Mid-December 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714

HAPPY HOLIDAYS EVERYONE!  As for next year, let’s hope that everything I say below is untrue or at least that readers have prepared themselves appropriately.  I am going to be busy for the next week, so I am putting this update out a few days early.  In the coming year, please stick to data or logic in your blog comments (that is the nature of this blog), and please try to validate any data before posting.  It will save everyone else a lot of work! 

UNEMPLOYMENT

Per the Technical Note on the Bureau of Labor Statistics web page, the drop in monthly unemployment from 10.2% to 10.0% is not statistically significant even at a 90% confidence level (and most statistics are generally checked at a higher 95% confidence level).  Both the 10.2% number and the 10.0% number have about a +/- 0.2% estimate error, SO WE CAN NOT SAY WITH CONFIDENCE THAT UNEMPLOYMENT HAS GONE DOWN.  The reasons for the low confidence level are related to accuracy of the statistics themselves, likely errors in the seasonal adjustments being applied, and the broad assumptions used for how many companies are going out of business and how many are being born. To minimize error when using these unemployment numbers, it is best to look at a rolling 2 or 3 month average.  Here is what the last 12 months’ unemployment percentages look like using a 2-month rolling average, starting with December, 2008: 7.0, 7.4, 7.9, 8.3, 8.7, 9.2, 9.5, 9.5, 9.6, 9.8, 10.0, 10.1.  As you can see, the upward trend has been consistent but the rate of increase has gone down in the last six months.  But it hasn’t leveled off or reversed.  And at the current increasing rate of 0.1% per month, unemployment will be over 11% by the end of 2010, which will be the highest unemployment level since The Great Depression. 

It is worth noting the response to the publication of this questionable unemployment number.  The dollar rose, gold fell, and politicians were out celebrating saying that the worst is now over.  Of course, these were the same people who were saying the day before that any improvement in unemployment would be many months away because unemployment is a lagging indicator.  I guess they now feel that unemployment is a leading indicator.

BETS ON THE STOCK MARKET

As I have mentioned, I am no good at predicting when the market will drop.  But I am confident that people buying stock at current prices are betting against historical odds.  The last half of my depression book is filled with data (which many people hate) demonstrating that past investors did better when they bought stock when market prices were historically low (using the price/dividend ratio for the S&P 500 as a baseline.)  Sure, you may be lucky and make money buying stock at these outrageous prices.  You can also go to Vegas and you might do well – but in the long run the house always wins because of the odds!

Stock buyers have been convincing themselves that fantasy earnings for 2010 will justify the current prices.  But once investors see next year’s earnings, they are going to have a hard time finding a rationale for continuing to bid up stocks.  Even with Goldman Sach’s bullish December 8, 2009 estimate of 2010 dividends going up by as much as 8.9%, stock prices would still have to drop by almost 50% to match historical price/dividend ratios. 

THE CONSUMER

When I wrote my book, my prediction of a depression was based on consumer debt hitting a wall, requiring a dramatic slowdown of the economy as spending was reduced.  Using the same type of analysis I did in my book, let’s look at current data on the consumers’ financial wellbeing.

SAVINGS   Per the Bureau of Economic Analysis, the Personal savings rate averaged 4.5% for September and October.  This is huge compared to the 0.5% consumers saved in 2005 and 2006 before all this began.  

DEBT PAYMENTS VERSUS INCOME   On the Federal Reserve Board website, looking at the Financial Obligation’s Ratio (a measure of the percentage of debt payments to disposable income), it reached its high early in 2008 at 18.84%.  The good news is that this ratio has now dropped to 18.05% (as of the second quarter, the most recent data available).  In fact, consumers borrowed less in October for the ninth straight month.  The bad news, at least for the economy, is that the 0.8% reduced Financial Obligations Ratio (which indicates that the consumer now isn’t quite against the wall as to debt payments) is being overwhelmed by the 4.0% increase in personal savings.  The net is a 3.2% drop in available funds for consumer spending (actually, the drop is more than that, since consumers had actually been INCREASING their debt ratios).  Obviously, increased government spending is partially covering for this.  And the government, through the Clunker and various programs, can get the consumer to temporarily splurge; but all that does is delay how long it will take the consumer to get down to the more healthy 15.75% Financial Obligations Ratio they had in the early 1980s. 

TOTAL DEBT VERSUS INCOME   Per a December 6, 2009 article in the International Business Times, the Total household Debt as a Percent of Disposable Income now stands at 129%.  This is below the 135% reached in 2007.  This is consistent with the other data we see that the consumer is attempting to reduce debt.  But again, he has a long way to go to get down to the 80% level he had in 1990 before all this mess began. 

BANKRUPTCIES   Quarterly personal bankruptcy filings are back up to the level they were in 2004.  This is remarkable since the bankruptcy law was changed in 2006 to make it far more difficult to declare bankruptcy.   

HOME PRICES   Per the Zillow Housing Report showing home prices through 9/2009, home prices continue to drop at a rate of 0.1% per month.  Using Zillow data adjusted for inflation, home prices must drop another 18% to get down to their 2000 level.  And with the excess number of homes on the market, this is very likely to happen.  This is critical, because many people who are currently not under water on their mortgages will become under water and become more likely to go into foreclosure.  The Zillow data showing homes dropping in price is in sharp contrast with the more publicized Case Shiller home price data that has been showing that housing prices are recovering.  The problem with the Case Shiller data is that they are strongly affected by the market shift from subprime mortgage foreclosures to prime mortgage foreclosures which are generally on higher priced homes. 

FORECLOSURES   Per RealtyTrac, the number of foreclosures was down 3% in October from the previous month.  But note that the DOLLAR VALUE (versus the NUMBER) of foreclosures is likely up because of the market change to prime mortgage foreclosures.  And the value of individual foreclosures is likely to continue upwards as nearly $71 billion of interest-only and option mortgages reset next year, increasing the mortgage payment dramatically for many home owners.  These mortgages were used mostly for higher priced homes, and many of these mortgages are now under water.  As a sign that more foreclosures could be on the horizon, 23% of people with mortgages owe more than their homes are worth, according to a report by research firm First American CoreLogic.  And people upside down on their mortgages are more likely to walk away from their mortgages.  And of course, the increasing unemployment will just exacerbate the problem. 

DELINQUENCIES   TransUnion reports that auto loan delinquencies jumped 10% in the third quarter.  The Mortgage Bankers report that the delinquency rate on mortgages jumped 12% in the third quarter to a record high 9.94%. (since records started in 1972). Delinquent mortgages are defined as those with at least one payment past due but not in foreclosure.  In fact, the only area where delinquencies are falling is on credit cards.  This is apparently because people are using credit cards to pay for their daily needs and consumers are doing what it takes to keep their credit cards from being cancelled.  They would rather risk losing their homes or cars. 

SUMMARY   So, many consumers are under water on their mortgages, delinquent on house and car payments, or going into bankruptcy.  17.2% are unemployed.  Those who are not in as much economic trouble are beginning to save rather than spend.  They are afraid of losing their jobs while they watch their homes continue to lose value.  Wages are not growing and people sense inflation despite government numbers to the contrary.  All of this is making the consumer very wary of spending, which is dramatically slowing the economy.  And there are no signs that any of this is going to reverse.  Everything is on the path to the depression that I outlined in my book, and the economy will not bottom out until 2012 or 2013. 

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 57.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop 54% to get down to its median P/D and drop 70% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree. 

Warren

December 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.” “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714

DEFLATION VERSUS INFLATION

One reader asked for an analysis that looks at “Will we have Deflation or Inflation.” He comments that I seem tied to rising inflation. He asked me to look at how I could be wrong and could I make the case for the other side? The reader specifically asked for a comparison to Japan, which has not drifted into an inflationary mode despite years of non-growth GDP and massive government stimulus.

First, I have to clarify that I am looking at CPI inflation, not asset bubbles. Asset bubbles eventually burst, be they stocks or real estate. They then regress back to their inflation-adjusted norm. Not so with the CPI. When we have a period of high CPI inflation, like in the late seventies and early eighties, the inflationary period is not then reversed by a period of deflation.

Also, despite what some headlines say, neither the U.S. nor Japan have been in a long-term deflationary mode. Yes, Japan has experienced 2.5% deflation for the last 12 months; but if you look at the last seven years, Japan’s CPI has basically been flat (http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?symbol=JPY). For the U.S., inflation for the last 12 months has basically been flat; whereas U.S. inflation for the last seven years (CPI-U) has averaged 2.6%. (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt).

CASE FOR INFLATION  The case I make for inflation in the U.S. versus Japan is the amount of debt each country owes to foreigners. In the U.S., per an Aug 27, 2009 CNBC article, 33% of our $11 trillion debt is owned by people outside the U.S. So, if we allow (or enable through money printing) inflation to diminish the value of our debt, 33% of the pain is felt by foreigners who financed our debt. In Japan, per a July 25, 2009 WSJ article, only 6.4% of their debt is owned outside Japan. So if their government allows inflation, 93.6% of the hurt is borne by their own citizens. So, politically, the Japanese government has to fight inflation. And the inflation burden to U.S. owners of our debt may be actually much less than the 67% indicated by the above numbers. The U.S. government owns 44% of our total debt, and the U.S. government can print money if needed, delaying the pain. So the portion of the total U.S. debt owned by foreigners plus the debt owned by our government is 77%. This means that the U.S. citizen will only experience 23% of the immediate pain of an inflated dollar, versus the 94% experienced by the Japanese if their country allows inflation. There is a big incentive for the U.S. to inflate our currency versus Japan!

CASE AGAINST INFLATION  The best case against inflation is the actual inflation numbers experienced for the last several years. We have been able to keep interest rates low and print money without causing high inflation. And we continue to be able to sell Treasuries with ridiculously low yields to finance our debt. There is no reason why this can not continue for several more years despite the grumbling of other nations who keep buying our Treasuries. They are so much in bed with us by owning so much of our debt that they cannot afford to rock the ship. Zero or low inflation for the next several years is a possibility (though I find it unlikely given the temptation to lower our debt through inflation.)

CASE FOR DEFLATION  Deflation is what happened in the first years of The Great Depression. And, in the current situation, excess production capacity may force companies to cut prices to get customers. And high unemployment may cause people to take less for the same job because they fear unemployment, enabling companies to continue making a profit at the lower prices.

CASE AGAINST DEFLATION  The U.S. is not acting like they did in the first three years of The Great Depression. They are spending like in the later years of the Great Depression, when our economy was slightly inflationary. The U.S. can print money and do other measures like Cash-for Clunkers and New-Home-Buyer credits that get money out into the economy. The printing of money and additional stimulus is the one tool that truly is in the government’s control. And the Fed has promised to do this rather than allow deflation. Also, although companies try to reduce costs to enable lower production, fixed and semi-variable costs (like heat and maintenance) start to dominate and put a limit on cost reduction. They will be forced to raise prices.

THE GENERAL ECONOMY

Here is an excerpt from a recent comment on this blog: “…I think you are missing the boat on this recovery. Judging by many different indicators such as retail sales, home sales, unemployment claims, manufacturing; the economy is now growing again. While you hung your hat on statistics in your book to try and prove your case, you sure seem to be conveniently ignoring many statistics now.”

Well, just to let the commenter know that he is not the first to think that I am “missing the boat,” here is an excerpt from one of my favorite negative reviews on Amazon, from May 25, 2006: “As for the author’s claim that the housing market rolling over is going to kick-start the next depression, and that it will start in 2007, I can hardly wait to see this play out, either for or against the author’s claim. Unfortunately, as I alluded to in my opening of this review, the book is more likely to land in the pile of outlandish claims than to provide you with accurate “what to do in case…”

Okay, let’s take a detailed look at the four areas that the recent commenter says proves that the economy is growing again: retail sales, home sales, unemployment claims, and manufacturing. And then we can see which one of us is “conveniently ignoring many statistics now.”

RETAIL SALES  Per Yahoo! Finance, October retail sales rose 1.4% due to auto sales driven by the Cash-for-Clunkers program. Excluding auto sales, retail sales were basically flat. According to a survey conducted by the National Retail Federation, consumers said they will have spent nearly 8 percent less on average, or about $343 per person, over the weekend that includes Thanksgiving, Black Friday and runs through last Sunday. That doesn’t sound like a growing economy to me!

HOUSING  The U.S. Census Bureau and the Department of Housing and Urban Development jointly estimated last week that sales of new one-family houses in October 2009 were at a seasonally adjusted annual rate of 430,000. This is 6.2% above the revised September rate of 405,000. This is an increase of 300,000 sales on an annual basis. And The National Association of Realtors reported a 10.1% surge in October of existing-home sales, equating to 560,000 additional sales on an annual rate. So the total increase of new and existing home sales was at an annual rate of 860,000. However, both new and existing home sales were juiced by the original November expiration date for the new-home-buyer stimulus credit. As I reported in my last update, The National Association of Realtors (NAR) reports that 1.8 million buyers got the first-time home buyer’s credit. So, without the added 1.8 million new home buyer sales, which were far larger than the 860,000 additional total sales, home sales would have dropped. And The National Association of Home Builders (NAHB) estimates that only 150,000 additional home sales were due to the first-time buyer credit, which means that the other additional home sales were robbed from future sales, which bodes poorly for the coming months. This does not seem like a recovery!

UNEMPLOYMENT  In the week ending Nov. 21, the advance figure for seasonally adjusted initial claims was 466,000, a decrease of 35,000 from the previous week’s revised figure of 501,000. At first glance, this indeed sounds like good news! But it is a meaningless number without knowing how many jobs are being created such that the total of number of people unemployed is going down. But per the government’s website http://data.bls.gov/PDQ/servlet/SurveyOutputServlet, here is the total percent unemployed for the last three months: Aug 16.8%, Sep 17.0%, Oct 17.5%. So it has steadily been increasing. Now, some might say that the initial lower claims number is a predictor of future unemployment numbers. But logically we would expect the number of people applying for initial claims to go down as companies find it more difficult to reduce staffing while still maintaining a business. At some point you are down to a critical few people with reductions far more difficult. But that is no indicator that the economy is growing.

MANUFACTURING  Per the government’s website http://www.bls.gov/news.release/empsit.nr0.htm, manufacturing continued to shed jobs (-61,000) in October, with losses in both durable and nondurable goods production. Over the past 4 months, job losses in manufacturing have averaged 51,000 per month, so the most recent month’s losses are actually higher. Manufacturing employment has fallen by 2.1 million since December 2007. The Federal Reserve Bank of Chicago said on Monday its Midwest manufacturing index, which covers five Midwestern states, rose in October but was sharply down compared with a year ago amid weak economic conditions. Even if this recent uptick in the manufacturing index is real and not just the result of rebuilding inventories or responding to temporary blips caused by the likes of the Cash-for-Clunkers programs, unless an improvement in manufacturing actually translates into additional manufacturing jobs it will not be sufficient to grow the economy.

OTHER BLOG INPUTS

One commenter said that “Things are not that bad. And while Warren is going off the deep end about Defense Spending (a rather humorous thing coming from a retired GE Engineer) the fact of the matter is the US government spends much more in interest payments on the 12 Trillion dollar debt than on defense.”

Perhaps this commenter would be wise to spend some time checking his facts before making such negative comments. Per the government web site www.treasurydirect.gov/govt/reports/ir/ir_expense.htm, we are paying interest on our debt at an annual rate of $274 billion, which is far less than our military budget that exceeds $650 billion?

THE STOCK MARKET

The Price/Dividend (P/D) ratio for the S&P 500 is now 56. This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market. At current dividends, the market will have to drop 54% to get down to its median P/D and drop almost 70% to get to my own entry target P/D. Do not interpret the P/D ratio as a predictor of the direction of the economy. It is a historical unemotional measure that I believe reflects whether the market is overpriced. The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information. Intelligent people can, and do, disagree.

Warren

Mid-November 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714 

PROCEDURAL CHANGE   This blog is getting too time-consuming; I actually considered shutting it down.  But, as an alternative, I decided to try a reduced-interface version.  I will still give my updates and readers are still welcome to comment.  But I will not be responding to individual comments.  Instead, I will read all of them and if the subject of a comment or question seems to have broad interest, I will attempt to incorporate it into my next update.  Of course, readers can still be discussing ideas among themselves, as long as the comments are kept civil.

WHAT HAS CHANGED   In this update, I am going to discuss what I think has changed, or surprised me, since I wrote my books on the economy.

POWER OF FINANCE   In 1961, President Dwight D. Eisenhower, in his Military-Industrial Complex Speech, warned, “In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”  Well, by any measure, the military industrial complex has indeed gotten exceedingly powerful.  Why else would we continue fighting unwinnable wars (does anybody even know what the term “win” means in Afghanistan) and our military budget exceed $650 billion? 

But equally frightening is the growth of the financial-political complex that is now in place.  Recent data shows that 44% of Congress is made up of millionaires, which certainly affects their perspective.  President Obama has surrounded himself with graduates from the Wall Street banks.  And to solve the problem of toxic investments, the government changed the accounting rules so the big investment firms could claim that their worthless investments were worth something; then the government bought the toxic investments at the inflated values.  When investment banks were judged as being “too big to fail,” the solution was to give them taxpayer money and combine them to make even bigger banks.  I completely missed seeing this coming.  I predicted bank failures and government rescues, but not the massive government response we have seen that only makes sense if you assume that they are protecting their own.

And now I am afraid that the two complexes, the industrial-military and the financial-political, are so in bed with each other that it will make it very difficult for the general populace to pressure the government to do what is required to get our country back on track.  As I mentioned in my previous update, in order to get our deficits under control, we must go after the money.  And a disproportionate portion of this country’s resources are with the extremely wealthy and in the military’s budget.  Going after this money runs smack into these two power complexes. 

We will need a leader who will take on these power groups.  President Obama came into power with the backing of the ordinary people, but he has yet to show if he has the intestinal fortitude to stand up to these power groups.  Unless he makes a remarkable turnaround (and it may be too late because he has lost a lot of his mystique), we will have to see if in 2012 a leader emerges that has the attraction of the masses yet has the power to take on these power groups.  Also, we have to see if President Obama will put the required resources and pressure to get clean renewable energy so our country can build good jobs that will eventually help us grow out of the depression.

A lot of commenters seem to worry about hyper-inflation.  I worry more about how much turmoil our country will go through once the masses demand their reasonable share of this country’s riches.  And the ordinary people WILL eventually demand their share; it is just a matter of when and how it happens.  The two complexes, the industrial-military and the financial-political, are going to fight them every step of the way.

FORECLOSURES   In my book, I had forecasted the foreclosure issue.  But I am beginning to think that this problem may get to be even bigger than what I had forecasted.  The 6 to 7 million homes now forecasted to go into foreclosure may be understated, because those estimates are based on how many people are already behind in their home payments and the programmed resets of ARMs.  None of these forecasts include the increase in foreclosures likely to come if our unemployment gets up close to 15% (on the media reported number), which I believe is likely.

Even World bank President Robert Zoellick said on November 11, related to the high U.S. unemployment, “You’re going to have problems with delinquencies of credit card loans, consumer loans, people won’t be able to pay their mortgages.  Some banks are going to continue to be troubled by bad loans.”  He also said that after the government stimulus money runs out, consumer spending must take the baton. “If you’ve got large scale unemployment, if you’ve got consumers rebuilding savings and deleveraging, I don’t think the consumer is going to play that role.”

The recent slowdown in foreclosures is temporary because it is caused by some states requiring mediation before foreclosures and lenders delaying foreclosures as they evaluate which borrowers might qualify for the federal loan modification program.  Since relatively few borrowers will qualify, once these delays are passed, increasing foreclosures will resume.  Also, although the number of foreclosures are slightly down, it is unlikely that the dollar value has dropped since more foreclosure have now switched to higher priced homes.

MISCELLANEOUS   One area I may have misjudged is how long it will take our country to recover from the coming depression.  I said 2020, which seems like a long time from now.  But looking at what Japan is going through, it could end up being much longer than that.

Another thing I didn’t foresee is the rising bubble in commodities.  A few people are going to make a lot of money on this; but most investors will buy near the top and ride it down as the bubble breaks, which all bubbles eventually do.

One last thought for those who still believe that our stock market is now okay.  Look at what happened to Japan’s Nikkei 225 Stock Index.  In the last 20 years, it has dropped 72%.  On its way down, it had three “major” recoveries.  But the downward trend always returned.  There are a lot of similarities in Japan’s market in the last twenty years and our current stock market.  

The stock market is charging ahead despite volumes being down 33% from March.  Those who are bullish are obviously willing to pay whatever it takes to buy stocks from others who then in turn buy different stocks from other investors for an even higher price.  Perhaps its time to dust off the books from 10 years ago:  “DOW 36,000” by Glassman & Hassett, “DOW 40,000” by Elias, or “DOW 100,000” by Kadlec.  As ridiculous as those predictions were then, at least they were made in a time of a booming economy, low inflation, rising corporate profits, low unemployment, and, perhaps even more amazing, a U.S. federal budget surplus.  Well, we do have low inflation!  I guess one-out-of-five isn’t bad!

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 56.5.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop 54% to get down to its median P/D and drop 70% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree. 

Warren

November 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714 

THE WEEK’S STOCK MARKET AND THE STIMULUS

The important thing to note is that the market gain realized on Thursday when the positive GDP numbers were released was overwhelmed by the down market on Friday when the negative consumer spending numbers were reported.  The S&P 500 actually lost 4% for the week.  Apparently, more investors are recognizing that the 3^rd quarter gain in the economy was driven by the cash-for-clunkers program and first-time-home-buyer credit, which are both now ending.  There was no real economic recovery.

Congress is also aware of this and is thinking about extending both stimulus programs, with some modifications.  For example, on the first-time-home-buyer credit, they are considering extending the end date beyond November and including a $6500 credit for those who want to trade-up from homes they have lived in for more than five years.  Neither program will have much effect except to give money to those who were going to buy anyway.  A $6500 credit to someone to buy a more expensive home in a market with falling prices (and with a difficulty of even being able to sell their existing home) is not likely to motivate anyone.  And most first-time buyers already made their move since they thought that the program was ending in November.  So we will just be giving away taxpayer money to those who are going to buy anyway with no resultant long-term gain in the economy.

In fact, as reported in CNN Money, Edmonds.com has calculated that taxpayers paid $24,000 for every extra car sale generated by the Cash-for-Clunkers program.  Of course, the White House disputes these numbers and the way Edmonds calculated these numbers; but even if the per car costs are off 50%, it was a very expensive program versus any long-term benefit. 

The first-time-home-buyer credit has a similar cost issue.  The National Association of Realtors (NAR) reports that 1.8 million buyers got the first-time home buyer’s credit.  But the NAR estimates that only 350,000 of these sales were due to the first-time buyer credit. The National Association of Home Builders (NAHB) estimates that only 150,000 additional home sales were due to the first-time buyer credit.  On the basis of the above numbers, each additional home sale cost the taxpayer either $41,000 per home or $96,000 per home.  It is worth noting that neither the NAR nor NAHB are politically motivated to make these numbers look worse than what they really are.

In fact, the whole stimulus program has had questionable and costly results.  CNN money reports that after $150 billion in stimulus spending, 650,000 jobs have been created.  That is a $230,769 cost per job.

OUR FRIENDS IN CHINA 

Chinese-made drywall that emits sulfurous gases carbon disulfide, carbonyl sulfide, and hydrogen sulfide, was used in an estimated 100,000 U.S. homes built in 2005/2006 at the height of the home price bubble.  Not only do these homes now smell like rotten eggs and perhaps cause health issues, the pipes and electrical components are corroding.  To repair these homes is going to cost an estimated $80,000 to $100,000 per home.  Insurance companies are not only refusing to pay for the costs of repair, but they are also refusing to renew insurance policies on these homes.  Since most mortgages require home insurance, this and the cost of repair is forcing many of these homes into foreclosure.  Since many of these homes will be unsalable even after repair (would you buy one?), the banks could end up eating the whole cost of the mortgage.  If the home values average $250,000, that will be a total loss of $25 billion. 

As this is going on, a Chinese producer of wind power turbines has just won the contract to supply the components for a $1.5 billion wind farm in Texas.  Just a year ago, T. Boone Pickens attempted to build a giant wind farm in Texas but was thwarted due to lack of funds.  Somehow, our stimulus to help develop clean U.S. renewable energy isn’t working.  And after the Chinese’s performance on baby formula, children’s toys, dog food, dry wall, etc, I don’t think that I would want to stand under those whirling wind turbine blades!

SO NOW WHAT?

Consumers continue to cut spending, foreclosures continue to rise, and unemployment is expected to keep growing.  So, the likelihood of the government being able to cut back on stimulus seems unlikely unless they want to risk the economy getting as bad as it was in The Great Depression.  However, continued high deficits are also unsustainable.  So what’s a government to do?  Here are some examples (note, examples only!) of what our government could do to continue stimulus support for our economy while reducing our deficit.  These steps would reduce the continuing drop in the dollar, reduce the likelihood of extreme inflation, and give our economy the time needed to heal from its excessive consumer and government debt.

For a start, it may be worthwhile to compare the U.S. to other countries.  First, the portion of our country’s wealth that is in the top few percentage of our population far exceeds that of any other democratic country.  In fact, the average annual income of the top 1% of U.S. households is $1.2 million.  So, let’s put a 20% off-the-top tax on this income, which will increase U.S. tax income by $276 billion.  Now, that doesn’t solve our nearly $1.5 trillion deficit; but it sure takes a big bite out of it.  Some may say that this tax is unfair.  But was it fair that this top income group was the only group that has prospered by the economic gains of the last 10 or 15 years?  And, it isn’t like this tax would put this group into the poor house.  The poor dears would just have to learn to get by on an average income of almost a million dollars per year.

Another area where we differ dramatically from most countries is how much money we put towards defense.  The amount we spend on defense is almost equal to the total of all other countries combined.  And we spend nine times as much as China, who, as mentioned above, is coming in to build a wind farm in Texas because we can’t afford to do it ourselves.  Our 2009 Department of Defense budget is $651 billion.  And that includes the $1,000,000 it costs us each year for each added soldier in Afghanistan and nearly $500,000,000 for each soldier in Iraq.  Well, we can no longer afford to be the world’s policeman.  So, let’s cut this in half by bringing half of our boys (and girls) home.  Note!  We want to keep them in the service because otherwise we would add to our unemployment issue.  Our returned military personnel will be used to guard our ports and to help rebuild our infrastructure.  From numbers I can find, there are roughly 300,000 U.S. troops overseas.  If we bring half of them home, that would be 150,000 more people requiring housing and spending money in our own economy, both a positive boost.  And, several of the countries that currently have our troops, like Japan, don’t want them there anyway.

As for us being needed in Iraq, Afghanistan, and near North Korea to protect our security, few can show how troops on our own borders won’t protect us even more.  In fact, many people believe that our presence in the Middle East does more to promote terrorists against the U.S. than anything else.  But, in any case, if we keep running $1.5 trillion deficits, we are likely endangering our long-term future far more than if we pull most of our military back to the U.S.

So, if we cut our military budget back 50%, we will save $325 billion a year, even more than what we gained by taxing the extremely rich.  Between the two, the increased taxes and reduced military budget, we reduce the deficit by $600 billion per year.  That would reduce our deficit from $1.5 trillion to $0.9 trillion.  Still high, but this reduction will greatly reduce the pressure on the dollar and enable us to keep helping the economy until the consumer is whole and unemployment starts to go down.  Then the stimulus can slowly be reduced along with the deficits.

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 54.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop more than 50% to get down to its median P/D and drop 68% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree. 

Warren