Thoughts From The Frontline : Housing

The Statistical Recovery, Part 2

John Mauldin — Sat, 15 Aug 2009 00:49:00 GMT

The Statistical Recovery, Part Two
A Recovery Statisticians Can Love
A Few Thoughts on the Housing Market
Some Thoughts from Maine
Tulsa, Birthdays, Weddings, and Paul McCartney

A few weeks ago I first used the term "statistical recovery" to describe the nature of today's economic environment. Today we are going to further explore that concept, as it is important to have a real understanding of what is happening. This coming "recovery" is not going to feel like a typical one, and those expecting a "V"-shaped recovery are simply making projections from previous economic recoveries, which, based on the fundamentals, are not warranted. And of course, a few thoughts coming back from Maine are in order. There is a lot to cover, and this may take more than one letter.

But first, let me note to subscribers to Conversations with John Mauldin that we have posted my Conversation with George Friedman of Stratfor and will soon post a very interesting Conversation I had with John Burns (of John Burns Real Estate Consulting) and Rick Sharga of RealtyTrac. These may be the two most knowledgeable people on the housing market in the country. There is a lot of poorly informed speculation about the housing market, and I think this Conversation will help clear away a lot of the fog. PLUS, they both agreed to allow me to post their eye-opening PowerPoint stacks to Conversation subscribers (normally only available to their clients), so you get a very special bonus. And finally, David Galland of Casey Research is allowing me to post a most thought-provoking interview he did with Neil Howe. This is one of the best things I have run across in a long time. I do work on giving my Conversations subscribers good value.

George and I are going to be doing a regular quarterly Conversation called Geopolitical Conversations with John Mauldin and George Friedman. We believe that these new Conversations will help you better understand not only the global political landscape but also how it affects the financial umbrella that we are under. In this first Conversation, we talked about the "exogenous" risks to the markets (those from outside the markets themselves) posed by the geopolitical world.

We will offer this service, which will be priced separately, at some point in the near future. Now, here is the important part: all current subscribers and anyone who subscribes now will receive these Geopolitical Conversations free, as a thank you. (Current members can log in now.) If you have not yet subscribed, you can do so and receive a discount by clicking the link and typing in the code JM47 to subscribe for $149. This is a large discount from our regular price of $199; plus, we are including the bonus Geopolitical Conversations that are worth $59. And now, to the regular letter.

The Statistical Recovery

The unemployment numbers came out last Friday, and Steve Liesman of CNBC did several interviews live from Leen's Lodge in Maine. I postponed an hour of fishing to be on air with Martin Barnes (of the Bank Credit Analyst) to comment on the numbers. Everyone seemed quite excited that the US lost "only" 247,000 jobs. However, it is still almost twice as large as a year ago, and at that time 128,000 lost jobs seemed pretty bleak. However, comparing it to the average of 692,000 lost jobs per month in the first quarter, those looking for good news immediately started talking about how a recovery is around the corner.

The unemployment numbers are some of the most seriously revised numbers in all of government data. The first monthly estimate is notoriously imprecise. Why people make investment decisions based on this release is beyond me. As I mention continuously, because of seasonal adjustment factors, the unemployment numbers understate job losses in a recession and also understate job gains in a recovery. About the most we can get from the current data is the broad trend. Admittedly, the trend is getting better, but we are still in a hole and no one has stopped digging.

What we can see is that we are down 6.7 million jobs since the beginning of 2008! We have roughly eliminated the job growth of the last five years. And that does not take into account the 150,000 new jobs that are needed each month just to maintain the employment rate because of the increase in population. It took 55 months once the 2001 recession was officially over to get back to the previous employment peak. That is 4.5 years, gentle reader, and we are further down now and faced with massive deleveraging. It is going to take a lot longer this time. Let's look at some of the reasons why.

I took a different tack in the CNBC interview. I pointed out that even though it is possible (likely?) we will see a positive number for GDP for the third quarter, it is not going to feel like a recovery for quite some time.

By the middle of next year (2010), when I think we will finally hit an unemployment bottom, we will be down close to 8 million jobs, wiping out all the jobs created since the middle of 2004. Unemployment is likely to be more than 10%, unless they keep playing games with the number.

A Recovery Statisticians Can Love

What I mean by that remark is that the unemployment number went down even though we lost 247,000 jobs. How can that be, you ask? Well, the government assumes that if you were not looking for a job within the last month, then you are not unemployed; therefore, on a statistical basis the number of people unemployed went down by 400,000. (There are 2.3 million such discouraged workers.) More in a minute on the problem that will cause down the road.

Assume that we will need 9 million jobs over the next five years (150, 000 jobs a month for 60 months) and add the 8 million lost jobs. That means we have to add 17 million jobs in the next five years to get back to the 4.5% unemployment of 2007, let alone the under-4% we saw in 2000.

That means we need to grow employment by about 12% over the next five years. But it's worse than that. What is known as U-6 unemployment is over 16%. There are another approximately 8.8 million people who are either working part-time but want full-time jobs or are among the 2.3 million discouraged workers as mentioned above.

(The definition of U-6 unemployment from the BLS web site: "Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not looking currently for a job. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule." http://www.bls.gov/news.release/empsit.t12.htm.)

Let's make the assumption that the part-time workers want to go to full-time (which they say they do). Typically employers will increase the hours of part-time employees before adding new workers. That will be a major drag on potential job growth. It is the equivalent of creating at least 4 million jobs, except that no new jobs are created. Plus, those who want jobs but are not looking will come back into the market if jobs are available. That adds another 2 million. Now we are seeing the need for 23 million new jobs in five years, to get back to the "Old Normal."

That is an increase of 15% total employment from today's levels over the next five years. That type of jobs growth will only happen with significant economic growth. Normally, you should expect the economy to rebound to at least 3% trend GDP growth. That is what has happened historically. But we are not in the Old Normal. We are entering the era of the New Normal, where looking back at historical trends will prove to be misleading at best.

On average, and VERY roughly, you would think you would need a minimum of 15% real GDP growth over five years to get us back to what we think of as acceptable levels of unemployment. Actually you would need more, as productivity growth lessens the need for more workers. Oh, and add in the Boomer-generation workers who are not going to retire because they now cannot afford to.

(I think we will be lucky to have 10% real GDP growth in the next five years, for a host of structural reasons that we will be going into below and over the next few weeks.)

Unemployment will be rising for at least another two quarters and probably through the middle of next year. That should not surprise us too much, as unemployment kept rising for almost two years after the last recession, which many dubbed "the jobless recovery." The recession ended in 2001, but as the graph below shows, the unemployment rate rose until the middle of 2003.

We may have a "statistical recovery." The numbers may be positive for a variety of reasons only a statistician could love, but it is not going to feel like a recovery to the rest of us. Maybe that is why consumer confidence took another hit today, dropping to its lowest level since March, helping to drive the market down.

The economists at economy.com, who normally have a bullish tinge to their writing, said it succinctly: "Confidence will struggle to gain ground in the months to come, as consumer budgets remain stretched. Little wage income, prospects for reduced bonus payments, reduced access to credit, and no capital gains are all constraining consumers' ability to meet their financial needs and recover from the sharp drops in wealth they have experienced. Many consumers are struggling to pay their debts. Supports are coming from reduced layoffs, equity market gains, and stimulus such as the cash for clunkers program, but that is proving inadequate to lift spirits so far. It will likely be some time before conditions turn enough for confidence to improve decisively. Key drivers of confidence include developments in the labor and housing markets and the path of energy and equity prices."

(My friend Bill Bonner described the Statistical Recovery as being just like a female impersonator. He is just like a real woman in every way, except for the essential ones.)

The consumer's sense of discomfort is shared in executive suites across the country. "Chief Executive Magazine's CEO Index, the nation's only monthly CEO Index, dropped to 63 in July, after showing gradual improvement. All components of the index are down, with Employment Confidence taking the largest hit...

"What's worse is that pessimism over employment is reaching new heights. The Employment Confidence Index declined 25 percent with 57 percent of CEOs expecting continued decrease in employment next quarter. Over 95 percent rate the current employment environment as bad—the highest level for 2009. Less than 5 percent think employment conditions are normal and virtually no one (0.4 percent) thinks they are good." (The Bill King Report)

A Few Thoughts on the Housing Market

Bill also sent me a link to a very interesting survey of the real estate market. Those in the real estate business will find this of value, although it makes for grim reading. (http://www.campbellsurveys.com/AgentSummaryReports/AgentSurveyReportSummary-June2009.pdf)

Three (of the sixteen) of their summary bullet points stood out:

The market for home purchases can be divided into segments of 26% for damaged REO, 23% for move-in ready REO, 14% for short sales, and [only!] 36% for non-distressed properties. [REO means "real estate owned," typically by a bank as a result of a foreclosure.]
43% of homebuyers are first-time homebuyers, 29% are current homeowners (relocation or retirement homes), and another 29% are investors.
Only 31% of non-REO home sale listings are unforced or optional; other major reasons for listings include financial stress (including short sales), long distance relocation, and divorce or estate sales.

Think about that for a minute. Two-thirds of home sales are either foreclosures or banks taking a loss on the mortgage. Of the remaining 36%, only 10% are as a result of something we could call a normal selling process. And that is nationwide. There are lots of places where foreclosures are low. Reading this report anecdotally, there are large areas (California, Nevada, Arizona, Florida) where almost the only housing action is distressed or forced sales, that is, sales at a significant discount to original asking price.

Look at the chart below from Rick Sharga at RealtyTrac. Today we learned from them that foreclosures set a new monthly record of 360,149 properties that received a default or auction notice or were seized last month. One in 355 households got a filing, the highest monthly rate in RealtyTrac records. Many hard-hit areas have rates higher than 1 in 39 homes! Foreclosures are now running about six times higher than just four years ago.

And there is little relief in sight. There is typically about one foreclosure for every 6-10 jobs lost. It will be higher this cycle, as so many homebuyers are underwater on their mortgages and have little incentive to try and keep up payments while they are unemployed. Further, there are 500,000 REO-owned homes that are not on the market as of yet (what Sharga calls shadow inventory), and a wave of foreclosures will result from option ARMs and Alt-A loans resetting next year. Note: July's record numbers are not in the chart below.

John Burns gives us the next graph, which is an estimate of foreclosures for the coming years. (www.realestateconsulting.com)

Notice that he estimates more foreclosures next year than this year, with very little relief until 2014! This does not bode well for housing prices, which are a big factor in consumer sentiment, which is a big factor in consumer spending.

It does mean that renters can find some very good deals, as there are now areas (like Phoenix) where it is cheaper to buy smaller homes than to rent. Remember the statistic above that first-time home buyers are 43% of the market and investors another 29%? Lower prices make housing more affordable, and with the government incentive programs for first-time buyers really working (for once), the lower end of the housing market may actually stabilize sooner than the overall market.

As I wrote almost two years ago, the housing market will not bottom before 2011 and maybe into 2012. We just built way too many homes in our exuberance; and with tightening lending standards (as there should be) the number of people who can qualify for a mortgage is down, although (again) falling prices make homes more affordable. The median price in California is down by 60%. (Although I saw today where Bill Gross bought a tear-down on the water in Newport Beach for $23 million. That will help the average some.)

Homeowner vacancy rates are close to 3% of total homes, which is well over 2 million homes. Many of these are not yet on the market.

Retail sales were down in July. And that was with Cash for Clunkers in full force. The headlines said that economists were shocked. Really? Consumers are saving more, and actually paying down credit-card and bank debt. We will go into those details more next week, as it is getting close to time to hit the send button.

Some Thoughts from Maine

Last weekend I got to go to Leen's Lodge at Grand Lake Stream in Maine (www.leenslodge.com - highly recommended) to meet with 35 economics types and their friends. This is a very knowledgeable group, with a lot of well-known names. We fish in the morning, meet at a campsite for lunch (drink wine and eat what we caught), fish some more, go back to the lodge, eat a gourmet meal and drink some more wine, and then go on talking. This goes on for 2-3 days. I throw my diet to the wind, and pay for it over the next month, but it's worth it.

On Friday Steve Liesman and some local guides bring out their guitars and entertain, with a lot of loud, if somewhat off-key, singing from the crowd. (Liesman, by the way, really can play the guitar quite well.) On Saturday night we bet on the future of the markets and events - typically small amounts, and lots of side bets. This year I won five out of six side bets I made last year.

As usual, bets were all over the board. But a few interesting ones surfaced. David Kotok and George Friedman offered rather (for this crowd) large sums to take on all comers that Bernanke would not be reappointed. I took part of that offer, as did a number of others (for the record, the Fed economists at the meeting do not bet and were quite closed on the topic). I was surprised at the intensity of that debate. This is a well-informed crowd when it comes to Fed policy and actions, and if this question is (politely) contentious among friends in July of 2009, what will it be like in the latter part of the year, when Obama has to make the appointment (Bernanke's appointment is up in January of 2010)? And among those who do not get along? This could be a very noisy appointment process.

A few years ago (2006 and 2007), I was repeatedly told I was "too bearish." Now, my Muddle Through prediction was seen either as overly optimistic or the most likely scenario by a large number of attendees. The concerns about the credit markets are still quite strong, with many thinking we will be facing banking problems for years. There were more than a few who bet that Citibank will not be around in its current form by this time next year. (I did not take that bet.)

A number of participants saw a double-dip recession as a distinct possibility. I think it is a probability in 2011 as the Bush tax cuts expire. If Congress moves up the increase in taxes to 2010, which is what the House Democrats want, that recession could start in 2010.

Tulsa, Birthdays, Weddings, and Paul McCartney

Today is my mother's 92^nd birthday, so I need to leave soon, as she eats early. The order of the day is Luby's Cafeteria. Interestingly, she had me when she was 32, and Tiffani is 32 and will have her first around Christmas. Other than her hearing, mother is still going strong, if a little more slowly, and shows no real signs of letting up. She is now bionic, with two new knees and hips over the last decade.

Next week I leave for Tulsa on Thursday to prepare to give away my daughter Amanda on Saturday to a nice young gentleman, Allen Porter. They (along with her twin sister Abigail) say they intend to move to Dallas after the first of the year, which will make Dad happy, as all the kids will be in the local area. A little golf on Friday morning with the new in-laws, parties, and so on. It should be a large wedding and a fun weekend. They have lots of friends, it seems. I do intend to write my letter as usual.

I also intend to be in the bar on Thursday night at the Hilton at 9:30-45, assuming Southwest is on time. If anyone cares to meet, feel free to drop by.

Thinking about Mother's birthday reminds me that I turn 60 on October 4. For whatever reason, it is not bothering me like 50 did. Maybe 60 is the new 45? Paul McCartney is now 66, and is on the road with what I am told is a very good show. I will find out Wednesday when he plays Dallas and I get to go to the new Cowboy Stadium to see him play. With most of his set scheduled to be Beatles tunes, I am really looking forward to being there. I got to see Eric Clapton last month. He is on top of his game. Maybe blowing through 60 is not all that bad.

Have a great week. I shall.

Your hoping I can avoid paying for another wedding for a few years analyst,

John Mauldin

This Way There Be Dragons

John Mauldin — Sat, 30 May 2009 04:02:58 GMT

This Way Be Dragons
A Housing Update
More Prime Foreclosures In Our Future
Are We Paying Too Much for Health Care?
Naples, London, and Home for June

In fantasy novels the intrepid heroes come across a sign saying "This Way Be Dragons." Of course, they venture on, facing calamity and death, but such is the nature of fantasy novels. We live in a very real world, and if we don't turn around there will be some very nasty dragons in our future. This week we look at three possible paths we can lead the world down. We then review a number of charts and data on the housing market.

If you just read the headlines on this week's data, you could be forgiven for assuming the worst is over -- not. And then finally we look at some rather stark comparative data on the health-care systems of the US, Canada, and Great Britain. Everyone knows the US pays way more in terms of GDP than the latter two countries. Are we getting our money's worth? There is a lot to cover, and I hope to finish this on a flight to Naples, so let's jump right in.

This Way Be Dragons

More and more we read about the growing concern over $1-trillion-dollar deficits. Stanford professor John Taylor (creator of the famous Taylor Rule) jumped into the debate with a rather alarming op-ed in the Financial Times this week, echoing much of what I wrote last week, but with some real insights into what trillion-dollar deficits mean. Quoting:

"I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor's considers. The deficit in 2019 is expected by the CBO [congressional Budget Office] to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

"Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth -- probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession."

You can read the rest at (http://www.ft.com/cms/s/0/71520770-4a2c-11de-8e7e-00144feabdc0.html?nclick_check=1)

While Obama gives lip service to cutting the deficit in half, his actual budget increases it over the next 10 years. As I have been writing for some time, this is a very dangerous path. And it is one that the bond market seems to be concerned about, as interest rates are rising, even on mortgages that the Federal Reserve is buying in massive quantities in its effort to hold down rates and stimulate the housing market.

"The good news," Taylor concludes, "is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one."

Taylor is right that the massive tax increases necessary to fund these deficits and programs should not happen. But it is not clear to me that they won't. A Democratic Congress is talking of adopting John McCain's plan to tax health-care benefits. While this would be a tax on the middle class (on everyone) that Obama said he would not do, he is clearly willing to sign a bill that has such a tax.

The administration is starting to float trial balloons about a new VAT, or value-added tax. Many of my non-US readers will be familiar with VAT taxes, especially in Europe. A combination of a VAT and taxing health-care benefits would raise enough to get us to a deficit of "only" a few hundred billion. Take away the Iraq war and you get even closer. You can make an economic case that a VAT tax would be preferable to an income tax.

However, the administration is not talking about a substitute but an additional tax. There is momentum in the heavily Democrat-controlled Congress for large new health-care programs. While there is resistance to large deficits on the part of a few moderate Democrats, there is a chance they could be brought on board with a tax or a series of new taxes that would offer the potential to pay for the new programs. (Even though everyone knows that the cost overruns on new health-care benefits will be much larger than estimated.)

As much as it grieves me to say it, a tax on health-care benefits or a VAT tax large enough to hold the proposed deficits to something under 3% of GDP would be preferable to running decade-long trillion-dollar deficits, which would destroy the US economy and the dollar and do severe damage to the world economy. (For the record, I am assuming the Bush tax cuts are history.)

But while a large tax increase would keep the economy from crisis and collapse, it is not without very serious consequences. It will put a serious crimp in economic growth. It will lock in European growth rates and European-like unemployment rates. And we will be using those tax increases to fund new spending and will still not have solved the future problems with Social Security and Medicare, which are going to require massive increases in spending in another 5-7 years. Which of course means that either a cut in benefits or another round of growth-crippling tax hikes is down the pike.

A third path would be to simply go ahead and raise taxes on the rich, say no to increased spending on programs until we can afford them, hold the line on any new spending, and see if we can reintroduce the gradual budget control that was the result of the stand-off (and to some extent cooperation) between Gingrich and Clinton.

I put about a 5% probability on the third scenario happening. Better than the chances of a snowball in hell, but not much. The first disaster scenario is about a 35% probability, which is quite scary. If we do choose such a path, then short the dollar, buy gold, and invest abroad. It will be a very tricky and difficult environment.

I assign a 60% probability to the middle path. Maybe it's my basically optimistic nature and I am simply being naive, but I am hopeful that cooler heads will prevail and we will not run continual massive deficits larger than the growth of GDP. While that means rather large tax increases, since the current leadership wants to create massive new health-care entitlements and will do so, I would rather have to simply overcome higher taxes in my business rather than deal with a collapse of the dollar, high unemployment, high interest rates, and an extremely sluggish economy.

Each scenario will create a different investment environment. Ironically, the middle scenario could be good for the dollar over the long term. But it will be hell on corporate profits from US sources. Given the above, it seems like a 95% chance that we should start looking at investing a significant percentage outside of the US and Europe. Think Canada, Australia, Asia (not Japan), Brazil, South Africa, etc.

Normally, politics does not have all that much of an impact on the stock market. As an example, both Democrats and Republicans can take credit for the '90s, but it was really the dynamic of the free market that worked in spite of government. Same for the Bush years. While the tax cuts did help, it was the free market and increasing leverage that were the dominating factors.

This time it will be different. The choices we make as to how to fund, or not fund, the increases in spending that are our clear and sad destiny, will have a major impact on not just the US but the world economy. As US consumers have been a major part of the growth of the developing world, and especially Asia (China), a slowing of consumption in the US will mean a very slow recovery for the rest of the world. It will happen, but the choices made by politicians this year will have many unintended consequences. Just as deciding we would take a major part of the corn crop and turn it into expensive ethanol raised the price of tortillas in Mexico, raising taxes in the US will mean lower global consumer spending and trade. It is a very tangled web we weave.

A Housing Update

If you read the headlines the last few days you would think that the housing market has turned. Mostly they read something like "Home Sales Rise 0.3%," and of course the reflexive bulls started talking about green shoots and a bottom in housing. And while someday we will actually have a bottom in housing, it will not be this month. It has been awhile since we have looked at the housing market, and it is time to review.

First. Of course home sales rose. It is April. Look at the graph below. It is the time of the year when home sales rise. And 0.3%? Really? The margin of error is close to plus or minus 10% or so, so 0.3% is a meaningless number. It will be revised. Who knows which way? I don't. (I am on the plane so I cannot access the exact margin of error, but 10% is not that far off.)

My main thesis since 2006 has been that the housing market was in a bubble that would burst. We built something like an extra 3 million homes over trend growth, and those homes are going to have to be absorbed in the normal way, through growth of population and the economy. We "need" about 1 million new homes a year to take care of population growth and demand. Further, we have cut off home availability to buyers who are in the subprime category, whereas during the boom you simply had to have a pulse, even a lying pulse, to get a home for which you did not have a chance of actually paying the mortgage.

The earliest we see a real bottom to housing is late 2010 or 2011. By real bottom I am talking about housing values in general being to rise (assuming we do not visit scenario one and have significant inflation.) There is nothing that can be done about that. We have to work through the excess capacity. (More later on that below.)

We had the Case-Shiller home price data come out this week. Home prices are still in free fall. They are down almost 19% year over year and 32% from their 2006 highs (see chart below). If we get back to the long-term price growth trend, we would see another average 10% drop; and as prices tend to overshoot on the upside and the downside, in some markets they could fall even further.

Yet there is hope that we will not see a fall below trend. Housing in many areas is starting to once again become affordable (see chart from Moody's below) to more and more Americans and even first-time home buyers. The cure for the housing crisis is actually lower prices, as that brings more and more potential home buyers into the market. While housing sales are still quite depressed, what are selling are homes in foreclosure, as buyers perceive that there are bargains. And they are right.

On the negative side, the supply of homes available for sale is again rising, as more and more foreclosures come onto the market. And as we will see, this foreclosure trend is going to slow down soon. (Thanks to Greg Weldon at www.weldononline.com for the chart.)

Notice in the above chart that the supply of homes for sale is over ten months. But that average can be misleading. If you are in Florida, I read recently that in many areas it is over 40 months. And that is for homes that can be financed with government-sponsored "conforming loans," typically up to $719,000. But what if your home cost more than that? National Association of Realtors chief economist Lawrence Yun said that the supply of existing homes for sale over $750,000 has reached a forty-month supply.

Diana Olick, the very on-top-of-it CNBC real estate reporter, had the following to say (emphasis mine).

"That's going to mean a new phase of the current housing recession. So far we've seen the 'correction' of a boom market that was driven by faulty, exotic loan products, investors looking to make a quick buck, and average Americans using their homes as ATMs. Now the losses are being driven by traditional economic factors and by sweeping price drops across the nation.

"Yesterday Fitch ratings estimated that up to 75 percent of the modifications now being done through the administration's Making Home Affordable program will re-default in six months to a year. I'm not talking about the old modifications, which were largely repayment plans that could actually raise monthly payments. I'm talking about the new mods, which lower monthly payments to 31 percent of a person's income. I couldn't understand Fitch's reasoning, so I called them.

"Diane Pendley, managing director at Fitch, said the problem is not on that "front-end" ratio, but on the back end, which is all of the borrowers other debt (credit cards, car loans, student loans, etc.). She said that in talking with servicers, she's hearing other debt is so high that most of today's troubled borrowers cannot afford any loan payment at all, even at a very modest debt-to-income ratio. 'Just getting the house payment done doesn't mean their lifestyle is sustainable,' she said.

"Another problem is that with home prices continuing to fall, more and more borrowers, who are essentially just renting their mortgages now because they will never see any home equity, are walking away. Even if the mortgage payment is low, the property taxes and home maintenance costs are padding that payment, and without an upside to the investment, there's simply no reason to pay. Suffice it to say, the foreclosure crisis, on the high and low ends, is not getting any better."

And it gets worse.

More Prime Foreclosures In Our Future

The Mortgage Bankers Association noted that a record 12%, or 1 in 8 homeowners, in the US are now behind on their payments or in foreclosure. 10.6% of the mortgages in Florida are now somewhere in the process of actual foreclosure. (My seatmate here on the flight says the prices on the condos where he lives are now back to 1998 levels. It would be scary, he said, if you had to sell. There are new developments that only have 10% actual occupancy, as the bulk of the condos were bought for speculation. Now those 10% of buyers are having to shoulder all the fees for upkeep. Nobody will buy, because the upkeep costs can be more than the mortgage. It is a vicious cycle.)

In Nevada foreclosures are 7.8%, Arizona 5.6%, and California 5.2%. 25% of subprime loans are now in foreclosure, 14% of FHA (government, taxpayer-guaranteed) loans and a growing 6% of all prime loans are now in foreclosure. (Note: the seasonal adjustments may overstate the actual numbers, as we are in new territory in terms of actual foreclosures.) Quoting from the MBA press release:

"In looking at these numbers, it is important to focus on what has changed as well what continue to be the key drivers of foreclosures. What has changed is the shifting of the problem somewhat away from the subprime and option ARM/Alt-A loans to the prime fixed-rate loans. The foreclosure rate on prime fixed-rate loans has doubled in the last year, and, for the first time since the rapid growth of subprime lending, prime fixed-rate loans now represent the largest share of new foreclosures. In addition, almost half of the overall increase in foreclosure starts we saw in the first quarter was due to the increase in prime fixed-rate loans." (emphasis mine)

How could so many prime loans be in foreclosure? These were people with good credit and jobs. The answer is the very deep and lengthy recession, coupled with high and rising unemployment. The number of foreclosures will not abate until unemployment starts to fall. And even optimistic forecasts assume unemployment will keep rising into 2010. As I have written for a long time, I think it is quite likely that we will see unemployment rise to over 10%. When I first wrote that a few years ago, many called me just another doom and gloom guy. Now, many think I am Pollyanna. Such is the life of those who believe in Muddle Through.

For those who think the end of the recession will be like all past recessions, the problems in the housing market should make for serious concern. As we will see on Monday in my Outside the Box, the average homeowner with a mortgage has very little, if any, equity. There is little room for home equity withdrawals -- if banks were lending. And recent data shows a very serious and un-American-like drop in credit card borrowing. US consumers are retrenching, and global trade figures echo that.

We are in for a slow, Muddle Through recovery, with the real potential to slip back into recession when the tax increases hit. Stay tuned.

Are We Paying Too Much for Health Care?

I want to pass on this quick note from Dennis Gartman's eponymous letter. It should give all of those who favor a nationalized healthcare system pause, before they jump right in. Quoting Dennis:

"Canada is a wonderful place to have a nasty gash on one's forehead stitched, or to break one's nose in a game of pick-up baseball; but have cancer, or need eye surgery, or want an MRI, and the business of medicine in Canada and/or the UK breaks down badly in favour of medical care here in the US. For example... and we wish to thank The Investor's Business Daily for the data noted here this morning...

"... here in the US men and women survived cancer at an average of just a bit better than 65%. In England only 46% survive. In the US, 93% of those diagnosed with diabetes receive treatment within six months; in Canada only 43% do, and in the UK only 15% do! For those seniors needing a hip replacement and getting one within six months, 15% get it done in the UK; 43% get it done in Canada ... and in the US 90% do! For those waiting to see a medical specialist, 23% of those in the US get in within four weeks, while 57% in Canada have not yet done so, and in the UK 60% are still waiting after four weeks.

"When it comes to proper medical equipment, in the US there are 71 MRI or CT scanners available per million people. In Canada there are but 18, and in the UK there are only 14! Ah, but the best figure of all is this: 11.7% of those 'seniors' in the US with 'low incomes' say they are in excellent health, which in and of itself sounds rather low ... rather disconcerting ... and an indictment of the system itself, doesn't it? But in Canada only 5.8% do!

"Yessiree bob, ya' jus' gotta' luv that collectivized, socialized medical care! Let's all go break a collective arm and enjoy the benefits of socialized medicine in the Commonwealth! (Canada) ... but heaven help you if you've got something really, really wrong. If that's the case, you'll be running south to the border faster than you can reach a specialist anywhere in Canada; of that we are certain."

Do we pay too much for health care here in the US? Everyone says yes. And there is a lot of waste (and waist) in the system. But if you are the person who needs treatment, maybe the answer is "not really." If you can't get the medical help you need when you need it, maybe the fact that it is theoretically free doesn't mean anything.

As an aside, I have two friends who have had immediate family members diagnosed with Lou Gehrig's Disease. For all practical purposes, it is a death sentence. Yet one family was told (at a top-five cancer hospital) there could be a cure within a few years, or at least clinical trials. But just not now. Unfortunately, the prognosis is less than a year.

I can guarantee you, if that was me or my family, I would like to be able to make the decision whether to try a radical treatment. What's my downside if I die a little earlier? Shouldn't that be my choice?

And if I don't want some nameless bureaucrat dictating who gets to live or die in the name of his scientific system, why in God's name would I want a bureaucrat deciding to ration my access to health care? But that is what the majority in Congress are planning for our future. And bluntly, I find that far harder to swallow than my taxes going up.

Naples, London, and East Europe

I am literally in the taxi in Naples as I finish this letter (even for me, this is a first). I am supposed to go right into meetings when I arrive. Ground zero for the housing crisis. But it is still a pretty city. Hopefully I can get out and do a little power walking on the beach tomorrow. I am looking forward to being with good friend and fellow writer Gary Scott and business partner Steve Blumenthal, as well as my friends from Jyske Bank.

The schedule says I am home all of June. Then I am off to London in the middle of July for my partner Niels Jensen's 50^th birthday, and then a vacation to far Eastern Europe. Thanks to everyone who wrote with suggestions and offers to help.

School is just about over for youngest son Trey, and we have been spending a lot of time reviewing material for his finals (with some success!) But then you get a call from the vice principal. Seems there was a little trash talk and the other (bigger) kid hit first, and then ... "Really, Dad, it wasn't my fault. This is just so stupid." Well, you know how that goes. (Trey is fine.) After seven kids, I should get used to the regular surprises. Well, there is always next year to teach him how to avoid bullies. (Which of course Dad was soooo good at.)

It is time to hit the send button. We are pulling up to the resort. I have a good feeling about this summer. It will be busy (what else is new?), but I think it will be fun. Have a great first week of summer!

Your real life just keeps on coming at you analyst,

John Mauldin

Is That Recovery We See?

John Mauldin — Sat, 11 Apr 2009 03:08:20 GMT

Is That Recovery We See?
Those Wild and Crazy Analysts
The Shadow Inventory of Homes
Commercial Real Estate Starts a Long, Slow Slide
P/E Ratios Go Negative!
The Effect of Earnings Surprises
Corporate Earnings and Recovery in Recessions
The Implosion in Social Security
Copenhagen, London, Newport Beach, etc.

The market, we keep hearing and reading, is telling us that there is recovery around the corner. And pundits point to data that seems to suggest the worst is behind us. The leading economic indicators, while still down significantly, seem to be in the process of bottoming. There is a large amount of stimulus in the pipeline. Mark-to-market has been modified. Housing seems to be finding a bottom, if you look at the rise in sales from January. And so on.

In this week's letter, we look at what past recoveries have looked like in terms of corporate earnings; and we look at the continued slide in earnings on the S&P 500, which has a negative price-to-earnings ratio looming in future months (yes, that is not a typo, we have an unprecedented earnings multiple). We take a peek at housing and foreclosures. There is just so much bad news out there (like continued unemployment) that it just has to get better, doesn't it? This should make for an interesting letter.

Is That Recovery We See?

This week the market seemed to like financial stocks and was buoyed on news that Pulte Homes would buy Centex to create the largest US homebuilder. And with banks having some room to adjust their writedowns as mark-to-market is modified, the market saw significant increases in the financial sector. Everywhere I keep hearing the old saw that the market predicts a recovery about six months out, so won't we see a recovery in the fourth quarter of 2009?

If you look at earnings estimates for 2009, that is what is suggested. Bloomberg reports that profits at S&P 500 companies probably fell 38% on average in the first quarter. The stretch of quarterly declines is the longest since at least the Great Depression, data compiled by S&P and Bloomberg show.

Earnings may drop 31% in the second quarter and 18% in the next before gaining 74% in the last three months of the year, analysts predict. Banks are projected to account for all of the rebound in the final quarter. Without financial companies, the gain turns into a 5% decline, the data show.

The above estimates are based on operating earnings, not as-reported earnings. Long-time readers know that operating earnings are actually earnings before interest and Bad Stuff. As-reported earnings are what companies actually report on their tax reports, and as a gauge of profitability they are much more reliable. Before the mid-'90s the difference between operating and as-reported earnings was typically quite small. Then companies found they could play the market if they played games with their operating earnings.

Operating earnings typically do not take into account one-time, nonrecurring events. The number of items which get classified as "nonrecurring" has mushroomed to the point where projected operating earnings for 2009 are more than double the estimates of as-reported earnings. Operating earnings for 2008 were almost three times actual, or as-reported, earnings. We certainly seem to have entered an era of really bad one-time events, which just keep on coming and coming. As recently as 2006, there was less than a 10% difference between the two. In some quarters it was only 5%. A far cry from today's 100%-plus.

Those Wild and Crazy Analysts

Analysts, who as a group have been egregiously bad at predicting earnings of financial stocks for the last two years, would have us believe they are due for a large rise in the 4^th quarter. Let's visit those assumptions for a few minutes.

They contend that much of the bad news in the subprime-loan and housing market has been written off. And one would have to admit that a lot has been; and with the relaxation of mark-to-market, there may indeed be some truth to that suggestion. But there are still some issues that remain for housing. Take a look at the graph below. (Not sure where it is from, as it was sent to me, but I have seen the same data elsewhere.) Notice that monthly mortgage-rate resets declined markedly in 2009 from 2008, but are expected to rise again in 2010 and 2011. There is still some heartburn in the mortgage market.

The Shadow Inventory of Homes

And foreclosures keep climbing, though some point to that fact that they seem to be leveling off. However, a strange thing is happening. We are seeing what is being called a "shadow inventory" of foreclosed homes.

"We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market," said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. "California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You'd have further depreciation and carnage." (San Francisco Chronicle)

A Realty Trac survey found that only 30% of foreclosures were listed for sale in real estate listings like the MLS (Multiple Listing Service). Add in homes that people would like to sell but simply can't find buyers for, and must either hold or rent, and the unsold inventory numbers that are public are likely far below actual available homes.

Might some homes in foreclosure be held off the market because banks eventually want to negotiate with the homeowner? Possibly, but other surveys show that anywhere from 30-40% of homes in the foreclosure process in many areas are actually already vacant. There is no one with whom to negotiate.

Typically a foreclosed home sells within a few weeks, as banks take the first "reasonable" offer. But it normally takes about three months from foreclosure to when the home is put on the market -- it takes a few months to get a home ready. But surveys show it is taking a lot longer now, and many homes have not made it onto the market, even as more homes are being foreclosed each month.

The Chronicle suggests several factors may be at work. First, there is the "pig-in-the-python" problem. There are just so many homes that it is hard to get them onto the market and sold. Normally there are about 160,000 homes a year in foreclosure sales. We are now seeing 80,000 a month, or six times normal levels, and rising.

Second, lenders could be deferring sales to put off having to acknowledge the actual extent of their losses. "With banks in the stress they're in, I don't think they're anxious to show losses in assets on their balance sheets," one observer said.

Finally, banks may not want to flood the market with foreclosures, driving prices down even more. They are simply managing their assets so as to recover the most capital they can.

Given that the graph above says there will be more mortgage misery as large numbers of mortgages reset in the next two years, and given the unknowable nature of the losses, it is somewhat optimistic to think financial profits will rise by 74% in the fourth quarter. But it gets worse.

Commercial Real Estate Starts a Long, Slow Slide

We are now starting to see some real deterioration in traditional bank lending. Delinquencies on home equity loans are rising rapidly. The American Banking Association released a composite index of eight different types of consumer loans, and the delinquency rate on this 35-year-old composite jumped to a record high of 3.22%.

The above reflects 4^th-quarter data. As unemployment is up 2% since then and is rising, it is more than reasonable to assume that we will see another record rise in delinquencies this quarter. With unemployment headed to over 10% and maybe 11% from today's 8.5%, delinquencies are likely to continue to rise for the entire year.

David Rosenberg reports that "The National Federation of Independent Business found in a poll that 28% of small firms said they had a line of credit or credit card limit cut back in the second half of last year; 69% stated they are facing worse terms. A new FICO study found that 11% of US consumers -- 22 million people -- have had their credit lines cut or accounts closed even though they have been paying their bills on time and retain a solid rating." This is certainly not good news for those who expect a positive 4^th quarter. Cutting credit to small business, the engine of job growth in the US, is hardly a prescription for a growing economy.

Commercial mortgages are in trouble. S&P has warned they may cut ratings on $97 billion in commercial-mortgage asset-backed debt. The country's 10 biggest banks have $327.6 billion in commercial mortgages, according to regulatory filings. A projected tripling in the default rate would result in losses of about 7% of total unpaid balances, according to estimates from analysts at research firm Reis Inc. (Bloomberg)

I think, given the track record of the analysts who project a 74% rise in earnings for financial stocks in the 4^th quarter of this year, that we should remain a tad skeptical. And speaking of earnings, let's go to the S&P web site and see how things are progressing.

But first, let's look at just how badly analysts blew it in estimating 2008 earnings. In the table below we see that as recently as October 15 they were estimating AS-REPORTED earnings to be $54, down from $92 when I first saw the 2008 estimates. There were only two months to go in 2008. So, what are the actual 2008 earnings? Down to $14.88!!!

Not exactly a record to inspire confidence. So, how are we doing in 2009? We see the same pattern. There is a clear deterioration in earnings estimates. Yet, even with the ever lower estimates, they are still projecting nearly a doubling from 2008. Care to make a wager as to what the estimates will look like in a few quarters? Think we will see earnings rise?

P/E Ratios Go Negative!

When we last visited the S&P web site a few weeks ago, the P/E ratio for the quarter ending September 30 was around 181. I must confess that when I looked at it today, as jaded as I am, I was shocked. You can see the numbers for yourself at http://www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS?GXHC_gx_session_id_=5350992f205e73e4&.

The P/E ratio for the end of the second quarter is 1944 (not a typo). The losses of the 4^th quarter wipe out almost all earnings for the 12 months ending June 30. But by the end of the 3^rd quarter, the estimated P/E ratio has dropped to a (negative) -467. That has never happened. We have never seen negative earnings over a 12-month period since WWII. (I don't have data for the Depression era.)

Then as the negative earnings of the 4^th quarter of 2008 drop off, we see the estimated P/E ratio rise back to 30, which is quite high. However, if actual earnings come in lower, as I think they will, the P/E ratio will rise and/or the market will fall as negative earnings surprises just keep on coming.

The Effect of Earnings Surprises

As William Hester of Hussman Funds writes in a recent article, the rise and fall of the stock market closely correlates with earnings surprises. Look at the following chart. (You can see the whole article at http://www.hussmanfunds.com/rsi/econsurprises.htm. I highly recommend it.)

As Hester writes, "To track the trends in economic performance, we keep an ongoing tally of how data is announced relative to expectations -- a method of analysis originally inspired by Bridgewater Advisors . Economic data that surpasses expectations gets added to a 3-month running total. Data that comes in weaker than expected gets subtracted. A rising line means that economic data is generally coming in above expectations, while a falling line means that the data has disappointed. A descending line could be the result of an economy that is not expanding as quickly as economists predict or -- like in 2008 -- it could be the result of an economy that is contracting at a faster rate than expected.

"... Much of the excitement in the stock market -- at least that is related to the current performance of the economy -- seems to be centered on an economy that is performing less badly than expected. The risks here seem to be that if the trends in data surprises change, so could investors' attitudes toward stocks that are currently overbought on a number of measures.

"... If the high correlation between stock prices and data surprises holds, the recent rally in stocks might be tested. Even if the economy has bottomed, it's very likely that the eventual recovery will prove to be uneven, causing the flow of positive surprises to be uneven. During these periods, the risks to stocks will be greatest when the market is overbought and investors have priced in high expectations of positive data surprises continuing."

The projections of many market analysts assume that we will have something that will look like a normal recovery. I have objected that that could be a very bad assumption, since we are not having a normal recession. This is already a very lengthy recession, and is just going to get longer. As I will note below, there are reasons to think we could see a mild recovery late this year, only to dip back into recession next year.

Corporate Earnings and Recovery in Recessions

Next, let's look at a very interesting chart sent to me by one of my readers, Chad Starliper of Rather and Kittrell in Knoxville, Tennessee. It shows all the cumulative drops in earnings from major peaks, along with the recovery paths. What is interesting is the divergence between the pre- and post-WWII periods. Our experience since 1945 is one of rather quick recoveries, averaging about 3-4 years until earnings rise above the old highs.

The thicker black line shows a drop of 69.2% from peak earnings since 2007. Prior to World War II, it took 12-20 years for earnings to recover. Earnings are still dropping. As I will point out in the next few e-letters, we live in a world (not just the US) that is in a deep recession. There is massive deleveraging and deflation. The recovery is going to be quite slow, and that portends a slow recovery in earnings, which suggests protracted churning in the stock market. (By the way, for those of you who print out this letter, the next graph will be hard to read if it is not in color.)

Even ignoring the disastrous 4^th quarter of 2008, what if earnings drop by 80% or more, which is quite possible? That means they have to rise by 400% to get back to new highs. That could take some time. Even if they could rise at an unlikely 24% a year, it would take six years to see new highs. Look at what a mountain corporate earnings must climb.

Consumers are retrenching, and savings rates are likely to rise for at least 3-4 years, back to 7% or more, leaving consumer spending not at 70% of US GDP but closer to 63%. That will be a rather large adjustment, and will mean that a lot of productive capacity will have to be closed or allowed to lie in disuse for a long time. We just built too many strip malls and car factories and restaurants. It is going to take some adjustments.

Further, the Democratic Congress and the Obama administration are going to enact the largest tax increase in history in 2010, just as the economy is barely recovering. The Bush tax cuts go away, because the Republicans could not make them permanent when they had the chance. We are going to pay for that with a likely dip back into a recession in 2010, or at the very least a prolonged weak economy.

The Implosion in Social Security

And then there is the last piece of data I want to bring to your attention, which is the most troubling of all. Everyone knows that the government spends the Social Security surpluses on current needs, "borrowing" the money and putting it into a "Social Security Trust Fund," which is basically just US debt we owe to the trust fund. In other words, there is no trust fund with anything other than paper debt. It is accounting legerdemain.

Everyone assumed that the real problem would come sometime later next decade, when there would no longer be surpluses. In 2008, the Congressional Budget Office (CBO) projected there would be $703 billion in surpluses from 2009-18. Recently, the CBO has revised those estimates downward. It now projects surpluses to be only $83 billion. Here is a table that was sent to me from a blog by Chris Martensen. (http://www.chrismartenson.com)

Writes Chris, "In the projections for the table above, the CBO has assumed no cost of living adjustments (COLAs) in 2010, 2011, or 2012 and a return to economic growth next year. If either of those assumptions proves wrong, the table above gets smoked to the downside."

Losing $700 billion (and likely a lot more) out of your budget projections is a huge blow to the US taxpayer. That money is going to have to be borrowed, or spending reduced. But the plans are for huge increases in spending.

In one of the great ironies, the Democrats and the Obama administration are going to have to deal with the Social Security crisis, and soon. Bush tried to do so, and he got torpedoed from both sides of the aisle. Politicians just do not want to be seen doing anything to SS. Given the massive, multi-trillion-dollar deficits that are projected, the US is going to face some difficulty in borrowing to meet those deficits in the not-too-distant future. Is it 3 years? 4? 5? No one can say for certain, but that day is coming and it now appears much closer.

Let's say that US consumers do save 7%. That's almost a trillion a year. The trade deficit dropped to $26 billion last month, as imports continued to drop. That's another $300 billion that foreign central banks could recycle. The Fed could print a few trillion here or there without really pushing up inflation in today's deflationary world.

But there is a limit to continued $2-trillion deficits without the appreciable rise in interest rates that will be needed to attract buyers of Treasury bonds, which of course would increase interest-rate payments on the national debt, while also crowding out corporate and personal borrowing. This is not going to end well, and the end game is getting a lot closer.

All in all, the next few years are going to be a very difficult environment for corporate earnings. To think we are headed back to the halcyon years of 2004-06 is not very realistic. And if you expect a major bull market to develop in this climate, you are not paying attention.

The original question was "Is that recovery we see?" I think the answer is no.

Copenhagen, London, Newport Beach, etc.

Last week's Strategic Investment Conference was the best we have ever had. Many attendees said it was the best investment conference they had ever attended. We are transcribing speeches and will make some of them available over time.

The Richard Russell Tribute Dinner was a great success. We had video crews there as well as photographers, and intend to allow those who wish they could have been there to see part of the evening. It was a very emotional evening, and I want to thank the roughly 450 people who came from all over the world just to pay tribute to one of the true wonders of the investment-writing world.

I leave Monday evening for Copenhagen, where I will meet with Tom Fischer of Jyske Bank, and then day-long, back-to-back board meetings with Niels Jensen of Absolute Return Partners, and back to London Wednesday night for more meetings.

I get back Friday in time to write the letter, then off the next Thursday to Orange County, where I will attend Rob Arnott's annual conference. More on that later. Back on Sunday, and then out Monday to the Charter Financial Analyst conference in Orlando, where I speak on the "state of the union" of the alternative investment world. Then I am home for awhile, and gladly.

We had 300 people in for the Strategic Investment Conference, and the staff of my partners and co-hosts, Altegris Investments, did a magnificent job making everything go smoothly. There were so many friends there, the only disappointment was that I did not have all the time I wanted to meet with everyone. It was like drinking from a fire hose for three days, but it was fun.

It's time to hit the send button, as all my kids are in town and most of us are going to have some dinner and then see the Dallas Mavericks play. Brunch on Easter, of course, with family and friends, and then the final day of the Masters to round out a perfect weekend. I have been watching some of it on ESPN, and seeing Augusta on high-definition TV is truly spectacular.

I hope your weekend will be as good as mine. Spend time with family and friends if you can. That time is an investment that will pay dividends forever, and doesn't run up the national debt. Well, a little bit, if you have to buy the tickets and pay for brunch for about 16. But that's what Dads are for.

Your starting to think about the end game more analyst,

John Mauldin

Why Bother With Bonds?

John Mauldin — Sat, 28 Mar 2009 13:32:00 GMT

Why Bother With Bonds?
So Then, Bonds for the Long Run?
P/E Ratios at 200? Really?
Mark-to-Market Slip Slides Away
Housing Sales Improve? Not Hardly
La Jolla, Copenhagen, London, etc.

Investors, we are told, demand a risk premium for investing in stocks rather than bonds. Without that extra return, why invest in risky stocks if you can get guaranteed returns in bonds? This week we look at a brilliantly done paper examining whether or not investors have gotten better returns from stocks over the really long run and not just the last ten years, when stocks have wandered in the wilderness. This will not sit well with the buy and hope crowd, but the data is what the data is. Then we look at how bulls are spinning bad news into good and, if we have time, look at how you should analyze GDP numbers. Are we really down 6%? (Short answer: no.) It should make for a very interesting letter.

And for the last time, let me remind you of the Richard Russell Tribute Dinner this Saturday, April 4 in San Diego. We have had over 400 of Richard's fans (I guess you could say we are all groupies) sign up. A significant number of my fellow writers and publishers have committed to attend. It is going to be an investment-writer, Richard-reader, star-studded event. You are going to be able to rub shoulders with some very famous analysts and writers. If you are a fellow writer, you should make plans to attend or send me a note that I can put in the tribute book we are preparing for Richard. And feel free to mention this event in your letter as well. We want to make this night a special event for Richard and his family of readers and friends. So, if you haven't, go ahead and log on to https://www.johnmauldin.com/russell-tribute.html and sign up today. The room will be full, so don't procrastinate. I wouldn't want any of you to miss out on this tribute. I look forward to sharing the evening with all of you. I am really looking forward to that evening.

Why Bother With Bonds?

If stocks outperform bonds by as much as 5% over the long run then, for our truly long-term money, why should we bother with bonds? Why not just ignore the volatility and collect the increased risk premium from stocks? That is the message of those who believe in "Stocks for the Long Run" and also from those who want you to invest in their long-only mutual fund or managed account program. Indeed, it is always a good day to buy their fund.

One of my favorite analysts is my really good friend Rob Arnott. Rob is Chairman of Research Affiliates, out of Newport Beach, California, a research house which is responsible for the Fundamental Indexes which are breaking out everywhere (and which I have written about in past letters), as well as the only outside manager that PIMCO uses, for his asset allocation abilities. He has won so many industry awards and honors that I won't take the time to mention them. In short, Rob is brilliant.

He recently sent me a research paper that will be published next month in the Journal of Indexes, entitled "Bonds: Why Bother?" The publisher of the journal, Jim Wiandt, has graciously allowed me to review it for you prior to it actually being sent out. The entire article will be available when the Journal of Indexes goes to print in late April, at www.journalofindexes.com. Qualified financial professionals can also get a free subscription there to pick up the print copy. There is some very interesting research at the website. But let's look at a small portion of the essay. I am reducing 17 pages down to a few, so there is a lot more meat than I can cover here, but I will try and hit a few things that really struck me.

It is written into our investment truisms that investors expect their stock investments to outpace their bond investments over really long periods of time. Rob notes, and I confirm, that there are many places where investors are told that stocks have about a 5% risk premium over bonds.

By "risk premium," we mean the forward-looking expected returns of stocks over bonds. As noted above, if you do not think stocks will outperform bonds by some reasonable margin, then you should invest in bonds. That "reasonable margin" is called the risk premium, about which there is some considerable and heated debate.

Most people would consider 40 years to be the "long run." So, it is rather disconcerting, or shocking as Rob puts it, to find that not only have stocks not outperformed bonds for the last 40 plus years, but there has actually been a small negative risk premium.

In a footnote, Rob gets off a great shot, pointing out that the 5% risk premium seen in a lot of sales pitches is at best unreliable and is probably little more than an urban legend of the finance community.

How bad is it? Starting at any time from 1980 up to 2008, an investor in 20-year treasuries, rolling them over every year, beats the S&P 500 through January 2009! Even worse, going back 40 years to 1969, the 20-year bond investors still win, although by a marginal amount. And that is with a very bad bond market in the '70s.

Let's go back to the really long run. Starting in 1802, we find that stocks have beat bonds by about 2.5%, which, compounding over two centuries, is a huge differential. But there were some periods just like the recent past where stocks did in fact not beat bonds.

Look at the following chart. It shows the cumulative relative performance of stocks over bonds for the last 207 years. What it shows is that early in the 19^th century there was a period of 68 years where bonds outperformed stocks, another similar 20-year period corresponding with the Great Depression, and then the recent episode of 1968-2009.

In fact, note that stocks only marginally beat bonds for over 90 years in the 19^th century. (Remember, this is not a graph of stock returns, but of how well stocks did or did not do against bonds. A chart of actual stock returns looks much, much better.

Bill Bernstein notes that in the last century, from 1901-2000, stocks rose 9.89% before inflation and 6.45% after. Bonds paid an average of 4.85% but only 1.57% after inflation, giving a real yield difference of almost 5%. In the 19^th century the real (inflation-adjusted) difference between stocks and bonds was only about 1.5%.

In the late '90s, stock bulls would point out that there was no 30-year period where stocks did not beat bonds in the 20^th century. The 19^th century for them was meaningless, as the stock market then was small, and we were now in a modern world.

But what we had was a stock market bubble, just like in 1929, which convinced people of the superiority of stocks. And then we had the crash. Also, from 1932 to 2000 stocks beat bonds rather handily, again convincing investors that stocks were almost riskless compared to bonds. But in the aftermath of the bubble, yields on stocks dropped to 1%, compared to 6% in bonds. If you assumed that investors wanted a 5% risk premium, then that means they were expecting to get a compound 10% going forward from stocks. Instead, they have seen their long-term stock portfolios collapse anywhere from 40-70%, depending on which index you use.

So what is the actual risk premium? Rob Arnott and Peter Bernstein wrote a paper in 2002 about that very point. Their conclusion was that the risk premium seems to be 2.5%. Arnott writes:

"My point in exploring this extended stock market history is to demonstrate that the widely accepted notion of a reliable 5% equity risk premium is a myth. Over this full

207-year span, the average stock market yield and the average bond yield have been nearly identical. The 2.5 percentage point difference in returns had two sources: inflation averaging 1.5 percent trimmed the real returns available on bonds, while real earnings and dividend growth averaging 1.0 percent boosted the real returns on stocks. Today, the yields are again nearly identical. Does that mean that we should expect history's 2.5 percentage point excess return or the five percent premium that most investors expect?

"As Peter Bernstein and I suggested in 2002, it's hard to construct a scenario which delivers a five percent risk premium for stocks, relative to Treasury bonds, except from the troughs of a deep depression, unless we make some rather aggressive assumptions. This remains true to this day."

One other quick point from this paper. Just as capitalization-weighted indexes will tend to emphasize the larger stocks, many bond indexes have the same problem, in that they will overweight large bond issuers. At one point in 2001, Argentina was 20% of the Emerging Market Bond Index, simply because they issued too many bonds. If you bought the index, you had large losses. The same with the recent high-yield index which had 12% devoted to GM and Ford. In general, I do not like bond index funds, and this is just one more reason to eschew them.

So Then, Bonds for the Long Run?

Let me be clear here. I am not saying you should put your portfolio in 20-year bonds, or that I even expect 20-year bonds to outperform stocks over the next 20 years. Far from it! The lesson here is to be very careful of geeks bearing charts and graphs (it will be a challenge for my Chinese translator to translate that pun!). Very often, they are designed with biases within them that may not even be apparent to the person who created them.

Professor and Nobel Laureate Paul Samuelson in late 1998 was quoted as saying, a bit sadly, "I have students of mine - PhDs - going around the country telling people it's a sure thing to be 100% invested in equities, if only you will sit out the temporary declines. It makes me cringe."

When someone tells you that stocks always beat bonds, or that stocks go up in the long run, they have not done their homework. At best, they are parroting bad research that makes their case, or they are simply trying to sell you something.

As I point out over and over, the long-run, 20-year returns you will get on your stock portfolios are VERY highly correlated with the valuations of the stock market at the time you invest. That is one reason why I contend that you can roughly time the stock market.

Valuations matter, as I wrote for many chapters in Bull's Eye Investing, where I suggested in 2003 that we were in a long-term secular bear market and that stocks would be a difficult place to be in the coming decade, based on valuations. I looked foolish in 2006 and most of 2007. Pundits on TV talked about a new bull market. But valuations were at nosebleed levels. And now?

I have been doing a lot of interviews with the press, with them wanting to know if I think this is the start of a new bull market. There are a lot of pundits on TV and in the press who think so. I also notice that many of them run mutual funds or long-only investment programs. What are they going to do, go on TV and say, "Sell my fund"? And get to keep their jobs?

Am I accusing them of being insincere? Maybe a few of them, but most have a built-in bias that points them to the positive news that would make their fund (finally!) perform. And believe me, I can empathize. It is part of the human condition. But you just need to keep that in mind when you are thinking about investing in a new fund, or rethinking your own portfolio.

P/E Ratios at 200? Really?

Just for fun, when I was interviewing with the New York Times today, I went to the S&P web site and looked at the earnings for the S&P 500. It's ugly. The as-reported loss for the S&P 500 for the 4^th quarter was $23.16 a share. This is the first reported quarterly loss in history. That almost wipes out the expected earnings for the next three quarters. For the trailing 12 months the P/E ratio, as of the end of the second quarter, is 199.97. Close enough to 200 for government work.

But it gets worse. The expected P/E ratio for the end of the third quarter is (drum roll, please) 258! However, taking the loss of the fourth quarter off the trailing returns allows us to get back to an estimated P/E of 23 by the end of 2009. The problem is that you have to believe the estimates, which I have shown are repeatedly being lowered each quarter, and which I expect to be lowered by at least another 25% in the coming months.

Now, much of that loss is coming from the financials, which showed staggering write-offs of $101 billion, $28 billion coming from (no surprise) AIG alone. Sales across the board are down almost 9%, with 290 companies reporting lower sales.

This quarter the estimated consensus GDP is somewhere between down 5% to down 7%. Last quarter we were down an annualized 6.3%. That would be two ugly quarters back to back. It is hard to believe earnings for nonfinancial companies are going to be all that much better.

Side note: The economy did not contract at 6.3% in the 4^th quarter. That is an annualized number. The quarter actually contracted at about 1.6%. If we go a whole year with a 6% contraction, that would be truly horrendous. We would blow right on through 10% unemployment. While it is possible, we should start to see somewhat better numbers in the second half of the year, although I still think they will be negative.

Mark-to-Market Slip Slides Away

But it is quite possible that the financial stocks see an improvement in earnings this quarter. The US Financial Accounting Standards Board (FASB) changed the mark-to-market rules last week, which many (including your humble analyst) thought was needed. First, they suspended the mark-to-market rules for assets in distressed markets. Second, they widened the definition of "temporary" impairments of troubled assets, which will "allow banks to write up the value of some troubled assets if these have been hit by falling markets without (yet) suffering any significant credit losses." (www.gavekal.com)

Here's the important part. The board decided to make the new changes effective immediately, prior to full board approval on April 2.

As my friend Charles Gave noted, this will allow banks to write up their paper, and it happens before Treasury Secretary Tim Geithner starts putting taxpayer money at risk. Expect to see a pop in valuations. It will be interesting to see if Citi and B of A post profits this quarter.

(I should note that the International Accounting Standards Board sent out a scathing press release. I guess from that we should assume that European banks will not be so fortunate as their US counterparts.)

In theory, as I understand it, the information will still be there, but the way it will be recorded will not be reflected in the profit and loss statement. I understand that this is a very controversial proposal, and I expect many readers will disagree. The key is whether or not the information is available to investors and how the proposals are put into actual practice. If there is abuse, and regulators should be all over this, then the old rules must quickly go back into place.

This could put some strength back into financials, at least until the commercial mortgage and credit card problems start having to be written off. At the least, it could make for another solid rise in the stock market until we start to get what I expect to be very bad 1^st and 2^nd quarter earnings.

Housing Sales Improve? Not Hardly

I opened the Wall Street Journal and read that new home sales were up in February. Bloomberg reported that sales were "unexpectedly" up by 4.7%. I was intrigued, so I went to the data. As it turns out, sales were down 41% year over year, but up slightly from January.

But if you look at the data series, there was nothing unexpected about it. For years on end, February sales are up over January. It seems we like to buy homes in the spring and summer and then sales fall off in the fall and winter. It is a very seasonal thing. If you use the seasonally adjusted numbers, you find sales were down 2.9% instead of up 4.7%. But the media reports the positive number. Interestingly, they report the seasonally adjusted numbers for initial claims, which have been a lot better than the actual numbers. Not that they are looking to just report positive news, you understand.

Plus, as my friend Barry Ritholtz points out, the 4.7% rise was "plus or minus 18.3%". That means sales could have risen as much as 23% or dropped 13%. We won't know for awhile until we get real numbers and not estimates. Hanging your outlook for the economy or the housing market on one-month estimates is an exercise in futility, and could come back to embarrass you.

But that brings up my final point tonight, and that is how data gets revised by the various government agencies. Typically with these government statistics, you get a preliminary number, which is a guess based on past trends, and then as time goes along that data is revised. In recessions like we are in now the revisions are almost always negative.

There is no conspiracy here. The people who work in the government offices have to create a model to make estimates. Each data series, whether new home sales, employment, or durable goods sales, etc., has its own unique sets of characteristics. The estimates are based on past historical performance. There is really no other way to do it.

So, past performance in a recession suggests higher estimates than what really happens. Then, the numbers in the following months are revised downward as actual numbers are obtained. But the estimates in the current months are still too high. That makes the comparisons generally favorable, at least for one month. And the media and the bulls leap all over the "data," and some silly economist goes on TV or in the press and says something like, "This is a sign that things are stabilizing." It drives me nuts.

Ignore month-to-month estimated data. The key thing to look for is the direction of the revisions. If they are down, as they have been for over a year, then that is a bad sign. Further, one month's estimates are just noise. Look at the year-over-year numbers. When the direction of the revisions is positive and the year-over-year numbers are starting to stabilize, then we will know things are starting to turn around.

La Jolla, Copenhagen, London, etc.

April is a travel month. Next week I am going to a presentation in Irvine on the state of stem cell research, which I must admit fascinates me. Then I'm in La Jolla for my Strategic Investment conference, co-hosted with my partners Altegris Investments. Then home for a week. Easter weekend, all seven kids will be home. Then the next week I go to Copenhagen for a board meeting; and I will be in London, Thursday April 16 to meet with my European partners, Absolute Return Partners, and clients. The next weekend I go back to California for a conference, and then the next week I'll be a day or so in Orlando, where I'll speak at the CFA conference on the state of the alternative investment industry.

While I'm in London, I need to drop by and buy a pint for David Stevenson, a columnist for the Financial Times. Seems that he was asking his readers for nominations for best financial websites. For whatever reason, he decided I deserved a special award: "Best online commentator goes to US analyst John Mauldin, whose weekly letters at www.frontlinethoughts.com are required reading for all the big City-based bears I encounter." It's nice to be appreciated.

At the end of May (29-31), I will be in Naples, where I will be doing a seminar with Jyske Global Asset Management and Gary Scott. I will try to line up a web site where you can see whether you would like to attend.

It's after midnight and time to hit the send button. The day simply vanished on me, although I did get to the gym, at least. I am working hard, but somebody turned the dial down on my metabolism.

Have a great weekend. It is spring in the northern hemisphere, and the azaleas in Texas are awesome this year. Make sure you stop and enjoy nature a little this spring (or fall, for you blokes Down Under).

Your getting more skeptical of data as I get older analyst,

John Mauldin

Solving the Housing Crisis

John Mauldin — Sat, 21 Mar 2009 21:05:00 GMT

Solving the Housing Crisis
Housing Could Drop Another 20% in Pricing
Buy A Home, Get a Green Card
A Real Stimulus Package
Las Vegas, La Jolla, and the OC

This last Tuesday the Wall Street Journal published an op-ed by my friend Gary Shilling and Richard LeFrak. They offer a simple solution for the housing crisis: give foreigners who will come to the US and buy a home resident status (green cards). This is a very important proposal and one that deserves national attention and action. Gary was kind enough to send me two lengthier white papers offering more facts. In this week's letter we are going to look at this proposal in more detail than the small space that an op-ed can offer. And while this letter will be somewhat controversial in some circles, I ask that you read it through, giving me the time to make the case. I will also add a few thoughts as to why this could not only help solve the housing crisis, but help put the nation back into growth mode.

Long-time readers know that I have been growing more and more bearish of late. I have been writing for a long time that we are in for a long period of slow Muddle Through growth as the twin crises of the housing bubble and credit bubbles require time to heal. Today we look at a serious proposal for cutting the time to healing for at least one of those bubbles (housing), and at least keep the other (credit) from getting worse. This is the most serious idea I have seen that could actually make a real positive contribution to the economy and help put us back on a growth path.

I will post Gary's papers and a link to the actual op-ed piece for those who want to do further research, but let me make one point at the beginning that he did not emphasize: the US is already allowing roughly 1 million immigrants a year into the country (which for a variety of reasons I and most serious economists of all stripes believe is a very good thing). We are suggesting that we simply change the nature of what constitutes the conditions for acceptance, so as to jump start the housing industry and the economy. We are not suggesting additional immigrants, although nothing would be wrong with that. I will also post a link for you to send this e-letter to your congressmen and senators.

Let me put up front a few benefits of a program that would allow legal status to immigrants buying a home. Housing values would stabilize and in many cases rise. The massive losses because of bad loans that are being subsidized by US taxpayers would be stemmed, saving many hundreds of billions, if not a trillion or more dollars. The excess inventory of homes would quickly disappear and the millions of jobs that were lost as home construction fell into a deep depression would come back. If housing values rise, many families would be able to refinance their homes at lower rates and have more income left over after paying their mortgages. $12 billion in commissions would end up in real estate agents' pockets, helping a very battered and bruised group. Hundreds of billions will flow into local businesses, as these new immigrants will need to furnish their homes. This could mean as much as a half trillion dollars in sorely needed stimulus in the next few years, without one penny of taxpayer money and actually adding taxes back to governments from local to national. And we are not bringing in 1 million foreigners, we are attracting 1 million mostly middle-class new Americans, which, if we are smart in how we do this, will result in more jobs for all Americans. So let's jump right in and look at the details.

Housing Could Drop Another 20% in Pricing

Let's review the situation as it will be if we do nothing. Shilling shows that we built 6.7 million more homes in this country between 1996-2005 than the normal trend would have projected, partially because we underbuilt the decade before that. New housing starts average about 1.5 million in normal times but have fallen to 500,000 recently, and could fall further as unemployment rises and demand declines. Even so, Shilling estimates that we still have about 2.4 million excess homes.

This compares rather well with estimates by independent analyst John Burns, which I cited in the e-letter early last year. What they both agree on is that it will take at least until 2012 to work through this excess inventory, and that assumes that foreclosures do not increase as housing prices drop.

Excess supply of anything means lower and continuously falling prices, and that has certainly been the case in housing. Here is what Shilling writes:

"We believe that if nothing is done to eliminate surplus housing, prices will fall another 20% between now and the end of 2010 for a total peak-to-trough decline of 37% (Chart 1 below). The resulting further negative effects on the economy will be devastating. At that point, almost 25 million homeowners, or almost half the 51 million total with mortgages, will be underwater… That's also a third of the 75 million total homeowners, with the remaining 24 million owning their houses free and clear. It would take a little over $1 trillion to reduce their mortgages to the value of their houses, compared to $449 billion for the almost 14 million currently underwater."

This is not inconsistent with similar projections by other acknowledged experts and independent analysts like John Burns and Professor Robert Shiller of Yale. If nothing happens to stimulate buying, there is a great deal more pain ahead for American homeowners.

For the great majority of Americans, their homes represent the largest portion of their assets. This is particularly true of Americans of more modest means, who have been hit the hardest. Watching their single biggest assert drop another 20% will be devastating and for many will mean they will not be able to retire as they had planned. More Americans own homes (68%) than own stocks (50%). This helps explain a recent poll which shows more Americans are worried about house prices than about the decline in stock prices.

Falling home prices means that consumers have to save more for retirement, which results in lower consumer spending, which translates into lost jobs and more homeowners coming under stress -- a vicious spiral that is increasing unemployment. Realistic estimates of unemployment rising to over 10% within the year abound.

Two years ago I and a few others foresaw the current housing crisis (and an accompanying credit crisis), predicting a protracted recession and a slow, multi-year Muddle Through recovery. Sadly, I was right about the housing crisis. Without some intervention, there is little to suggest that the prediction of a long, protracted recovery will not come true.

Lowering rates, as is being discussed in various circles, will help homeowners who can make their payments, but it does nothing to really bite into excessive inventory. Until we reduce the inventory, housing prices in many neighborhoods all across America are going to continue to come under pressure. And as Barry Habib points out, while the Fed may be lowering rates for securitized packages of loans, those low rates are not available to the average home buyer. The cost of packaging and securitization adds considerable cost.

Shilling discusses the "traditional" options for reducing home inventories, but in the end there is no real solution other than time, or massive amounts (read trillions) in taxpayer money being given to homeowners, which will be very unpopular, as homeowners who were responsible and are paying their mortgages would get no benefits. Waiting another two and a half years for the excessive inventory to sell will keep this country in a very slow or no-growth economy, and devastate the wealth of millions of homeowners.

But there is a solution. There are millions of foreigners throughout the world who would like to come to live in the US. In 2006, there were 1.1 million immigrants allowed into the US, some 63% of whom were allowed in simply because they already had relatives here. Only 13% of visas were granted to people because of their skills. While allowing relatives of current residents to come to the US may be a humane and reasonable policy, it does nothing to assure they bring more than that relationship to help them make their way in the US.

Buy A Home, Get a Green Card

What if we changed the rules for a few years? Starting as soon as possible, we should allow anyone to come into the country who would buy a home. They would be given a temporary visa which would become permanent if they had no problems after, say, five years.

While Gary proposes that they be allowed to borrow against the value of their homes, I lean toward suggesting that initially we take those who buy their homes outright (with a few exceptions). That means they have enough capital to purchase a home to begin with, which probably means they are educated and have skills. In fact, if they have enough cash to buy a home, that means they would have more actual savings than most US citizens. We would be attracting future citizens with the capital to invest in job-creating businesses and/or who have useful skills to assist in the recovery of the US economy.

Of course, there should be some rules that go along with this proposal. Background checks and references should be required. The home could not be rented for a period of time (at least two years), to help reduce the supply of available housing, and could not be resold for at least two years unless another home was purchased. There should be a minimal price, which could be somewhat different for various regions, but $100,000 would seem to be a good minimum for most areas, with higher minimums in certain areas.

The immigrant should demonstrate the ability to support himself and his family for a period of time (at least one year, preferably two), including the purchase of health insurance. Cash or letters of credit or other guaranteed commitments would be required. Only immediate family members (spouse and children) would be allowed to come with the immigrant. Cousins and siblings must buy their own homes. The permanent visa should be contingent on not having gone on welfare or public assistance at any time in the past five years. We are trying to solve a housing problem, not looking to create others.

I would make an exception in having 100% financing for immigrants with advanced degrees or special skills, especially those who did their schooling in the United States. If the US is to remain competitive in an increasingly technological world, we need more scientists and engineers. But getting permission to stay is becoming increasingly difficult. We are seeing a brain drain of those who would like to stay and create new jobs and technologies (and buy houses) here in the US. Shilling and Le Frak write:

"The authors of this report believe that a number of people have given up waiting for those visas or don't want to put up with the hassle and are leaving the country. This "brain drain" is unfortunate since many of these foreigners are highly productive. In 2006, foreign nationals residing in the U.S. were named as inventors or co-inventors on 25.6% of the 42,019 international patent applications filed from this country, up from 7.6% in 1998. Studies of the authorship of academic papers show the same trend.

"U.S. educational institutions are considered the best in the world by many and are magnets for foreign students, especially at the graduate level. Many of them are inclined to settle and work in this country after completing their studies, if they can obtain permanent resident status.

"The Council of Graduate Schools survey revealed that in the fall of 2007, 241,095 non-U.S. citizens were enrolled in graduate programs. Technological progress and the productivity it generates depends on people educated in biological sciences, engineering and physical sciences, but only 16% of U.S. citizen graduate enrollment was in these three disciplines. In contrast, 55% of total non-U.S. citizen enrollment was in those fields. Conversely, 53% of graduate enrollment by Americans was in education, business and health sciences while those three fields accounted for only 24% of foreign graduate students."

(There is a great deal more background detail in the second white paper. See link below.)

Much can be learned from similar programs already in place in immigrant-hungry countries such as Canada, Australia, and New Zealand. The United Kingdom has recently added new programs. Many countries realize that in the coming years there is going to be increasing competition for the best and brightest of the world. Again, there are more details in the white papers, but let's turn to the effects that would result from such a program.

A Real Stimulus Package

First, upon Congressional approval, it would almost immediately stop the seemingly inexorable slide in house prices, as initial demand would be significant. Let's assume one million new immigrants would buy homes. At an average price of almost $200,000, that would be $200 billion injected into the economy. And each of those homes has to be furnished, food has to be bought, clothing will be needed, local taxes will be paid. Airplane tickets to research potential areas, hotels needed during the interim period, and other related expenditures would add up. Over two years, this could easily be another $100 billion.

Couple 1 million new buyers with current US demand, and the excess inventory would be worked through within a year, and possibly faster. This puts a floor under the housing market, and home values could once again to begin to rise in line with a growing economy.

Such a program would have a salutary effect on the value of the dollar, as not only the initial purchases of homes and materials would need to be converted to dollars, but it is likely that immigrants would bring even more capital into the country.

By stemming the fall of home values, it would decrease the likelihood of foreclosures and help homeowners get refinancing at lower rates. Refinancing now is difficult because most lenders want a substantial slice of equity to go along with any new mortgage. If your home value has dropped 20% and is likely to fall another 20%, it is hard to have enough equity to qualify for a new mortgage. Stopping the fall in prices is critically important; and maybe if prices rise in some areas, homeowners will be able to refinance at better rates, giving them more cash each month to save or spend.

As I have written in previous letters, the psyche of the American consumer is permanently scarred. We are on our way back to a savings rates that will look more like 1987 than 2007, when it was almost zero. Just a few decades ago, we saved 7-10%. Consumer spending was only 64% of US GDP in 1987. It was 71% in 2007. It is on its way back to that lower level.

Lower consumer spending will be a drag on growth for years. But bringing in 1 million already middle-class new immigrant families will help make up for a lot of that reduced spending. If you can spend $200,000 on a home, you are likely skilled at something and well-educated. You will find a job, or create one, as many immigrants do, and then you will add to our total consumer spending.

If you are a real estate agent, you should love this proposal, as it would result in an additional $12 billion in commissions.

If you are a home builder, what a great way to reduce inventory and get back to the conditions where there is a demand for your product. This would help put back to work those who have lost their jobs in the home construction collapse. Home Depot and Lowe's and local stores? It would help them to increase sales, which leads to more jobs.

We are on the cusp of the Baby Boomers beginning a huge wave of retirement, both in the US and elsewhere in the developed world. There is going to be a need for skilled workers to replace those Boomers, as well to provide services to the retirees. Further, the promised Social Security and Medicare expenditures are going to start increasing at a significant rate. We are going to need immigrants to help pay for those benefits. Given the controversy over immigration, we will look back with some irony in ten years when we find we are in a serious competition with other nations to attract skilled immigrants. We should start now. I think the concept is, let's not waste a good crisis.

Let's look at some of the potential critics of this proposal. I was on Yahoo Tech Ticker yesterday talking about this, and got a few irate emails and phone calls.

"Why," I was asked, "do I hate American workers? Isn't there enough unemployment? Why do we need more immigrants taking American jobs?" And there was considerable angst about illegal immigrants.

First, I am suggesting we transform the already existing legal immigrant flow, which is going to happen anyway, into a form which helps us solve a major crisis. I am not talking about adding another 1 million immigrants on top of the current legal inflow. Just change the nature of that inflow until the excess housing inventory is settled, and then we can go back to the current program, if that is what is wanted (more on that below).

Second, I am not suggesting we bring in or condone illegal immigrants. That is another issue altogether, for another debate at another time.

If we do nothing, unemployment is going to rise to at least 10%. That is certainly not good for the American worker. Home values are going to continue to fall. That is certainly not good for the American worker. The economy is likely to be stagnant for an extended period of time, which means job growth in a Muddle Through recovery will be slow and stagnant. That is not good for the American worker.

Hundreds of billions more of taxpayer dollars will have to go to banks to keep them solvent as falling home prices and increasing unemployment increase foreclosures. That is not good for the American worker and taxpayer.

And further, I am not talking about bringing 1 million foreigners to this country. I am talking about bringing 1 million future Americans, who want to work hard and live the American dream.

Let me say a few words to those who are opposed to immigration -- and I have heard from you. With few exceptions, US citizens reading this have an immigrant in their genealogies. Some of mine go back to the 1600s. Some of mine were not exactly considered welcome. "No Irish and Dogs allowed" read the signs. But immigrants and their children have been the driver for growth in this country for generations. It is hard-working immigrants who leave their homes for the dream of being Americans that have been the backbone of the building of the nation -- the hewers and shapers, if you will.

It is precisely that melting pot of human diversity that is the strength of the American idea. Each new wave of immigrants has been viewed with trepidation or scorn, yet within one generation they have become American. And in turn, their children's children forget that their forebears had to deal with discrimination.

America -- the US -- is not so much a country as it is an idea, the idea that anyone, regardless of race or religion or gender, can come here and with hard work and determination make their own way. Some end up owning the local deli, and some end up founding Google. Some 25% of Silicon Valley start-ups, I am told, are by immigrants, creating jobs at the bleeding edge of technology. They see the US as a land of opportunity. That is why so many want to come and that is why we can attract a new generation of affluent, self-reliant immigrants who can help us solve a problem that we created.

I can see no downside to changing our immigration policy for a few years. We solve the housing crisis, stabilize home values, brings hundreds of billions in stimulus to the US, and with no taxpayer outlay. For a short time, we substitute one class of immigrant for another, to solve a serious crisis. It is not a matter of immigrants or no immigrants, just which immigrants

So which do you want? 10% unemployment and a decade of lower home values and increasing foreclosures, with a slow, Muddle Through, jobless recovery, or a stable housing market and home construction back to trend?

If you agree with me, I suggest you contact your Congressman. You can go to http://www.visi.com/juan/congress/ (selected at random from many such sites) and type in your address and get the name of your congressperson and senators. Just tell them you like this idea, and cut and paste the link where you read this into the letter. And tell them to get into gear! I would like to point out that this proposal is not Republican or Democrat, it is just common sense. I hope we can get broad bipartisan support.

The link to the Wall Street Journal editorial is: http://online.wsj.com/article/SB123725421857750565.html

The links to the white papers are:

http://www.investorsinsight.com/samples/Housing_Whitepaper_1.pdf
http://www.investorsinsight.com/samples/Housing_Whitepaper_2.pdf

Las Vegas, La Jolla and the OC

I expect I will get a few new readers from this letter. Normally, at the end of my regular weekly letter, I make a few personal comments. I write this free weekly letter to my 1 million closest friends, and you can add yourself to the list at http://www.investorsinsight.com. You can find out more about me at www.johnmauldin.com.

Parts of this letter have been written in New York and Dallas, and as I write this I am on a flight to Las Vegas to speak at a conference on natural resources. I am sure the recent Fed actions will be at the center of conversation. There is not enough space now to comment on that; but I did do a few segments on Yahoo Tech Ticker (one of which evidently made the Yahoo home page), which you can listen to at the following links.

Links to the Yahoo segments:

D.C. to America: You Can't Handle the Truth
http://bit.ly/10rUiF

Plan to Solve Crisis: Let Immigrants Buy Houses 2
http://bit.ly/W0XLq

Fed Strategy: Spread Economic Pain Over Multiple Years
http://bit.ly/wgGjA

I will be in La Jolla for my annual Strategic Investment Conference in two weeks, as well as hosting the Richard Russell Tribute Dinner. The dinner is shaping up to be a big event, with hundreds of attendees and many of the brightest lights in the investment writing world present to honor Richard for 50 years of brilliant commentary.

I really enjoyed my trip to NYC. I had a great steak dinner with Art Cashin, everybody's favorite commentator on CNBC. Breakfast with Tom Romero and then a meeting with Jim Cramer, who I found to be very personable and genuinely likeable. Meetings in the afternoon with business partner Steve Blumenthal, then breakfast the next day with Barry Ritholtz, Yahoo at the NASDAQ, and then a speech at noon, back on the last flight and up writing -- and then this plane, which I hope ends up in Las Vegas.

In addition to being with old friends Doug Casey and David Galland (and their posse), I intend to see the inside of the gym and spa. I need it. Tiffani has been gone for two weeks, working on our book, and will get back on Monday; and the new chapter I was supposed to have for her has disappeared in a reboot from this laptop. I am quite distressed, but evidently the book gods decided it needed a major rewrite.

Have a great week, and find a few friends and share some laughs and your adult beverage of choice.

Ok, the computer crashed again, and this letter is going out on Saturday rather Friday night. But I did get to see the Jersey Boys (The Story and Music of Frankie Valli and The Four Seasons) here in Vegas last night. One of the best shows I have seen in years. See it when it comes near you.

And if you are in Las Vegas, eat at Wolfgang Puck's new place, called Cut. One of the best pieces of steak I have inhaled in years. And now it really is time to hit the send button and go attend the conference.

Your wondering if we can actually get some action analyst,

John Mauldin

Forecast 2009: Deflation and Recession

John Mauldin — Sat, 10 Jan 2009 14:38:00 GMT

Forecast 2009: Deflation, Deleveraging, and the Stimulus Effect
Muddle Through on Hold
Lies, Damned Lies, and Government Unemployment Numbers
Central Bankers of the World, Unite!
Predictions 2009
La Jolla, Bermuda, and Europe

Where are we headed in 2009? We will explore that in detail over the next few issues of Thoughts from the Frontline, but today we will start with some of the larger forces which will have a major impact on the economies of the world, and I will end with my usual attempt to forecast the various markets. We will look at deflation, deleveraging, the fallout from the stimulus plans (note plural), housing, consumer spending, unemployment, and a lot more. There is a lot to cover. But first two quick announcements.

Along with my partners Altegris Investments I will be co-hosting our 6^th annual Strategic Investment Conference in La Jolla, California, April 2-4. I have invited some of the top economic minds in the country to come and address us, giving us their views on what seem to be a continuing crisis. It will be a mix of economic theory and practical investment advice. Already committed to speak are Martin Barnes, Woody Brock, Dennis Gartman, Louis Gave, George Friedman (of Stratfor), and Paul McCulley. I anticipate adding another stellar name or two. This is as strong a lineup as we have ever had, and on par with any conference I know of anywhere.

Due to securities regulations, attendance is limited to qualified high-net-worth investors and/or institutional investors. Early registrants will get a discount. Last year we had to close registration, and I anticipate we will run out of room again, so I would not procrastinate. Simply click on the link below, give us your name and email, and you will be sent a form next week to register.

https://hedge-fund-conference.com/2009/interest.aspx?m=t

I should note that most attendees say this conference is the best investment conference they have ever been to. One of the benefits is being with several hundred very nice people in a relaxed setting. We do it up right.

Second, I and some of my fellow newsletter writers (Bill Bonner and Dennis Gartman, among others, are slated to be there) are going to be hosting a special tribute dinner to honor Richard Russell for his outstanding contribution of over 50 years to not only the craft of investment writing but also to the lives and investment portfolios of his readers. He is one of my personal heroes as well as a good friend. At 84, his writing today is better than ever, and now he writes every day, not just once a month! Richard is an institution in the investment writing world, and after talking with his wife Faye he has said he will let us plan the dinner.

Richard has some of the most loyal readers anywhere. I have personally talked to people who have been reading Dow Theory Letters almost since the beginning (1956), and their enthusiasm for all things Richard has not waned. We have a long list of people who want to attend.

Based on the response so far, we believe we can get a large roomful of Richard's friends, writing colleagues, and fans who have benefitted from his wisdom over the years, to honor him for a life well-lived and a true servant's spirit, as well as being a guide not just in the markets but in life. The dinner will be Saturday evening, April 4, 2009 in San Diego. In order to know how many people we should plan for, please send an email to russelltribute@2000wave.com indicating how many tickets you would like. If you have already responded, you will get an email with a link next week for you to register. If you have not and want to come, I suggest you do so quickly, as again we anticipate a packed room. The tickets will be $195, with any money left over going to Richard's favorite charity.

(Note: If you register for my conference, you must register separately for the Russell Tribute Dinner, which will be held at a different venue, after the close of my conference on Saturday. Thanks!)

And for new readers and those who get this letter forwarded to them, you can get a free subscription of your own just by going to www.frontlinethoughts.com. And now to our regular letter.

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Muddle Through on Hold

First, a quick look back at how I did in my 2008 forecast issue. In general, it was not a bad year in terms of getting the direction right on many of the markets, including gold, oil, the dollar (especially against the pound sterling), and stocks. Some predictions were on target, like a second-half rebound in the dollar.

But I missed the economy. I noted then that I believed we were already in recession (which we have now found out that we were), and I wrote that a recovery would begin by the end of the year, but that it would be a very weak one for a long time -- my basic Muddle Through scenario. Obviously, the recession is a lot worse than I thought it would be at the time. Looking to the end of this letter, I now think we will be in recession through at least 2009 before we begin a recovery, which will again be a rather anemic Muddle Through period of maybe two years, for a variety of reasons, some of which I cover today and others over the next few weeks.

And I should note that it was not long into the year before I began to get decidedly more gloomy, as many of you noted. And I expect that this year will bring a few surprises that will cause me to change my opinions yet again. When the facts change, I will try and change with them.

Forecast 2009: Deflation, Deleveraging, and the Stimulus Effect

For a very long time, I have been adamant that deflation is in our future. In the next few pages I outline how inflation might come back, but I doubt it will be this year. For now, deflation is the economic factor that the Fed and central banks will be battling. And believe me, it will be a very large and controversial battle.

We had a brief period last summer where inflation (as measured by the Consumer Price Index or CPI) was over 5%, and the trend was clearly up. The increase was almost entirely due to food and energy costs. Core inflation (less food and energy) was around 2%. Many commentators noted that real people actually bought gas and food and we should look at overall CPI and not just core. Now, with the drop in food and energy costs, their impact has vanished.

For the three months ending last November, the compound annual rate for the CPI was a negative(!) -10.2%, reflecting the almost 70% drop in energy. Annualized core CPI for the last three months ending November was a very low 0.4%. November CPI was a flat 0.0%. It has been falling steadily for the last five months.

December is likely to be negative. There is a trend here, and if you are a central banker it is not one you like. And that trend is being manifested in every part of the developed and much of the developing world. It is a global problem.

Given how high inflation was last summer, how could I credibly maintain that deflation was in our future? For reasons that I wrote about extensively then. Briefly, we were in a recession. Recessions are almost by definition deflationary. We had two massive bubbles bursting: the very visible housing bubble which was massively destroying wealth, and the less visible but even more powerful bursting of the credit bubble, which was accompanied by profound deleveraging and the destruction of what Paul McCulley termed the Shadow Banking System.

It would be a strange, strange world indeed if inflation could get any real traction in such an environment, and it didn't.

But now we have a structural problem in that deflation has the potential to get some very real traction going forward. Why? Because not just in the US, but all over the world, we built too much of almost everything. Too many houses, too many manufacturing plants, too many retail stores -- and just too much stuff.

In the US, capacity utilization is falling rapidly. Typically, if we produce "stuff" (cars, food, lumber, etc.) in the range of 80% of potential capacity, that is considered to be a good economy. Capacity utilization has been dropping for some time and is down below 75% for all industries, but in many industries is close to 70%. And the clear trend when looking at ISM manufacturing statistics is that it has a lot further to fall.

That means industries have no pricing power, as they can make a lot more "stuff" than they can sell. And when demand due to the recession drops as well, prices fall as producers try to stay in business.

As a very visible example, global output capacity for automobiles is 92 million cars, but sales will probably be around 60 million. Output in the US will be around 12 million, but right now sales are only about ten million. The average American household has 2.2 cars. Evidently, consumers are reducing the number of cars they own, buying used cars, and making their current vehicles last an average of 6 months longer -- all in just the last year.

Many auto plants, both in the US and abroad, are simply going to have to be closed. "Super-efficient Toyota expects its first operating loss in 70 years in the fiscal year ending March 31. Weak sales in China will probably force many of her 80 automakers to merge. Russian sales dropped 15% in November and 25% in Brazil from a year earlier." (Gary Shilling)

Just as there are too many auto dealers and too much auto manufacturing capacity, there are too many stores for a country whose consumers are in retreat. Consumer spending could easily drop 7% as the saving rate heads back up to 5% (or even more). It is estimated that over 70,000 retail stores will go out of business in the next six months. That would be in line with the 140,000 that closed doors last year. The economy and its businesses have to adjust to a new level of spending that will be the first serious consumer recession in 26 years.

Looking at Federal Reserve data, both total household debt and mortgage debt outstanding dropped in the third quarter, for the largest drop in 40 years. As I wrote almost two years ago, the disappearance of Mortgage Equity Withdrawals is having a negative impact of about 3% on US GDP. Evidence shows that this is also happening in Great Britain and other parts of Europe where there was a housing bubble.

Lies, Damned Lies, and Government Unemployment Numbers

There are some who see a ray of hope in the recent jobless claims reports, which have dropped back to "only" 467,000 in initial unemployment claims, down from 491,000 for the last week, after being over 500,000 for several weeks. Those numbers are seasonally adjusted. That hope disappears if you look at the actual numbers. For the current reporting week ending January 3, 2009, the advance number of initial claims came in at 726,420. Last week's advance number was 717,000. We have been above 600,000 new initial claims every week since the third week of November. Continuing claims jumped massively, by 744,000 to 5,316,124.

No conspiracy here. This is what happens when you try to smooth a volatile trend by using seasonal adjustments. If you use past performance as the tool by which you smooth the trend, when the trend changes, the seasonally adjusted numbers will be either too large or too small. Thus, the data understated the growth of jobs in 2003 because recent past performance had been bad, and it is now understating the number of unemployment claims and actual unemployment.

In December, the number of unemployed persons increased by a seasonally adjusted 632,000 to 11.1 million and the unemployment rate rose to 7.2%. Since the start of the recession in December 2007, the number of unemployed persons has grown by 3.6 million, and the unemployment rate has risen by 2.3% and is now at 7.2%.

I happened to be watching CNBC at the time of the release of the data, and several commentators remarked how much better the number was than they thought it would be. I wish they were right, but again, the actual numbers showed a loss of 954,000 jobs, over 50% more than the headline number reported in the press release. And that assumes that new businesses created 72,000 jobs from the birth/death model that I so frequently write about. It is possible that almost 1 million jobs were lost in December. I doubt the market would have liked that number.

I should note that the Bureau of Labor Statistics does not hide that number. You can find it if you dig for it. But most analysts seem to prefer just to take the press release and go with it. And most of the time that is fine. But in times like this, when trends are changing, you miss the bigger picture and get misleading data.

Unemployment could rise to 9-10% or more this year and on into 2010. That means we could easily see another 3 million lost jobs over the next year. That is going to put a lot of negative pressure on consumer spending. It also means that wages are not likely to rise, and we have already hard evidence of wages falling in many industries as companies try to find ways to remain solvent.

And that 9% will be the headline number. If you add people who have part-time jobs but would like a full-time job, and what are called marginally attached workers, the current rate is already 13.5%.

Average hours worked dropped to the lowest level since they began collecting data in 1964, as did hourly income. Given the increasing difficulty for consumers to borrow money and with income dropping, plus increased savings on the part of consumers, it is difficult to see how pricing power is going to come back any time soon.

This problem is multiplied throughout the developed world. The developing world, which sells products and goods to the US and European consumers, is starting to feel the pinch. Chinese and other Asian exports are dropping (more on that in future letters, but the data is ugly).

Overcapacity, rising unemployment, imploding leverage, lack of borrowing and/or lending, a serious retreat by consumers, and increased savings are all the conditions needed to bring about deflation. Left unchecked, we could soon see something like what Japan has experienced, and even potentially worse, as they started with a savings rate of 13%.

But deflation is not going to be left unchecked. It will be fought by central banks everywhere with low rates and the printing press, as well as government spending. And so, let's turn our attention to that process.

Central Bankers of the World, Unite!

There are many people who believe that the Fed and the Treasury increasing the money supply will bring about uncomfortably high inflation. And it is indeed their intention to "reflate" the economy. They are well aware of the problems that would develop if the US (and Europe!) caught "Japanese disease" or a prolonged bout of deflation. Bernanke has made it clear that "it" (as he called deflation in his 2002 speech) would not be allowe to happen on his watch.

And we have already seen a rather large growth in the monetary base. But as I wrote a few weeks ago, the velocity factor of money is slowing rapidly, creating the ability -- or dare I say it? -- the actual need to expand the money supply (you can read that in my December 5, 2008 post). But is it having an effect?

Good friend Gary Shilling raises some doubts (emphasis mine):

"Central banks around the world continue to cut their target rates, although in today's frozen credit market, that won't ever get the horse up on his feet, let alone to the water and drinking. The distrust of banks for even loans to other banks is shown by the still wide spread between LIBOR and the Treasury bills they covet.

"The M2 money supply is 60 times bank reserves, so normally when the Fed gives the bank another dollar in reserves, M2 rises by $60. But between August and November of last year, the $577 billion rise in reserves resulted in a mere $264 billion growth in M2, less than one half!"

See the chart below (the red, smooth line is M2, the dotted line is the adjusted reserves).

The Fed is aggressively expanding its balance sheet. They have made clear that they intend to purchase mortgage securities, consumer loans, and credit card securities. Corporate loans are on the table, as well as other forms of debt. (Finland is getting ready to purchase corporate debt. The list of countries that do so will rise very quickly.) This will be direct infusion of money into the system. As Bernanke said in 2002, he knows where the keys are to the room that has the printing press. And they are going to use it.

Obama and his advisors have signaled they intend to run a deficit of at least a trillion dollars. Right now, as I add it up, it is more like $1.3 trillion (the stimulus number keeps moving), and given that tax receipts are going to drop and unemployment benefits will rise (care to bet that unemployment benefits won't be extended to 52 weeks instead of the current 26?), it could be closer to $1.7-2 trillion. That would be almost 15% of GDP!

Let's get this straight. The only difference between the Treasury and the Fed under an Obama administration and the Bush administration is that Obama will be even more willing to spend (although Bush certainly showed little restraint). Incoming Treasury Secretary Tim Geithner has worked at Treasury and is now president of the New York Fed. There will be little difference between his policies (and those of Larry Summers, Obama's economic advisor) and those of Bernanke and Paulson. And like Paulson, he is going to have to make up the play book as he goes.

The Fed and the new administration are "all in," as they say in Texas hold 'em poker, in the fight to defeat deflation and get the economy growing. And eventually England and Europe will get it and join the fight (both the European Central Bank [especially!] and the Bank of England are behind the curve).

But there is a problem.

Lowering rates isn't enough to get consumers to spend when they have seen their wealth erode from losses in the value of their houses and investment portfolios and retirement accounts. The stimulus last summer was largely saved or used to pay down debt. What was an annualized stimulus of 3% of GDP in the second quarter, which is quite large, only kept GDP growth positive for one quarter.

Obama talks about creating 3 million jobs. If he can do it, that would only partially offset the job losses that will happen in his first year in office. But it will take a long time for much of the stimulus he is talking about to make its way into the economy. You can't turn on infrastructure projects in one quarter. It takes a lot of time to plan. New green power plants? Wonderful. I'm all for it. But they take years to authorize and build. Tax cuts? Again, much of it will be saved or used for debt.

The reality is that the US and much of the world are going to see their economies shrink for at least another year. And when that new, lower level is reached, the economy will slowly start to grow again. Remember those 71,000 retail stores closing? That means that those left standing will get more business and will be able to expand and grow and hire people. That is how recessions work. Excess capacity is worked through. Businesses cut back until they can get positive cash flow.

In 1978, in the midst of high inflation, bear markets, and malaise about all our jobs going overseas, the correct answer to the question "Where will all the needed new jobs come from?" was "I don't know, but they will." That is the correct answer today. That is what free markets and capitalism do. They find a way to make new paths and new businesses where none existed before. And it will happen again. Just with a little lag this time.

In the meantime, there is a lot of pain. An Obama administration is going to do what it can to help relieve that pain, even at the cost of trillion-dollar deficits for several years.

This you can take to the bank: If the Fed buys $500 billion in assets of various kinds and if the US government spends an extra trillion dollars and deflation is still a concern, they are going to double down and do it again. And yet again if they think it is necessary. They are not going to stop until the nominal economy is growing and inflation is above at least 1%.

How much will that number finally be? No one really knows. This has never been attempted. Maybe the initial stimulus package and Fed debt purchases will be enough. My bet is that it won't be, but that is just a guess. We are in uncharted waters. But the captains of the boats are all Keynesians. They are going to fight a recession and deflation with old-fashioned stimulus. And that means we had better adjust our portfolios and businesses for that reality.

Just to give you a picture of what economists think about the effect of the stimulus, let's turn to the Levy Economics Institute of Bard College, which is one of my favorite sources for original economic insight (http://www.levy.org/). They are a rather conservative lot. The graph below shows what two different levels of government stimulus will mean to the economy. They graph unemployment at no stimulus (top black line) and at two levels of "shock" or stimulus. Shock 1 is about $380 billion and shock 2 is about $760 billion. The dotted lines are what is known as "output gap," or the measure of the difference between the actual output (actual GDP) of an economy and what it could produce at its most efficient (potential GDP).

"The implication of these projections is that, even with the application of almost unbelievably large fiscal stimuli, output will not increase enough to prevent unemployment from continuing to rise through the next two years.

"It seems to us unlikely that U.S. budget deficits on the order of 8--10 percent through the next two years could be tolerated for purely political reasons, given the strong and widespread belief that the budget should normally be balanced. But looking at the matter more rationally, we are bound to accept that nothing like the configuration of balances and other variables displayed in Figures 3 and 4 could possibly be sustained over any long period of time. The budget deficits imply that the public debt relative to GDP would rise permanently to about 80 percent, while GDP would remain below trend, with unemployment above 6 percent.

"Fiscal policy alone cannot, therefore, resolve the current crisis. A large enough stimulus will help counter the drop in private expenditure, reducing unemployment, but it will bring back a large and growing external imbalance, which will keep world growth on an unsustainable path.

"É At the moment, the recovery plans under consideration by the United States and many other countries seem to be concentrated on the possibility of using expansionary fiscal and monetary policies.

"But, however well coordinated, this approach will not be sufficient.

"What must come to pass, perhaps obviously, is a worldwide recovery of output, combined with sustainable balances in international trade."

Let me wrap up with a quick note about housing. The economy is going to have a rough time getting back to trend growth with the housing market in the tank. New home sales fell 2.9% in November, while the median price declined 11.5%. Unsold inventories stood at a rate of 11.5-month supply. Housing starts fell nearly 19% in November, while the number of building permits was down 15.6%. Sales of existing homes in November fell more than 8%. The S&P/Case-Shiller 20-city housing index showed an 18% drop in prices in October from a year earlier, while the 10-city index declined 19.1%. Prices in the 20-city index have fallen more than 23% since their July 2006 peak, while the 10-city index is down 25% since its top in June 2006.

It will be 2011 before we work through the excess supply of homes, especially as we are seeing more and more come onto the market because of foreclosures. Prices are likely to drop another 10%. There will be more wealth destruction and more pressure on consumers. 10% of all mortgages are either delinquent or in foreclosure.

Predictions 2009

Let's close with some predictions. Ten out of ten analysts in the recent Barron's forecast saw stock prices rising 10-20% this year. For reasons I outlined last week, I think we could see a tradable rally in the next few months, but at the very least test the lows this summer, if not set new lows. Earnings are going to be far worse than any analyst's projections I have seen. And earnings drive stock prices.

Further, this recession is going to be the longest in anyone's memory. It is going to seem like it is never going to end (it will, I promise), and more and more investors are just going to give up on stocks. The buy and hold for the long run mantra is wearing thin. In inflation-adjusted terms, the stock market is about where it was in 1973! If you reinvested dividends, that gets you to 1991 (again, inflation-adjusted). It takes a lot of buying to make a bull market. It only takes an absence of buying to make a bear market.

Could we get a rally after the summer or fall lows? Sure. And it could be a good one. A lot depends on how fast the stimulus kicks in and whether it really has an effect. Will the Fed really buy large-cap corporate debt? I hope we can see something like a 1974 bottom in stocks develop.

I think the correlation between the US stock market, other developed markets, and emerging markets is close to one. I prefer to stand aside until the US economy has a clear direction and we can see whether the stimulus actually works. And then we can look at the world economy. I won't embarrass them by naming names, but those who argued for "decoupling" between the US and the rest of the world are not looking good. Someday, but not this decade.

I would be a buyer of quality bonds, both corporate and municipal. The key is to have a bond analyst who knows what they are doing and not just looking at ratings. There are some real values in the bond market today.

I would not be a buyer of US government debt. Treasuries, if not in a mini-bubble, have little upside potential and just don't yield enough. Why would I hold a ten-year treasury for 2.39%? I like TIPS at these prices. TIPS are pricing in deflation for ten years and, as I outlined above, I don't think the Fed will allow deflation to take hold.

With all the massive printing of money, you would think I expect the dollar to crash. I don't. The question is, what will it fall against? The euro? Really? The pound is better valued, but England and Europe are going to have to cut rates and apply massive stimulus as well. Every developed country will have problems. I can see holding Canadian, Australian, and other commodity-country currencies, but the leverage needed to make it a reasonable investment potential is too risky for individuals.

I can't see the Japanese letting the yen get too much stronger. China seems to want to halt the rise of the yuan, and the rest of Asia will devalue their currencies to maintain whatever they think of as a competitive advantage. Longer term, I like Asian currencies.

After a year of bouncing around, gold may be poised to rise against all major currencies. We could easily see new highs in the next year.

I think oil is going lower (and maybe much lower -- can you say $1-a-gallon gas?) in the near term. As I have written about before, oil is now in the steepest contango on record. That means oil is cheap today and more expensive in a few months. That is not normal. Oil is bidding for storage. You can make 20-25% on your money in a few months if you can buy oil and find somewhere to store it. At least 25 supertankers have been leased to store oil, and sources say another ten are being bid for. It remains to be seen if OPEC can really cut enough to make a difference in the near term.

As for the other metals, I think it is quite likely copper and its industrial allies will fall in price at least for the near term, until production can be cut and demand in Asia begin to rise again. I would not be a buyer of long-only commodity funds for the near term. Someday the bull market in commodities will return, but not until Asian demand picks up.

The risks to my forecasts are quite clear. The stimulus could happen quicker and be more effective than I think, and the economy and the markets could surprise to the upside. On the other hand, and more scarily, the Fed could be pushing on a string in a liquidity trap and the economy and markets could get hit harder, along with most assets.

Briefly, if you would like to look at a range of money managers I think have the potential to navigate the current market successfully, let me suggest you contact some of my partners around the world. If you are an accredited investor (net worth $1.5 million) and would like to look at a group of hedge funds and especially commodity funds in the US, go to www.accreditedinvestor.ws and fill out the form, and my partners at Altegris Investments will get in touch with you. If you are in Europe, use the same link and I will get you in touch with Absolute Return Partners in London. In South Africa, my partner is Plexus Asset Management. We will soon be announcing new partners in Canada and in Latin America.

If your net worth is less than $1.5 million, my US partners at CMG have a platform of managers and traders that take direct-managed accounts with minimums of $100,000. These are liquid and fully transparent accounts with managers with long-term track records. You really should check it out. The link is http://www.cmgfunds.net/public/mauldin_questionnaire.asp.

And if you are an advisor or broker and would like to see the managers on the Altegris or CMG platforms and how you can access them for your clients, sign up and note on the form you are in the business. It might actually be fun to make a client call with a recommendation for a fund or manager that was up in 2008.

La Jolla, Bermuda, and Europe

Tiffani and I head out to La Jolla Monday to meet with Jon Sundt and his partners at Altegris Investments. There have been a lot of positive developments of late, including new managers, and of course we will be talking about the upcoming conference. And I will get to have a quick happy hour with Richard Russell and his son. The Tribute dinner is going to be so much fun.

On Wednesday, I am hosting a dinner at my new home for a small group of family office heads, hedge fund managers, and local businessmen. We are calling it an "Idea Dinner" and will throw out thoughts on how to invest in the coming year. I will report anything interesting.

I will be in Bermuda January 28-31 for a speech and some time away from the office to write on the book Tiffani and I are doing on millionaires. It is a fun project. And I have to have it finished by the end of February so I can get to London and Europe and New York in March.

I am always optimistic at the beginning of the year. Even though I see a serious recession, I am working, like every businessman in the world, on making my business grow in spite of problems in the economy. Free markets with motivated entrepreneurs will be what really creates a growing economy.

It is time to hit the send button. There is a fire in the family room, and it is time to relax. Enjoy your week. I know I will.

Your more optimistic than this letter implies analyst,

John Mauldin

The Rise of A New Asset Class

John Mauldin — Fri, 01 Aug 2008 15:44:36 GMT

This week I am in Maine on vacation with my son, and next week is my daughter Tiffani's wedding, so for the next two weeks I am going to send an updated version of a speech I have been giving the past few months on what I think is the likely potential for the rise of a brand new asset class. It is too long to be sent as one letter, so we will start with the first part today and finish with the second part next week. This first part can be read as a standalone letter.

The Rise of A New Asset Class

I think we're at a watershed moment, what Peter Bernstein defines as an "epochal event," with the very order of the investment world changing as it did in 1929, in '50, in 1981, where a number of things came together - it wasn't just one thing but a number of events happening that conspired to change the nature of what worked in the investment world for the next period of time. It took most people a decade after 1981-2 to recognize that we were in a different period, because we make our future expectations out of past experience. It's very hard for us to recognize a watershed moment in the process. We're going to look back in five or ten years and go, "Wow, things changed." As we will see, it's going to be a change that's going to cost people in their portfolios and in their retirement habits.

We're going to look at a number of different concepts and separate ideas that in and of themselves don't make that much difference. But I think their confluence in the present moment is going to change things.

Now, some of this is new, some of it is old. The old stuff we're going to fly through. Most of you have been reading me for a while now, and you've got the concepts down. So let's start.

The first thing to note is that we're in a Muddle Through Economy. We're in a recession that's fueled by the bursting of two bubbles: the housing bubble and the credit crisis. The real question is: when do we come out of the recession? At what time do we come back to trend growth, which is 3 to 3.5 percent a year?

I believe that over the next 20 years the US economy will grow at roughly a rate of 3 percent compounded, in real terms. But I believe that we have some headwinds for the next year or two. So I think the real bottom of this economic cycle will be later this year, during the fourth quarter and possibly into the first quarter of next year. But it will take two years, for some reasons we are going to get into, to get back to long-term trend growth. It will take much longer than normal because the things that created the problem – the housing bubble and the credit crisis – aren't things that can respond to Fed policy, and they aren't things that can respond to the normal cycles. It's going to take a long time to work through these.

First, we had an investor-driven transaction bubble in housing. There were 48% more houses built since 2005 than should have been built, if you were simply looking at trends.

What that means is there are 3.5 million homes we have to work through. Now, that means that the 8 or 9 hundred thousand homes that we're now down to building a year, is going to end up going down to 400,000. It's going to take some time to work through those excess homes – for the prices to drop enough that people can go in and buy them or rent them. We are probably talking 2011 before we finally work through this housing crisis and get back to a normal market where housing contributes significantly to GDP growth.

Sales activity is probably going to correct another 30 percent. That's not fun. By the middle to the end of this year, sales are going to be really low. As a side issue, those of you who like to invest in real estate and actually want to own a home to rent are going to have some good opportunities.

Let's look at the credit crisis very quickly. We vaporized 60 percent to the shadow banking system, the SIVs and CDOs, the people who actually bought US mortgages, who bought student loans, who bought credit cards, who bought car loans. That's gone and it's never coming back. As we'll see, it's going to take well into the next decade for us to create a completely new infrastructure to replace the broken one. It took decades to get to where we were last year. I don't think it will take decades to recover, but it's going to take five, six, seven years. That means things are going to be difficult if you want to borrow money. Credit spreads are going to be wider; it's going to affect you more. By the way, if you're in business, if you're paying more, it's going to put pressure on your profits.

Let's look at GDP growth for the last ten years, with and without mortgage equity withdrawal.

Without MEW, we would have had two years, in 2001 and 2002, with negative GDP growth. We're not going to go get those levels of mortgage equity withdrawals today, not in this environment. We're still seeing some cash-out borrowing, but it's getting more and more difficult; and as home values drop, there are going to be fewer and fewer people pulling less and less money out of the "home ATMs." As Paul McCulley says, your home ATM is starting to spit out negative twenty-dollar bills.

That means consumer spending is going to continue to slow. We haven't had a consumer recession since 1990-91. There are a lot of people today who have kind of forgotten that consumer spending can actually slow down. That's going to happen from lower mortgage equity withdrawals, and it's going to happen because of higher gas and energy costs that are displacing normal spending. You've got to fill up your Ford F-150 to be able to get to work. I saw $4 a gallon gasoline when we arrived in La Jolla. I mean, I guess around here people don't really pay attention, but that means it would cost a hundred bucks to fill up my big SUV. That's just a lot of money. That's a hundred bucks I can't spend on something else – on clothes or kids or education. It means I'm going to be consuming less.

We're in a recession. Recessions by definition mean that we're going to be seeing rising unemployment. We're already up past 5.5 percent. We'll probably see 6 percent and maybe higher. We're not going to see the 9 and 10 percents like we did in the '70s or '80s, because we're not as subject to the manufacturing cycle as we were back then. That's both good and bad. We don't have that boom-bust in the manufacturing world. We're seeing a bust in the construction world and we're starting to see commercial lending and commercial building go down. But I don't think we're going to see the large 8 and 9 percent unemployment rates that we typically see in a recession. But still, if you see rising unemployment – and unemployment rises by 20 percent, from 5 to 6 — that means those people are going to have less money and they're not going to be spending it.

We're seeing inflation in an environment of low real-income growth. Inflation is running over 4 percent now. And real-income growth is running a little bit less. While we may see some nominal growth in consumer spending, real spending is going to be dropping over the next year. That has some consequences that we'll talk about later. Also, consumer spending is going to drop because we have less availability of easy credit. Now, it probably hasn't hit this room. But there is a wave of letters going out from credit card companies, cutting people's credit lines, cutting people's home mortgage lines. There are a lot of people actually hitting their home equity credit lines and putting it in a savings account because they're afraid that it's going away. They're afraid that they may not be able to get the cash when they need it. "What happens if I lose my job? I better get the cash, and I'll pay the difference in interest costs just to make sure that I'm OK." That's happening a lot.

In summary, lower mortgage equity withdrawals, higher gas and energy costs, rising unemployment, inflation in an environment of low real-income growth, and less availability of cheap and easy credit are all contributing factors to slowing consumer spending.

This has three major effects. First, lower corporate earnings. We're in a period where earnings disappointments are going to be the rule and not the exception. We're going to go into this in detail in just a little bit. But GE wasn't a one-off announcement. Yes, it was their financial system. But we're going to see a lot of earnings disappointments from all sorts of retailers, from all sorts of companies, for a variety of reasons. We're going to look at the documentation for a minute to demonstrate that. Second, lower corporate profits put pressure on the stock market. There's a relationship between earnings, valuations, and stock prices. And third, that also means we're going to see lower than expected long-term returns. That's going to be a problem for people who are looking for traditional assets to be the bulk of the growth for their retirement portfolios.

Now, I think we're still in a bear market. Remember that in 2000 and 2001, we had three corrections of over plus 20% percent and one in the plus 30% range. It's not unusual to see large corrections inside an overall bear market.

Why do I think we're in a bear market? Long-term markets – and we're going to talk long term for a second and then come to the shorter term – long-term markets in bear cycles have several characteristics. Number one, they all start with high P/E ratios. Now, Vitaliy Katsenelson, who wrote my e-letter this week so that I could be here, lays out what he calls "cowardly lion markets," as distinct from bear markets, because stocks tend to go sideways for a long period of time. We'll talk about why that is in a minute, but I think he's right on that.

You are told that you should invest for the long run. Twenty years for a lot of people is the long run. However, what they do not tell you is that you can see negative real stock market returns over 20 years. It's happened four or five times. So when you're reading in somebody's book that says, "Hey stocks are going to compound at 11 percent a year" or whatever la-la number can be seduced from the data, think twice.

In secular bear markets, you can have returns for long periods of time from zero to 3 percent, every 15 to 30 years. We're kind of starting one here again. If you went to Standard and Poor's website in March of 2007 and you asked what the earnings were going to be for 2008, their analysts said that earnings would be $92 for 2008. Two months later, at the end of the year in December 2007 – this is four months ago – they were projecting $84. In February, it was $71.20. Today Merrill Lynch estimates that earnings could drop to as low as $45 next year. Notice a trend here?

When you go into a recession, analysts begin to project lower earnings. They keep ratcheting them down. What do they use to project future earnings? Past performance. There are very few analysts who actually go out and say, "OK, how is this company going to perform in a recession?" They all say, "The company that I cover is an exception." This is how they're going to cover it, because they're talking to management.

And when's the last time management said, "Oh man, we're really going to get clobbered; there's a recession coming." Not if they want to keep their jobs. John Chambers will be telling us that Cisco's going to be doing wonderfully, just like he did all of '99, all of 2000 and all of 2001.

Now, what does this mean for P/E ratios? About 30 days ago, it was estimated, based on prices, that the P/E ratio for the end of the last quarter would be 20.5. Today, as companies mark their earnings down, the P/E ratio is 22.5. For the end of September, third quarter, a month ago, they were saying the P/E ratio would be 21. Today they're projecting that if the market stayed at the same price, it would be 28. Now, does anyone think we're going to see a P/E ratio of 28 at the end of the third quarter? People are going to be projecting positive earnings forward – and we're going to see one earnings surprise after another.

Remember, it takes three to four really good earnings disappointments to reach a point where investors really begin to understand that things are different, because we project future performance from past performance. When past performance disappoints us three or four times, then we begin to project negative performance, and that's when the stock market drops. It's not that the stock market is telling us that things are going to be better. It's that we have expectations of things getting better because that's what our past experience has been – so we need those disappointments.

This is from Vitaliy Katsenelson's book: If you take 10-year trailing P/Es – you average them together so you don't have the effect of just one year – you find that valuations go from high to low from where bull markets start, in what he calls a range-bound market or what I would call a secular bear.

They go from high valuations to low valuations and back. Around 2000 we were at 48. It's down to 30 today on those long, ten-year runs, and it always corrects below the mean. Valuations are mean-reverting machines.

If you just look at one year, you get the same effect. You have a P/E average of 15 – remember they're projecting 28. You don't have a projection of 28 in a recession and not have the stock market feel that.

Maine, Maryland, and Weddings

It takes a full day to get from Texas to Leen's Lodge (http://www.leenslodge.com/) in Grand Lake Stream, Maine. Trey and I make the last part of the trip by float plane. This is the third time I've gone with Trey, and I really look forward to the trip. It's just a great bunch of guys. As I have noted, we do make predictions about the markets. Last year a number of readers sent in their predictions, and we have tabulated those. I will report back on how well we all did, and some of you will win a book for being the best predictors.

It looks like I am going to Maryland for a day in a few weeks, and New York is looming on the horizon again, as well as another trip to Baltimore to be with my really good friend Bill Bonner (of Daily Reckoning fame) for his 60^th birthday party. Now that should be a blast.

It is amazing how many details have to be worked out for a wedding. And it is just a few days away. Tiffani will be gone on her honeymoon for almost an entire month, so a lot of business details have to be worked out for the interim. She and Ryan will be in South Africa and Ireland, and I really do want to leave her alone. She deserves some time away. When she comes back, we will really start to work on our book.

Have a great week. Enjoy the summer with friends and family.

Your ready for some fishing analyst,

John Mauldin

The World Will Not End

John Mauldin — Sat, 19 Jul 2008 04:14:11 GMT

The World Will Not End
Take a Deep Breath
9% Growth in Housing or a 4% Loss?
A Little Stress

Housing starts rose 9% and the market cheerleaders proclaimed that we have seen a bottom. But not if you look at the actual numbers. New unemployment claims were OK, but not if you look at the actual numbers. And inflation was simply ugly, no matter what numbers you look at. However, oil is down and there is reason to think it may have further to go on the downside. We cover all this and more, as we first look at why the world is not going to end.

Take a Deep Breath

It is easy to find bad news these days, and the torrent that seems to keep coming can ruin a person's summer (or winter, for my southern hemisphere readers). The credit crisis, as noted last week, is nowhere near an end. Housing, as we will see, is actually getting worse. Foreclosures, auctions, government bailouts, higher taxes, inflation, the price of energy and food - the list goes on and on.

I thought, since so many think of me as a rather bearish person, I would show you my more optimistic side. Yes, I am bearish in the short term, for reasons I have documented at length in this letter. But long-term I am a wild-eyed optimist.

With all the negative news thrown at us today, why is the United States not in the midst of a deep recession? How, many of you ask, can I be so sanguine as to suggest a milder recession and a Muddle Through Economy?

First, things are somewhat different now than in the '70s and early '80s. Back then, a great deal of the US and developed world economies and their resulting employment were linked to manufacturing, which was largely geared to domestic sales. Exports were a much smaller part of the economy for most businesses. When the economy and consumption slowed down, manufacturers laid employees off rather rapidly. Unemployment would soar and a V-shaped recession would occur.

Now, the number of people employed in manufacturing is less in percentage terms than it was back then, and more of what is produced in the developed world is bought by a growing developing world. Exports from the US are booming. The number of TEUs (the large containers on ships: Twenty-foot Equivalent Units) moving through the ports of Los Angeles and Long Beach is up 23% in May year over year and up 26% since the beginning of the year. Because of the weak dollar, imports are down by 7% year to date. It is export growth that is keeping the US from sliding into the usual deep recession.

So, not only is manufacturing not down as in usual cycles, it is up quite handsomely for many products, except of course for automobiles, which are not just in a recession but facing a depression. But that growth in exports is keeping unemployment from going to 9%.

But let's take a longer-term outlook. My view has been, and is, that we are in for a period of very tepid growth that will last through at least 2009. We have to work our way through the after effects of the twin bubbles of housing and the credit crisis bursting. There is no magic Fed wand. That simply takes time. No (rational) government or Fed policy is going to change the facts on the ground (although they can make things worse). But, in the fullness of time, we will in fact get through this.

If you look back over the decades, things are getting better. Goldman Sachs estimates about 70 million people a year worldwide are entering the "middle class" and that by 2030 two billion people will be in a far better condition than the poverty they experience today. That will also keep demand steady for all sorts of products and services produced in the developed world, even as our population (except for the US) declines.

The old joke is that a recession is when your neighbor loses his job and a depression is when you lose yours. And a rise in unemployment and lower corporate profits are no laughing matter. But the simple trend is that we will adjust and free markets in America and the world will grow, as they have always done.

My daughter and business partner Tiffani is getting married in three weeks on 08-08-08. Next year there will be 2.3 million weddings in the US, at an average cost of $30,000 (we have helped increase the average this year considerably). That is $72 billion on weddings. And many of those new families start with the need to find a place to live, furnish a home, and build their nest.

Tiffani and her fiancée are an example. They have bought a home at a pretty good price in an older neighborhood that is fast becoming trendy, as there are a lot of wonderful restorations and teardowns. They have lived rather simply and find they "need" all sorts of items to make their house a home. Each day sees another delivery of gifts from their registry and a smile on her face.

(Sidebar: When I first got married I seem to remember getting three toasters and not a lot of other things we needed. Now, couples register online for what they need and want, and when an item is bought it is taken off the list. How cool is that?)

Last year a record 4.3 million babies were born in the US. Each of them will need all sorts of "stuff" - food, education, and places to live - in (hopefully) 20-25 years.

Yes, consumers are cutting back, but they are still buying the basics. (See more below.) Manufacturing in the US is starting to make a comeback, with the lower dollar and management driven to compete globally. In free-market economies, every economic slowdown is followed by a period of solid growth driven by innovation. The point is that life goes on. Births, weddings, eating, living and enjoying friends and family. It is all part of the cycle.

The next 20 years are going to see the most powerful wave of technologically driven growth the world has ever seen. The accelerating pace of technological change did not slow down last century through multiple world wars, scores of "minor" wars, a depression, all sorts of natural disasters, and an unbelievable amount of government folly. Why should that trend stop now?

As we add two billion people to the middle class, we are also going to bring the internet to even billions more. The explosion in information and creativity that we have seen in the last 20 years will double and double again. A small percentage of those people are going to invent amazing new technologies, new drugs, and create companies that will make life better for all of us.

That is one reason that technological growth will continue to accelerate. We will simply be throwing more people at an ever wider array of problems, and they will be able to share their discoveries at the speed of light.

We are on the verge of a revolution in biotechnology that is going to truly revolutionize medicine. No one in 20 years will look back on today as the good old days. And it will probably create yet another stock market bubble, but that is a story for another letter.

US diplomats are talking to Iran. Iraq may actually work out. In most places of the world, most people are better off today than they were 20 years ago. There is still a lot of progress to be made, but the point is that we are making it. There is a ton of opportunity for those prepared to look for it. It may not be in the usual places, it may not be where we would like it to be, but it is there. World GDP will have roughly doubled (or more) by the end of the next decade.

Yes, I know there are a lot of problems. Really big scary ones. I write about a lot of them all the time. But go back to any year ending in 8 for the last 100 years. When were there not problems? And in most times and places, the problems were bigger. And in the next ten years? There will be lots of problems. Some will be the same old problems and some will be new. I am not certain why mankind seems to have a need to find new ways to create mischief and lose money when the old ways work so well. But those too will pass.

So, when you read about current problems - and I will point some out in the next few pages - just remember that things will work out. Markets will adjust, and the world will be a better place. Things will work out better for you as an individual if you anticipate the problems and make the proper adjustments, as much as possible, in advance.

The next 20 years are going to be the most exciting time that the human race has experienced. Yes, there will be issues, but we will adjust. That is what we do. And now, let's look at some of the adjustments going on in the markets.

9% Growth in Housing or a 4% Loss?

When the news flashed on my screen that housing construction had jumped by 9%, I raised an eyebrow. That did not make sense given other data I was looking at. Immediately the media was full of talking heads and stories about the turnaround in housing and the end of the slowdown. I must admit to being a little confused.

Then we find the rest of the story. Asha Bangalore from Northern Trust actually took the time to read the details. It turns out that New York City had a change in its construction codes, and that affected what is considered a housing start in the Northeast, especially in multi-family construction, which "jumped" 42% because of the code change. If it were not for the change, housing starts nationwide would have fallen by 4%. Because of the code change, housing starts jumped 102% in the Northeast. However, single-family starts nationwide declined 9.3% in June, to an annual rate of 647,000 units. That level of single-family starts is the lowest since January 1991. Look at the following chart from Northern Trust. Does this look like a 9% increase?

More Government Statistical Fun

Each week we see a release of initial unemployment claims. This week initial claims jumped to 366,000 on a seasonally adjusted basis. But what are the real underlying numbers? Every Thursday, I get a thorough review of the actual data from John Vogel, going back and looking at trends over the past 8 years in the non-seasonally adjusted data. That can be more interesting.

This week the actual number of initial claims of unemployment was 475,954, compared to 383,839 last year (2007). And the number of actual claims has been trending up. Taking the three first weeks of the current quarter, we are still below the recession years of 2001-3; but the trend is not what you would like to see, and given the decline in consumer spending (see below) it is likely to continue to trend up.

The actual data is very "noisy" and jumps all over the place, hence the use of seasonally adjusted numbers for public consumption. Economy.com thinks the difficulty may be in accounting for auto-related plant shutdowns in the seasonally adjusted number. Vogel speculates that employers are no longer waiting until the end of the quarter to lay personnel off but are doing it at any time in the quarter.

Given the issues, it is likely we will see a rise in the number back toward the 400,000 range (SA) that we saw earlier last month. But just be aware that there can be something really different in the actual numbers.

Below is a graph from economy.com showing where the employment problems are. The majority of the states are seeing payroll employment drop.

Fannie and Freddie and Bears, Oh My!

Let me see if I have this straight. It is OK to short oil but not OK to short Fannie Mae? Or is it that it is OK to be long Freddie Mac but not long oil?

Oh, those evil speculators. As Barry Ritholtz points out, why is it that management blames speculators when their stock is being pummeled, when the usual reason is that management made some very bad decisions?

And let's not forget the importance of rumors. We all know rumors can bring down a stock. So, let's start one. Let's start a whisper campaign that Goldman Sachs is going to have to take down $100 billion in losses next quarter, and then we can all short the stock. What would happen is that we would all lose our money when we had to cover, because there was no basis in fact.

The best way for a company to deal with short selling is to increase earnings and blow the shorts out of the water. Good management trumps rumors.

This week the SEC has made it more difficult to short Fannie Mae, Freddie Mac, and other large financial firms. They are actually going to enforce the rule already on the books that says you must actually be able to deliver the shares you are shorting.

"Naked" short selling has been against the rules for some time. (That is, short selling a stock that you cannot actually borrow to sell.) Institutions make rather tidy sums offering the shares they own to short sellers for a price.

Making it more difficult to short Fannie or Freddie is not going to do one thing for their balance sheets, which is the real source of their problem. As former Fed governor William Poole said a few weeks ago, they are basically insolvent. Five-year bonds sold by Fannie Mae yield 90 basis points (0.9%) more than US Treasuries of similar maturity, almost double the average over the past 10 years, according to data compiled by Bloomberg. That spread, which translates to $90,000 in extra annual interest per $10 million of bonds, exists even after Treasury Secretary Paulson signaled the US would ensure the debt is repaid by offering larger amounts of backup financing and potential capital infusions.

Given Paulson's guarantee, why would you buy US bonds when you can get the same guarantee and almost 1% more?

Fannie and Freddie are private companies where the profits go to shareholders and losses go to taxpayers. There are a lot of people (including your humble analyst) who have complained about the current set-up. Basically, they were allowed to leverage their capital beyond what even your most leveraged hedge fund would think prudent. How could the value of homes go down? Leverage up and show huge profits, pay monster salaries and bonuses to management who did nothing but increase risk, and spend $170 million on lobbyists to make sure that no one changes the rules.

Paulson had no realistic choice but to do what he did. But the true point is, he should have never had to make that choice. A real regulator would not have let them leverage their capital to the extent they did. If taxpayers have to invest one penny before shareholders are wiped out, then there is no justice. Fannie and Freddie should be broken up into several much smaller firms which are not too big too fail, their shares floated to new owners, and taxpayers should get preferred shares until they are made whole. And the implicit, but now explicit, guarantee should be taken away.

And while we are on regulators, it is time for Bernanke and Paulson and SEC chairman Cox to force the credit default swap (CDS) market to move to a regulated exchange. If there is a major risk to my happy news scenario at the beginning of this e-letter, it is the credit default swap market collapsing. That is why Bear Stearns had to be rescued, and why other firms like them are too big to fail.

If the CDS markets were on an exchange like any futures contract, Bear could have been allowed to fail. It would have been a sad day, but the Fed would not have had to risk $30 billion. Greenspan was wrong when he said these derivatives did not need to be regulated. They are good for the markets, and I think they are necessary. But let's put them on an exchange where there is clear transparency and the entire economy of Western Civilization is not put at risk by some cowboys who decide to leverage up.

A Little Stress

This is my first really big wedding. As I said, it is as carefully planned as the Normandy invasion and about as expensive. I can really understand now when brides talk about stress. But poor Tiffani has had a triple dose. She moves next week into their new home (kind of). But then, there is not a lot to move.

Of course, we have also started on our new book project, and the response to our survey has been rather large. For those of you who want to do personal interviews, we will get back to you. As a reminder, we are doing on online survey about investors of all sizes and backgrounds. If you take the ten minutes to fill out this thought-provoking survey, we will give you a link to a recent speech I made about what I think is a new asset class that is being created because of the credit crisis. The link is here: http://survey.frontlinethoughts.com/index.php?sid=12431&lang=en

But then the real stress started a few weeks ago when FINRA (the former NASD) called and said it is time for an audit. We get one about every 3-4 years. It is about as stressful as any part of the investment business, and Tiffani has to deal with 98% of it, as Dad is clueless. So, she has spent very long hours getting ready for the audit. Yesterday, after three and a half days, we had our exit interview, and it went about as well as we could have hoped. But the timing would have been better either earlier or after the honeymoon. Oh, well.

We have had an audit from some regulator every year for the last five years. Just part of the business, but it does create some stress. We are due for an NFA audit sometime soon. I just hope they do not come when Tiffani is on her honeymoon in some fairly remote places in South Africa.

Below is a picture of Tiffani and Ryan in front of their new home. Dad is proud. You can see a lot more pictures (some VERY funny ones) if you care, at their wedding web site at http://www.fatedlove888.com/Site/888.html

It is time to hit the send button. I see a Batman movie with the kids in my future. It should be a great weekend.

Your having fun being an optimistic analyst,

John Mauldin

Whip Inflation Now

John Mauldin — Sat, 14 Jun 2008 05:06:39 GMT

Whip Inflation Now
Where Can We Get Help on Inflation?
The Patient Died Anyway
Inflation in Asia and Europe
There Are No Good Solutions

President Nixon instated price controls on the 15^th of August, 1971. Inflation was a little over 4% at the time. Price controls manifestly did not work (resulting in shortages of all sorts and a deep recession) and were rescinded a few years later. President Ford went to Congress with programs to fight inflation that was running closer to 10% in October of 1974, with a speech entitled "Whip Inflation Now" (WIN). He famously urged Americans to wear "WIN" buttons. That policy too was less than effective, and the buttons, in a history replete with silly gestures by governments, should stand on anyone's top ten list of such silly gestures.

Cynics more thoughtfully wore the buttons upside down and said the inverted letters (which looked like NIM) stood for "No Immediate Miracles." They were right. There was no miracle, just eventual pain and lots of it. Ultimately, Paul Volker defeated inflation, but at the cost of two serious recessions and a lot of economic misery, with unemployment levels over 10% for nine months in 1983.

This week we were given the data that inflation as measured by the Consumer Price Index (CPI) over the last year was 4.2% and unemployment is now 5.5%. Some call for the Fed to raise rates so that we do not have to experience another lost decade like the '70s and then ultimately see some future Volker forced to raise rates and drive unemployment back to 10%. Others suggest that "core" inflation is what should be paid heed to, and urge caution.

This week we look at the cost of what could be a renewed effort to Whip Inflation Now, not just here but in countries worldwide. Will Trichet in Europe raise rates even as the European economy seems to be slowing down? If you think inflation is bad in the US and Europe, take a peek at Asia. And I ask, "What will Ben do?" It should make for an interesting letter.

Whip Inflation Now

Nixon and his advisors thought inflation at 4% was serious enough to institute price controls. Headline inflation in the US is now 4.2%. What kind of economic policy should we pursue to bring inflation back into the Fed's comfort zone of 1-2%? Would it work and would it be worth the pain? To get a handle on the question, let's go to the data from the Bureau of Labor Statistics and see where inflation is coming from.

And let me note, this is the same exercise we could do for a host of countries. The answer will be roughly the same: there are no easy solutions.

Core inflation, or inflation without food and energy, grew at 2.3%. Inflation without food costs was an even 4% and without energy was 2.7%. Clearly energy was the leading contributor to inflation in the past year.

But the recent trend in rising inflation is even more worrying. If you look at just the last three months of data and compute an annualized rate of inflation, you find that overall inflation has risen to 4.9%, energy inflation is running at a staggering 28%, and food costs have risen 6.2%. Meanwhile, core inflation during that period dropped to 1.8%. You can see all the data at http://www.bls.gov/news.release/cpi.nr0.htm.

Now, gentle reader, let's think about these numbers. Food (over 14%) and energy (over 9%) combined make up roughly 24% of the CPI, yet were responsible for over 60% of the recent three-month trend in inflation. By the way, housing was up 4.9% and transportation up 8.7%, so it was not just food and energy.

What would it take to drop headline inflation back to under 2%? Well, one way would be for food and energy prices to fall. Let's look at the possibilities.

As Donald Coxe has noted, North America has had an 18-year run of remarkably good weather in our growing season. You have to go back 800 years to get a string of years that were that good. Yet today food reserves of all types are at decades-long lows. There is very little room for any type of problem.

This growing season is not off to a good start. It looks like the yield on the corn crop will be lower than normal, and that is if we get very benign weather this fall. Given how late much of the US corn crop was planted, and how torrential rains in the corn belt have devastated crops (not to mention flooding cities, and our thoughts and prayers go out to those who have lost their homes to flooding), an early frost would be disastrous.

Because we have devoted so much of our arable land to corn (in a very misguided policy to turn food into ethanol), we have less for soybeans, which is putting upward price pressure on beans and other grains that are used to feed cattle, hogs, chickens, etc. In fact, it costs so much to feed livestock that ranchers are shrinking their herds.. This means more meat is coming into the system now, which is dampening prices. Increased supply will reduce prices in the short term, but next fall we will find that supplies of all types of meat will be short. That will potentially send meat prices soaring. Cereal and bakery products are up 10% over the last year. They could continue to rise in the fall if the corn crop does not yield more than currently projected. It will cost even more to feed your household and feed the animals we need for meat.

Food is the most basic of commodities. Demand is fairly consistent, and supplies may come under pressure. Looking for food inflation to drop back by the fall to 2% is not realistic in the current environment.

What about energy? There is some more hope there, at least on the oil front. High prices have reduced demand in the US, with gasoline usage down about 4%.

I think we have reached a tipping point. The psyche of the US consumer has been permanently scarred. Slowly, this country is going to replace its fleet of cars with smaller, more fuel-efficient cars. Over time, we will see demand continue to fall. We could see further drops in the demand for gas in the next few months.

Much of Asia used to subsidize oil prices to their consumers. That is changing, as Indonesia, Sri Lanka, and Taiwan have announced they are decreasing their subsidies, as the cost is simply too much. Malaysia now spends 25% of its budget on oil subsidies, and must raise prices or cut other services - or watch inflation get worse. India is now contemplating how to cut its subsidies. Even China is likely to start to raise costs after the Olympics. These countries are going to go through their own price shocks. All this will reduce world demand for oil.

And while there are those who are convinced the high price of oil is due to speculators, there are reasons to think the real culprit is still demand. Refiners are paying anywhere from $5-7 more per barrel than futures prices for "light sweet" crude (oil with low sulfur content) and $7 less for heavy sour crude. Much of the oil from the Middle East is of the latter variety, and supplies are increasing. There is not enough refinery capacity for heavy sour crude. That is why you see OPEC representatives say there is enough supply. For the crude they produce, there is. Spot prices are reacting to supply and demand and not speculative futures prices.

Over time, reducing demand should reduce price. I would expect to see oil get back to $120 or lower by the end of the year. But by year-over-year comparisons, inflation will still be ugly for some time. Oil prices have risen approximately 90% in the last 12 months (the actual percentage is highly dependent upon which measure you use). The bulk of that has been in the last four months. For energy inflation to go down on a year-over-year basis, we would need to see oil drop below $100. How likely is that in the next two quarters?

Where Can We Get Help on Inflation?

So, the two main sources of inflation are unlikely to drop in the next two quarters. If we want to get overall inflation down to 2%, we will need to look for help in other areas of the economy. How about medical care? Not likely. Education costs? Get real.

Housing costs make up 42% of the CPI, and thus are the biggest component. That is broken down into several categories: owners' equivalent rent for those who own their homes (32%), actual rent for those who do not (around 6%), utilities, furnishings, etc.

Rents have been up by 3.5% over the last year and owners' equivalent rent by 2.6%. If rent increases were to drop to zero, that would just about get us to 2% overall inflation. But let's think about that. Such a low number would mean an economy on its heels and a lack of buying power on the part of consumers. The only way that happens is with serious unemployment.

You can go to http://www.bls.gov/news.release/cpi.t01.htm and look at the various components of the CPI. Spend some time thinking about what costs are likely to drop. New and used vehicles are now dropping year over year, but only by a little, and that is only 7% of the index. Most items are rising at least a little.

Now, in a second thought exercise, think about what would happen if Bernanke decided to raise rates. A rising Fed funds rate is unlikely to have much effect on oil or food prices, unless he raises them enough to put the US and world economies in a serious recession.

How much would he have to raise rates to really slow the rest of the economy down? If you push up rates by 2% with the economy either in recession or close to it, you risk putting the economy into a much deeper recession.

Look at the yield curve below. This is exactly what the banks and financial services lend. They like to have a nice positive differential between the cost of their deposits and what they can charge for lending.

If you raise rates by 2%, you would more than likely invert the yield curve, making it that much more difficult for financial service companies to be able to recover. Given that they are already in trouble, and therefore less able to lend to businesses and consumers, do you really want to make things worse?

Look at the banking index below. This is an ugly chart. Another inverted yield curve would do serious damage to an industry already reeling. We are going to see more write-offs from banks. This chart will get uglier, but it will collapse without a positively sloped yield curve. (chart courtesy of www.fullermoney.com)

Further, raising rates would make it more difficult for consumers whose mortgage rates are tied to short-term rates. Is that what a housing industry needs right now?

Bottom line, Bernanke is in a very difficult position. Inflation by any standards is too high. But the cause of the inflation is not something in the Fed's control. To bring inflation back to 2%, he would have to savage the economy, perhaps at least as much as Volker did. Do you want to see unemployment go to 8-10%?

Volker was dealing with wage inflation. Everything had cost of living adjustments (COLAs) back in the late '70s and early '80s. Spiraling wages were one of the primary causes of inflation, if not the most important. A higher Fed funds rate could do something about rising wages by increasing the unemployment rate. Tough love, but effective.

Volker had to kill inflation expectations. Today, that is not (so far) Bernanke's problem. If you look at the implied inflation in the TIPS market, which is the difference between a ten-year treasury note and the ten-year TIP rate, it has only risen from a recent low of 226 bps on May 1 to 249 bps on June 10. Look at the following chart from Asha Bangalore of Northern Trust. Note that inflation expectations are not at recent highs.

The Patient Died Anyway

An expected inflation rate of 2.5% is well within "contained." It would be irresponsible to put the economy into a serious recession under such a set of circumstances. My Dad had a saying, "The operation was a success, but the patient died anyway." Raising rates in any serious manner would whip inflation but would kill the economy at this point. Rates will need to go back up at some point, but not until the economy shows signs of a rebound. I think the chances of the Fed raising rates by the 75 basis points, by January, that the market has priced in, is quite low.

What will happen is that over time the annual comparisons will begin to be less problematic. The cure for high prices is high prices, as the true cliché goes.

Sadly, we may get some help on the housing inflation component. Foreclosure filings last month were up nearly 50% compared with a year earlier. Nationwide, 261,255 homes received at least one foreclosure-related filing in May, up 48 percent from 176,137 in the same month last year and up 7% from April, foreclosure listing service RealtyTrac Inc. said Friday.

The prices of homes in many areas are going to fall to the level at which they can be rented. As more homes come onto the market for rent, the pressure on rent prices will fall. And the measure of owners' equivalent rent will fall along with it. Mark Zandi, chief economist of Moody's Economy.com (and an adviser to Republican John McCain's campaign), wrote earlier this week that "the Bush administration's efforts to encourage loan modifications and delay foreclosures are being completely overwhelmed."

Separately, a Credit Suisse report from this spring predicted that 6.5 million loans will fall into foreclosure over the next five years, reaching more than 8 percent of all US homes. (AP) That is going to keep pressure on housing prices for several years at the least.

Thus, it is likely that Bernanke and company will continue to talk tough on inflation. But, as noted above, I also doubt that they will raise rates this year, and probably not until well into the next.

The only reason to raise rates would be to protect the dollar from a serious collapse. I think it more likely the Treasury would intervene in the markets to prevent such a collapse. Dennis Gartman, at dinner Wednesday night, suggested that if the administration really wanted to get the market's attention, they could intervene in the currency markets and release oil from the Strategic Petroleum Reserve at the same time. While it would only be a temporary fix, it would make speculators nervous. However, they might consider such an experiment preferable to having the Fed raise rates during the middle of a slowdown/recession.

And the dollar seems to have found at least a temporary bottom, and we could see further strengthening next week, as Ireland voted today to reject the proposed European central government. Since it takes an absolute 100% consensus among all member nations, that kills the deal. Europe now has a very odd shape. They have a commercial union. Some of the members share a currency. Some of them share actual membership in the EU. Some of them are in NATO. They have competing and very different needs for monetary policy.

In fact, it will be hard to get anything done in Europe apart from commercial treaties, etc., as any one country can veto any particular item which is not to their advantage. Over time, this is going to be seen by the world as an issue for the euro. And given the demographic and pension problems of "Old Europe," the currency is going to come under increased pressure from competing needs for funding, taxes, and an easy monetary policy.

Six years ago I talked about the euro rising to $1.50, but I also noted that by the middle of the next decade it is likely to come back to par. We are halfway on that journey, and I still think we will arrive at my predicted point.

I think it is possible that the dollar could rise 10% or more this year against the euro, which would help inflationary pressures. Import prices into the US are up 17.8% year over year. A stronger dollar will help alleviate that.

Inflation in Asia and Europe

Countries throughout Asia would love to have a 4.2% inflation rate. Indonesia is at 10.4%, almost twice what they were a year ago. Vietnam would love to have such mild inflation, as its own level is up over 25%. Inflation in China is 8%. Inflation is up throughout the continent. And oil and food are the culprits.

Korea is particularly strained. Korea has seen its import prices rise by almost 45% in the last 12 months. Read this note from Stratfor:

"South Korea is among the most vulnerable of Asia's top economic players to global price increases due to its heavy reliance on imports for many of life's basic essentials - including oil, wheat, corn and coarse grains. At least 96 percent to 100 percent of its annual consumption in each of these items is imported. With global supplies in these basic necessities set to tighten, South Korea's inflation and the associated social unrest can only rise. (Protests in South Korea can draw hundreds of thousands of marchers.)

"Interest rate hikes are one of the most readily available tools for fighting inflation and for propping up a weak currency. In theory, raising rates would help attract foreign money into South Korea by raising the rate of return on investments in the country, thus helping to increase the value of the local currency and to contain rising energy import costs and inflation. But just June 12, South Korea's central bank decided to keep interest rates frozen at 5 percent. This was because the potential economic slow-down an interest rate increase could trigger is too politically risky for the government, and because there are less controversial means to bolster the won.

"If interest rates were raised to tackle the problem of increasingly expensive imports, the access of Korean businesses and households to credit to fund their operating costs or mortgage payments would shrink. This would make the government of President Lee Myung Bak even less popular."

What to do? Each country will try its own particular witch's brew. China is raising interest rates, increasing bank reserves, and allowing its currency to continue to rise. But make no mistake, there are no easy answers. Each choice has its own unintended consequences.

But a large part of the problem in Asia is food and energy. And monetary policy alone cannot address world supply imbalances. To a greater or lesser degree, every country is faced with the same conundrum. Do you risk higher unemployment and your economy to fight inflation that is not strictly speaking a monetary problem? If food is rising 40% in Vietnam, its workers will have to make more in order to eat? Will such a price increase force higher wages and perhaps a wage increase spiral like the US saw in the '70s? If you increase the value of your currency too fast, you risk losing your competitive price advantage and thus losing business and jobs.

There Are No Good Solutions

Over in Europe, I noted last week that one Jean Claude Trichet, the president of the European Central Bank, virtually promised the markets a series of rate hikes. This sent the dollar into the tank and the euro back to new highs. Gold loved it.

But this week has seen a very unusual set of speeches by fellow ECB members disavowing Trichet's promise, and even Trichet had to try and "explain" away what he had said. "We aren't talking about a series of rate hikes. Maybe, just possibly, we would raise in the event of more inflation." Confusion reigns. There is clearly not consensus at the ECB.

You can bet Trichet heard from various finance ministers in the countries whose economies are weakening. They are not interested in a stronger euro or higher rates. What one person called the PIGS countries are surely objecting (Portugal, Italy, Greece and Spain, whose economies are not exactly robust).

And their objections are the same ones that would be made here. What good would a rate hike do? How much more oil or corn would be produced? Why increase our pain when there could be no positive result?

The central banks of the world got by for years with easy monetary policies (think Greenspan) because of rising productivity, cheap energy, increased international trade, a disinflationary environment because of cheap Asian labor and imports, etc. Now that economic regime has come to an end. Stability had bred instability in a very uncomfortable Minsky Moment.

There are no good solutions. There will only be a choice of how much and what type of pain. The US, Europe, and Japan are entering Muddle Through World. The rest of the world is faced with increased volatility. This is a tough environment in which to be a central banker.

New York, "Chicago," and Wedding Showers

It looks like I am going to have to go to New York and Philadelphia the first week of July for a day of meetings with partners. Larry Kudlow has asked me to come on his show July 1, and that sounds like fun. And then I am looking forward to the annual Maine fishing trip hosted by David Kotok of Cumberland Partners. A lot of good friends will be there. And I get to go with my youngest son Trey, who always catches more fish than I do. Maybe this year I can manage to at least stay competitive.

Tomorrow is Tiffani's wedding shower, and it looks like there will be a lot of friends at my home. Her wedding is August 8, and it gets closer every day. There is so much that has to be done. While I am not doing any of the heavy lifting, I am amazed at how much the coordination resembles the Normandy invasion.

I will be speaking at the National Association of Business Economists at the Dallas Fed this next Wednesday, on the assigned topic of how I use earnings forecasts in my economic analysis. That portends to be a very contrarian speech, as long-time readers know my view of the value of stock analysts and the reliability of their forecasts.

On a very sad note, I am distressed to learn that Tim Russert passed away. I have thoroughly enjoyed his analysis and interviews over the years. He has been like an old friend coming into my home each week, and I will miss him. Rest in Peace.

On a lighter note, this Sunday evening The Doobie Brothers and Chicago are in town for a concert, and I am going to go for a little nostalgic evening. Can you believe it has been almost 40 years? Where has the time gone?

Let me say thanks to Pierre and Guy Casgraine, who hosted your humble analyst, Martin Barnes and Dennis Gartman, and a few friends in Montreal on Wednesday. It was an exceptionally fine evening. I so enjoy good food and wine and great friends and conversation. It is one of the true pleasures of life.

Enjoy your week, as I know I will. And look for a major announcement from me this Tuesday, as Tiffani and I need your help on a new project. (No, not the wedding!)

Your getting ready to be an old rocker for a weekend analyst,

John Mauldin

Lies and Other Statistics

John Mauldin — Sat, 03 May 2008 03:21:00 GMT

If we are to believe the government statistics, the GDP of the US grew by 0.6% in the first quarter of this year. And unemployment actually fell. And there were only 20,000 job losses. This week we do a quick review of why the statistics can be so misleading. We also look at why I was wrong about the housing number last week, and I highlight what could be a very serious Black Swan lurking in the agricultural bushes....(read more)

Where is the Bottom in Housing?

John Mauldin — Fri, 28 Mar 2008 15:10:15 GMT

Housing - Finding the Elusive Bottom Where is the Value in Housing? Bottom Line? There is no Bottom in Sight The Real ARMs Race Cancun, La Jolla, London, and Switzerland Existing home sales rose by 2.9% in February, the first significant rise in home...(read more)

Sea Change at the Fed

John Mauldin — Fri, 21 Sep 2007 08:12:00 GMT

Sea Change at the Fed "Of his bones are coral made: Those are pearls that were his eyes: Nothing of him that doth fade, But doth suffer a sea change Into something rich and strange" (The Tempest - Shakespeare) The term "sea change"...(read more)

Should the Fed Cut Interest Rates?

John Mauldin — Fri, 07 Sep 2007 08:10:00 GMT

Should the Fed Cut Interest Rates? The Shocker in the Employment Numbers Should the Federal Reserve Cut Interest Rates? Will A Cut Make Any Difference? How Housing Woes Hurt the Rest of the Economy Home Again, Home Again The unemployment numbers came...(read more)

The Mortgage Pig in the Python

John Mauldin — Fri, 03 Aug 2007 08:06:00 GMT

The Mortgage Pig in the Python Inflation is Baked into the CPI Numbers The Mortgage Pig in the Python Housing Starts Look to Stop A Few Thoughts on the Recent Credit Crisis Half of All Hedge Funds Gone? Golf, Weddings, and Europe With the economy increasingly...(read more)

$250 Billion in Subprime Losses?

John Mauldin — Fri, 29 Jun 2007 07:59:00 GMT

$250 Billion in Subprime Losses? Is the subprime mortgage market collapsing before our eyes, or did we avoid a disaster as Bear Stearns stepped up to the plate with $3.2 billion to help its ailing funds? As we will see from the data, the problems in the...(read more)