It is the Feds Vs. the markets

Mar 18, 2011

Baltimore, Maryland

What a nuisance! Our laptop computer collapsed this morning. Hours were wasted trying to revive it. We were like a carpenter without a hammer...a clown without a red idiot without a village.

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Meanwhile, the financial world seemed to be on verge of collapse too. Stocks rose 161 points on the Dow yesterday...after a big drop the day before. Gold rose a bit too.

This is the kind of market nervousness that usually resolves itself -- in a big drop. Yes, our 'Crash Alert' flag -- tattered, faded, and frayed -- is out. Ignore it at your peril!

The Fed is still pumping $4 billion of new money into the system every day. And the federal government is putting in another $5 billion of deficit spending every day.

With this kind of support, you wouldn't expect asset prices to fall. Instead, they should be soaring.

"Don't fight the Fed," the old timers warn.

But watch out. The Fed might have lost control.

The Great Correction isn't going away. It's intensifying.

As you know, it's been war out there. The feds against the market. The market wants change. The feds fight to protect the status quo.

It's an ancient struggle. But this phase of it has been going on for more than 10 years. The markets try to go correct their reduce the amount of debt in the system. And the feds fight back with overwhelming firepower -- forcing prices to back up...adding more debt...preventing bankruptcies. And now the battle is heating up.

What to make of it? First, the feds can destroy wealth. They can prevent it. They can move it around. But it's only the private sector -- and market forces -- that create it.

Second, the more the feds meddle in the markets, the more distorted and grotesque the outcome becomes. Regulation, rigged credit markets, bailouts and subsidies -- all pervert the natural outcome of market forces.

Third, the feds' current use of overwhelming force to block a market correction is creating overwhelming unforeseen and pernicious problems. They put money into the system to try to encourage spending and investment. The money pushes up stocks -- giving investors more 'wealth' to spend. But it also tempts speculators into risky trades...and pushes up oil business and consumers higher energy prices...and less money to spend on other things.

Let's look at what happens next.

No, the feds didn't cause earthquakes in Japan or revolutions and civil wars in North Africa. But they created such a rickety financial top-heavy with debt...that almost any calamity can bring it down.

As it happens, political troubles in the Arab states...and Japan's nuclear problems...both grip the world's single most important market -- oil -- like the jaws of a vise.

The Arab world produces the stuff. Japan consumes it. Without its nuclear reactors, Japan will rely even more heavily on other forms of energy...leaving more people standing in line with gas cans in their hands.

And here's where the feds come in -- their funny money had already sent the price of oil from a low near $30 at the bottom of the '09 a high over $100 before the first coffee cup started to rattle in Japan.

Where the price will go next, we don't know. But it's being squeezed on both sides -- supply and demand -- simultaneously.

And here's something you should know:

According to Nomura Securities, everytime there is a big increase in the price of oil -- 170% or more -- there is also a recession.

We mean every time in the last 40 years -- '74, '79, '90, and '00.

And don't forget, it wasn't just sub-prime debt in the US that spelled doom for the economy in '08. It was also skyrocketing oil prices...that pinched houshold budgets all over the world.

And guess what? The price of oil has already risen more than 170%. It had hit the critical point even before the revolutions in North Africa or the earthquakes off the coast of Japan. Now, under even more pressure, we can expect a higher price of oil...until the bottom falls out again.

*** Whoa...this looks bad too.

In the housing sector, the fed's ultra-low interest rates are supposed to make it easier to refinance...which is supposed to help firm up prices. But prices haven't firmed. They're still giving way.

The latest numbers show prices falling, hitting post-bubble lows in 11 cities. Of the 20 major cities in the survey, only two of them had positive price movements last year. No surprise, only one -- Zombietown itself, Washington DC, home of the feds -- showed an increase of more than 2%.

Worst hit were the sunshine states -- California, Florida, Nevada, Arizona and Georgia. Along with Michigan, more than a third of homeowners in these states have negative equity in their houses...with 70% of them underwater in Nevada.

Wealth effect? Not in housing. According to the Case/Shiller numbers, homeowners saw their net housing wealth decline by $650 billion in the last quarter of 2010. And since many more households own houses than stocks -- 66% are homeowners -- falling housing prices has a much bigger effect on the economy than rising stock prices.

And it gets worse. The big wave of resetting (and recasting) ARM loans begins to crash into the housing market next month. There are about $700 billion worth of loans in this group. Many will not be successfully rewritten. Falling housing prices will make it impossible. Homeowners will prefer to walk away, rather than be shackled to a long-term mortgage 30% to 50% higher than the value of the house.

Says housing expert Robert M. Campbell:

"I continue to believe that the second downward leg in house prices that began in 2010 will likely take US housing prices to a point that is 15% to 20% below current levels."

*** And what's this...

"This is's down 35% since we bought it."

This is not the kind of message you usually get from your financial advisor. But this was no ordinary advisor...and no ordinary advice.

Rob Marstrand advises our Family Office on what to do with money for really good, really long-term returns. He was speaking about a Chinese food producer; he thinks this is one of the greatest opportunities to come along in many years.

"Doesn't sound so great to me," we responded. "We've lost a third of our money."

"You don't understand Bill, this is not the same sort of investing most people do. We let time work for us. The average guy would be petrified. He'd be looking at his retirement account...and wondering how he would make up for a 35% loss. He'll need more than a 50% gain to get back to even.

"But we're not concerned about retirement. The key to family office investing success is to find the right positions…get in them at the best prices possible... and stay in until they go where they ought to go. This is a stock that is debt free...and it is trading at less than 3 times this year's earnings.

"This is an almost unbelievable gift...but only if you've got the time to take advantage of it. If China blows up...or the world sinks into another big slump...this could stay down for years. But over the long run, this is likely to produce huge gains. If it just went to a "normal" p/e of'd quadruple your money. But this is a company whose revenues are growing at 20% per you might expect a p/e more like 20 -- which would be about a 700% gain."

Will Rob be right about this? We don't know. But our family office investing strategy is a little like the advice we gave to Edward. In the short run, you can't know what will be a big winner and what won't. So, you invest in the things that deserve to be winners in the long run.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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