The Greater Depression or - How I Learned To Stop Worrying and Love The Bear 2011.10.15

The Greater Depression or:
How l Learned to Stop Worrying and Love the Bear

October 14, 2011 Private & Confidential
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Preface
Throughout all my years of investing I've found that the big money was never made in the buying or the selling. The big money was made in the waiting. - Jesse Livermore A few months back, I turned on the news while getting ready for work to see what the weather was going to be like that day. It had been particularly hot and dry for the past couple of months with basically no rain except for a random thunderstorm a few weeks prior. I wanted to wear this new pair of expensive shoes I had just purchased, but hadnt had a chance to waterproof yet, and while we hadnt had a lot of rain lately, I wanted to be sure that they would be safe. There is nothing worse than buying a new pair of shoes and ruining them the first time you wear them. The first meteorologist I landed on said it was slight chance of clouds, but overall a beautiful day with no rain in the forecast. This meteorologist had been notoriously wrong to my recollection, and being the skeptic I am, I turned to another station to get a second opinion. Just to be sure. The next one was a new weathergirl in town, who gave a similar story, except she didnt even mention a chance for clouds. She went on to say that as we were clearly in a drought, and it hadnt rained for weeks, there was an extremely low chance for rain today. While she was pretty and bubbly and seemed trustworthy, she didnt even show a shot of the radar, which I thought was kind of odd until I later found out that her shtick was giving sunny day forecast regardless of what the instruments said. As a matter of fact, it was later discovered that she couldnt even read meteorological equipment. Unsatisfied, I decided to go out on to my balcony and take a look at the sky for myself. While it was a little dark outside, I thought it was just because it was still early - until I looked toward the west. There I saw massive storm heads moving in, black with rain. Call me crazy, but I not only decided to wear another pair of shoes, but I also brought an umbrella. Just to be sure. My point is that I dont need a weather man to tell me if its raining, and even if the weatherman says, No rain, I might plan for rain anyway if I see storm clouds on the horizon with my own eyes. There is a lot of this going on right now.
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The MSM tends to spin the news to serve its own purpose/agenda because doing so is in their best interest; appealing to a certain demographic, or telling its target market what it wants to hear helps retain viewership. Few will argue that media bias exists. If wellinformed conservative turns on CNN, he will likely be repulsed by the blatant liberal slant to its reporting. Same for a liberal watching Fox News. What some people do not realize, however, is that this same bias that can be seen so clearly on politically-based news stations also exists within business-oriented news outlets. I have learned, for example, that getting all my economic news from CNBC is akin to getting all my political news from CNN and the New York Times. Currently, the MSM is trying to sell us on an economic recovery that, frankly, has failed to materialize. As you might know, I tend to get most of my economic news from non-mainstream media outlets because I believe it can be dangerous to get all my news from one place, through one filter. And I have found some that provide true, unbiased analysis of what is going on without the spin. I have been following some people such as Mish Shedlock and Reggie Middleton for years, and have continued to read their analyses because they have been so spot-on and very far ahead of the curve. The sites I read called the top in residential real estate, the collapse of Bear Sterns weeks before it imploded, the Lehman collapse months before it imploded, and so on. I have tried to aggregate information from several of these and other sources outside of the mainstream, with the intent of objectively basing my research on the data that is out there, not what I want or hope to see or what some talking head wants me to think. To be sure, I would like nothing more than to see another 20year bull market, especially at this stage in my life and career. However, I believe it is more prudent to base my plans on the outcome that is likely to occur rather than the one I simply hope will occur, because only then will I be able to avoid being caught off guard and hopefully be able to position myself to profit from it.
Preface
My father taught me to analyze the world around me, the claims that people made. He taught me how to apply logic and how to debate. He taught me to do my homework, to investigate to find the truth, to develop a healthy skepticism and look to corroborate evidence. He used to say: You can lie about numbers, but numbers dont lie. Perhaps (and this might sound kind of nerdy) this is why finance and economics is my passion. I like trying to uncover the truth, trying to solve the puzzle, trying to beat the market, especially because in this realm one can also be rewarded so handsomely for being good taking calculated risks. This is what drives me to search for the truth and to pick apart the claims being made every day about the economy. Please keep in mind: This was not written to detract from our investment direction, but rather to add to it, as I believe diversity of opinion and healthy debate increases the likelihood of our making the right decisions at the right time. I hope you will approach this report with an open mind that is truly objective and unbiased. I put this together because I believe we are on the precipice of a global economic collapse and I dont believe we are currently positioned to profit from it. Most likely we would be hurt by a significant downturn in the economy given our current portfolios exposure. My hope is that this will help generate thoughtful and meaningful debate to arrive at a course of action for our firm, as the purpose of this report is to investigate the forecast and determine if it might be prudent to pack an umbrella. Just to be sure. ng
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p.s. I know there is a lot here, but I tried to be both brief and thorough. Pay particular attention to Key Slides with Red Star in bottom corner.
October 14, 2011
Table of Contents
Section
Executive Summary Appendix I: Appendix II: Stock Market Employment
Page
6 40 55 68 78 86 95 115 124
Appendix III: Confidence Appendix IV: Personal Consumption Appendix V: Gross Domestic Product
Appendix VI: Housing Appendix VII: Europe Appendix VIII: Miscellaneous
October 14, 2011
Executive Summary
Overview
Executive Summary
Overview
The Global Financial Crisis (GFC) is not over and Things have not looked this bad for the global economy since 2008 Analysis of current economic data indicates that the occurrence of another global downturn is not only possible, but probable The U.S. is currently close to falling into another recession, if its not already there. Expect negative GDP growth through 2012 The new Normal is an era of increased volatility and uncertainty From both an isolated, and, more importantly, a TotalPortfolio perspective, the establishment of a directionally short market position offers a compelling riskreward Outline In the Executive Summary, we will begin with Overview of our current situation and how we got here, followed by a discussion surrounding the Economic Outlook. Next, we will consider a simple framework for analyzing where we are in our current economic cycle while discussing what we are seeing the data related to the factors of Jobs, Confidence, Consumption, and Growth. We will then take an inventory of where we are currently, and discuss the Recovery to this point. Next, we will discuss how the Federal Reserves policies over the last 30 years lead to the financial collapse in 2008, what the Fed has done since then to fix the economy, and what they are signaling for the near term along with the effect on the broader market will likely be. Next, we will investigate the concept of Secular Markets and see how the returns one ultimately gets from an investment is largely determined by when he invest, not by simply being invested. Finally, we will consider an investment idea that could present a compelling risk-adjusted return on its own, and concurrently lower the volatility of our overall portfolios returns. The second part of this report is an Appendix, which explores each of the related topics in further detail: The Market Employment Confidence Consumption Gross Domestic Product Housing Europe Miscellaneous
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Overview The global economy is currently experiencing a slight depression, which is basically a prolonged recession that lasts several years. At its core, these problems are the result of loose credit and expansive monetary policies by the worlds Central Banks. The global financial system is a house of cards built on a foundation of debt, leverage, and risk. 2008 will pale in comparison to the global credit crunch we are headed for because none of the fundamental problems that caused the GFC have been fixed. Anywhere. In the recent Fed minutes release, the august phrase "downside risks to the economic outlook have increased" was changed to "there are significant downside risks to the economic outlook, including strains in global financial markets. We are currently seeing the acceleration in the deterioration of global financial conditions. Many statistics support the fact that the U.S. is worse off today than it was prior to the previous recession, which officially ended 21 short months ago. 9.5 million fewer workers than the 2007 peak Real GDP lower than Q4 2007 Real retail sales $13 billion below 2007 peak Real personal income $515 billion below 2008 peak S&P 20% lower than peak (officially a bear market) 40% drop in bond yields since peak in 2007
It takes a long time to unwind the previous borrowing excesses. Over-borrowing leads to bankruptcy and financial ruin. And we are approaching a day of reckoning. We have been living in the largest debt bubble in the history of the world, and that bubble is ending. This is natural. We will soon see that the debt-fueled prosperity we have enjoyed over the last few decades was nothing but an illusion.
Executive Summary
Overview (cont.)
The Global Financial Crisis (GFC) is not over and Things have not looked this bad for the global economy since 2008 Analysis of current economic data indicates that the occurrence of another global downturn is not only possible, but probable The U.S. is currently close to falling into another recession, if its not already there. Expect negative GDP growth through 2012 The new Normal is an era of increased volatility and uncertainty From both an isolated, and, more importantly, a TotalPortfolio perspective, the establishment of a directionally short market position offers a compelling riskreward The financial avalanche we are about to witness will destroy the wealth of millions of people, making it glaringly apparent why excessive debt is unsustainable and a bad thing. The problem is not debt, per se, but rather the excessive level of debt and the associated increase in systematic risk, which itself is exacerbated by both the increased integration of and the increased correlations between the worlds financial markets and economies. The modern financial system is dependent on perpetual growth. As all (fiat) money is loaned into existence, it carries with it an obligation to repay both principal and interest. As the economy is able to grow at a 2% rate, debt servicing is not a problem. But when growth slows, or worse, goes negative, the problems begin to arise. One need only consider the following graph, which shows the total debt (public and private) as a percent of each countrys GDP, to see that the excess debt problem is a huge problem in every major economy around the globe:
Total (Private & Government) Debt as Percent of GDP 470% 500% 450% 450% 450% 410%
Aggregate (private & gov't) debt to GDP
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Debt can only be rolled or repaid through growth and growth is over, because the growth we have witnessed has been driven by the expansion of debt, which is not expanding any longer. Put simply, countries or economies built on debt cannot be strong, unless growth in true value creation and productivity per capita outpaces the cost of the debt. The last bull market, which lasted from 1982 to 2000, was driven by the secular decline in interest rates and the expansion of credit, which allowed for the expansion of investment, which led to increased risk-taking, which led to more easy money, which not only helped change the structure of our economy to one that is now consumption-based, but also allowed for the investment in new technologies, which led to the Internet Boom, which led to the Internet Bubble, which topped in 2000, then popped. The Feds response to fixing the economy and restoring growth was to ease credit further by lowering the Fed Funds rate more, which lead to more risk-seeking behavior, which led to more growth, more consumption, and more credit expansion, which ultimately led to the Housing Bubble, which topped in 2007, then popped. True to form, the Fed responded by lowered the Fed Funds rate further in an attempt to generate growth, however, it also expanded its manipulation of the financial markets beyond simply buying short-term Treasury bills by making large scale asset purchases. In essence, the Fed, which historically was the Lender of Last Resort, also became the Buyer of Last Resort, and effectively bailed out the entire banking system by increasing the size of its balance sheet by about $2 Trillion. However, wide-scale asset purchases and fiscal stimulus have failed to generate the growth expected.
400% 350% 300% 250% 200% 150% 100%
350%
50%
0% U.S EuroZone UK Japan Canada
Executive Summary
Overview (cont.)
The Global Financial Crisis (GFC) is not over and Things have not looked this bad for the global economy since 2008 Analysis of current economic data indicates that the occurrence of another global downturn is not only possible, but probable The U.S. is currently close to falling into another recession, if its not already there. Expect negative GDP growth through 2012 The new Normal is an era of increased volatility and uncertainty From both an isolated, and, more importantly, a TotalPortfolio perspective, the establishment of a directionally short market position offers a compelling riskreward This should come as no surprise. There is too much waste and too much debt still clogging the system, which is leading to the law of diminishing returns for the Feds policies. There is no way to unwind this debt spiral easily, at least not without creating severe financial instability in the short-run. However, putting off the pain that needs to be felt in order for the waste still in the system to be flushed out, will only make the problem worse in the future. Our political leaders and policy makers have made it apparent that they are not willing to take the tough steps necessary to truly fix our problems. This is evident by the kick the can down the road solutions that have been applied so far. To be sure, you cannot solve a debt problem with more debt. We cannot afford to ignore the macroeconomic landscape and invest based on hope. When we look at a company to buy, we focus on the fundamentals of the organization, consider the growth opportunities, and develop a road map for the future. I believe it is prudent and possible to apply a similar framework for the analysis of the overall economy, which is particularly important because each and every investment in our portfolio has a positive correlation to the overall health of the market. The financial crisis in 2008 threw the world into the worst recession since the Great Depression. The next financial crisis will hit the world even harder and throw us into the Greater Depression. And we are tipping into another recession right now. The same problems that brought down the banks in 2008 are the same issues that are present right now with almost no difference, save for some government backing. Nothing has changed, at least not for the better.
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The macro fundamentals are actually worse. Housing is still in a decline, unemployment is still extremely high, and we have more concentration of risk. For example, ca. 95% of notional derivative exposure, which is at all-time highs, is currently concentrated in 5 banks. It is important to realize that all the losses are actually incurred during the heady euphoria of the Boom, that the Bust is nothing more than the overdue recognition of those mistakes, and that to procrastinate thereafter in their acknowledgement is not to avoid the pain, but to exacerbate it in much the same way as a sufferer from a cancer can do himself nothing but harm by trying to delay the awfulness of the therapy which sadly must await. We are about to experience the most terrifying opportunity of our lifetimes. Will we be a part of the minority who are positioned to profit from this Collapse, or part of the majority that is taken by surprised?
Executive Summary
Economic Outlook
The U.S. economy will likely register negative growth during Q4 2011 and through 2012. While monetary and fiscal policies helped create the backdrop for the slowdown in growth, it has been aggravated by: Falling productivity Inventory reversal Falling real-wages The case of an impending recession rests not only on cyclical precursors evident in productivity, real wages, and inventory investment, but also in dysfunctional fiscal and monetary policies. Source: http://goo.gl/LTrxK Productivity Real GDP grew at approximately 2.5% in the last half of 2010. The consensus forecast was for growth to continue to accelerate at a rate of 3-4%, due to assumed economic impact of quantitative easing and other fiscal stimulus. However, growth slowed to less than 1% for the first half of this year. Such an abrupt slowdown in growth, especially when it comes as a surprise, leaves businesses with more workers than are necessary. As most are slow to resort to layoffs, they instead see their unit labor cost increase as output per man hour (productivity) falls. In the first half of 2011, we saw productivity decrease at a 0.7% annual rate with a corresponding increase in unit labor cost of 4.8%. A drop in productivity coupled accompanied by an increase in unit labor cost has historically been the preamble to a surge in layoffs as companies try to fight margin compression.
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Inventory Reversal (cont.) In July and August production of consumer goods increased at 3.2% over Q2 2011, while retail sales contracted at a 1.4% rate, pushing inventory investment to an even higher level of GDP. This has set the stage for a slow-down in production, which will only exacerbate the need to increase layoffs. Real Wages Real hourly earnings has fallen by 2.2% over the 12 months ended August 2011, and real disposable income is lower now than in December 2010. First, consumers simply cut savings (back to recession low of 4.5%) to compensate for the lack of income growth, but now a slowdown in spending is occurring.
Inventory Reversal Inventory investment accounted for 35% of the rise in real GDP between Q2 2009 and 2Q 2011, and now accounts for 1.18% of real GDP (the 20 year average of 1%).
First, consumers simply cut savings (back to recession low of 4.5%) to compensate for the lack of income growth, but now a slowdown in spending is occurring. Real spending expanded only 0.7% in Q2 and remains sluggish. The case of an impending recession rests not only on cyclical precursors evident in productivity, real wages, and inventory investment, but also in dysfunctional fiscal and monetary policies.
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Executive Summary
The Jobs > Confidence > Consumption > Growth Economic Model
The Jobs > Confidence > Consumption > Growth Model can serve as a simple framework to see where we are in an economic cycle by focusing on the key drivers of economic growth in an economy. When jobs are plentiful, people become more confident about the future and their personal financial security, which prompts increased consumption, which leads to increased growth, and vice versa.
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Jobs
9.1% unemployment rate, 11% if adjusted for decrease in workforce U-6 Unemployment back above 16% Record unemployment duration 40.5 weeks Labor force participation rate at 30-year low S&P indicating unemployment about to spike Disproportionate increase in long-term unemployment with 4% > 27 weeks
Confidence
University of Michigan Consumer confidence lowest it has been in 30 years Fed Business Survey suggests further weakness Pule of Commerce Index turning down, @ Sept-04 levels 73% of Americans think the country is headed in the wrong direction
In order for this potentially self-sustaining cycle to perpetuate, one of these factors needs to generate inertia to lead to the next step. In order for the Recovery to take hold and gain momentum, one of these key factors must reverse course.
Consider our current situation: High structural unemployment Record low confidence Extremely low consumption Slowing growth
Consumption
Real private wages have grown only 4.2% over the last 10 years Labor share of national income has fallen to its lowest level in modern history (57.5%) Over 42 million Americans now receive food stamps 48.5% of Americans live in a household that receives some kind of government aid; 5m on welfare; 50m on Medicaid, 8m receiving unemployment compensation, 10.5m on SS disability Growth during the later half of 2010 was driven by consumers lowering their savings rate
Growth
Growth is rolling over across the globe ECRI Weekly Leading Index pointing toward another recession Goldman and adjusted yield curve indicating between 40-65% chance of another recession Estimates of growth, at both the country and individual company level, have been continually revised throughout the current year We have seen this trend in all major economies during 2011 (U.S. Europe, China, Japan)
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Executive Summary
The Tectonic Shift 2009-2013

Gordon T. Long presents a compelling roadmap for the Global Financial Crisis, which has been spot-on to date. Housing is set to leg down once again, which will lead to Commercial Real Estate double dip, which will usher in a new era a consumer frugality. This will spur on retail closing and an entitlement funding crisis that could lead to a fiat currency crisis, ultimately ending with a US Reserve currency crisis.
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New New Deal
ZIRP QE Fiscal Stimulus
U.S. Reserve Currency Crisis Bretton Woods II
Economic Crisis
2009 2013 2010
Job Eliminations & Layoffs
QE2
Credit & Debit Card Restrictions
Food & Energy Price Pressures
The GFC began with a Financial Crisis; currently, we are seeing the beginning of the Sovereign Debt Crisis; this will lead to Currency Crisis/Fiat Failure
Again, it is natural and inevitable that a system built on fiat currency and the expansion of credit to drive growth would go through a purging process as described here. Source: Gordon T. Long Research & Analytics October 2011 Global Macro Tipping Points 9/30/2011 www.gordontlong.com
Currency Crisis International Swap Crisis
2012
2011
Sate & Local -Budget CrisisFederal Insurance & Finance Distress
2012
2011-2012
Retail Store Closings
Entitlement Funding Crisis
Residential Real Estate Double Dip Rising Interest Rates
We are here
Consumer Frugality
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Executive Summary
You Call This a Recovery?!

While the MSM goes great lengths to sell us all on this so-called Recovery, anyone actually believing it needs to get their head checked.
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Growth in Real GDP Components: Current & 3 Previous Recoveries

As you can see from the charts, Residential Investment has been a major driving force in previous economic recoveries. While it is a small component of GDP, it had been an important monetary policy transmission mechanism in the past because it can expand quickly as interest rates fall. With low U.S. mortgage rates currently, residential investment has failed to gain traction and help drive us out of this recession. This is due partially to the huge overhang of vacant housing units. Also personal consumption has not accelerated as quickly as it has in the past, and with PCE at approx. 70% of GDP, the lack of participation is creating a drag.
Job Growth: Current & 3 Previous Recoveries

Far fewer jobs have been created in this recovery than in the last three, and again, this is influenced by housing. Take a look at the decline in construction jobs: down 9% vs. increase of 4% in the last three recoveries. This is because there is existing capacity in most industries and excess housing units still in the marketplace, coupled with household and corporate deleveraging.
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Executive Summary
ECRI Weekly Leading Index & Gross Domestic Product

The Weekly Leading Index (WLI) growth indicator of the Economic Cycle Research Institute (ECRI) has now dropped further into negative territory after oscillating in a narrow range (1.5 to 2.1) from late June through the first week of August.
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The sequence that follows the pattern seen to the right is: P/E Ratio compression GDP reductions in outlook Reduced earnings estimates Markets regress to their mean
Without fiscal and monetary support the economy is prone to further weakness given the underlying weakness in fundamentals: Weak housing market Sustained high unemployment levels Rising commodity prices Stagnating wages Low overall levels of GDP growth
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Executive Summary
US Inventory Cycle Set to Force Headline ISM Much Lower

From Albert Edwards of Societe Generale: One of the US indicators that has held up quite well and maintained some sense of hope that recession can still be avoided is the ISM which has stayed above the critical 50 level. But further pronounced weakness seems baked in the cake and will disabuse the optimists. The excess of inventories over new orders suggests a very sharp slowdown (see left-hand chart below), and the inventory de-stocking cycle is set to remove one source of component strength from the overall ISM indicator
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Executive Summary
Percent of Previous Peaks

Graph shows the percentage of the previous peak for Real GDP, Real GDP per Capita, and Employment. We can see that not only was the drop from the previous peak more severe than that which we have experienced over the last 50 years, but also that we have a long way to go before we are back at pre-recession levels, particularly for employment and per capita GDP.
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Executive Summary
Household Income Index and Unemployment Rate

Income here is indexed to 2000, which means that household income is 10% lower than it was a decade ago. An economy built on Consumer Spending cannot rebound until either consumer spending rebounds or is replaced by something else (e.g., exports).
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Executive Summary
The Breaking Point

Notice how the Debt-toGDP ratio has increased since the Breaking Point around 1980. Since this broke we have had a tremendous bull market of over 20 years, but corresponding general decline in average GDP growth rates (A) The excess debt that has been accumulated over the last 30 years as interest rates were in a steady decline, lending standards were reduced and massive pools of available credit were supplied has now begun the inevitable unwinding process.
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Executive Summary
Rise of Debt Drained The Economy

The drop in the 10-year yield was accompanied by a parabolic increase in the total credit market debt owed. The result has been a secular decline in the GDP year-over-year percent change. Our problem isn't low interest rates; it is excess debt, which literally drains the demand for more credit. The NFIB Small Business Survey stated Poor sales" are the number one concern (not lack of credit) and the lack of demand on their businesses do not warrant adding on more leverage. The number of businesses currently thinking this is a "good time to expand" is at some of the lowest levels on record. Likewise, consumers are trying to pay down debt, as worries about job security, rising food and energy costs and stagnant wages reduce their desire to consume and make debt reduction a priority.
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Executive Summary
GDP vs 10 Year Treasury

During the previous "Operation Twist" the economy was experiencing an increasing trend of growth. Interest rates were also steadily rising as stronger economic growth allowed for higher rates of interest to be charged. Debt, as a function of GDP, remained well constrained at low, structurally manageable levels. However, beginning in 1980, the economy shifted and interest rates began a very steady decent. This decline of interest rates led to a massive expansion of debt, which ultimately sowed the seeds for a slowing rate of growth in the economy.
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Executive Summary
Rising Money Supply & Credit = Declining Wages & GDP

What we are seeing play out before our eyes is exactly what is predicted by the Austrian School of Economics (more here and here), which holds the view that economic cycles are the consequence of excessive bank credit, exacerbated by inherently damaging central bank policies, which tend to keep interest rates too low for too long, result in excessive credit creation, speculative economic bubbles and lowered savings. Or simply, a period of sustained low interest rates and excessive credit creation results in a volatile and unstable imbalance between savings and investment.
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From StreeTalkLive.com: We are not entirely sure what created this breaking point specifically whether it was deficit spending by the Reagan Administration to break the back of inflation, deregulation, exportation of manufacturing and a shift to a serviced based economy, or a myriad of other possibilities or even a combination of all of them. Whatever the specific reason; the policies that have been followed since the breaking point have continued to work at odds with the American Dream to the benefit of Wall Street. Beginning in 1980 our world changed as we discovered the world of financial engineering, easy money and the wealth creation ability of successful use of leverage. However, what we didn't realize then, and are slowly coming to grips with today, is that financial engineering had a very negative side effect - it deteriorated our economic prosperity. As the use of leverage crept through the system it slowly chipped away at the savings and productive investment. Without savings - consumers can't consume, producers can't produce and the economy grinds to a halt as the cycle of economic growth is thrown into a "balance sheet recession" strangle hold that is slowly pushing the economy towards unconsciousness. Regardless of the specific cause, each interest rate reduction that was used from that point forward to stimulate economic growth did, in fact, lead to a recovery in the economy; just not at levels as strong as they were in the previous cycle. Therefore, each cycle led to lower interest rates and economic growth slowed and as a result of consumers and producers turning to credit and savings to finance the shortfall which in turn led to lower productive investment. It was like an undetectable cancer slowing building in system. The Breaking Point was the beginning of the end of the Keynesian economic model.
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Executive Summary
Amount of Debt Required to Finance $1.00 of GDP

This graph is astounding. It really puts the last 30 years of growth we have experienced in its proper perspective. At the height of the housing bubble, it took over $3 of debt to finance $1 of GDP. Notice the change in slope of this line at (A) leading up to Tech Bubble and then (B) to the housing bubble. It is taking increasingly more debt to generate our GDP. How sustainable is this?
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Executive Summary
What Has (Really)Driven Our Growth?

This chart really sums up the fact that all of our recent growth has been totally driven by debt/credit expansion, which is problem because of the diminishing returns of more debt. This would not be an issue if the economy was able to grow faster than the corresponding debt needed to fuel that growth. Unfortunately, this is not the case. And what have we ended up with? Well, banks across the globe full of toxic debt and pseudoassets and countries and consumers leveraged to the hilt.
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Executive Summary
Debt Fueled Growth Leads to Deleveraging

This shows that Total Credit Market Debt as a % of GDP more than doubled over the last 30 years. While some deleveraging has occurred recently, dropping the ratio from its high of 375% to about 350% in March 2011, we are still almost 3x the low in the early 1950s and more than 2x the level in the early 1980s. This suggest more deleveraging is ahead, which would follow if, in fact, credit has fueled the growth. Deleveraging = asset price deflation.
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Executive Summary
The S&P 500 & Federal Reserve Intervention

This graph makes it clear that the last cyclical bull market, starting from the low in March 2009 was driven totally by Fed intervention and quantitative easing. Over this time, the Fed has driven the Fed Funds rate from a pre-market level of approximately 5% to current near-zero levels, which they have indicated will continue for the near term. Notice how at (A) and (B) the market fell off a cliff following the conclusion of respective Fed intervention. In short, the only thing holding up the market has been the Fed. See slide 148 in the Appendix of this report for a more detailed look at Federal Reserve Intervention.
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B A
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Executive Summary
The $200 Trillion Gorilla

The major driver of Fed Treasury purchases of over $1.2 trillion since the Great Collapse began in 2008 was not to satisfy its dual mandate, per se, but rather to keep the interest rate based derivative market in check. Of the $244 trillion in derivative exposure sitting on the balance sheets of U.S. commercial banks, $200 trillion of it is interest rate based. Levels of financial leverage are higher today than during the Tech Bubble. While the stated purpose of the Feds interventionist policies over the last couple of years has been to satisfy its dual mandate of employment and economic stability, it seems like Bernanke is interested in interest rates for other reasons. After looking at a chart of 30-year Treasury yields, it is clear that QE has not lowered interest rates. Further, the only time interest rates did fall was when the Fed was not engaging in quantitative easing. The Fed is engaging in QE to: Absorb the debt fueled by the U.S.s enormous deficit Manage the interest rate based derivative market Since the Great Crisis began, we have seen The Powers That Be (TPTB) spend massive amounts of money in an attempt to stop gap the downturn in private sector spending. 82% of the $244 trillion of U.S. commercial banks derivative exposure is interest rate based. The graph at right shows the banks with the largest exposure. These are also the banks that the Fed has been funneling money into. This $200 trillion gorilla in the room. Compare this to the CDS market, a major contributor to the initial downturn in 2008, which was only $50-60 trillion at that time. Again, the real risk here is with counter party risk and if anyone one has unhedged/naked exposure (like AIG did), which can lead to cross-defaults.
Credit-based Derivative Exposure of Largest U.S. Banks 30-Year Treasury Yield
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Keep in mind that the large majority of interest rate swaps are nominal payments on the 30-year fixed rate mortgages, and the majority of bank profits come from the spread on these derivative transactions. If the 10 year jumps 5%, putting anyone with a fixed rate in the money, none of these banks would be solvent.
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Executive Summary
Daily Treasury Yields

The Fed has pushed the Fed Funds rate from a pre-recession level of 5% to near zero, with no plans on allowing them to increase at least through 2013. Notice how rates fell again after QE2 ended during the summer. The adjusted yield curve (which removes the distortions caused by extreme volatility and Fed manipulation) is currently 20 bps away from inversion between the 2year and the 5-year rates. An inverted yield curve preceded every recession since 1970. Current estimates based on this methodology (out of BofA) puts the occurrence of another recession in the U.S. at approximately 60%.
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Executive Summary
Were Turning Japanese (I really think so)

The issue now is that we have entered into the "Japan Syndrome". Almost 30 years ago Japan experienced its own real estate/credit bubble bust. Japan has attempted virtually everything the Fed has tried from lowering interest rates, liquidity injections and currency deflation in order to restart their ailing economy. It has all failed. As a result of these monetary experiments, Japan has remained in a protracted economic slump. Notice how Japan, a net export country with one of the highest domestic savings rates globally, faced deflation following the implementation of its ZIRP (zero interest rate policy).
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Executive Summary
Inflation?
While the Fed stopped publishing M3 data in March of 2006, ShadowStats.com continues to publish an estimate. Note that only when Money Supply Growth falls below zero (A), does this indicate a contraction over the previous 12 months. While the impact of the Feds QE efforts (in their various forms) began to finally work as M3 finally began to have positive growth after point (A), QE2 has ended and M3 appears to be rolling over again (B). Source: http://goo.gl/y9XA0
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B A
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Executive Summary
Inflation? (2)
So we have money supply flattening out (previous slide), and here we have the velocity of money turning down again. This is deflationary. The risk of hyperinflation, at least in the short/medium term, is low in my opinion because we have money supply flattening out and velocity of money turning down. Source: http://goo.gl/y9XA0
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Executive Summary
10-Year Treasury Yield & Inflation

Since the Fed Funds Rate peaked in January of 1981 at 20.06% (!!!), it has fallen to a current level of approximately zero. Over this same period, the 10-year Treasury has fallen from 15.7% to approximately 2% currently. This indicates a secular loosening of credit over the last few decades.
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Executive Summary
S&P 500, 10-Year Treasury Yield, & FFR

The precipitous drop in both the Fed Funds Rate and, more importantly, the 10-year, has virtually driven all of the growth in the U.S. economy since the early 80s. This is simply showing that the economic growth we have experienced has been credit-driven. With the FFR near zero and the Fed is out of bullets, in the traditional sense. This is not to say further easing will not occur, however, it is likely to take a new form.
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Executive Summary
Inflation-Adjusted Regression to Trend

Graph shows inflationadjusted (i.e., real) S&P historical returns (excluding inflation and dividends), along with a regression line and callouts at extreme points above and below that line. Blue and Red portions of the line denote secular bull and secular bear markets, respectively. Purple is unknown. While we cannot tell the future, and whether or not 2009 (A) was the start of another secular bull market or simply a bounce within a secular bear started in 2000. Excluding 1877, you will note that the start of any true secular bull market came only after a print at least 50% below the regression line. This implies that we have much further to fall before the next secular bull, as our recent print below the regression line was a mere 9%.
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Executive Summary
Negative Annualized Returns Over The Next Decade Very Likely

The stock market returns over the last century can be divided between periods of above- and below-average returns, denoted in the graph by green or red bars, respectively. Valuation level at the time of investment (i.e., price-to-earnings ratio) relative to changes in that valuation level over the holding period generally drive the return ultimately realized by an investor. For example, investing at a time of above-average P/E ratios will generally only yield positive results if the P/E ratio at exit is even further aboveaverage.
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Executive Summary
Negative Annualized Returns Over The Next Decade Very Likely

The first table shows a mix of 20 year annualized returns from different points in time using the Nominal Returns (not inflation adjusted), including dividends (reinvested), transaction costs, and taxes paid. Notice how much the starting P/E ratio matters in influencing the returns over the following 20 years. (http://goo.gl/gwYUv)
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The bulk of investment gains tend to generally come from expansion in the P/E ratio over time, and not from improvements in earnings, per se.
Thus, it is important to understand where we are in a PE cycle, as when you invest has more of a bearing on the returns you can expect than simply being invested. Next, we see the compression and expansion of PE ratios since 1965. Again, the values in the squares represent the annualized rates of return since 1965.
An investment made in 1996 would have yielded an annualized return of only 3% over the last 14 years
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Executive Summary
Negative Annualized Returns Over The Next Decade Very Likely (2)
Reasons current earnings growth is unsustainable: Much of recent earnings growth has been driven by unsustainable federal stimulus Much of recent financial earnings are a mirage, driven by assets not being marked-to-market, insufficient loan loss reserves, and their prior ability to borrow short (essentially for free) and lend long, which is currently changing through Operation Twist Both Financial and nonfinancial sectors have margins outside of historical norms, driven by low headcounts and increased outsourcing
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Source: http://goo.gl/OEW6E
Essential Ideas In spite of what efficient market theorists say, for a period of at least 20 years, it very much matters whether the starting valuation (PE) is high or low when one starts to invest. However, in any given year (or even for several years), stock market returns may do random things. In other words, just because a market is richly valued does not mean it cannot get more so. Likewise, just because a market is cheaply valued, does not mean it cannot get cheaper. As a result of the preceding point, many think that returns are random. While that may be true in a given year, over a sufficient period of time, expected future returns are anything but random. The bulk of stock market gains frequently come from PE expansion, not from improved earnings. It is important to know where in the cycle one is (whether PEs are in a state of expansion or contraction).
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Executive Summary
Secular Markets: S&P Historical Inflation Adjusted Composite

If we were at (A) right now, would you rather be a buyer or a seller? Do we have enough empirical data to reasonably believe we are more likely at a point such as (X) or (Y) right now?
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A Y
37
Executive Summary
Fear, Hope, & Greed: Where Are We Now?

The business cycle oscillates between fear and greed. Where one decides to go long has all the influence over the returns ultimately realized. Given the growing anxiety about the global economy, the constant bottom calling (i.e, denial) since the Collapse began, and fear about the future, coupled with the fact that we have yet to see capitulation, panic, despondency, et. al., where do you think we are in the cycle?
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I am pretty smart. This is fun!
Temporary set-back. Im a long-term investor anyway.
or are we here?
How could I have been so wrong?
Are we here
38
Executive Summary
Recommendation
Given the current economic environment, the establishment of a short market position would be a relatively lowrisk mechanism that could be employed efficiently while both providing outsided returns relative to the capital deployed, as well lowering the standard deviation of the total returns of the MOI portfolio as a whole. The graph at the right depicts the payout on the purchase of $1 million of SPY $108 March 2012 puts (in-the-money if SPY falls below $108 by March 2012). The red line is the payout at expiration. If we were to revisit the lows set in March of 2009, this position would return over $7 million in profit. Stops would be placed at resistance points above current market levels and the position would be monitored for confirmation of the trades antithesis.
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Overview Recommendation
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October 14, 2011
Appendix I
The Market
The Market
Current Market Snapshot: S&P 500
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The Market
S&P Regression to Trend

Things tend to revert to their mean over time. This chart shows the inflation-adjusted S&P from 1870 to present, along with its regression line. Below, the variance between the market price at a particular point in time and the regression line is plotted. You can see that the market is still about 30% above trend. Note also that each true bottom did not occur until a variance of 50% or more below the trend line. Note also the duration of the last few cycles: approximately 18-19 years.
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The Market
Q Ratio Since 1900

The Q Ratio is the ratio of market value to replacement value for a particular asset. It gives an indication as to how over- or under-valued a particular asset is. So, for an individual company, a Q ratio greater than one implies that its market value is greater than its corporate net worth. We can see here that the current Q ratio is still well above its arithmetic mean (0.71), implying that in spite of the declines since the bursting of the tech bubble (in real terms), we are still significantly overvalued.
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The Market
Q Ratio Percent Change from Geometric Mean

Here, the Q ratio is plotted as a percent deviation from its geometric mean. Again, it is showing that the market is still significantly overvalued.
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The Market
Inflation-Adjusted S&P and Q Ratio

Here we can see the correlation between the S&P and the Q Ratio.
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The Market
S&P Composite and the Crestmont P/E Ratio

The Crestmont P/E Ratio is currently in the top quintile. This indicates relatively high level. Definitely not a bottom.
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The Market
Q Ratio, Crestmont P/E, Cyclical P/E10, and S&P Variance from Regression
All 4 of these indicators are showing the market as significantly overvalued and due for a secular correction. Notice, each other bottom has printed approximately -50% below the zero line. Another way to look at this is the extent to which we are still in a bubble. In short, We have a long way to go.
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The Market
Market Cap as a % of GDP

The market is still at over 120% of nominal GDP, implying that we are still in a bubble.
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The Market
Changes in Profit Margins Lead Changes in Stock Price

We have discussed already the margin contraction corporations are experiencing during 2011. As further slowdowns in demand will only exacerbate this problem further, causing margins to fall even more, expect future stock prices to fall.
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The Market
Technical Evidence for a Bear Market Decline

There currently exists substantial evidence that a further bear market decline is ahead. A.Over the last two months, the market has experienced severe volatility, which is not typical of a bear market. Also, its inability to overcome its 50 day moving average is bearish. B.Breaks below the 200 week moving average are extremely bearish. Notice how it has provided support and resistance. C. Notice what occurred after the last real break of the 200 week moving average. D.This chart suggests a low of 600 will be retested after a test of the March 2009 lows. This represents a decline of almost 50% from current levels. Source: http://goo.gl/SIi2b
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The Market
High-Yield Credit Signaling Another Market Downturn

Remember: anticipates, confirms Credit equity
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Notice how the 50 day moving average crossed under the 200 day moving average [1] prior to the last major market correction. You can see at [2], the 50 has recently crossed under the 200 once again. This indicates that the market is heading for a period of contraction.
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The Market
High-Yield Credit Signaling Another Market Downturn (2)

Notice how High Yield broke support and 30year bonds broke resistance prior to the last crash [1]. This signals Risk Off as funds flow from the riskier high yield to the safer 30-year fund. We can see at [2] that this is occurring again as the Market is shifting into Risk Off mode once again.
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The Market
Street Talk Advisors Intermediate Buy/Sell Indicator

STA developed a proprietary model that provides intermediate term signals for increasing/reducing equity exposure.
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The Market
2-10 Spread and the S&P 500

The expansion of the 2-10 yield spread has helped prop up the market since the Collapse began in 2008. As the yield curve flattens, this support will begin to fade.
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October 14, 2011
Appendix II
Employment (or lack thereof)
Employment
Weakest Employment Index Since March 2010; Respondents Uniformly Bearish

While the overall NMI came at 53, a drop from 53.3, but better than expected 52.8, it is the Employment index that is attracting everyone's attention, printing at 48.7, down from 51.6: the lowest from March 2010, which has offset an improvement in both New Orders and Business Activity. And the kicker, all the responses in the survey were negative across the board Source: http://goo.gl/O4AeR
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Respondents were uniformly bearish:

"It appears everyone is waiting to see what happens next. No trust in the economy or the federal government to do what is needed. "Weak consumer confidence and high gas prices are placing downward pressure on retail sales volume." (Information) "Business volume outlook and confidence across many market areas in North America appear to be softening." (Mining) "The 2012 outlook is not optimistic; though we keep hoping for a rebound, we see little sign of an improved economy nothing at least that will spur growth, investment or expansion. Improved investment performance in early 2011 caused us to begin several large capital projects, and although we have broken ground, we cannot help but question if our timing was right." (Educational Services) "Third and fourth quarters appear to be slowing down in order volumes. Uncertainty over U.S. and European economy is causing clients to hold off on new orders." (Professional, Scientific & Technical Services) "Negative forecast for housing market's future leads us to think we will be at current levels of business at best for the foreseeable future." (Wholesale Trade)
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Employment
Percent Job Losses in Post WWII Recessions

The current contraction has generated the most severe job losses in any recession since WW2. The fact that the unemployment situation is structural, rather than cyclical or transitional, is evident by the fact that over 40 months since the employment peak, we are still 5% below.
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Employment
Initial Jobless Claims Over 400,000 (Still)

For the week ended October 1, 2011, initial jobless claims came in at 401,000, the 26th consecutive week over 395,000. Red lines indicate averages over highlighted periods.
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Employment
Average Duration of Unemployment at All-Time High

Average unemployment duration is at the highest level ever seen, and shows no signs of rolling over currently. Unprecedented This has clearly been influenced by the continual extensions of unemployment benefits, which are currently up to 99 weeks (!!!).
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Employment
Declining Labor Force Participation

The falling labor force participation rate is the primary reason that unemployment is 9.1% currently instead of 11%. "It takes GDP growth of about 2.5 percent to keep the jobless rate constant. But the Fed expects growth of only about 1 percent in the last six months of the year. So that's not enough to bring down the unemployment rate. Bernanke While this may not look bad from a historical standpoint, it is important to remember that the 1970s ushered in a new era of dual-income households as more women entered the work force.
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Employment
Unemployment by Duration
This Collapse has seen a disproportionate rise in longer term unemployment with 4% of the labor force currently unemployed for more than 6 months. Also note that this is only marginally off of its highs.
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Employment
Unemployment Weekly Claims

We seem to have stalled at about 400k weekly claims. Keep in mind that claims over 300k are not good for economic growth.
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Employment
Needs To Generate 261,200 Jobs/mo. To Return To Pre-Depression Employment by 11/2016

To provide some perspective about how bad the job situation really is. The economy would need to create 261,200 jobs per month through the end of Obamas potential second term in office in order to return to pre-depression unemployment. This calculation takes into account the historical natural growth in the labor force of 90,000/month extrapolated out. How likely is it that we will be able to create 16.2 million jobs over the next 62 months?
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Employment
Hypothetical Employment Paths

Here we examine the time it will take to arrive back at Peak Employment, varying the rate at which jobs are added on a monthly basis. You can see that we will not return to peak employment for some time, even if we were able to add 158k jobs per month, which is extremely high.
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Employment
Manufacturing Jobs
This shows the decline in manufacturing jobs and speaks to the impact that outsourcing our production over the last 15 years has had on our domestic employment base. Average levels of each period are in red. The manufacturing jobs are gone because we dont make anything in the country any longer its all been outsourced.
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Employment
S&P Composite
This shows that unemployment is a lagging indicator that moves inversely with stock prices. This makes sense, as we have already discussed that a) changes in profitability lead to changes in stock price, and that b) in an attempt to regain lost profitability, companies, must fire workers in order to reduce unit labor costs, which increase with drops in productivity. Recent stock market drops imply that another surge in unemployment is right around the corner.
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Employment
Jobless Claims vs. S&P 500 (Inverted)

As employment lags the inverted S&P, this indicates that unemployment is set to spike.
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From StreetTalkLive.com: Let's take a quick look at some numbers: 8, 160, 400, 350, 12 and 5. There have only been 8 weeks out of last 160 weeks that unemployment claims have been below 400 thousand claims. In normal circumstances we are worried about recessions when claims are rising above 350 thousand. Furthermore, jobless claims tend to plunge below 350 thousand a week within 12 months after the end of a recession. Currently we are still holding above 400 thousand claims after more than two full years since the recession officially ended.
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October 14, 2011
Appendix III
Confidence
Confidence
Sentiment Leads Consumption

Remember: Sentiment leads consumption
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Confidence
Fed Business Outlook Survey Report

The recent Fed Business Outlook survey suggest further weakness.
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Source: http://www.philadelphiaf ed.org/research-anddata/regionaleconomy/businessoutlooksurvey/2011/bos0911.pdf
"Responses to the Business Outlook Survey this month suggest that regional manufacturing activity is continuing to contract, but declines are less widespread than in August. The surveys broad indicators for activity, shipments, and new orders all remained negative for the second consecutive month. Responding firms, however, indicated that employment was slightly higher this month. The broadest indicator of future activity remained positive and rebounded this month, suggesting that recent declines are not expected to continue over the next six months." And inflation is back Increasing costs were somewhat more widespread this month compared to last month. Nearly 29 percent of firms reported paying higher prices for inputs this month. Only 6 percent reported lower prices. The prices paid diffusion index increased 10 points, its first one-month increase in seven months.
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Confidence
U of M Consumer Sentiment Index with GDP (August 2011)

Shows the Michigan Consumer Sentiment Index along with GDP and recessions. Note that every other precipitous fall in the magnitude we have just seen has been followed by diminish, if not negative, GDP prints.
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Confidence
Conference Board Consumer Confidence Index & NFIB Small Business Optimism Index
Both indices are falling precipitously again.
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Confidence
Ceridian-UCLA Pulse of Commerce Index

The PCI is rolling over again.
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Confidence
Confidence Board Consumer Confidence Index

Consumer Confidence Index dropping hard. Drops this steep are typically followed by declines in GDP. Our current GDP levels are already close to falling into the red.
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Confidence
Pulse of
CommerceTM
Index: 3-Month Moving Average
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Pulse of Commerce rolling over again, back at September 2004 levels. Also showing a similar fractal to that which was seen prior to the last recession.
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Confidence
NFIB Small Business Optimism Index

Small business confidence falling back to recession levels.
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Confidence
U.S Misery Index

This is a graph of CPI Inflation plus Unemployment Rate Percentage. You can see it has just hit a new 28 year high.
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October 14, 2011
Appendix IV
Consumption
Consumption
Components of Real GDP since 2007

Clearly the Personal Consumption Expenditures (PCE) component has the highest correlation to Real GDP. We are clearly downtrend. in a
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Consumption
Real Mean Household Income Cumulative Growth

Data from the recently released Census Bureau report showing the cumulative growth in real household income since 1967, by quintile , along with the top 5%. You will see that growth was much higher for the top quintile in general, and for the top 5% in particular. Also, purchasing power of 2010 incomes has shrunk to approximately mid1990s levels. This lack of purchasing power has a huge drag on consumer confidence.
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Consumption
Declining Household Income

Household income has continued to fall since the recession ended in 2009. In a separate study by Henry S. Farber, an economics professor from Princeton found that those who lost jobs during the recession and later found work made an average of 17.5% less than they had in their old job. Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household Income fell 6.7 percent, to $49,909, according to a study by two former Census Bureau officials. During the recession from December 2007 to June 2009 household income fell 3.2 percent. Source: http://goo.gl/aX6bZ
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Consumption
Consumer Credit
Consumer credit fell in August by the most in over a year. This is the largest month-overmonth contraction since 1998. This is equivalent to a six standard deviation deceleration in credit availability (based on the last 60 years).
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Consumption
Consumer Credit (2)

Here is the breakdown between revolving and non-revolving credit. You can see the bulk of the drop was attributable to the non-revolving component, which spiked in July.
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Consumption
Consumer Credit
The Government has increased it share of total consumer credit from below 5% before the Collapse, to over 15% currently.
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Consumption
Food Stamp Participation and U-6 (Total) Unemployment

With U-6 unemployment still over 16%, we currently have a record of over 45 million Americans receiving food stamp benefits.
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October 14, 2011
Appendix V
Gross Domestic Product
Real Annualized GDP Growth

The 2nd Estimate for Q2 2011, which was revised down from the initial estimate, came in at a mere 1% annualized rate. We can see here not only the initial recovery here, but also the slowing of said recovery, with growth rolling over. While we have not seen any negative prints since the official end of the recession, we are getting dangerously close. I expect to see a negative print in Q4 2011.
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ECRI Weekly Leading Index with Gross Domestic Product

The Weekly Leading Index (WLI) growth indicator of the Economic Cycle Research Institute (ECRI) has now dropped further into negative territory after oscillating in a narrow range (1.5 to 2.1) from late June through the first week of August. The sequence that follows the pattern seen to the right is: P/E Ratio compression GDP reductions in outlook Reduced earnings estimates Markets regress to their mean Without fiscal and monetary support the economy is prone to further weakness given the underlying weakness in fundamentals: Weak housing market Sustained high unemployment levels Rising commodity prices Stagnating wages Low overall levels of GDP growth
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Investment Contributions to Percent Change in Real GDP

Notice how Residential has not only remained in negative territory since the start of the housing bubble bursting, but also that it has currently turned downward once again. Equipment and software purchases is also turning down, with NonResidential structures barely in positive territory.
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Non-Residential Investments as Percent of GDP

While we have seen a general rise in Equipment and Software purchases/investment since the end of the recession, investments in Structures have failed to come off of their recession lows.
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Real GDP (Billions of Chained 2005 Dollars), Seasonally-Adjusted Annual Rate

Real GDP is still below its pre-recession peak. Also note the consistent direction of revisionsInteresting. This is GDP in real terms rolling over.
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State Coincident Index, Number of States Showing Increased Activity

In the past month, the indexes increased in 26 states, decreased in 17, and remained unchanged in seven. From the Philly Fed: The coincident indexes combine four state-level indicators to summarize current economic conditions in a single statistic. The four state-level variables in each coincident index are nonfarm payroll employment, average hours worked in manufacturing, the unemployment rate, and wage and salary disbursements deflated by the consumer price index (U.S. city average). The trend for each states index is set to the trend of its gross domestic product (GDP), so longterm growth in the states index matches long-term growth in its GDP. Source: http://goo.gl/NW8rw
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Total Household Net Worth as Percent of GDP

Household net worth peaked at $65.9 trillion in Q2 2007, and then net worth fell to $49.5 trillion in Q1 2009 (a loss of $16 trillion). Household net worth was at $58.5 trillion in Q2 2011 (up $8.9 trillion from the trough, but before the recent stock sell-off). This includes real estate and financial assets (stocks, bonds, pension reserves, deposits, etc) net of liabilities (mostly mortgages). Note that this does NOT include public debt obligations. Source: http://goo.gl/gAqtu
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Total Household Net Worth as Percent of GDP

While asset prices have fallen significantly and are only slightly above historical levels, household mortgage debt as a % of GDP is still historically high. This suggest that more deleveraging is ahead for households. Source: http://goo.gl/gAqtu
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October 14, 2011
Appendix VI
Housing
Housing
S&P/Case-Shiller U.S. National Home Price Index

Notice how when the rate of change (solid line) went into negative territory in 2007 at (A), it signaled the wave down in prices (B). Also notice that the rate of change again has just crossed over into negative territory once again (C)., which could be signaling the next wave down in housing prices is right around the corner. Source: http://goo.gl/vzpQg
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C A
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Housing
Real House Prices

In a recent survey by the Professional Risk Managers International Association (PRMIA), 60% of bankers surveyed expect home prices to stay below peak-2007 levels until at least 2020. 73% or respondents also expect delinquencies to remain elevated for at least another 5 years. And while 30 yr. mortgage rates are at historic lows (slipping below 4% for the first time in history), another fly in the housing recovery ointment is the fact that 19% of borrowers who owned a home in 2007 no longer qualify. Further, Fitch Ratings just revealed that 1/3 of prime borrowers are currently underwater, with expectations that about half of prime borrowers ending up underwater before the dust settles. 12% of prime borrowers are already seriously delinquent. Sources: http://goo.gl/Lt5J3 http://goo.gl/eRXP5
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Housing: New Home Sales
New Home Sales & Recessions

New home sales in August came in at 295k, which was the consensus estimate, and close to the average of approximately 300k/month in the 16 months since the expiration of the tax credit in 2010. We are moving sideways at a very low level. Sales of new single-family houses in August 2011 were at a seasonally adjusted annual rate of 295,000 ... This is 2.3 percent (13.9%) below the revised July rate of 302,000, but is 6.1 percent (18.8%) above the August 2010 estimate of 278,000. Source: http://goo.gl/TMphu
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New Homes: Months Supply

New Homes months of supply increased slightly in August to 6.6 months, while well below the peak of over 12 months supply in January 2009, this is still at elevated levels (less than 6 months is normal). This is based on the 162k seasonallyadjusted new homes for sale at the end of August. On inventory, according to the Census Bureau: "A house is considered for sale when a permit to build has been issued in permit-issuing places or work has begun on the footings or foundation in nonpermit areas and a sales contract has not been signed nor a deposit accepted."
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New Home Inventory

This is the breakdown of the 162k new homes for sale mentioned on the previous slide. The combined total of completed and under construction is at the lowest level since this series started. Source: http://goo.gl/iXzYX
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New Home Sales by Month (not seasonally adjusted)

26k new homes were sold in August, slightly above the all-time low for August new home sales set in 2010 of 23k, following the expiration of the new home buyer tax credit.
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Housing: Existing Home Sales
Existing Home Sales (Seasonally-Adjusted Annual Rate)

This graph shows existing home sales, on a Seasonally Adjusted Annual Rate (SAAR) basis since 1993. Sales in August 2011 (5.03 million SAAR) were 7.7% higher than last month, and were 18.6% above the August 2010 rate (depressed in Aug 2010 following expiration of tax credit).
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Source: http://goo.gl/JMbbn
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Existing Home Sales

Total housing inventory at the end of August fell 3.0 percent to 3.58 million existing homes available for sale, which represents an 8.5-month supply at the current sales pace, down from a 9.5-month supply in July Source: http://goo.gl/LPhK0
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Existing Home Inventory

At least we are working through a bit of inventory, although we remain at elevated levels of months supply on hand.
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Housing: Shadow Inventory
Shadow Inventory Detail

The shadow inventory of residential properties as of July 2011 fell to 1.6 million units, or 5 months worth of supply, down from 1.9 million units, or a 6-months supply, as compared to July 2010.
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As of July 2011 the shadow inventory is 22 percent lower than the peak in January 2010 at 2 million units, 8.4-months supply.
The total shadow and visible inventory was 5.4 million units in July 2011, down from 6.1 million units a year ago. The shadow inventory accounts for 29 percent of the combined shadow and visible inventories. Source: CoreLogic September 2011 Shadow Inventory Report http://goo.gl/4jh8B
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Housing: Shadow Inventory
Months Supply Shadow Inventory Detail

Of the 1.6 million properties currently in the shadow inventory, 770,000 units are seriously delinquent (2.2-months supply), 430,000 are in some stage of foreclosure (1.2-months supply) and 390,000 are already in REO (1.1-months supply) Source: http://goo.gl/qI9YW
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Housing: Equity
Household Real Estate Percent Equity

Household Real Estate Percent Equity is once again turning down. As the plethora of Alt-A loans come up for reset and recast, the bulk of which are set to do so over the next 12-18 months, expect this to fall further.
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Housing: Equity
Distribution of Home Equity

10.9 million, or 22.5%, of residential properties with mortgages have negative equity as of the end of Q2 2011. An additional 2.4 million borrowers had between 5% and 0% equity. Negative and nearnegative equity accounted for 27.58% of all borrowers at the end of Q2 2011.
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Source: CoreLogic 2011 Q2 Negative Equity Report http://goo.gl/3eStV
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Housing: Equity
Percentage of Homeowners with Mortgage Negative Equity by State

Here is the breakdown by state, with the usual suspects all over 35% negative equity.
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Housing: Delinquencies
Mortgage Delinquencies & Foreclosures by Period Past Due

After rebounding slightly from the highs in Q1 2010, total delinquencies and foreclosures have flat lined for the last three quarters, still well above historical levels. Assuming the August increase in activity is captured in the forthcoming Q3 report, expect this to increase above 13% again.
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Total Delinquent & Foreclosure Percent by Month

Delinquencies are turning up from its recent bottom to over 8% in July 2011. Foreclosures have flatlined at about 4%, but are expected to turn up as well, given the marked uptick in foreclosure starts in every state during the month of August. This was driven by Bank of America and related entities, which saw a 116% increase in foreclosure starts in August vs. July. "Bank of America appears to be primarily responsible for the surge in foreclosure starts this month," says Sean O'Toole, Founder and CEO of ForeclosureRadar.com. "Since their average time to foreclose has recently increased to more than a year, it is unclear that these foreclosure starts will lead to an increase in foreclosure sales anytime soon. Source: http://goo.gl/sgqYu
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Total Balance by Delinquency Status

We have seen an increase in Severely Derogatory delinquencies over the past two years, even while the total percentage of Current mortgages have rebounded off of its 2009 lows.
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Average Days to Foreclose

This is mind blowing With the potential for over 3 years of living for free, it is easy to see why becoming severely delinquent is such an attractive option for so many homeowners. Two disturbing trends: Average default amounts are increasing for properties entering the foreclosure process; and foreclosure timelines are getting longer Source: http://goo.gl/4Bdzd
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Loans Delinquent, In-Foreclosure & Real Estate Owned

While we have see general improvements versus 2010, each category, particularly those beyond the 30-60 day bucket, remain at elevated levels relative to historical norms.
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Appendix VII
Europe
Europe
Euro-Tarp
The Euro Zone bailout is a derivation of our (failed) TARP Program, and is simply kicking the can down the road further by way of yet another Ponzi scheme. Success is contingent on levering up toxic debt (perhaps 9x) housed in a SPV and transferring it to good countries (Germany and France). This is like an obese woman getting on a strict diet of McDonalds and Mountain Dew in order to lose weight.
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Markets have been rallying off of the assumption that the EuroZone Bailout will alleviate some of the pressures across the pond. The plan, as outlined by Timmy Geithner on a recent trip to Europe, was dismissed by the G20, who could not come to terms on the structure. The current idea, as outlined by the CNBC article published on Monday, September 26, 2011, is as follows: The European Investment Bank (EIB), which is owned by member states of the EU, would take money from the European Financial Stability Facility (EFSF) and fund a special purpose vehicle (SPV) The SPV will issue bonds to market investors, and use the proceeds of the sales to purchase the distressed European sovereign debt with the hopes of alleviating the pressure on the PIIGS and the banks holding their debt. (Youll love this) The SPV could possibly then be used as collateral for borrowing from the European Central Bank (ECB) . This would allow the ECB to make loans to banks that are in need of liquidity. So the already over-leveraged/under-capitalized European banks will buy bonds issued by this SPV that is comprised of bonds from the weakest European countries. The banks will then use these bonds as collateral to get loans from the ECB. Thus, the ECB will have loans out to these over-leveraged/under-capitalized banks, with collateral provided by the bonds they purchased from the SPV, which, remember, is made up of the distressed debt from the broke European states. How could this not work? As the EFSF has already committed to providing another 100m euros to bailing out Greece, it will leave the fund with ca. 300m euros left. Even if they used the remainder to fund the SPV, it will not be nearly enough to fix the problem(s) in Europe. What to do? Timmy had the idea to simply lever the SPV 9x its capital (!!!) in order to give it ca. $1.9 trillion to work with. Any way you cut it, broke countries are taking in debt from countries that cannot pay their debts, issuing a SPV to sell to other broke banks so they can use that as collateral to borrow
money after it has been leveraged 9x. This is a kick the can down the road solution at best, and one, I would argue, that will only make the inevitable shakeout even worse, as it shifts even more of the toxic debt to Germany and France, two countries that are not currently in a position to handle it by any means. Of course everyone would love a solution to this problem unfortunately this does not solve anything. The problem, of course, being that the PIIGS are broke and need an orderly process in which they can default. How else can the excess that is still in the system be flushed out? In any case, this plan will be difficult to get passed in Germany. On September 27th, Andreas Vosskuhle, the head of the German constitutional court, stated that politicians do not have the right to sign the birthright of the German people away with our their explicit consent. He said to a German reporter, 'The sovereignty of the German state is inviolate and anchored in perpetuity by basic law. It may not be abandoned by the legislature (even with its powers to amend the constitution),' There is little leeway left for giving up core powers to the EU. If one wants to go beyond this limit which might be politically legitimate and desirable then Germany must give itself a new constitution. A referendum would be necessary. This cannot be done without the people. In short, because the expansion of EFSF and the creation of the proposed SPV are not even legal from a German standpoint, this deal is likely dead before it even gets out of the gate. If it doesnt get off the ground, the markets will feel it, and probably soon. And if it does somehow get passed, it will succeed in lowering the credit quality of the only two remaining good credits in Europe, namely Germany and France, which should do well to speed up and deepen the Eurozone collapse. The bottom line is that any solution short of allowing the insolvent/bankrupt PIIGS to collapse is not a solution at all, but simply delaying and complicating the inevitable. This will surely end very badly.
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Europe
European Debt Situation

This shows that (i) the bailouts for the PIIGS are not for the PIIGS, but for the German, French, and British banks, and (ii) while we hear a lot about Greece presently, the problems in the Other PIIGS are much bigger and built on the same shaky foundation upon which Greece was built. Think of Europe as a warehouse, and each countrys debt as a powder keg in that warehouse. If one of the powder kegs explode, they will all explode. It is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels. - Deutsche Bank CEO
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Europe
U.S. Banks Exposure to the European Debt Crisis

It is estimated the U.S. banks have direct exposure to the PIIGS of over $641 billion. Further, loan exposure to French and German banks is in excess of $1.2 trillion.
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A collapse in a major bank in Europe will likely cause similar problems for U.S. banks.
When insolvency contagion takes hold, net exposure quickly become gross exposure, showing the flaw in bilateral netting during a systemic breakdown.
In testimony before Congress recently, Timmy Geitner said in his attempt to defend Morgan Stanley that "The direct exposure of the U.S. financial system to the countries under the most pressure in Europe is very modest. Hmm According to the Congress Research Service said the U.S. banks exposure to the European debt crisis is estimated to be at least $641 billion. This seems like a pretty big number. However, the estimate doesn't include U.S. bank exposure to European bank portfolios that include assets in the weak member countries. Also, it doesn't account for euro-zone assets held by money market, pension, and insurance funds. "Depending on the exposure of non-bank financial institutions and exposure through secondary channels, U.S. exposure to Greece and other euro-zone countries could be considerably higher. Given that the U.S. banks have direct exposure to the PIIGS at over $641 billion, and loan exposure to French and German banks of more than $1.2 trillion, a collapse of a major European bank would likely produce similar problems for our institutions. Estimates of exposure include direct holdings, such as loans, and other exposures such as derivative contracts, guarantees and credit commitments. The interconnectedness and fragility of the global banking system has only increased since the onset of this crisis a few years ago, and thus, so has the risk of contagion. Remember that the big problem with bilateral netting, which CNBC will say is not a problem at all, is that it is based on the assumption that in a orderly collapse all derivative contracts will be honored by the issuing bank. But, what if the counter party you hedged your exposure with goes bankrupt?
For example, if Counterparty 1 has purchased protection on Bank A from Bank Z, and has later sold protection itself on Bank A to Counterparty 2 as a hedge, it assumes that Counterparty 1 is fine because his long exposure is netted against his short exposure. However, what if Bank Z doesnt honor its contract? Is this out of the realm of possibility? We saw with AIG that insolvency contagion is a big issue and something that can take hold of the markets very quickly. The U.S. financial system is not insulated from the issues in Europe by any means.
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Sovereign Credit-Default Swaps

Credit Default Swaps show how risky an entitys debt is perceived to be. Anything over 200 is worrisome. The issue is this, per the IMF: European banks remain insufficiently funded European Stress Tests assumed insufficient loss of value on government bonds Capitalization of banks in Europe remain relatively low European Banks are lagging behind in securing funding for 2011 G20 progress on strengthening and repairing the financial sector has been too slow
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Europe
Change in 5 Year Sovereign CDS

Even healthy countries, such as France and Germany, and feeling it. Expect these to go up significantly higher if the EFSF is passes, as this facility will push the toxic assets to these healthy countries and could even threaten their AAA ratings.
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Europe
International Government Long-Term Interest Rates

We are essentially One Market now Source: http://goo.gl/xndKh
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Europe
Top 25 Global Banks: Total Assets to Home Country GDP

With the threat of sovereign default and contagion now pervasive within the Eurozone periphery, it is relevant to quantify the relative exposure of various banking centers' assets as a percentage of host countries' total GDP. The reason for this is that in Europe for many countries a sovereign default would not have as great an impact, as a riskflaring contagion impacting these countries' primary financial entities, whose assets account in some cases for multiples of host GDP. Dexia was just nationalized last week. Credit Suisse has just said that the entire Chinese banking system is between 66% & 100% overvalued (!!!).
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Europe
4 Largest Banks as Percent of GDP

Another way to see how large the banking problem is in Europe is to consider this graph, which shows each countrys four largest banks as a percent of its GDP. It is estimated that the 400 billion EFSF will need to be levered up to 3+ trillion, amidst sovereign downgrades, like Spain, which was recently downgraded from AA to AA-. As the healthy countries (France & Germany) are forced to take on the toxic debt from their neighbors, they run the risk of losing their AAA status. Source: http://goo.gl/T4P3N
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Appendix VIII
Miscellaneous
Miscellaneous
Kondratieff Cycle (1)

All economic cycles follow a similar pattern as depicted to the right. Kondratieff found that the economy expanded and contracted in 50 to 54 year cycles of catastrophe and renewal.
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The Kondratieff Cycle is a theory based on the study of price behavior, which includes wages, interest rates, raw material prices, foreign trade, bank deposits, and other data. Kondratieff, who developed this theory by studying 19th century price behavior, believed that economies follow a long rhythmic pattern that lasts about a half century, and an understanding of the long term order of economic behavior and could be used to anticipate future economic developments. The long wave model (illustrated on the following slide) begins with an upwave during which prices begin to slowly rise along with the new economic expansion.
Source: http://goo.gl/pRlFw
The Summer period tends to last 25-30 years, and by its end, inflation runs very high. Its peak sets the stage for a deep recession that jolts the economy. This recession, which begins when commodity prices break from their highs, tends to be longer and deeper than any mini-recessions that may have taken place during that Upwave. Eventually, prices stabilize and the economy recovers, beginning with a period of selective expansion that last approximately 10 years, which is referred to as the Secondary Plateau. As this expansion persists, many get the impression that things are the way they used to be, however, its anemic nature begins to take a toll as conditions within the economy never reach the same dynamic state that drove the previous expansion.
The Secondary Plateau ends with a sudden shock (e.g., financial panic, market crash) and the economy rolls over into the contractionary phase, characterized by deflation and the start of an economic depression.
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Miscellaneous

Looking at the factors within the rings presented at right, I would argue that we are beyond the Autumn and are likely in early Winter currently, as we see: Concern about economic future Increase uncertainty Credit crunch Falling real estate values Falling inflation, increasing deflation And so on.
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Miscellaneous

Interesting chart to study, as it graphs several different indicators, including: Bond yields, stock prices, U.S. debt-to-GDP, and so on.
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12 Quotes from Insiders About the Horrific Economic Crisis that is Almost Here
Many of the worlds smartest agree with the bear case Source: http://goo.gl/Cd71G
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#1 George Soros: "Financial markets are driving the world towards another Great Depression with incalculable political consequences. The authorities, particularly in Europe, have lost control of the situation. #2 PIMCO CEO Mohammed El-Erian: "These are all signs of an institutional run on French banks. If it persists, the banks would have no choice but to delever their balance sheets in a very drastic and disorderly fashion. Retail depositors would get edgy and be tempted to follow trading and institutional clients through the exit doors. Europe would thus be thrown into a fullblown banking crisis that aggravates the sovereign debt trap, renders certain another economic recession, and significantly worsens the outlook for the global economy. #3 Attila Szalay-Berzeviczy, global head of securities services at UniCredit SpA (Italy's largest bank): "The only remaining question is how many days the hopeless rearguard action of European governments and the European Central Bank can keep up Greeces spirits. #4 Stefan Homburg, the head of Germany's Institute for Public Finance: "The euro is nearing its ugly end. A collapse of monetary union now appears unavoidable. #5 EU Parliament Member Nigel Farage: "I think the worst in the financial system is yet to come, a possible cataclysm and if that happens the gold price could go (higher) to a number that we simply cannot, at this moment, even imagine. #6 Carl Weinberg, the chief economist at High Frequency Economics: "At this point, our base case is that Greece will default within weeks.
#7 Goldman Sachs strategist Alan Brazil: "Solving a debt problem with more debt has not solved the underlying problem. In the US, Treasury debt growth financed the US consumer but has not had enough of an impact on job growth. Can the US continue to depreciate the worlds base currency?
#8 International Labour Organization director general Juan Somavia recently stated that total unemployment could "increase by some 20m to a total of 40m in G20 countries" by the end of 2012.
#9 Deutsche Bank CEO Josef Ackerman: "It is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels. #10 Alastair Newton, a strategist for Nomura Securities in London: "We believe that we are just about to enter a critical period for the eurozone and that the threat of some sort of break-up between now and year-end is greater than it has been at any time since the start of the crisis #11 Ann Barnhardt, head of Barnhardt Capital Management, Inc.: "It's over. There is no coming back from this. The only thing that can happen is a total and complete collapse of EVERYTHING we now know, and humanity starts from scratch. And if you think that this collapse is going to play out without one hell of a big hot war, you are sadly, sadly mistaken. #12 Lakshman Achuthan of ECRI: "When I call a recession...that means that process is starting to feed on itself, which means that you can yell and scream and you can write a big check, but it's not going to stop."
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Is It Time For The Financial World To Panic? 25 Reasons Why The Answer May Be Yes
Source: http://goo.gl/6yUGp
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The following are 25 signs that the financial world is about to hit the big red panic button.... #1 According to a new study just released by Merrill Lynch, the U.S. economy has an 80% chance of going into another recession. #2 Will Bank of America be the next Lehman Brothers? Shares of Bank of America have fallen more than 40% over the past couple of months. Even though Warren Buffet recently stepped in with 5 billion dollars, the reality is that the problems for Bank of America are far from over. In fact, one analyst is projecting that Bank of America is going to need to raise 40 or 50 billion dollars in new capital. #3 European bank stocks have gotten absolutely hammered in recent weeks. #4 So far, major international banks have announced layoffs of more than 60,000 workers, and more layoff announcements are expected this fall. A recent article in the New York Times detailed some of the carnage.... A new wave of layoffs is emblematic of this shift as nearly every major bank undertakes a cost-cutting initiative, some with names like Project Compass. UBS has announced 3,500 layoffs, 5 percent of its staff, and Citigroup is quietly cutting dozens of traders. Bank of America could cut as many as 10,000 jobs, or 3.5 percent of its work force. ABN Amro, Barclays, Bank of New York Mellon, Credit Suisse, Goldman Sachs, HSBC, Lloyds, State Street and Wells Fargo have in recent months all announced plans to cut jobs tens of thousands all told. #5 Credit markets are really drying up. Do you remember what happened in 2008 when that happened? Many are now warning that we are getting very close to a repeat of that.
#6 The Conference Board has announced that the U.S. Consumer Confidence Index fell from 59.2 in July to 44.5 in August. That is the lowest reading that we have seen since the last recession ended. #7 The University of Michigan Consumer Sentiment Index has fallen by almost 20 points over the last three months. This index is now the lowest it has been in 30 years. #8 The Philadelphia Fed's latest survey of regional manufacturing activity was absolutely nightmarish.... The surveys broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from a slightly positive reading of 3.2 in July to -30.7 in August. The index is now at its lowest level since March 2009 #9 According to Bloomberg, since World War II almost every time that the year over year change in real GDP has fallen below 2% the U.S. economy has fallen into a recession.... Since 1948, every time the four-quarter change has fallen below 2 percent, the economy has entered a recession. Its hard to argue against an indicator with such a long history of accuracy. #10 Economic sentiment is falling in Europe as well. The following is from a recent Reuters article.... A monthly European Commission survey showed economic sentiment in the 17 countries using the euro, a good indication of future economic activity, fell to 98.3 in August from a revised 103 in July with optimism declining in all sectors. #11 The yield on 2 year Greek bonds is now an astronomical 42.47%.
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Is It Time For The Financial World To Panic? 25 Reasons Why The Answer May Be Yes (2)
#12 As I wrote about recently, the European Central Bank has stepped into the marketplace and is buying up huge amounts of sovereign debt from troubled nations such as Greece, Portugal, Spain and Italy. As a result, the ECB is also massively overleveraged at this point.
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#16 Polish finance minister Jacek Rostowski is warning that the status quo in Europe will lead to "collapse". According to Rostowski, if the EU does not choose the path of much deeper economic integration the eurozone simply is not going to survive much longer....
#13 Most of the major banks in Europe are also leveraged to the hilt and have tremendous exposure to European sovereign debt.
#14 Political wrangling in Europe is threatening to unravel the Greek bailout package. In a recent article,Satyajit Das described what has been going on behind the scenes in the EU.... The sticking point is a demand for collateral for the second bailout package. Finland demanded and got Euro 500 million in cash as security against their Euro 1,400 million share of the second bailout package. Hearing of the ill-advised side deal between Greece and Finland, Austria, the Netherlands and Slovakia also are now demanding collateral, arguing that their banks were less exposed to Greece than their counterparts in Germany and France entitling them to special treatment. #15 German Chancellor Angela Merkel is trying to hold the Greek bailout deal together, but a wave of anti-bailout "hysteria" is sweeping Germany, and nowaccording to Ambrose EvansPritchard it looks like Merkel may not have enough votes to approve the latest bailout package.... German media reported that the latest tally of votes in the Bundestag shows that 23 members from Mrs Merkel's own coalition plan to vote against the package, including twelve of the 44 members of Bavaria's Social Christians (CSU). This may force the Chancellor to rely on opposition votes, risking a government collapse.
"The choice is: much deeper macroeconomic integration in the eurozone or its collapse. There is no third way."
#17 German voters are against the introduction of "Eurobonds" by about a 5 to 1 margin, so deeper economic integration in Europe does not look real promising at this point. #18 If something goes wrong with the Greek bailout, Greece is financially doomed. Just consider the following excerpt from a recent article by Puru Saxena.... In Greece, government debt now represents almost 160% of GDP and the average yield on Greek debt is around 15%. Thus, if Greeces debt is rolled over without restructuring, its interest costs alone will amount to approximately 24% of GDP. In other words, if debt pardoning does not occur, nearly a quarter of Greeces economic output will be gobbled up by interest repayments! #19 The global banking system has a total of 2 trillion dollars of exposure to Greek, Irish, Portuguese, Spanish and Italian debt. Considering how much the global banking system is leveraged, this amount of exposure could end up wiping out a lot of major financial institutions. #20 The head of the IMF, Christine Largarde, recently warned that European banks are in need of "urgent recapitalization".
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Is It Time For The Financial World To Panic? 25 Reasons Why The Answer May Be Yes (3)
#21 Once the European crisis unravels, things could move very rapidly downhill. In a recent article, John Mauldin put it this way.... It is only a matter of time until Europe has a true crisis, which will happen faster BANG! than any of us can now imagine. Think Lehman on steroids. The U.S. gave Europe our subprime woes. Europe gets to repay the favor with an even more severe banking crisis that, given that the U.S. is at best at stall speed, will tip us into a long and serious recession. Stay tuned. #22 The U.S. housing market is still a complete and total mess. According to a recently released report, U.S. home prices fell 5.9% in the second quarter compared to a year earlier. That was the biggest decline that we have seen since 2009. But even with lower prices very few people are buying. According to the National Association of Realtors, sales of previously owned homes dropped 3.5 percent during July. That was the third decline in the last four months. Sales of previously owned homes are even lagging behind last year's pathetic pace. #23 According to John Lohman, the decline in U.S. economic data over the past three months has beenabsolutely unprecedented. #24 Morgan Stanley now says that the U.S. and Europe are "hovering dangerously close to a recession" and that there is a good chance we could enter one at some point in the next 6 to 12 months.
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#25 Minneapolis Fed President Narayana Kocherlakota says that he is so alarmed about the state of the economy that he may drop his opposition to more monetary easing. Could more quantitative easing by the Federal Reserve soon be on the way?
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The Top 100 Statistics About The Collapse Of The Economy

Source: http://goo.gl/mG6x1
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The U.S. economy is dying and most American voters have no idea why. Unfortunately, the mainstream media and most of our politicians are not telling the truth about the collapse of the economy. This generation was handed the keys to the greatest economic machine that the world has ever seen, and we have completely wrecked it. Decades of incredibly foolish decisions have left us drowning in an ocean of corruption, greed and bad debt. Thousands of businesses and millions of jobs have left the country and poverty is exploding from coast to coast. We are literally becoming a joke to the rest of the world. It is absolutely imperative that we educate America about what is happening. Until the American people truly understand the problems that we are facing, they will not be willing to implement the solutions that are necessary. The following are the top 100 statistics about the collapse of the economy that every American voter should know.... #100 A staggering 48.5% of all Americans live in a household that receives some form of government benefits. Back in 1983, that number was below 30 percent. #99 During the Obama administration, the U.S. government has accumulated more debt than it did from the time that George Washington took office to the time that Bill Clinton took office. #98 Since Barack Obama was sworn in, the share of the national debt per household has increased by $35,835. #97 The U.S. national debt has been increasing by an average of more than 4 billion dollars per day since the beginning of the Obama administration. #96 It is being projected that the U.S. national debt will hit 344% of GDP by the year 2050 if we continue on our current course. #95 The Congressional Budget Office is projecting that U.S. government debt held by the public will reach a staggering 716 percent of GDP by the year 2080. #94 In 2010, the U.S. government paid $413 billion in interest on the national debt. That is projected to at least double over the next decade.
#93 According to one new survey, one out of every three Americans would not be able to make a mortgage or rent payment next month if they suddenly lost their current job. #92 State and local government debt has reached an all-time high of 22 percent of U.S. GDP. #91 In 1980, government transfer payments accounted for just 11.7% of all income. Today, government transfer payments account for 18.4% of all income. #90 U.S. households are now receiving more income from the U.S. government than they are paying to the government in taxes. #89 According to a new study conducted by the BlackRock Investment Institute, the ratio of household debt to personal income in the United States is now 154 percent. #88 If you can believe it, one out of every seven Americans has at least 10 credit cards. #87 According to the Bureau of Economic Analysis, health care costs accounted for just 9.5% of all personal consumption back in 1980. Today they account for approximately 16.3%. #86 The cost of a health insurance policy for the average American family rose by a whopping 9 percent last year, and according to a report put out by the Kaiser Family Foundation and the Health Research and Educational Trust, the average family health insurance policy now costs over $15,000 a year. #85 One study found that approximately 41 percent of working age Americans either have medical bill problems or are currently paying off medical debt. #84 An all-time record 49.9 million Americans do not have any health insurance at all at this point, and the percentage of Americans covered by employer-based health plans has fallen for 11 years in a row.
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The Top 100 Statistics About The Collapse Of The Economy (2)
#83 According to a report published in The American Journal of Medicine, medical bills are a major factor in more than 60 percent of the personal bankruptcies in the United States. Of those bankruptcies that were caused by medical bills, approximately 75 percent of them involved individuals that actually did have health insurance. #82 Average yearly tuition at U.S. private universities is now up to $27,293. #81 The cost of college tuition in the United States has gone up by over 900 percent since 1978. #80 In America today, approximately two-thirds of all college students graduate with student loans. #79 In 2010, the average college graduate had accumulated approximately $25,000 in student loan debt by graduation day. #78 The total amount of student loan debt in the United States now exceeds the total amount of credit card debt in the United States. #77 One-third of all college graduates end up taking jobs that don't even require college degrees. #76 In the United States today, there are more than 100,000 janitors that have college degrees. #75 In the United States today, 317,000 waiters and waitresses have college degrees. #74 In the United States today, approximately 365,000 cashiers have college degrees. #73 It is being projected that for the first time ever, the OPEC nations are going to bring in over a trillion dollars from exporting oil this year. Their biggest customer is the United States. #72 U.S. oil companies will bring in about $200 billion in pre-tax profits this year. They will also receive about $4.4 billion in specialized tax breaks from the U.S. government. #71 The United States has had a negative trade balance every single year since 1976, and since that time the United States has run a total trade deficit of more than 7.5 trillion dollars with the rest of the world.
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#70 The United States has lost an average of 50,000 manufacturing jobs per month since China joined the World Trade Organization in 2001. #69 The U.S. trade deficit with China is now 27 times larger than it was back in 1990. #68 Today, the United States spends more than 4 dollars on goods and services from China for every one dollar that China spends on goods and services from the United States. #67 China has surpassed the United States and is now the largest PC market in the entire world. #66 In 2002, the United States had a trade deficit in "advanced technology products" of $16 billion with the rest of the world. In 2010, that number skyrocketed to $82 billion. #65 In 2010, the number one U.S. export to China was "scrap and trash". #64 Do you remember when the United States was the dominant manufacturer of automobiles and trucks on the globe? Well, in 2010 the U.S. ran a trade deficit in automobiles, trucks and parts of $110 billion. #63 The United States has lost a staggering 32 percent of its manufacturing jobs since the year 2000. #62 More than 42,000 manufacturing facilities in the United States have been closed down since 2001. #61 Between December 2000 and December 2010, 38 percent of the manufacturing jobs in Ohio were lost, 42 percent of the manufacturing jobs in North Carolina were lost and 48 percent of the manufacturing jobs in Michigan were lost. #60 Back in 1970, 25 percent of all jobs in the United States were manufacturing jobs. Today, only 9 percent of the jobs in the United States are manufacturing jobs. #59 According to Professor Alan Blinder of Princeton University, 40 million more U.S. jobs could be sent offshore over the next two decades. #58 If you gathered together all of the workers that are "officially" unemployed in the United States today, they would constitute the 68th largest country in the world.
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#57 There are fewer payroll jobs in the United States right now than there were back in 2000 even though we have added 30 million extra people to the population since then. #56 Back in 1969, 95 percent of all men between the ages of 25 and 54 had a job. In July, only 81.2 percent of men in that age group had a job. #55 Only 55.3% of all Americans between the ages of 18 and 29 were employed last year. That was the lowest level that we have seen since World War II. #54 Today, there are 5.9 million Americans between the ages of 25 and 34 that are living with their parents. #53 The economic downturn has been particularly tough on men. According to Census data, men are twice as likely to live with their parents as women are. #52 According to one recent survey, only 14 percent of all Americans that are 28 or 29 years old are optimistic about their financial futures. #51 Incredibly, less than 30 percent of all U.S. teens had a job this summer. #50 According to one study, between 1969 and 2009 the median wages earned by American men between the ages of 30 and 50 dropped by 27 percent after you account for inflation. #49 Since the year 2000, we have lost approximately 10% of our middle class jobs. In the year 2000 there were about 72 million middle class jobs in the United States but today there are only about 65 million middle class jobs. #48 In 1980, 52 percent of all jobs in the United States were middle income jobs. Today, only 42 percent of all jobs are middle income jobs. #47 Back in 1980, less than 30% of all jobs in the United States were low income jobs. Today, more than 40% of all jobs in the United States are low income jobs. #46 According to Paul Osterman, a professor of economics at MIT, approximately 20 percent of all employed Americans are making $10.65 an hour or less.
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#45 Half of all American workers now earn $505 or less per week. #44 Since December 2007, median household income in the United States has declined by a total of 6.8% once you account for inflation. #43 New home sales in the United States are now down 80% from the peak in July 2005. #42 The all-time record for fewest number of new homes sold in the United States was broken in 2009. Then it was broken again in 2010. It is on pace to be broken once again in 2011. #41 At one point this year, U.S. home prices had fallen a whopping 33%from where they were at during the peak of the housing bubble. #40 U.S. home values have fallen approximately 6 trillion dollars since the housing crisis first began. #39 According to the U.S. Census Bureau, 18 percent of all homes in the state of Florida are sitting vacant. That figure is 63 percent larger than it was just ten years ago. #38 Historically, the percentage of residential mortgages in foreclosure in the United States has tended to hover between 1 and 1.5 percent. Today, it is up around 4.5 percent. #37 According to the Mortgage Bankers Association, at least 8 million Americans are currently at least one month behind on their mortgage payments. #36 According to a Harris Interactive survey taken near the end of last year, 77 percent of all Americans are now living paycheck to paycheck. In 2007, the same survey found that only 43 percent of Americans were living paycheck to paycheck. #35 Starting on January 1st, 2011 the Baby Boomers began to hit retirement age. From now on, every single day more than 10,000 Baby Boomers will reach the age of 65. That is going to keep happening every single day for the next 19 years.
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Miscellaneous
#34 According to a new poll by Americans for Secure Retirement, 88 percent of all Americans are worried about "maintaining a comfortable standard of living in retirement". Last year, that figure was at 73 percent. #33 One out of every six elderly Americans now lives below the federal poverty line. #32 In 1950, each retiree's Social Security benefit was paid for by 16 U.S. workers. According to new data from the U.S. Bureau of Labor Statistics, there are now only 1.75 full-time private sector workers for each person that is receiving Social Security benefits in the United States. #31 According to the Congressional Budget Office, the Social Security system paid out more in benefits than it received in payroll taxes in 2010. That was not supposed to happen until at least 2016. #30 The U.S. government now says that the Medicare trust fund will run outfive years faster than they were projecting just last year. #29 According to one study, the 50 U.S. state governments are collectively 3.2 trillion dollars short of what they need to meet their pension obligations. #28 A different study has shown that individual Americans are $6.6 trillion short of what they need to retire comfortably. #27 Between 1991 and 2007 the number of Americans between the ages of 65 and 74 that filed for bankruptcy rose by a staggering 178 percent. #26 According to a shocking AARP survey of Baby Boomers that are still in the workforce, 40 percent of them plan to work "until they drop". #25 Last year, 2.6 million more Americans dropped into poverty. That was the largest increase that we have seen since the U.S. government began keeping statistics on this back in 1959. #24 Back in the year 2000, 11.3% of all Americans were living in poverty. Today, 15.1% of all Americans are living in poverty.
DRAFT
#23 More than 50 million Americans are now on Medicaid. Back in 1965, only one out of every 50 Americans was on Medicaid. Today, approximately one out of every 6 Americans is on Medicaid. #22 More than 45 million Americans are now on food stamps. #21 The number of Americans on food stamps has increased 74% since 2007. #20 Approximately one-third of the entire population of the state of Alabama is now on food stamps. #19 Right now, one out of every four American children is on food stamps. #18 It is being projected that approximately 50 percent of all U.S. children will be on food stamps at some point in their lives before they reach the age of 18. #17 The poverty rate for children living in the United States increased to 22% in 2010. #16 There are 314 counties in the United States where at least 30% of the children are facing food insecurity. #15 In Washington D.C., the "child food insecurity rate" is 32.3%. #14 More than 20 million U.S. children rely on school meal programs to keep from going hungry. #13 It is estimated that up to half a million children may currently be homeless in the United States. #12 The number of Americans that are going to food pantries and soup kitchens has increased by 46% since 2006. #11 According to a recent report from the AFL-CIO, the average CEO made 343 times more money than the average American did last year. #10 The wealthiest 1% of all Americans now own more than a third of all the wealth in the United States. #9 The poorest 50% of all Americans collectively own just 2.5% of all the wealth in the United States. #8 The percentage of millionaires in Congress is more than 50 times higher than the percentage of millionaires in the general population.
135
Miscellaneous
#7 According to the Bureau of Labor Statistics, 16.6 million Americans were self-employed back in December 2006. Today, that number has shrunk to 14.5 million. #6 According to one recent poll, 90 percent of the American people believe that economic conditions in the United States are "poor". To put this in perspective, only 11 percent of Americans rated economic conditions in the U.S. as "poor" back in January of 1999. #5 According to another recent poll, 80 percent of the American people believe that we are actually in a recession right now. #4 Our dollar is being systematically destroyed by the Federal Reserve. An item that cost $20.00 in 1970 will cost you $116.78 today. An item that cost $20.00 in 1913 will cost you $457.67 today. #3 The Federal Reserve made $16.1 trillion in secret loans to their friends during the last financial crisis. #2 The Federal Reserve is a perpetual debt machine. Today, the U.S. national debt is more than 4700 times larger than it was when the Federal Reserve was created back in 1913. #1 According to a new CNN/ORC International Poll, 27 percent of all Americans have never even heard of Federal Reserve Chairman Ben Bernanke.
DRAFT
136
Miscellaneous
World Currency Reserves

In spite of the problems in the U.S., the dollar is still the predominant reserve currency around the world, and with the European credit crisis heating up (which some have argued could lead to a break-up of the Euro itself), the dollars place seems secure, at least in the near term, as no other options really exist to replace it.
DRAFT
137
Miscellaneous
Historical Log Scale Dow Jones Industrial Average

If we know it is best to buy at a bottom, how can we be sure we are at a bottom now when the data tells a different story?
DRAFT
What if we are here
instead of here?
Miscellaneous
Real Mega-Bear Comparison

Compares the S&P secular bear market from 19681982 to the current market, which peaked during March of 2000 in real terms.
DRAFT
139
Miscellaneous
Dow Jones & NASDAQ Composite

Compares the Dow Jones high of 1929 to the NASDAQ high of 2000.
DRAFT
140
Miscellaneous
Nikkei 225 & NASDAQ Composite

Compares the Nikkei 225 high of 1989 with the NASDAQ high of 2000.
DRAFT
141
Miscellaneous
Dow Jones Industrial Average vs. Dow Jones Industrial Average

Compares the Dow Jones high of 1909 with the Dow Jones high of May 2011.
DRAFT
142
Miscellaneous
Real Mega-Bears
Compares the S&P 500 (2000) with the highs of the Nikkei 225 (1989) and the Dow (1929).
DRAFT
143
Miscellaneous
Nikkei 225 & S&P 500 Real Monthly Overlay

Compares the Nikkei 225 high with the S&P high in 2000, along with associated Japanese deflation. Incidentally, we are currently nearing the point where Japan experienced deflation in its cycle.
DRAFT
144
Miscellaneous
$14,790,340,328,557.15 and counting

The definition of government is the monopoly of force within a geographic area that will use said force in coercive manner to get what it needs. Regardless of who is in office, debt seems to fill the available ceiling; each increase in the debt ceiling was met with increase in debt. Over the last year, the government debt has increased $1.2 trillion. At a rate of $125 billion per month, the total US debt to GDP will surpass 100 in just over a month.
DRAFT
145
Miscellaneous
Insane Volatility
What a healthy market looks like, or is this just the New Normal? This is typical of a market top.
DRAFT
146
Miscellaneous
3 Month LIBOR-OIS Spread

The increase in 3 Month LIBOR-OIS Spread, which really started running up after QE2 ended in June, provides an indication that banks believe that other banks they are lending to have a higher chance of defaulting on their loans, so they are charging higher rates to each other. Source: http://goo.gl/aiveY
DRAFT
147
Miscellaneous
Detailed Look at Fed Intervention
DRAFT
148
Miscellaneous
Federal Reserves Assets

The total size of the Federal Reserves balance sheet increased by $4.75 billion over the week ending August 31, 2011. Surprise surprise! The majority of that increase was manifest in an increase in the Feds holdings of US Treasury notes & bonds and Other Assets (meaning, unidentifiable junk). Interestingly the Feds holdings of Federal Agency Debt securities and Mortgage-backed securities were flat on the week, and the Maiden Lane, TALF items were also relatively flat. These holdings have been decreasing recently; perhaps this halting could suggest that the public sectors plan is not quite going well to plan. Source: http://goo.gl/UVfXM
DRAFT
Miscellaneous
Federal Reserves Assets (Proportional Basis)

Notice the shift in the balance sheet composition since the onset of the financial crisis, particularly i) the increase in notes and bonds (remember that notes and bonds are longer term that bills), and ii) the increase in all that other stuff (i.e. agency debt securities, mortgage backed securities, swaps, et. al.)
DRAFT
Source: http://goo.gl/UVfXM
Miscellaneous
Federal Reserves Liabilities

The change in the Feds liabilities showed a switcheroo between the US Treasurys general account (-$19.6 billion) and the deposits held by depository institutions (+$18 billion). This is highly suspect to say the least! The net increase in the Feds liabilities came from an increase in the outstanding stock of Federal Reserve notes. Source: http://goo.gl/UVfXM
DRAFT
Miscellaneous
Federal Reserves Liabilities (Proportional Basis)

Notice the explosion of reserve balances at Fed Reserve banks since 2008. Source: http://goo.gl/UVfXM
DRAFT
DRAFT

The Greater Depression or - How I Learned To Stop Worrying and Love The Bear 2011.10.15

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The Greater Depression or - How I Learned To Stop Worrying and Love The Bear 2011.10.15

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The Greater Depression or:

How l Learned to Stop Worrying and Love the Bear

October 14, 2011

Appendix VI: Housing Appendix VII: Europe Appendix VIII: Miscellaneous

October 14, 2011

400% 350% 300% 250% 200% 150% 100%

The Tectonic Shift 2009-2013

New New Deal

ZIRP QE Fiscal Stimulus

U.S. Reserve Currency Crisis Bretton Woods II

2009 2013 2010

Job Eliminations & Layoffs

Credit & Debit Card Restrictions

Food & Energy Price Pressures

Currency Crisis International Swap Crisis

Sate & Local -Budget CrisisFederal Insurance & Finance Distress

Retail Store Closings

Entitlement Funding Crisis

Residential Real Estate Double Dip Rising Interest Rates

You Call This a Recovery?!

Growth in Real GDP Components: Current & 3 Previous Recoveries

Job Growth: Current & 3 Previous Recoveries

ECRI Weekly Leading Index & Gross Domestic Product

US Inventory Cycle Set to Force Headline ISM Much Lower

Percent of Previous Peaks

Household Income Index and Unemployment Rate

The Breaking Point

Rise of Debt Drained The Economy

GDP vs 10 Year Treasury

Rising Money Supply & Credit = Declining Wages & GDP

Amount of Debt Required to Finance $1.00 of GDP

What Has (Really)Driven Our Growth?

Debt Fueled Growth Leads to Deleveraging

The S&P 500 & Federal Reserve Intervention

The $200 Trillion Gorilla

Daily Treasury Yields

Were Turning Japanese (I really think so)

10-Year Treasury Yield & Inflation

S&P 500, 10-Year Treasury Yield, & FFR

Inflation-Adjusted Regression to Trend

Negative Annualized Returns Over The Next Decade Very Likely

Negative Annualized Returns Over The Next Decade Very Likely

Secular Markets: S&P Historical Inflation Adjusted Composite

Fear, Hope, & Greed: Where Are We Now?

I am pretty smart. This is fun!

Temporary set-back. Im a long-term investor anyway.

How could I have been so wrong?

October 14, 2011

Current Market Snapshot: S&P 500

S&P Regression to Trend

Q Ratio Since 1900

Q Ratio Percent Change from Geometric Mean

Inflation-Adjusted S&P and Q Ratio

S&P Composite and the Crestmont P/E Ratio

Market Cap as a % of GDP

Changes in Profit Margins Lead Changes in Stock Price

Technical Evidence for a Bear Market Decline

High-Yield Credit Signaling Another Market Downturn

High-Yield Credit Signaling Another Market Downturn (2)

Street Talk Advisors Intermediate Buy/Sell Indicator

2-10 Spread and the S&P 500

October 14, 2011