find more parking for the cars that were still en route.
• In a mall store a day or so after New Years day I remarked to the clerk how dead it seemed. He said it was worse the day before when the store (Radio Shack) did only about $1,500. On a slow day he rarely did less than $5,000.”

*** A friend reports that it is worse in Ireland:

“It’s unbelievable how fast that country has gone downhill. We had a house there that we sold in 2006. Now, the people who bought it from us are trying to resell it at a quarter of the price they paid us. Even at that price, there are no buyers.”

** “WWFM is what we call it in the family,” Elizabeth explained at a dinner party. “The Worldwide Financial Meltdown. Bill just goes on and on about it. He keeps hounding us all to cut expenses. So this year, we’re trying to cut back… turning out the lights… and staying at home.”

Yes, dear reader, the Bonner family is getting in the spirit of the WWFM. And it is amazing how much you can save, when you put your back into it.

“Elizabeth, can you sew up this hole in my sweater,” we asked on the weekend.

“Just give it to Katya [the cleaning lady]… she’ll sew it up for you.”

“But she charges us 10 euros an hour.”

“Well, it’s cheaper than buying a new sweater.”

We also found a guitar on the street. Someone had just thrown it away. We took it home and put on new strings. It’s not much to look at and it sounds funny; but it works.

And on Saturday, the heating system developed a leak.

“No, don’t call the plumber; Edward and I will fix it ourselves.”

“Uh oh…”

The connection between male and female is always a bit tricky. In the plumbing world no less than the rest of the world. Our union was uncooperative. But an economist armed with a wrench is a formidable foe. We banged the joint and then cursed it. And when the battle was over there was water all over the floor but the leak was fixed.

“There… see, we fixed it!” we announced in triumph.

“I don’t know if you really saved any money. The water probably leaked down to the apartment below us… they’ll probably have to fix the ceiling. And we’ll have to pay for it.”

Source: What’s Really Wrong With The World Economy…

This from Investment U:

Investing requires tough decisions. What to buy? When to buy? How much?

But none more difficult than this: Admitting the fundamentals no longer support an investment you own. Or, as the French philosopher Geoffrey F. Abert summed it up over 900 years ago, “It often takes more courage to change one’s opinion than to stick to it.”

And today I’m living proof.

Just three weeks ago, to the day, I declared, “The dollar’s not done.” I laid out my case about Jim Roger’s being wrong.

But I’m officially changing my stance on the falling U.S. dollar.

To be clear, it’s not because I finally saw the light, recognized the error of my ways, or heeded the “sage” advice of so many of you that wrote in to chastise my “foolishness” or “ignorance.” And I didn’t get a personal phone call from Jim Rogers, either.

I don’t cave to bullying or criticism. Just fundamentals. And the bottom line is this – for most of the year, the fundamentals supported a stronger dollar. Enough so to allow my subscribers to lock in gains shorting the euro versus the dollar of 12%, 58%, 60%, even 267%.

But those fundamentals changed. Big time. So here’s what you need to know, and how this fundamental change could be as profitable as the last one.

U.S. Dollar Doubts Surface As Investors Give Up On Yield & Value

My first doubts about the U.S. dollar surfaced when investors gave up on yield and value. In return for, well, no return. Remember, last week I reported demand for four-week Treasury bills – offering ZERO percent interest – outstripped supply four times over.

If that wasn’t bad enough, I noticed investors on the long-end of the bond market weren’t investing any smarter. All they want is “safety-only,” too. Case in point – the yield on 10-year and 30-year Treasuries fell below 3%.

Forget below average. Such paltry yields represent the lowest levels in the last 50 years.

So what’s the big deal? Well, it’s the equivalent of Bank of America putting out a curbside sign during the real estate run-up advertising “no-documentation1% mortgages.” People can’t resist cheap money. And we shouldn’t expect our elected representatives to show any better restraint. They will borrow cheaply and spend freely, while they can.

And it’s the extent of this spending that troubles me, and threatens the dollar the most.

The Flood is Coming and There’s No Ark to Save The Dollar

Forget the $530 billion of government debt that flooded the market last quarter. Or the $550 billion estimated for this quarter. President-elect Obama is planning a tsunami.

If you have any doubt, just consider the trend in estimates for his soon to be released economic stimulus package.

• A few weeks ago, $500 billion was the consensus number.
• Then it crept up to $700 billion.
• Now, Republicans and Democrats alike believe the final plan will top $1 trillion.
• And that’s on top of the $4 trillion price tag for his proposed middle-class tax cut and universal health care.

The only way to absorb the impending and massive Treasury issuances will be for the Fed to flood the market with dollars. Or put more plainly, to run the printing presses 24/7 – which many of you already suspect they’re doing.

Arguably, these factors alone should be enough. But I’m stubborn. I wanted one more thing before I let go of my dollar bullishness. And yesterday I got it.

The U.S. Dollar Index Breaks An Uptrend

Recall, in July the U.S. dollar index bottomed out and entered a confirmed uptrend. But after rattling off about a 20% gain, everything just came unglued. And yesterday, the U.S. dollar index officially broke through the uptrend line. So look out below. Because there’s no telling where the next support level rests.

That being said, I don’t think it’s time to do the opposite of my previous recommendation, and get long the euro. Not hardly. The recent hawkish comments out of the European Central Bank scare me. They won’t be able to escape this financial crisis either, no matter how defiant the rhetoric. Plus, euro-zone banks still need to unwind as much as $800 billion of dollar-denominated leverage.

In short, the upside in the euro versus the dollar will be subdued. Not to mention, a far better opportunity exists shorting long-dated Treasuries.

As The Bond Market See-Saws…

The bond market is remarkably simple – it’s a seesaw, with interest rates on one end & bond prices on the other. When one goes up, the other goes down.

If you have any doubt, consider recent history. As the Fed aggressively cut interest rates, bond prices went vertical. Up 20% in some cases. That’s unheard of for bonds. And it represents our newest bubble (first real estate, then oil, now treasuries).

Make no mistake, this bubble will end just the same.

• First, because the government can’t get away with near zero yields forever. Investors will eventually demand a respectable return on their money. Especially foreign governments. In the last quarter alone they increased their U.S. debt holdings by 12%, according to Bloomberg. To load up even more will require additional compensation.
• Second, because inflation is around the corner. Never has a world government spent (or planned to spend) so much and avoided it. The only way to curb the resulting inflation will be for the Fed to abruptly reverse course, and begin raising rates at the first signs of an economic recovery.
• Bottom line, the only way for rates to go from here is up, which means bond prices will head the opposite direction.

Again, I aim to be transparent in my analysis. Always. And that includes defying Lillian Hellman’s observation that “people change and forget to tell each other.”

Consider this your notice. My outlook for the falling U.S. dollar has changed, albeit quickly.

This isn’t an apology. It’s simply a head’s up that more compelling opportunities exist. One a fellow colleague summed up perfectly, “If you don’t short Treasuries right now, you’re dumber than investors buying them for a zero percent return.”

A bit harsh. But hard to refute.

Source: The Falling U.S. Dollar: Taking An About-Face

This from Whiskey & Gunpowder:

Lately I’ve been discussing concept of scarcity in the energy and natural resource sectors. In one recent note, I discussed how the idea of scarcity has transformed from a “geological” basis to an “above ground” basis. In another note I discussed how the financial system of the world has broken down. This breakdown has damaged many a portfolio. But I still believe that an investment focus that is based on future scarcity of energy and mineral resources is basically correct.

In the future there will still be profound restraints on the availability of energy and natural resources. So owning shares in firms that “do energy” or “do resources” is still a good idea over the medium and long term.

We Still Have a Big Problem

We still have a big problem. The credit system is broken (and that’s the nicest thing you can say about it). Many large banks in the world are broken too (ditto). The investment model of the modern era, starting back in the 1860s during the U.S. Civil War, has almost ground to a halt. That is, the idea and method of “floating capital” is not functioning. Indeed, capital no longer seems to float. Actually, it seems like capital has been sinking like a stone.

The lack of capital (at least, in the forms that we’ve come to utilize it for large scale investments) means that it is difficult – impossible in some cases – to go forward with the new energy and resource projects that are designed to mitigate the present depletion’s in older oil fields and other resource provinces.

In the face of this, most governments of the world are trying just to look good for the TV cameras. Central banks and government treasuries across the world have been reduced simply to throwing money at whatever problems catch their collective eye. Squeaky wheels get the grease. So we see the national treasuries “recapitalizing” busted banks. We see the likes of the U.S. Big Three automakers coming hat-in-hand to Congress for a bailout, and Congress in turn acting like it knows how to run a sophisticated manufacturing business. And we hear announcements, from China to the U.S., of massive new public works programs to get the world moving again.

It’s like if we pour enough concrete, and then everything will turn out all right. Somebody ought to ask the Japanese about that. They all but paved the island of Honshu in the 1990s, and still lived through a stagnating era.

Can things really turn out all right? Can we return to some happy past? As Heraclitus once noted, “You cannot step twice into the same river, for other waters are continually flowing on.”

Prosperity Stolen from Fort Knox

Indeed, all rivers flow to the sea. In Asia Times Online, the always insightful Henry C. K. Liu recently wrote that the credit crash has “turned out to be a catastrophic, global, financial perfect storm of unprecedented dimension that will cause serious structural damage to all market economies around the world. It may even spell the end of the cowboy finance capitalism of the past two decades in which risks are socialized and gains privatized, with debt manipulated to act as phantom capital.” Yep.

A fellow Pittsburgher, financial writer Jim Willie, is even more pessimistic. He thinks that in 2008 the U.S. economy and financial structure suffered “mortal wounds.” Jim states – using a very clever turn of phrase (I wish I’d said this) — that a “decade of prosperity was stolen from Fort Knox.” That is, major elements of U.S. monetary policy in recent years involved the gold carry trade enacted by the U.S. Treasury in the 1990s.

What is the gold carry trade? The U.S. Treasury and Federal Reserve treat the details like state secrets. But what has leaked out makes for a sordid story – treasonous, even. It’s enough to make you wish that we still executed people by firing squad in this country. Let me put it this way. Perhaps President-Elect Barack Obama thinks that his biggest surprise will come when he gets “THE briefing” and finally learns what is really out in the tightly guarded hangars near Groom Dry Lake in Nevada (a/k/a “Area 51”), and Dugway Proving Ground in Utah. Well just wait until Pres. Obama asks how much of the original Fort Knox gold still remains the unencumbered property of the U.S. government. Surprise, surprise.

The Wolf is At the Door – Say Hello to the Nice Wolf

In 2008 we all experienced the destruction of a world-wide credit bubble. This was the end of many decades of dollar-abuse and monetary malpractice by the U.S. Federal Reserve and the utterly profligate U.S. government in general. As Gresham’s Law states, “Bad money drives out the good.” And decades of bad money did not just drive out the good stuff. In turn it sowed the seeds of its own destruction.

It was just a question of time before the wolf showed up at the door, and that time has arrived. Say hello to the nice wolf. So now it’s time to face the fact that the U.S. economy is in far worse shape than most people believe. And it will be in bad shape for a long time to come. If everything goes right, it might take a generation to clean out the stables.

But we are already off to a bad start. The 2008 credit meltdown has caused huge collateral damage. And in 2009 we will see an extraordinary attempt to re-inflate that bubble. Will it work? Probably not like people expect.

The traditional financial system is now in the fight of its existence. The system was based on U.S. dollar hegemony and the supremacy of U.S. national power. That, and the way that the U.S. benefited from ingrained habits of foreign monetary authorities kowtowing to Washington based on decades of living with Bretton Woods and its ghosts. It all hit the wall in 2008. But like the creatures in the Aliens movies, these critters won’t stay dead for long. The Wall Street/Treasury Axis will come back to fight hard and play dirty.

Things to Do to Ensure Your Security

I believe that the old system is irretrievably doomed. But you cannot replace something with nothing. There is still no “new” system that has come around to take the place of the old one. Thus the big task for 2009 is to save your personal wealth from going down with the ship. So how do you ensure your security?

In the short term you can protect your financial interests by increasing your cash position as a percentage of your assets. When all else fails, add to cash. Yes, we will probably see inflation in the future, but for now more cash is better.

Also, in anticipation of inflation you should own physical metals like gold and silver. I mean it. I’ve said it before. OWN GOLD! And I mean OWN THE METAL. Take delivery! Maybe I sound like the Mogambo Guru on this, but he’s right. Let me quote Mogambo. “Own freaking gold!”

And get out of any but the very best shares. The first requirement for share ownership is to look for companies with enough cash to fund operations and make it through some very lean times. Then you also want to invest in firms that are going to be important in the world that’s coming down the tracks.

What kinds of firms will be important? Well, energy and resource firms for starters.

Source: Falling Prices and Scarce Energy

The following is an excerpt from Bill Bonner and James Davidson’s crisis report, How to Survive and Prosper in the Coming Global Depression.

To read the full report, simply enter your e-mail address below. You’ll also begin receiving critical updates to the report via e-mail.

Contrarian Profits readers are probably familiar will Bill’s commentary from his Daily Reckoning column. But here is some information about James Davidson:

Davidson is a self-made multi-millionaire, venture capitalist and best-selling author.

His books include Blood in the Streets, Financial Reckoning Day and The Sovereign Individual.

As an author and editor of private financial advisory service Strategic Investment, Davidson has made a number of bull’s-eye crisis predictions.

He is the founder and chairman of the National Tax Payers Union, the largest and oldest grassroots taxpayer organization in US.

His forecasts and his war against taxes and deficits have earned him frequent invitations on programs such as Good Morning America, The Tonight Show and MacNeil-Lehrer.

Read on…

This Is a ‘Credit Cycle’ Bust

One of the saddest lessons of history is this: If we’ve been bamboozled long enough, we tend to reject any evidence of the bamboozle. We’re no longer interested in finding out the truth. The bamboozle has captured us. It is simply too painful to acknowledge — even to ourselves — that we’ve been so credulous.

We turn here to the words of American astronomer Carl Sagan because they so aptly describe our current economic predicament.

Americans have come to believe the particular bamboozle that we can get rich by spending…that we can get something for nothing.

As Bill put it in Financial Day of Reckoning, “Americans can no more retreat from this dream than Napoleon could have brought his troops back from Germany, Italy and Spain and renounced his empire.”

And here’s where our story gets really interesting.

Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.

- John Stuart Mill

Because what becomes clear is that this is no ordinary collapse.

Let us explain…

When left to themselves, the markets are natural phenomena. There is a wonderful simplicity about them.

Failure follows success. What goes up eventually comes down. Like a tree, they cannot continue to grow forever.

We can easily illustrate this by describing the pattern of pig farmers.

When the price of pigs rises, pig farmers naturally raise new pigs to increase production. About 18 months later, these new creatures arrive on the market. This increase in supply causes prices to fall. Farmers decide to cut back, which caused prices to rise again.

This is nothing more than the cyclical boom-and-bust cycle that defined the US economy from the end of World War II to 2001.

Then something changed radically. The Fed, under eager-to-please chairman Alan Greenspan, decided it could avoid the bust part of the cycle altogether.

The result is a different beast from your garden-variety downturn. You get a “credit cycle” bust instead.

This is exactly what we are experiencing now. And it’s more like the post-bubble depression of the 1930s than the downturn of 1973 to 1974 or 1981 to 1982…

‘Catastrophic Acceleration’ of Losses

Here’s the big worry.

The severity of this kind of bust depends on the magnitude of the bubble that preceded it. And the bubble that came before this bust was the biggest ever in history.

In fact, it wasn’t really a bubble at all. It was a “hyper-bubble.”

Now this hyper-bubble has popped, and the losses are catastrophic.

Billionaire investor George Soros recently explained just how dangerous the unwinding of these kinds of bubbles can be.

The typical sequence of boom and bust has an asymmetric shape. The boom develops slowly and accelerates gradually. The bust, when it occurs, tends to be short and sharp.

The asymmetry is due to the role that credit plays. As prices rise, the same collateral can support a greater amount of credit. Rising prices also tend to generate optimism and encourage a greater use of leverage — borrowing for investment purposes.

At the peak of the boom both the value of the collateral and the degree of leverage reach a peak.

When the price trend is reversed, participants are vulnerable to margin calls and, as we’ve seen in 2008, the forced liquidation of collateral leads to a catastrophic acceleration on the downside.

Of course, all this was inevitable.

Bill repeatedly warned the more than half a million subscribers of his newsletter, The Daily Reckoning.

No doubt, many got tired of hearing his warnings. But all he was doing was pointing out the obvious.

******************************************************************************************************

Audio Commentary from Resource Investor Rick Rule

Click to play with Media Player

Key points summary:

* The crisis is not limited to mortgages… Financial institutions are over leveraged
* There is a wipe out of shareholder equity in financial services
* Financial service companies don’t know what their derivatives are worth
* They are keeping liquidity for themselves because they don’t know value of derivatives of others banks
* The US is the leading edge of a worldwide trend of over-leveraged financial services
* An extreme example of over-leverage is Iceland

Rick Rule is chairman of Global Resource Investments. He has dedicated his life to all aspects of the natural resource industry. His contacts and knowledge of this market are unmatched.

*******************************************************************************************************

A Monster of Deleveraging

Instead of getting a typical bear market in 2001, we now face a monster of deleveraging as the biggest credit boom in history unwinds.

Deleveraging is simply the cutting back on the amount of money borrowed compared to equity.

In the case of this crisis, financial institutions sell off assets to recoup losses inflicted on their balance sheets by toxic mortgage-related securities.

These forced sales push down asset prices, hurting the balance sheets of other investors, forcing more asset sales and so on.

Nothing can stop this process. It’s a necessary cure for the credit bubble that Greenspan puffed up.

The problem is it is devastating the wider economy.

As The Economist magazine puts it, “What hurts finance affects the rest of the economy in spades.”

Because of leverage, a shortfall of bank capital of around $100 billion may reduce the potential supply of credit by $1 trillion.

This assumes banking system leveraging of around ten times…the geniuses running Lehman Brothers leveraged 25 times to equity.

But let’s assume that leverage of ten times to equity is about right.

So far, financial institutions have admitted to about $600 billion in credit-related losses and writedowns (net of re-capitalization via new equity issues).

This means cuts of $4 to $6 trillion to the potential supply of credit.

This, in turn, leads to higher cost and lower availability of credit to the real economy. And it forces consumers to reduce debt and consumption, most of which was based on borrowing in the first place.

This is bad enough. But it doesn’t end there…

So-called “negative feedback loops” mean the reductions in consumer spending and investment further hurt the economy. This puts further financial stress on corporations and individuals and triggers more debt defaults and more losses for the financial system. These then reduce lending capacity.

And so on…

Like a giant forest fire, the deleveraging process can’t be extinguished.

And although the government believes it can put the fire out with bonehead bailouts, at the very best all it can do is create firebreaks that limit the damage until the fire burns itself out.

Right now, the bailouts are stopping companies such AIG and Citigroup from going under. But banks are still refusing to lend to each other despite all the money the government is giving them.

The bottom line?

This massive unwinding is nowhere near finished.

Remember, Wall Street has only admitted to a small fraction of its mortgage-related losses and writedowns.

And the very, very bad news is total losses are estimated to clock in at $2.5 to $3 trillion…

PS. To read the rest of this report, simply enter your e-mail address below. You’ll also begin receiving critical updates to the report via e-mail.

MSNBC reported last night that Obama is already getting advice from Ben Bernanke.  That ought to make you feel warm and fuzzy right there.

But wait, there’s more!  As of this writing it appears Lawrence Summers is the leading candidate for Treasury Secretary.  As in, the guy who was Clinton’s last Treasury Secretary.  So much for the promise of “no retreads” in an Obama administration.

I mean, Larry Summers?!  That’s really in-your-face, on any number of levels.  PC-liberal types are still up in arms over his remarks about the size of women’s brains when he was running Harvard, and the general consensus in Cambridge was that he ran Harvard with all the people skills of Attila the Hun.

More to the point is this: Summers was among those present at the creation of the biggest credit bubble of all time — when the Glass-Stegall Act was repealed in 1999.  As I’ve written before, tearing down the wall of separation between commercial banking and investment banking is a good idea in principle.  But written between the lines of the replacement legislation was a guarantee of government bailout if big leveraged bets went awry — one reason that the ultimate deregulator, Ron Paul, voted against it.

But hey, it’ll make for a nigh-seamless transition at Treasury — Paulson to Summers to national bankruptcy.*

And if it’s not Summers, the other candidates whose names have been floated will substitute just fine.  Tim Geithner?  The New York Fed chief was the architect of the (NYSE:JPM) JPMorgan-Bear Stearns deal, and has quietly kept his hand in every bailout and associated scheme since then.  New Jersey Sen. Jon Corzine?  Ex-Goldman Sachs.  Nuff said.

Presidents might change.  Taxes go down, taxes go up.  But the criminal finance class always makes sure to provide for itself first.

*Speaking of national bankruptcy, what sort of omen is it that the book version of I.O.U.S.A. was Amazon’s top seller Tuesday night as Obama snagged his victory?

Source: The Fix Is in