It's The End Of The World As We Know It...

...And I feel fine?

Actually, I don't know about you, but I have an ever-growing sinking feeling that this house of cards we've built up around us is about to come tumbling down! As I sit here drinking my early morning coffee and musing over the latest round of disappointing headlines, I'm beginning to see that despite all the vain attempts by the Federal Reserve to plug their finger in the levee, there are just too many holes and cracks to even think about stopping the floodwaters now.

I find all this talk of the "green shoots" of recovery a little insulting, it's kind of like the emperor's new clothes - everybody is too afraid to tell the mighty emperor that he is in fact naked, and those magnificent garments are just a figment of his overactive imagination! I have no idea how we managed to have such a great rally during March and April, I figure that many people decided that "it couldn't really get much worse" and just jumped in regardless! The bank stress tests were little more than a sick joke and a waste of tax payers money, even the so called "worst case scenario" that they incorporated is a better state of the economy than what is actually happening in reality right now!! I'm sure that makes sense to someone somewhere, but it seems like a another cover-up to me. I've just about had enough of all the smoke and mirrors, let's just bring the facts out into the light and deal with them.

So, moving on. Retail figures anyone? Er...yeah, they're less than pretty. With consumer spending continuing to drop, we should be expecting another round of corporate losses, missed earnings, and falling stock prices. Add into that the continuing increase in unemployment figures, which are not going to improve anytime soon in the light of continued corporate bankruptcies and cost cutting exercises and you will soon realize that we're in for even lower consumer spending and a fresh wave of home foreclosures and credit card defaults. In fact, while the stock market was putting in a huge rally during March and April, the number of home foreclosures surged to a record high according to RealtyTrac. If it was the bursting of the housing bubble that got us into this mess, then I find it hard to imagine getting out of the mess without a significant improvement in the real estate sector and I don't see this happening for a few years yet. Yes, I did really say YEARS. I don't subscribe to the permanent mantra of "we should expect to see recovery in ...insert time 2 quarters away..." That's just not realistic. The huge wave of mortgage losses and loan defaults that we will continue to see is going to finally expose many banks as being little more than bankrupt shell corporations. The government cannot save them all, and really shouldn't try.

Actually, given the huge shortfall in the funds needed to pay Social Security and Medicare to the millions of baby boomers retiring this year, I wonder in the Federal Reserve should really be trying to save any company, period. I think the latest estimate for the shortfall is somewhere north of $50 trillion which dwarfs many other economic issues right now. We already know that the Chinese and Japanese have taken on just about as much US debt as they are likely to, so the Federal Reserve can't just keep on running the printing presses without decimating the US dollar which is only going to harm the country further. We've already started to see the beginnings of the unraveling of the dollar, and I'm sure there is much worse to come.

So where do we go from here? Down.

Disclosure - At the time of writing the author held shares in ProShares Ultrashort 20+ Year Treasury ETF (TBT) and Direxion Financial Bear 3X ETF (FAZ).

Selling Out On China?

On Tuesday morning, Bank of America (BAC) announced the sale of 13.5 billion shares of China Construction Bank, representing a 5.8% stake in the company. Bank of America (BAC) raised around $7.3 billion through this sale, which was required in order to meet capital requirements following on from last week's stress tests.

So what's the big deal you might ask? Well, where do I start? There are a number of interesting observations that you could make.

* The shares were sold at around a 14% discount to China Construction Bank's previous closing price of HK$4.91.
* Back in January, Bank of America (BAC) had already sold around $2.8 billion of China Construction Bank shares.
* There is no shortage of buyers for the shares, with a private fund headed by Fang Fenglei, picking up the lion's share.
* Rather than plummeting, the stock price actually rose slightly following the huge sale.

In fact, this year overseas financial companies have sold over $15 billion of Chinese financial stocks as they are forced to try to repair their shattered balance sheets. I see this in a lot of ways as counter-productive. They are being forced to sell valuable assets that will inevitably see tremendous growth in coming years and yet will have to hold onto a lot of the toxic assets that got them into the mess in the first place. Bank of America (BAC) was obviously very desperate to sell their shares, as they had to offload them far below market price, and I'm sure if they weren't locked into holding the remainder of their stake (around 11% of CCB) until 2011, that they would've attempted to offload much of that too.

It would appear that there is good liquidity among Chinese financial stocks, with this huge glut of shares being absorbed relatively quietly by a small group of investors. Where US financial institutions are resorting to desperate measures to try to raise capital, Asian bargain hunters are snapping up golden opportunities at great prices. It appears to be yet another example of the Chinese propping up the failing US economy. The Chinese are already the largest holders of US government debt, and now have the opportunity to use their vast cash reserves to buy up Chinese assets held by overseas institutions, as well as continuing to fuel their insatiable appetite for commodities.

I am confident that China will continue its amazing growth story, despite the recent global economic downturn. The reduced US demand for Chinese goods will only cause temporary harm to the Chinese economy as manufacturers will be forced to focus more on intrinsic growth within China rather than being dependent on foreign economies. This will fuel the next stage in the growth of China, resulting in a stronger, more independent, economic superpower which no longer needs to rely on the economies of the West. It is a little ironic that overseas institutions are being forced to sell out of such great Chinese opportunities as they are forced to take their cash off the table now.

Disclosure: At the time of writing the author did not hold shares in Bank of America (BAC).

Are We Headed For A Credit Card Meltdown?

Everybody likes to point their fingers at the government, or blame the banks for the economic mess that we currently find ourselves in, but maybe we as consumers have helped facilitate things more than most of us like to admit. Everybody likes to accuse the banks of being greedy, but ultimately they are in the business to make money for themselves and their shareholders, not to be charitable to the general public. We are all grown adults, and those of us that have made poor financial choices should take responsibility for them, learn from them, and move on.

The current financial crisis stems in part from people over extending themselves in the real estate market, obtaining mortgages that they couldn't really afford to pay, for assets that were declining in value. Not to mention the individuals using their property as an ATM to fund their indulgent lifestyles. The rapidly depreciating real estate market led to many individuals being in way over their heads, leading to foreclosures, short sales and the like. Many of us want to blame the banks, but they didn't force anyone to buy a house they couldn't really afford, they didn't force anyone to borrow beyond what they could feasibly pay back based on their incomes, they didn't force anyone to take equity out of the homes to spend on luxuries they didn't need, they simply helped facilitate what the consumer demanded.

Now don't get me wrong, I am not supporting some of the banks actions - they were irresponsible and reckless at times. I believe that if we knew more of what goes on behind the scenes and off the balance sheets at many banks, then the markets would fall much more than we have already witnessed, but I do think we need to take part of the responsibility.

Now we are left with a situation where those of us that were responsible with our finances, and made "smart" choices, are the people having to bail out the irresponsible and greedy! The scariest part of the situation is where we are headed from here.

The government and the media seem to be painting an overly optimistic picture of the current economic environment, saying that the worst is over and that the Federal Reserve has everything under control. I don't think we could be further from the truth, as two further bubbles are readying themselves to pop. I have already touched on the treasury bubble in a previous post, so I will not discuss it here, but the other bubble that is looming large is the credit card bubble.

Credit card companies have been seen to be raising interest rates, cutting credit lines, and closing inactive accounts. This serves to reduce consumer spending and confidence, and is a self-feeding cycle as it leads to reduced FICO scores, leading to reduced access to credit which in turn causes a further reduction in spending, hurting the economy further in the process.

The worrying thing is that with the level of unemployment still rising, we are seeing more and more people using credit just to survive and make essential purchases. People have already cut back significantly on large purchases such as houses, cars and vacations, they have also cut back on luxuries, electronics and the like. People are now relying on credit for essential, day to day purchases such as food, clothing and energy. Now, I don't know about you but I find this scary! Credit card companies have been reporting increasing numbers of delinquencies, and I fear the worst is still to come.

The Federal Reserve already has it's hands full with the banks, auto makers, insurance companies and the like, it cannot start bailing out individuals too! With rising unemployment, and reduced access to credit, the economy is close to a tipping point where the whole house of cards could come down at any minute.

Disclosure - At the time of writing the author held shares in ProShares Ultrashort 20+ Year Treasury ETF (TBT) and Direxion Financial Bear 3X ETF (FAZ).

Musings About Treasuries - Can We Make Sense Of Them Anymore?

A term which you are going to hear a lot in the coming weeks is "quantitative easing" which, put very simply, refers to the practice of central banks creating money. On March 6th, The Bank of England announced £150bn of quantitative easing, increasing the risk of inflation in the UK and now the US is following suit. The FOMC announced this week that it would purchase $300 billion worth of longer term US treasuries over the next six months. Unsurprisingly, this announcement caused the US dollar (USD) to fall, particularly against the euro (EUR), and the price of gold to jump.

The Chinese government has the world's largest holding of US treasuries and has recently openly expressed their discontent over the devaluing nature of the US government's activities toward their investment. If they were to fear that the value of their holdings was going to decline, they would most likely be obliged to sell them off and salvage whatever value they can before the market for US treasuries crashes. Which leads me to an interesting supposition, that the Federal Reserve is not going to be buying freshly created treasuries, which would have a strong inflationary effect, but in actual fact is going to buying existing treasuries from China! This in turn carries with it the implication that the Chinese will not be purchasing any more new treasuries from the US in the near future, increasing speculation that the Federal Reserve is set on devaluing the US dollar (USD), thus inflating asset values.

Of course, there are deeper implications to this as this effectively gives China the chance to increase its share of the global market and continue with its incredible economic growth. The credibility and influence of the US government over China is weakening, and attempts to coerce China into allowing the yuan (CNY) to appreciate will likely fall on deaf ears. There is even the scary possibility that China may decide to devalue the yuan (CNY) as the US dollar (USD) begins to slide. This will effectively bolster the Chinese economy and increase global market share. Of course, in practice it cannot be that simple, as the US government can always retaliate by increasing import taxes on Chinese goods and before you know it, the global depression is worse than it was to start with!

I believe that the discussion of the Chinese yuan's (CNY) valuation is going to be high on everyone's agendas in the coming weeks, particularly following the FOMC's move to devalue the US dollar (USD). Added to which we are likely to see some real fireworks in the treasury market. The outrage following the AIG bonus scandal will soon pale into insignificance in the light of more important events with much more dire consequences. I don't for one second buy into the heavily touted deflation banter and think that we're in for steady paced inflation in the upcoming months.

I expect continuing increases in the price of oil, gold and other commodities, and I ultimately fear a collapse in the treasury market. The collapse when it comes leaves me with the fear in the back of my mind that there is a strong probability that the US will have to default on its debts, as they cannot keep on printing money indefinitely. I do anticipate that the eurozone will crash first, which may somehow enable the US to crawl from the wreckage intact, but either way I don't believe the ride is close to being over.

Disclosure: At the time of writing the author held shares in ProShares Ultrashort 20+ Year Treasury ETF (TBT).

Reasons To Short Stocks

I was recently asked by a Mostly Money Musings reader about reasons that I would look for in order to consider shorting a stock. Rather than just post a comment reply, I thought this raised an interesting thought for a regular posting.

Put simply, when an investor goes long on an investment, it means they have bought a stock believing that its price will rise in the future. Conversely, when an investor goes short, they are anticipating a decrease in the share price.

Shorting is the process of borrowing a security, then selling it with the belief that it will fall in value so you can buy it back at a lower price before returning it to its rightful owner. The security will be loaned to you by your brokerage, either from their own inventory or from another client. It will be sold and the proceeds credited to your account, and after a time you will be required to buy the shares back and return them. A lot of the time, you can hold a short for as long as you want. However, you can be forced to cover if the lender wants the stock back for any reason.

The key difference between going long and going short is the potential loss in each case. If you go long, your potential for loss is limited solely to the money invested in the stock should its value fall to zero. If you go short, your potential for loss is unlimited, since the price of a security can (in theory at least) rise forever. In practice, this does not happen, however a shorted stock can easily rise enough to wipe somebody out! I'm sure that many short sellers lost their shirts during the technology stock bubble.

So, why short any stocks at all? The most common reason to short is to profit from an overvalued stock or market, although some will use shorting as a means of hedging - to protect their long positions.

What should you look for when considering a short sale? I believe that the most important factor to look at is deteriorating fundamentals. Ultimately, it is strong fundamentals that cause a stock price to rise, as they are the foundation of a company or market, conversely deteriorating fundamentals damage the foundations of the company or market.

In particular, you may wish to consider factors such as rising debts, rising inventories, falling sales and revenues, over-valuation. You may also wish to look for outdated technologies, companies that fail to keep up with the times. You may wish to consider the effects of changes in management or keep a watch on the amount of insider ownership.

In addition to looking at deteriorating fundamentals, it also pays to look at technical factors too, as they offer a clue that all the buyers have bought and there is no-one left to hold up the security. In this case, a price drop would be expected, and a short sale could be possible.

Disclosure: At the time of writing the author did not hold any short positions.

AIG - A Money Pit

Ok, so I don't know about you but my head is spinning! Not only has American International Group (AIG) posted the worst quarterly results in the history of the stock market, but it has been rewarded with more government bailout money! The insurance group managed to lose an historic $61 billion in just three months, and has just been granted access to a further $30 billion from the US government.

It is a mystery to me that American International Group (AIG) can still be a publicly listed company, it is a mystery to me than any single individual would go anywhere near their shares, and it is a mystery to me how they didn't see this coming!

Only the government can provide insurance where private companies cannot - after all, they are the only ones with enough resources available. Essentially, American International Group (AIG) got into the business of insuring a significant amount of the world's financial system against the consequences of a global financial meltdown. The US government had to step in and bail them out because AIG was totally incapable of delivering on that insurance. Ultimately, American International Group's (AIG) business of selling credit default swaps was a huge scam, as there was no way they could ever pay out on them.

The total bailout for AIG so far is in the region of $170 billion, which blows my mind. The worst part of the whole thing is that, I very much doubt that that will be enough. With American International Group (AIG) so intertwined in the global economy, they pretty much have the US government held at gunpoint whenever they need more money because of the disasterous repercussions following potentially bankruptcy of the company. Simply put, the government cannot afford not to bail them out, which is a really scary thought! If AIG were to fail, then the entire global economy would end up in a lot of pain, and very very few individuals would not feel it in some way or another.

Disclosure: At the time of writing the author would not touch shares in American International Group (AIG) with someone else's barge pole.

Inauguration Day Musings

Well I don't know about you, but I wasn't really expecting an "Obama bounce" in the stock markets today. I know there are many people out there, from Wall St to blogspace that have been trying to feed the bull, but there really isn't a whole lot to get excited about. Sure, it is an historic day. Sure, Obama is a great orator. Sure, he gave a very inspiring speech, but at the end of the day the markets tanked! I think that any "Obama bounce" is already priced into the markets, perhaps we're not down quite as far as we would've been had he not won the election, but we're down none-the-less. Maybe we'll see a true bull run in a few years time? 2011-2012 anyone? Your guess is as good as mine!

I think I'm correct in saying that today marks the worst Inauguration Day in the history of the stock market! I think that says a great deal more about the country's outlook than Obama could express in his speech. We're not quite in as bad shape as countries like Iceland, Russia or the UK, but there is a lot that needs to be done in order to inspire confidence in the economy. The proposed stimulus packages may work, but what if they don't? Can the country handle that vast amount of debt? And cut taxes at the same time?? In my mind, for any plan to truly have the desired effect in righting the economy, it has to tackle the debt mountain that is piling up. Is the US Treasury too big to fall? I know it thinks that it is.... but what if overseas investors refuse to buy our paper anymore? What does that mean for the US dollar?

Maybe all the bulls were watching the ceremonies in Washington, leaving the bears to run the show for the day?! I for one will be keeping a close eye on how the markets open in the morning!