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Here are the current top three stories in the NY Times Business Section as of 9:30pm ET, July 28th:

Back in January, I posted a short article basically saying that it was way too early to call a bottom in financial stocks.  I had been reading an article on TheStreet.com by Doug Kass where he made the case that it was time to buy the financial sector, via XLF.  

While I agreed with much of his analysis, I didn’t think the financials were anywhere near a bottom - most banks and brokerages simply hadn’t taken into account the full impact of the sub-prime mortgage debacle.  Those relatively few bad mortgages were so highly leveraged that just a few percent failure rate is enough to make the whole house come tumbling down.

Despite the best efforts of the Fed, Bear Stearns has disappeared.  It took a $30 billion taxpayer backed guarantee to do it, and I think the buyout simply swept the underlying problems under the rug and out of sight - for a few months.

The last few months are looking more and more like a rehash of the Internet bubble and the resulting bear market from 2001 through 2003.  during that time, I lost count of how many times I heard things like “buy and hold”, “stay the course”, “this is a great buying opportunity”, etc. 

The people who listened “to the experts” back then STILL aren’t back to even on their investments, while those who got out and waited for the smoke to clear are way ahead.  Those of us who are conservative investors, who follow broad trends and don’t move in and out of the market very often know that this isn’t the time to buy back in.

Could this be the bottom?  Sure - but I don’t think so.   I move in and out of the market in my 401K based on the crossover of the 75 day EMA and the 200 day EMA.  I usually go with an S&P 500 index fund, and here’s what the chart looks like today.

The 75 and 200 day EMA’s are nowhere near signaling the start of another bull market, so my retirement money is 80% in cash and 20% in overseas funds.  I’m down about 4% for the year - how’s your 401K YTD? 

If you’re still fully invested (like the “pro’s” tell you to be) you’re down over 12% YTD, and you’re right back where you where in July of 2006.  If you’re retired and you’ve been fully invested for the last decade, you’re right back where you were in March of 1999. 

9 plus years and zero return - how’s that “buy and hold” strategy working for you?

Anyway, it’s time for a check on Mr. Kass’s buy call on XLF.  I normally don’t make a big deal about stuff like this - after all, analysts make bad calls everyday - but he titled his original analysis “Buy the Financials. Yes, Buy” to emphasize what a great opportunity it was.  So, let’s see how XLF is doing since Jan 14th.

XLF closed at $27.88 on Jan 14th.  It closed today at $20.57.  That’s down $7.31 - or about 26% in about 6 months. 

Great timing on the “Buy the Financials.  Yes, Buy” call Mr. Kass!  I hope you haven’t screwed over too many investors with your advice.

In my original post, I made this prediction: “In my humble opinion, we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.”

Since I recomended investing in commodities instead of stocks, let’s see how my pick (gold) is doing.  Gold closed at $903.40 on Jan 14th, and it closed today at $931.30.  That’s up $27.90 - or about 3% in 6 months.

Yup, gold is up just a tad, and it’s actually off the highs of a few months ago.  It’s also just come back up over $900 after being stuck in the $860 to $890 range for a while - I mention that because it just came back up this week, and I don’t want to appear to be trying to hide that it’s been lower.

But as long as the Fed keeps printing extra money (inflating the supply) the dollar will keep falling, so gold will continue to hold its’ value for now. 

Only if Bernanke gets serious about fighting inflation and ensuring a stable dollar (which is the Fed’s primary purpose - read the Fed website if you don’t believe me) will the dollar rebound and gold fall.  And “Helicopter Ben” isn’t Paul Volker, so it ain’t gonna happen anytime soon.

For you too young to remember the late 70’s, inflation was high and the economy was stagnant - the term “stagflation” was coined to describe it.   We’re in the early stages of it now, and unless we get the Fed to grow a pair of brass balls, it’ll be 1980 all over again.

Raising rates and restricting money supply killed the stagflation, but it also caused a deep recession.  But that recession led to one of the greatest bursts of prosperity this country has ever seen.   We can do it again - if the Fed would administer the medicine.

As is stands, Bernanke is simply trying to keep a sinking ship afloat.  He doesn’t want a deep recession (or worse) to mar his tenure.  After all, he is an “expert” on the Great Depression, and he know’s what he’s doing.  Just like the experts calling repeated bottoms in the stock market.

I didn’t come up with any of this on my own.  Read  Warren Buffett’s annual letters to shareholders.  Read Phil Town’s “Rule #1″.  Read damn near anything by anyone who isn’t a Wall Street “expert”.  Their jobs are going away as the companies they work for are revealed to be a highly leveraged house of cards.  They’re running scared and are trying anything to keep up the pretense of the 80’s and dot com years.

What about the next 6 months?  I don’t see the financials (banks and brokerage houses) coming clean with their books yet - many are still pretending that their “level 3″ securities are still worth a lot of money.  Until they ‘fess up and take the losses they’ll just be on a long slow bleedout. 

This part is simply a guess, but I think Goldman Sachs is priced way too high.   At some point I think they’ll come down to earth just like the rest of the investment banks.  This might sound “out there” but I would not be suprised to see GS lose 50% (or more) of their value over the next 2 years.   Maybe sooner.  Something is fishy in their financial statements, but I can’t put my finger on what.  Just doesn’t smell right….

Back to the “hard vs soft stuff” that started this.  Don’t take my word for it - read and look at the situation for yourself.  Decide where to put your money because YOU want to put it there - not because some so-called “expert” on TV or the Internet said “Buy the Financials.  Yes, Buy”.

gk

I was responding to some comments to a post I made to www.seekingalpha.com a few minutes ago, when I said something that I think needs to be explained further.  I mentioned “leverage” and since that’s been in the news (especially regarding financial stocks) quite a lot over the past few months, I decided to expound on it a bit.

In the comment I referenced above, I said “Let’s say you have $1 million equity in your house, and you take it out in a HELOC. You take that $1 million and put 10% down on 10 other $1 million properties - and you depend on the renters to make your payments.“

That’s leverage.  I just took $1 million in assets (my home equity) and used it to gain control on $10 million in assets.  I used the words “gain control” rather than saying “to buy” because I don’t actually own them - the bank I borrowed the other $9 million from actually owns those properties.

It’s an important distinction, because what happens to my $10 million in assets if just one renter falls behind on their payments?  Suddenly I can’t make my mortgage payments.  It’s only 10% less income, but it causes me to suddenly have to sell the whole $10 million in leveraged assets - because I can’t make the payments.

That’s what happened to Bear Stearns.  They had some assets which they leveraged (borrowed against) in order to buy (with other peoples money) other assets.  When one small part of the initial asset didn’t make their payment, the whole house of cards fell.

In my example, I used a leverage ratio of 10 to 1.  Bear Stearns was leveraged over 30 to 1.  I’ve sen some arguments from pundits (including Ben Stein) where they say the markets have over reacted; that a 10 percent jump in the rate of defaults doesn’t warrant a 20 or 30 percent drop in the stock price of financial companies. 

They’re wrong.  And they’re wrong for the reason above.  When you’re that highly leveraged; when you have 20 (or more) dollars of debt for every dollar of assets; you are hosed when just one percent of the underlying assets doesn’t pay up.

Suddenly you can’t make your payments on all the debt you’ve borrowed.  And since you really didn’t make much of a down payment anyway, you have no equity in the investment.  If you had some equity, you’d have a little breathing room.

But you don’t.  You need every dollar that you’ve counted on to make those payments - because you’ve leveraged your equity. 

And what happens when the value of thoseleveraged assets turns out to be too high?  You’re fucked.  Not only are you highly leveraged, but the base value of thoseassets has dropped, so now you are more leveraged than you were just a monthago.  And so you’re even more vulnerable when there’s a small rise in loan defaults and bankruptcies.

It’s a wild, wild world right now.  I can’t think of a single bank or REIT that I’d touch with a 10 foot pole.  Go ahead and Google the news results for the 3rd quarter of last year.  Check out all the stories that claimed that the 4th quarter was the “kitchen sink” quarter.  Be sure to read how damn near everyone thought that the banks and investment houses have finally fessed up and come clean.

Now watch the headlines during the week ahead.  Let’s se how many additional write-downs there are.  A lot of people have written me saying that I’m overestimating the impact of the sub prime stuff.  Many have told me that all of those losses for the upcoming rate adjustments (for the Option ARM’s and ARM’s written in 2005 through 2007) have been accounted for, and that there’s no where to go but up.

They may be right, but I don’t think so.  I don’t think people truly understand the impact of leverage.  I don’t think they truly understand that just a 3 or 4 percent drop in the base asset (mortgages) can cause a company to disappear.  

I’m not putting my money back into the market until I’m sure that risk has been priced in.  Given the (in my view) extremely optimistic earnings forecasts for 2008 and 2009, that risk is being ignored right now.  I may be wrong (I often am!) but I think I’ll be getting 2 or 3 percent in my money market funds while the optimists are losing 10 to 20 percent (or more) trying to bottom fish the market.

Any questions?

gk

I’m sure Henry Paulson is a bright guy, but you’d never know it from some of his public statements.  Here’s what he said today according to FoxNews:

“There are always difficulties during periods such as this. There may be more bumps in the road,” Paulson said in a statement to reporters at the conclusion of the meeting of G7 finance ministers and central bank governors.

Duh.

After meeting with the world’s top financial guru’s, the people who are supposedly in charge of their respective countrys’ economies, that’s the best he can come up with?  Anyone who’s read a paper, seen 10 minutes of TV news, or even glanced at the front pages of the NY Times, CNN, FoxNews, ABC News, USA Today, or Google News knows this drivel.

“There may be more bumps in the road.”  Way to go out on a limb Hank.  Do you think you could be bothered to actually say something pertinent next time?  Or should we expect more enlightenment like this from you in the future?

The complete incompetence of this administration continues to astound me.  I’m basically a libertarian, so I don’t want the federal government to actually do anything about the current financial mess, but I do expect them to know what’s going on, and to make statements that give us peons a clue as to what they’re thinking - that way we can prepare for the inevitable mess they’ll make of the situation.

I say inevitable, because they can’t help themselves.  The government is basically powerless to do anything constructive to repair the mess they helped to create - but that won’t keep them from passing a bunch of stupid, worthless, costly laws that we’ll all need to spend time and money on in order to make sure we’re in compliance.

I’m talking about the current financial mess, but you could apply the same statement “The government is basically powerless to do anything constructive to repair the mess they helped to create - but that won’t keep them from passing a bunch of stupid, worthless, costly laws that we’ll all need to spend time and money on in order to make sure we’re in compliance.” to damn near anything the federal government touches.

Wow - I just quoted myself one sentence after I wrote it.  That must be some kind of record….

Anyway, thanks for the warm fuzzies Hank.  You displayed your awesome intellect with your statement today, and I’l glad that you think there “MAY be more bumps in the road.”   Good stuff, you ought to pass that line onto Bush, as it would sound even more profound coming from his mouth.

gk

Some headlines from today for perspective.

Fed Officials Saw Contraction in Economy `Likely'

Washington Mutual to slash jobs despite cash injection

Pending home sales index off 1.9% in February: NAR

Credit crunch cost $1 trillion estimates IMF

Basically there was a lot of bad news that came out today, and the US stock markets were down a little for the day.  Given the news today, I don’t understand why they weren’t down more - but you can’t argue with the markets. 

The market is always right (no, I’m not being sarcastic) and no matter what I think are compelling reasons for it to drop, the market will do what it wants to do.  The market is the ultimate arbitrator of right and wrong, because it will do what it wants to do regardless of what I think.

That’s the short term view anyway, and successful traders already know this.  I’m not a trader - I look strictly at long term trends - but I confess to being annoyed when the market doesn’t do what I think it should do based on the fundamentals and the news.

I’ve started to do a little analysis of the S&P 500 earnings based on Standard and Poors own published data.  No conclusions yet, but the estimates for Q4 2007 were way high, and I expect the estimates for Q1 2008 will be even more off base. 

The estimates I’ve seen are for a 12% drop in earnings in Q1.  That’s simply wishful thinking.  I’m expecting a minimum of a 25% drop (year over year) and I will not be surprised if the total S&P 500 earnings ends up 50% lower that Q1 of 07.

Any takers?

gk

A few weeks ago I disagreed with Doug Kass about when to buy stocks in the financial sector, but in reading his latest article on TheStreet.com, I’m in full agreement with him on this topic.  I too had read Ben Stein’s NY Times column “Can Their Wish Be the Market’s Command?” and I also disagreed with Ben Stein’s conclusions.  I even started a blog post detailing why I thought Mr. Stein was wrong, but I didn’t have enough time to make my points at the time, so I didn’t publish it.

It looks like Doug Kass has the same thoughts that I do regard Ben Steins column - it’s basically nonsense!  Mr. Kass did a better job of explaining it that I could have done, so I encourage you to read his post - he makes the points I was going to make, and he makes them better than I would have.

gk

http://www.thestreet.com/story/10400657/1/kass-ben-stein-blames-you.html

I wonder how Doug Kass is feeling about this advice he gave on Jan 14th?

http://www.thestreet.com/s/kass-katch-buy-the-financials-yes-buy/newsanalysis/investing/10398482.html

Yup, you read that right - he said to “Buy the Financials. Yes, Buy”.  Since Mr. Kass published his story on the 14th, the Financial Sector Index (XLF) is down more than 8% - and it was down 10% at one time Friday.  I may be wrong (I often am!) but I don’t think buying on the 14th would have been a good idea….

I think it’s waaay to soon to be looking at this sector.  Personally, I think we’ll see a couple of big bank failures before the financial house of cards has collapsed fully.  No, I don’t know who it will be, but I do know that you don’t make money in the long run by borrowing money (especially at today’s higher rates) to pay down debt.  Eventually you run out of willing lenders (can you say credit crunch?) and you have to face the music.

Banks and other lenders have been putting off the inevitable for quite awhile, and they may be able to postpone it a bit longer, but borrowing from Peter to pay Paul still works the same way it did 100 years ago.  It doesn’t.  Infusions of capital from the Middle East, reductions in the Fed Funds Rate, and issuing corporate bonds simply makes the eventual crash worse.

In my humble opinion, we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.  Another 20% to 30% decline from here is not out of the question, so sell some stocks and put the proceeds into simple money market funds or commodities.  In other words, it’s time to keep your powder dry (conserve your capital) so you can afford to pick up some bargains when this train wreck is over.

gk