WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.
The only difference between a gambler and an investor in commodities is that a gambler knows she might lose money. --Steven Jon Kaplan
GLOBAL EQUITY MARKETS ARE SET FOR THE NEXT PHASE IN THEIR CORRECTION (March 3, 2008): U.S. equity indices have declined for four consecutive months from November 2007 through February 2008, as global equities have eventually joined them without exception. As the availability of credit becomes an increasingly serious issue and the lack of new borrowed money makes its contractionary impact on the global economy, evidence of a worldwide slowdown is becoming increasingly apparent. However, fear of an additional decline, as is most accurately measured by the index VXO, has shown that most investors throughout the world believe that the stock-market correction ended in January. This lack of concern will soon translate into substantially lower lows for equity indices in all countries, with the greatest declines about to occur in emerging markets where growth expectations are by far the most unrealistic. Eventually, major equity index and fund support levels from 2006 and even 2005 will be experienced as the euphoria of 2007 leads to the panic of 2008. You can't have one extreme without the other.
COMMODITIES WILL SOON JOIN EQUITIES IN THE GLOBAL DOWNTREND (March 3, 2008): In the early weeks of the U.S. stock market's decline, there was a popular theory that certain Nasdaq stocks like Apple Computer (AAPL) and Google (GOOG), along with some emerging markets like India, would somehow be magically exempt from the global downtrend. This illusion persisted for weeks, and even took on the popular title of "decoupling", until the above securities plunged dramatically in order to catch up to the reality of reduced desire for equity risk.
Since then, as all equity markets around the globe have joined in the downtrend, investors have not abandoned their Peter Pan illusions of Neverland, but have simply shifted their fantasies from equities to commodities. Actual supply/demand data from all reliable sources demonstrate that the physical demand for all commodities has contracted sharply in recent weeks as the global economic contraction and sharply higher prices have combined to create significantly lower buying. Meanwhile, supply has progressively increased as miners and farmers have sharply accelerated production to take advantage of windfall profits.
The only reason that this combination of lower demand and higher supply has not led to sharply lower commodity prices is that the introduction of new futures contracts and exchange-traded funds, at the same time that investors are fleeing the global equity market, has encouraged a huge speculative buying binge. This has caused commodities to soar to multi-decade peaks. There has never been such a sharp divergence between reduced physical demand and increased speculative demand. People who never cared about commodities are now the biggest buyers and cheerleaders, which always happens just before a plunge. Even the non-financial media have been promoting the myth of unlimited potential gains in commodities, which is one very reliable sign of a major peak.
Speculative demand, however, cannot replace physical demand. The illusion of shortage created by fund buying will become a transparent farce once a critical mass of investors decides that additional gains are likely to be limited, and begin selling. The sudden influx of commodities into the open market, especially with no proven support levels for a long way down, will lead to a short-term collapse that will be dramatic in its intensity and a huge surprise to most investors.
THE U.S. DOLLAR WILL SURGE HIGHER AT LEAST UNTIL THE END OF 2008 (March 3, 2008): The current growth forecasts by most economists are for the U.S. to enter a mild recession, while the rest of the world enjoys strong growth. While the U.S. projections are likely to be fairly accurate, the rest of the world will greatly suffer from decreased U.S. demand, while the credit crisis is already spreading around the globe. Current double-digit growth projections for many emerging markets are far too optimistic. Once the reality of a true global slowdown becomes evident, the U.S. dollar will benefit enormously as a safe haven. Its currently deeply depressed valuation will become an asset once it begins to rise, as it will be seen as one of the few truly underpriced global securities.
In addition, the inevitable reduced U.S. military spending in Iraq, along with the increased likelihood of higher U.S. income taxes, will decrease the huge U.S. budget deficit and will provide additional support for the greenback. The anticipation of a new U.S. President will also create an aura of "moving in the right direction" that will contribute to a sharply higher U.S. currency.
Once the U.S. dollar soon begins to rally, the huge army of speculative short positions will inevitably be forced to start covering their positions, which will accelerate the move and will lead to additional short covering. This will likely enable the greenback to rally for at least the rest of 2008, and possibly into early 2009.
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HOUSING-PRICE DECLINES IN THE SWING STATES WILL LEAD THE DEMOCRATS TO VICTORY IN NOVEMBER (February 18, 2008): There has been a lot of excitement in the U.S. and abroad over the Presidential elections to be held on November 4, 2008. Much has been debated in the media about whether the nearly even Democratic race will cause disunity at the convention, and whether or not that favors the likely Republican challenger, John McCain. The pundits are wondering if the presence of the first serious female or black challenger could tip the balance either for or against such a candidate. The possible future composition of the Supreme Court is a popular topic for discussion. As usual, there are plenty of conspiracy theories and enough misinformation to last for a lifetime.
What is rarely mentioned is that when the average person goes into a voting both, he or she almost always has basic pocketbook issues as the critical deciding factor in that person's ultimate decision. With a roughly 70% home-ownership rate among registered voters, the average person's main worry this November will be falling housing prices. This concern is especially magnified since the value of the median voter's house far exceeds his or her liquid net worth.
Those states which were either staunchly Republican or solidly Democratic in the past two elections are likely to remain that way in 2008. The real question is how the swing states will tilt.
In a rather amazing coincidence that I have not seen mentioned elsewhere in the media, it happens to be the case that several of the most important swing states have had the most serious problems in the housing market. Ohio and Michigan have seen record foreclosure rates, with rapidly falling prices in many cities in those states. Florida, also a key swing state in both 2000 and 2004, has had among the largest percentage declines for housing prices nationwide. Nevada, while it has fewer electoral votes, has also been very hard hit by the collapse of the housing bubble; to a lesser extent, so have Colorado, New Mexico, and Pennsylvania.
By November 4, 2008, you can be sure that in the back of the mind of homeowners of all of the above states will be the knowledge that housing prices will have fallen for three consecutive years. Rightly or wrongly--clearly there was no housing bubble prior to the Bush Presidency--the blame for the collapse will be attributed almost entirely to the Republican Party. (Probably Alan Greenspan was the main direct culprit, but there can be no question that his actions were undertaken with the full knowledge and approval of the current administration.)
Therefore, I think that no matter what else happens in Iraq, with the economy, or on any other issue in 2008, the Democrats will regain the White House in 2008. Even if that prestigious residence has also seen a decline in its underlying land value, its importance remains as high as ever.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, which appeared on newsstands worldwide, and then again on page M14 of their February 25, 2008 issue.
CURRENT ASSET ALLOCATION (March 3, 2008): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 2.5%; municipal bonds, including MYJ, 2.5%; KRE, 1%; XRT, 0.5%; TOC, 1.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX and in the PayPal money-market fund, 5.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, NDX, GOOG, in that order), 38.5%; short EWM, 1%; short ILF, 1%; short GLD, 20%; short GDX, 3%; short USO, 4.5%; short SLV, 2%; short DBA, 8%; short BIK, 1%; short EWZ, 1%.
REMINISCENCE OF THE WEEK (February 18, 2008): When my sister Beth was in ninth grade, she began an independent science project that took several months to design and investigate. She created a special colorful display on a wooden board; she accumulated a huge amount of data; and one day after exhausting herself with some meticulous painting, she asked me what I thought. I looked carefully at everything, and finally told her truthfully, "You've done a wonderful job collecting information, and your artistic ability is amazing. What you need is some way of connecting it all together." "Can you be more specific?", my sister insisted. "I'm not even sure what I'm looking for," I admitted. "Let me study it this weekend." That Saturday afternoon after piano and composition classes at the Peabody Preparatory, I went to my favorite hideout, the Enoch Pratt Free Library in Baltimore, and spent a few hours skimming through several science books. I was beginning to get discouraged, when finally I discovered something called the "chi-square test". I borrowed the book, studied it, and explained it to my sister. She immediately realized its importance, and redesigned her entire project as though she had years of experience with significance levels and frequency distributions. In a major regional competition, my sister won numerous awards from the state statistical society and other organizations.
