Long on the U.S. Consumer --Mark’s Market Commentary

Bad news continues to drip out about the coming weakness. From today’s The Wall Street Journal: “There is a sense that things have not gotten better in the world economy. The outlook for the global economy is deteriorating amid fading optimism of a second half rebound”

“As long as the economy hasn’t gained strength and momentum, it remains vulnerable to new shocks, be they external or homemade”, the Bundesbank warned.

“Nearly everything that has occurred since the beginning of the summer has been an economic negative. This is a vicious cycle”, says Laurence Meyer.

Yet the equity speculators are a stubborn lot, and refuse to give up hope on a 1999-style equity meltup, sparked by a second half recovery:

“Growing expectations of a recovery have been particularly apparent in the financial markets”, says the IMF.

All eyes are currently on the U.S. consumer. The global speculating community has made a giant sized bet that despite all the hints of economic weakness, the U.S. consumer will continue to borrow and spend himself into oblivion.

After some recent observations, I must agree. I see no visible signs of restraint in my neighborhood.

There is still an explosion of new vehicles hitting the road today with those paper tags from the dealer.

There are still too many partially-employed posers hanging around the beach cities, killing time, talking on their 4 oz. stainless steel cell phones.

The largest big screen TV retailer in Southern California has just turned on the afterburners, running full page ads in The Los Angeles Times offering “no interest, no payments until January 2004.”

The same type program is also being offered by Guitar Center and Mars Music, where drumsets can be purchased by unemployed wannabe rock stars on credit.

Honda and Yamaha just offered zero payment programs available on any motorcycle for six months.

There will be no correction in the economy and/or the stock market until these guys face the repo man. All of these were spotted in Manhattan Beach over the weekend:

The mixed race floor supervisor in the car stereo department at Best Buy (BBY), driving a leased Lexus GS430, with 20” custom wheels financed by Primerica, driving around with his overweight drama queen girlfriend with overprocessed hair and heavy makeup.

The bodybuilding framing supervisor for the luxury spec home builder, driving a Ford F350 crew cab, complete with a $14,000 lift kit financed by Household International (HI), pulling a flatbed trailer with $30,000 of fourwheeler ATV’s.

The 25-year old blonde public relations director, fresh out of college, paying $1,800/mo. for a one bedroom apartment near the beach, driving a new BMW 330 convertible, with the latest fashions financed on her Capital One (COF) credit card, barely making the minimum payments while seeking a high income boyfriend to start taking over the bills.

The ex-stripper, now married to the managing director of the Black Oak Hedge Fund, working out at the Sports Center L.A., driving the latest model Mercedes SL500, on her way to the antique dealer, scratching the back of her head wondering what her stressed out husband was talking about on the phone at 3:00am last night discussing “systemic risks” and “illiquid trading”.

The artsy movie producer, dressed and tattooed in a manner which would make him incapable of gaining employment at a 7-Eleven, driving a Porsche Carrera 4, wearing $500 sunglasses, wondering how he is going to explain to corporate how is latest $90 million movie flop only grossed $2 million on its opening weekend. Especially since he’s now getting cash calls from the 47 real estate partnerships he invested in because of excessive office vacancies.

The current consumption binge since November 2001 will go down in the record books as the greatest of all time.

What is fascinating is how this activity has manifested itself during the beginning stages of what could be a severe multi-year recession.

Prior to 2001, global investors regularly expected and traded the usual ebb and flow of spending cycles. After a 6 – 9 month binge, it was expected that the consumer would step back and take a breather. After a 3 - 5 year cycle of strong employment, it was expected that some contraction would occur, and stocks would be sold well in advance of the contraction.

The entire financial planet is now making a bet that the Magic Wand has repealed the business cycle, normal consumer spending cycles, real estate bubbles, and credit booms and busts.

Everybody is making uni-direction bets that global prosperity is a virtual certainty. Prosperity gunned by the mighty U.S. consumer, who is assumed to be a giant vacuum cleaner ready to suck up what ever goods Asia, Europe, and Latin America can produce.

And the expectation that consumer debt and spending levels can remain in the parabola mode indefinitely has been hyperaccelerated by the financial speculator’s desire to flip stocks, bonds, options, or derivatives using the highest leverage possible.

After all, that is every educated person’s dream. To put a small amount of money in somebody’s hedge fund, and watch it explode in value so you can retire in 10 years.

There remains a heavy divergence between the corporate bond market and the equity markets. Although some of the higher profile potential bankruptcies have been averted, we don’t see any improvement in junk bond prices. Qwest finally unloaded its phone directory business. That is, unless some accounting irregularities spring forth which would trigger a “material adverse change” and cancel the deal. There are some murmurings about more revenue recognition tricks in this area.

Our favorite junk bond fund may have marked some type of a short term top today: Huge volume needs to come in very soon to take out that big white candle. [ Chart ]

The real estate bubble recorded a final, blowoff top, according to several “Mark to Market Indicators”

The Wall Street Journal reported homeowners refusing to pay appraisers and demanding new ones sent out by Countrywide (CCR) when they don’t get the airball valuations they expected. The last time I witnessed this activity was in August of 1989.

A large percentage of homes sold in my neighborhood have “In Escrow” or “Sale Pending” signs instead of “Sold”. Translation: “We have this house sold, but the buyer is not likely to qualify. Other offers are welcome”. The last time I witnessed this phenomenon was in August of 1989.

One of my largest clients called me on the phone today, and told me that Northern Trust was prepared to refinance all 7 of his properties with no loan fees or appraisal fees. The fixed rate offered on the residences was 5.9%, and a start rate on the apartment buildings was 3.90%. That’s unheard of, and has to be a record. I’ve never witnessed such insanity in my 25 years of lending experience.

The constant drone heard at the cocktail parties is the “in your face” bragging about how many real estate properties have been acquired for minimal down payments, and how real estate will never go down because “this time its different”. The last time I heard that was in August of 1989.

As for today’s action, there isn’t much to report today, other than that the market chopped around a lot today. The volume was kind of light, so its too early to determine what will happen next. If we are going to go sideways a couple more days on lighter volume, then we could build up more power for the high volume dynamite blast necessary to get past the September lows.

Or, we have already seen short covering exhaustion. And if the hopers start selling now, then we could continue to see the beginning of another slow death march down. At the January and March tops, after the hysteria INTC explosions, it appeared that the market was ready for a significant multi-week advance, where all momentum indicators appeared to be charging firmly to the upside.

TODAY, WE HAVE A NEW RECORD LOW 5-DAY ARMS READINGS: 3.38 ON THE NYSE, AND 3.03 ON THE NASDAQ. THESE READINGS ARE LOWER THAN THOSE RECORDED AT ANY OF THE HIGHS THIS YEAR.

Just in case of a top has been put in, we’ll add this milestone. It will be invalidated if we make new highs from here.

The major indexes completed a “three drives to a top” wedge, fueled by three Invisible Hand interventions in the U.S. Dollar and OEX futures, supercharged by thin trading during options expiration week. The interventions occurred in the morning of the July 24 lows when JPM and Citigroup were on the brink of derivative failure, at 3:00am on August 5 after the IMF Brazil bailout, at midday on August 14, and finally in the early morning hours on August 19, culminating in a “fakeout punch” through the 50-day averages.

The drive was topped off by the lowest ARMS readings of the year, at the end of an all time record fastest point collapse in the VXN.

The last major countertrend rally of a cyclical bear market is always the most convincing – Damon Vickers.

Here's the Prudent Bear Market Summary by Rob Peebles

Northern Trust’s insightful and understandable economist Paul Kasriel recently noted that the consumer spending spree during the bubble years was no mirage. In fact, consumer spending as a percentage of disposable personal income broke out of a 35-year range around 1995. Household net worth as a percent of disposable personal income did the same. More amazing, Kasriel notes that in the Postwar period, household net worth never declined year-end over year-end until 2000. It declined again last year, and Kasriel thinks it will come in lower still at year-end 2002. It’s hard to believe that consumption will be vigorous in such an environment.

The problem with shrinking net worth is that debt loads don’t shrink along with them. In a recent interview, elliottwave.com’s Bob Prechter summed upon the debt situation thusly: ”During that third wave, from 1942 to 1966, consumer debt was only 64% of annual disposable personal income on average. At the end of the fifth wave in the year 2000, it was 97%, and as you point out, right now, it’s over 100%. So debt is greater than annual disposable income. We had total credit market debt at 150% of GDP back in the third wave. It’s 300% today.”

Debt is a drag.

Dukie - increases in the monetary supply are not, in and of themselves, necessarily inflationary. Inflation/Deflation are monetary phenomenons that relate to the demand for money. When demand for money grows and it is not supplied (via the money supply), money becomes more valuable and is not spent but conserved. When too few dollars are chasing too many goods, you have deflation. the exact opposite is true for inflation. In this case, is M3 and MZM are increasing but not enough to meet the increased demand, you have deflation. That is what we have been seeing for the last 5 years.

The problem with shrinking net worth is that debt loads don’t shrink along with them.

This is the essence of the horrors of deflation. As more current assets are devalued (result of deflation) to the new, lowered dollar value, the long-term debt is still at the old, pre-deflation dollar levels. More valuable dollars paying off less valuable denominated debt. This is the fear in the real-estate market as this is the only asset left that hasn't devalued due to it's extremely long contract lengths.

I can't give you a source right now, but these numbers are nowhere close to what I have seen. Basically, consumer debt to household equity was slightly higher in the 1990s than the 1980s. SLIGHTLY. You can jimmy the figures however you want to arrive at the ABSURD "300%" stat, but you know that simply defies reality. Americans do not owe THREE TIMES what they own.

This MIGHT mean 300% debt to INCOME (and I think that is high). But what has happened in the last 30 years is that "forced" savings of all sorts, along with government subsidized home ownership, has soared. Think about company pension plans, social security, health insurance (which is a form of income): Like it or not, all of these are "assets," along with life insurance, the home, and outside-the-company savings. As I say, the 300% number is nowhere close---not in the same UNIVERSE---as the numbers other economists have come up with.

Hi W.T.

I understand your point, that while the monetary aggregates have been growing, the preference for holding the dollars - or investing them real estate for example - rather than spending them has resulted in the flat to declining trend in consumer prices. See the following from Stepher Roach at Morgan Stanley & his concern about outright deflation.

http://www.morganstanley.com/GEFdata/digests/20020815-thu.html#anchor0

But what about the virtual ocean of dollars held by Europe, Japan, China, etc. and the claims they eventually represent against the US economy as a catalyst for consumer price inflation ?

Look, no matter WHO "HOLDS" the dollars, they are "inflationary" if PRINTED. Either in the form of investment interest or in the form of money being used for purchases, no money is "inactive". So either we have inflation or we don't---you can't point to "pools" of money held by others as if it is a big poker chit waiting to be played. It's a flawed assumption.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.