Friday the 13th

By: David Chapman | Sat, Aug 14, 2004
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It's Friday the 13th and most people will immediately conjure up images of Jason in his hockey mask slicing and dicing horny teenagers at Camp Crystal Lake. Of course the myth of Friday the 13th is steeped in superstition as a day of bad luck. There are even those who have a fear of Friday the 13th called paraskavedekatriaphobia. It is itself a form of triskaidekaphobia or a fear of the number 13. There are numerous origins of the superstition from the fact that there were 13 people at the last supper of Jesus Christ who was in turn crucified on Good Friday to old Norse myths and differences in the a lunisolar calendar that has 13 months to the Gregorian and Islamic calendars that have 12 months.

Oddly the 13th is more likely to be a Friday than any other day of the week but that has not stopped Hollywood, those with phobias, strange evidence that suggests that Friday the 13th is actually unlucky for some and that businesses particularly airlines lose millions of dollars in business because people will not travel or go to work on the day. So in keeping with the spirit of the day we thought it would be ideal to lay out some of the scary things that are occurring in both the financial and political world that could derail investors in the coming months and even now.

Of course if you listen almost exclusively to Alan Greenspan and Kudlow and Cramer of CNBC fame you might be excused for thinking that all was normal and that despite short term problems the market will right itself and inevitably move higher. Of course what all of this is premised on is the undying faith many have in Alan Greenspan that he will consistently and persistently maintain system liquidity and provide the conditions to allow us to get through these problems.

So far it has worked, witness the huge stock market rally in the markets in 2003 and the improvement in the economic numbers and despite some sluggishness even some growth in employment. Despite the weakness seen in the markets in 2004 and recent sluggishness in the economy, the byword is to maintain a good mood especially leading into the November elections and that we are continuing a robust recovery. Further there is no bubble in the housing market, the debt is manageable and interest rates will rise but very slowly. Many others and we of course believe that this is merely wishful thinking and the economy and the stock market are so full of cracks and dangers that hiding the truth is just irresponsible.

Of course for the authorities to tell the truth we would have a financial panic of unprecedented scope. Wisely, we guess, they leave the doom saying to pundits such as numerous others and me to point out the cracks in the system and hope of course that nothing untoward actually happens leaving our credibility in shreds. We find that patronizing as it ignores the fact that numerous analysts actually come from many years of experience working for the very financial institutions, which we now criticize.

But that being said one cannot ignore the power of the Fed and its abilities to provide the liquidity and monetary conditions for the market to survive. They cannot prevent a market collapse per se nor can they save everyone from bankruptcy or prevent a sharp drop in housing prices but they can contain it if it were to happen. Even if we do not see conditions on the scale of the 1930's happening, there is always the nagging feeling that it could under the worst of conditions.

The stock market rally of 2003 was fuelled primarily by huge monetary growth with M3 growing almost consistently in the 10% range especially in the first half of 2003. After a sharp slow down in monetary growth late last year there was a further burst of monetary growth in the first half of 2004. Thus far the rapid monetary growth coupled with the ongoing low interest rate environment and no real shock to the system has allowed the economy to show signs of growth, provided a better business environment for profits and has helped maintain employment levels with some employment growth. But in terms of past recoveries it has been very anaemic.

But with the stock markets falling now to new lows for the years and highs almost consistently being lower than the previous high, as we move into the traditional seasonal weak period of the year there is some concern that we may have already seen the highs for the year. Not only may we have seen the highs for the year but also we may be headed significantly lower than most pundits are currently expecting. The following is our economic reasons as to why the cracks in the system may widen in the coming months. We follow it with political risk.

· Oil prices have shot to the highest levels ever crossing over $46 per barrel. While in inflation adjusted terms we are no where near the levels we experienced at the time of the Iranian Revolution in 1979/1980 rising oil prices act like a tax on the economy. Rising oil prices are an inflationary shock to the economy and they are an inflationary shock to financial asset bubbles. Financial asset bubbles are all built on the premise of ongoing low price inflation and a low interest rate environment. The US imports over 50% of its oil. Oil imports have hit record levels.

· Interest rates are starting to rise. While thus far the Fed has only hiked by 50 basis points it may not take a big rise to destabilize the market. The housing market has been fuelled by low interest rates and the big financial institutions and hedge funds use the low cost of short-term money (controlled by the Fed) to speculate in numerous financial instruments at a spread (carry trade). Rising short term rates and as well rising long term rates quell the housing market, make mortgages more expensive and spell the beginning of the end of the carry trade.

· The housing markets have been in a bubble now for the past two years despite claims otherwise that the market is not in a bubble. This is simply nonsense as in some areas of the US and elsewhere housing and condo prices have shot up 50% or more over the past couple of years. This is unsustainable and with interest rates rising the market is vulnerable. Worse, numerous mortgages over the past few years have been made on some of the worst terms we have ever heard. Loans up to 125% of value have occurred and 100% to 110% mortgages are not unusual. When the market crashes, as it will, people will walk away from these mortgages leaving the financial institutions with an oversupply. A Morgan Stanley report has noted that they believe that 25% of the global economy is infected by speculative exuberance in the housing market including Australia, Britain, China, South Korea, Spain, the Netherlands, and South Africa. Another 40% of the world economy there is a threat of speculative bubbles in Canada, the USA, France, Sweden, Italy, Hong Kong, Thailand, Russia and Argentina (Executive Intelligence Review, August 2004).

· The US triple deficits of trade, budget and current account are simply unsustainable. The trade deficit announced today was a record $55.8 billion and is currently on target for a yearly trade deficit of about $575 billion. Exports fell and imports rose primarily due to increased oil imports and higher oil prices. Predictably the US$ fell sharply and gold rose. The budget deficit also is on projection for $400 billion. Taken together the US is adding upwards of a trillion dollars a year in new debt. Much of this debt is dependent on foreigners to finance it primarily Japan and China. China, Japan and Asia in general are the major economic competitors of the US. With a growing dependence on financing coming from foreigners there is the risk that foreigners could pull back or even sell their holdings if they begin losing substantially on their holdings because of the combined rising interest rates and a falling US$.

· Hedge Funds and the financial institutions of investment dealers and banks increasing investments in carry trades and highly leveraged positions and massive derivative positions leaves them more vulnerable to shocks including rising interest rates, rising oil prices, and the threat of terrorist attacks. It has already been determined that hedge funds in particular were hit hard in the first half of 2004 with the sharp drop in the bond market. They too have been guilty of believing that the Fed will ride to the rescue and maintain an environment of low interest rates and endless liquidity in order to continue the leverage games they have been playing. It would be one thing that if it was just the hedge funds but the banks and the investment dealers are heavily into the same leveraged positions themselves. Could the Fed handle a financial meltdown across the entire banking and financial system?

· The consumer is, as they say, up to his eyeballs in debt. Never in history has the economy been as leveraged as it is today. It is estimated that in barely five years the consumer has gone from a 93% debt to income ratio to one of 115% and climbing. Most of it is mortgage debt but consumer credit card debt is also at unprecedented levels. Personal bankruptcies, defaults and mortgage foreclosures continue at record levels despite the supposed buoyant economy. The consumer is 75% of the economy and if the consumer is tapped out on debt and can no longer buy the economy will falter. Retail sales are showing some signs of faltering as the consumer is forced to spend more on basics such as food and energy. While oil prices may not yet have reached that point where it has a serious negative impact we are rapidly approaching that point.

If the cracks in the financial system are vulnerable it is in the political sphere where the shock may come that causes a financial panic.

· Oil prices are rising because of vulnerabilities of terrorist and insurgent attacks on pipelines in Iraq and Saudi Arabia. Two thirds of the world's oil supply is in the very vulnerable Mid-East and there have been attacks in Saudi Arabia although not on the oil facilities, attacks in Iraq and Iran also are potential flash points. Oil prices are also being impacted by the ongoing bankruptcy of Yukos in Russia (who supplies 2% of the world's oil) and in Venezuela where a recall vote this weekend may leave Chavez in power. There have been two previous attempts at a coup in Venezuela but Chavez has managed to stay in power. According to polls the recall vote will fail as Chavez remains very popular with the electorate. The US has been consistently linked to coup attempts.

· Iraq remains on a knife-edge. The insurgency of the militia Muqtada Sadr has the potential to turn into a full-scale civil war. No matter what one thinks of Sadr he is a powerful Iraqi cleric with a substantial following and they are fighting the US foreign occupiers. As with all foreign occupiers throughout history they fail to understand the people and their own history. There is a high risk of serious damage to the Islamic holy site of the Imam Ali Mosque as well as to one of the world's largest cemeteries of Wadi Salam. This would inflame Muslims globally as it would be seen as holy war. Imagine a comparable attack on the Vatican or Arlington Cemetery. Turning Sadr into a martyr would accomplish nothing. It was his father who fought the British during the British occupation following WW1. Some states are threatening to secede from Iraq, which in turn would trigger succession of the Sunni Kurds, which in turn could trigger a war with Turkey. The hand of Iran is increasingly been seen in Iraq supporting the 60% Shia population. The government of Ayad Allawi is seen as strictly an American puppet especially given his ties to the CIA and eyewitness reports of Allawi personally executing prisoners. Iraq, compared to the relative stability of Saddam, is in chaos and threatens to get worse. Even the trial of Saddam is in doubt as the chief prosecutor is being charged with murder. Mistrial anyone?

· There is a risk of a clash with Iran. Rhetoric has been rising in the US over the past several weeks concerning Iran's nuclear program. That the credibility of the US with regard to WMD is completely shot especially after Iraq does not seem to faze them as similar arguments are being made as to why Iran is a threat. As well there is some evidence that Iran is supplying Iraqi insurgents. Iran is part of Bush's Axis of Evil along with Iraq and North Korea. Further Russia is cementing ties with Iran and is providing them substantial assistance. Russia itself is planning a huge increase in military expenditures in the coming year. Russia, unlike Iran and Iraq, does have WMD and can deliver them in 45 minutes. The Russians have become increasingly concerned about the growing US hegemony in Central Asia and the Middle East in control of the oil supply and the proximity of US military bases to Russia.

· No matter what one thinks of the Orange alerts there is a risk of a terrorist attack. Trouble is being warned of its coming leaves it open to manipulation and far more questions then there are answers. The conclusion that it is Al Qaeda almost seems too simplistic given the ongoing warnings. One feels as if we are being set up to fail. Amongst the warnings are sources that say it is from Osama Bin Laden himself. There has been considerable capital spent on trying to prepare the American public that a terrorist attack not only could happen but that it will happen. Plans have been set in place to cancel the elections including what legal steps are necessary. The thought that the elections could be cancelled is being met more with a yawn then with outrage as the major media play their role of asking the question in a matter of fact manner. A terrorist attack triggering Red Alert could in effect turn the US into a military dictatorship. This is not to discount that it can't or won't happen. Indeed we almost seem to be guaranteed that it will. The bigger question of who could be behind it will be met with the pat answer of Al Qaeda because that is the answer we are being prepared with. This isn't to say it won't be Al Qaeda but that constant warning raises the question of who benefits and why. But no matter from where the attack comes from, the stock market would swoon and the financial system would be destabilized in a manner worse then it was at the time of 9/11.

An over leveraged economy, rampant speculation, the threat of terrorist attacks, sharply rising oil prices suggests one should just hunker down and stay out of sight. Indeed a pundit even suggested maybe I should just slit my wrists and go. Of course that would be foolishness in the extreme. Not that we are immune here in Canada but whatever the worst case scenario envisaged is undoubtedly no where near as bad as say those directly impacted in a terrorist attack or the people of Iraq caught in the crossfire.

We are showing two charts both of which we mentioned on a recent ROBTV appearance. The first is the chart of the Tokyo Nikkei Dow 1990-1995. We bring your attention to the consolidation patterns seen in 1991/1992 and again in 1993/1994. These were drifting patterns after rallies that followed sharp drops in the market. The rallies that followed the sharp drops looked impressive but ultimately they failed and the market fell to new lows.

Similarly the markets of the early millennium demonstrate comparable patterns. We have always been struck in the similarity between the collapse of the Tokyo Nikkei Dow of the 1990's and the current market. The giant topping pattern of the summer of 2000 played out as a drifting triangle until it collapsed. Similarly the drifting pattern of late 2001/2002 was a drifting pattern that collapsed into the financial crash of 2002.

Once again we are seeing this listless drifting pattern in 2004. Many believe that the rally of 2003 was a powerful first leg rally of a new bull market. It is not. It was a corrective rally fuelled by the easy monetary policies of the Federal Reserve. It saw little or no corrections. Now we are drifting aimlessly but with a series of lower highs and lower lows. These patterns that have characteristics of descending triangles ultimately collapse to test the previous lows and probably see new lows.

We are now coming perilously close to breaking the downside of the pattern. If we do we will collapse first to the S&P 500 960 area then most likely to the lows of 2002 and possibly even lower. It is time to batten down the hatches if you have not already done so. The oils and the golds could or should thrive in this environment. But others will suffer. It is now Friday the 13th and the real scary part may be about to begin. Haaa Haaa Haaa Haaa Chhhh Chhhh Chhhh Chhhh!!! (Theme from Friday the 13th The Movie).


 

David Chapman

Author: David Chapman

DavidChapman.com
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