The (Rude) Awakening
Last week, a friend sent me a link to a Saturday Night Live (SNL) skit, wherein they present a "new consumer credit program." It's called, Don't Buy Stuff You Cannot Afford . What follows is a conversation between one of SNL's "credit counselors," as he happens upon a couple trying to balance their checkbook.
Wife: (sighs) I just can't get these numbers to add up.
Husband: Like, we're never going to get out of this hole.
Wife: Credit card debt, does it ever end?
Credit Counselor (CC): [walks in] Maybe I can help.
Husband: We sure could use it.
Wife: We've tried debt consolidation companies.
Husband: We've even taken out loans to help make payments.
CC: Well, you're not the only ones. Did you know that millions of Americans live with debt they cannot control? That's why I developed this unique new program for managing your debt. It's called, [presents book] Don't Buy Stuff You Cannot Afford.
Wife: Let me see that... [Grabs book, reads] "If you don't have any money, you should not buy anything." Hmm, sounds interesting?
Husband: Sounds confusing.
Wife: I don't know honey; this makes a lot of sense. There's a whole section here on how to buy expensive things using money you save.
Husband: Give me that... [Grabs book, looks at it] And where would you get this saved money?
CC: I tell you where and how in Chapter 3.
Wife: Ok, so what if I want something, but I don't' have any money?
CC: You don't buy it.
Husband: Well, let's say I don't have enough money to buy something. Should I buy it anyway?
Husband: Now I'm really confused!
CC: It's a little confusing at first. It's in the book. It's only one page long. The advice is priceless, and the book is free.
Wife: Well, I like the sound of that.
Husband: Yeah, we can put it on our credit card.
CC: [shakes head]
Announcer: So get out of debt now. Write for your free copy of Don't Buy Stuff You Cannot Afford. If you buy now, you'll also receive Seriously, If You Don't Have the Money, Don't Buy It, along with a 12-month subscription to "Stop Buying Stuff Magazine." So order today!
While satire can be useful in pointing out the folly of America's unprecedented borrowing and spending binge, the remedy will likely be so harsh that it precludes humor. Yet, the aspect of the effects of this credit phenomenon on the average American has long concerned me. So, with your permission, I will continue the story of the couple above, whom I'll call Bob and Sally Smith, in my own admittedly dour way. If you are fortunate enough to be reading this article with no credit problems, you still have been, and will be, affected by this historic, reckless expansion of credit. Beyond the effects of inflation, and the probability of deflation, the consequences of our profligacy will not play out in a vacuum and will not be nearly as hygienic as an academic discussion of this problem.
In response to the bursting of the stock market bubble of the late 90s, in 2001, the Federal Reserve began slashing interest rates, from 6.5 to 1 percent by 2003, bringing rates to their lowest levels since the Great Depression. Not surprisingly, as the credit spigot was opened wide, housing prices went parabolic. The unsustainable stock prices of the late 90s gave way to the unsustainable real estate prices of today. In 2004 and 2005, thousands of articles warned of a real estate bust, but the bust has yet to occur. Over the last two years, like us, many have cautioned that the stock market is again nearing a significant decline, yet no such decline has unfolded.
So, if things have been "good" for so long (three years is forever to most Americans), why do we so doggedly hold to the idea that there is a problem and that our current course is not self-sustaining? I think that we are nearing the end of this present course, and while no person can know that this is "the top" (until it is too late to do anything about it), keeping watch for "the top" has never been more crucial. So once again, this time - through the eyes of Mr. and Mrs. Smith, we will look at the line of dominoes, the first of which is teetering and appears to be starting to fall.
The Smiths have heard stories from friends, family, and associates that are very close to their own experience. One day, Bob recognizes a common denominator and becomes concerned. He realizes that a lot of the people he knows have taken on increasing amounts of debt and ponders whether his small view of the world is a microcosm of what is happening on a much larger scale across the U.S. While they are certainly not "pessimists," the Smiths decide to do some research on debt, which eventually leads them to a website called, prudentbear.com. There they happen upon the chart below. As they take in the size of household debt and the pace at which it's growing, and realize that this is not a chart of a few families in their circle of friends, but a look at the 300 million people that comprise the United States, they become increasingly ill at ease.
Bob and Sally have had enough bad news for one night and decide to veg out in front of the TV for a while. While they are watching their favorite nighttime drama, their show is interrupted by a funny commercial that starts off with a man riding his lawnmower over the front lawn of his new house. He talks to the audience about how he owns a new house, a new boat, a new car, a new country club membership, and his new lawnmower. And, with a smile on his face, he says, "How do I do it. I'm in debt up to my eyeballs." The solution, of course, is to "have bankers compete for your debt." For the first time, it seems to Bob that the lack of a suggestion that the man on the commercial lower his lifestyle or stop spending is a rather grievous omission.
Concerned that this massive amount of debt is starting to look like a ponzi scheme, where people take on more debt to pay for their existing debt (or debt payments), the Smith's decide to explore the financial state of our country a little more. Sally finds out that, since April of 2005, as a nation, the U.S. has not experienced one month where we actually saved money. She also notices that while the U.S. savings rate had been declining since the early 1980s, it's only gone into negative territory over the last year.
Bob thinks back on that home equity loan he took out a few years back. Luckily, he wasn't faced with the same decision he saw his friends go through. A good amount of them had to decide to either use up a chunk of their savings or take on a proportionate amount of debt during their prolonged job searches. Bob took out his loan to help out his son, Tim, who had lost his job. With no savings, a brand new house, and a wife and two children, Tim had never looked for a job so hard in his life. He'd lowered his lifestyle and slashed his spending, but he still took on a lot of debt. He finally ended up taking a lower paying job in another industry, but with the job paying less, things were so tight he was barely making ends meet. The debt was swamping him, so Bob, looking at his own options, felt compelled to take out a home equity loan and pay off his son's debts. Bob starts to think about all the people he knows who took out home equity loans, and decides to poke around and see if he kind find out how much people have taken out of their homes on the whole.
He comes across a chart from Dr. Paul Kasriel of Northern Trust Company. What he sees isn't pretty. With the help of soaring house prices, in 2005 alone, America as a whole, borrowed over $600 billion from the value of their homes. Bob tries to grasp the size of that number. The fact that it's a huge number and a record bothers him. But, what's making him nauseas is the rate at which it has grown since 2000.
Sally's had enough. She's ready to forget all this and watch her favorite sitcom. Then the phone rings. Her brother, Jeff, sounds really concerned. You see, he bought four townhouses as investment properties in a fast growing area of the city. Now, a fifth of the townhomes in that area are for sale, and the local paper just ran a piece showing that the number of homes listed for sale has jumped 250 percent over the last year.
The next morning an out-of-state friend calls Sally. She can't believe what's happened. She knew that a 99 percent increase in the value of her land over an 18-month period was unrealistic, but a 47% price drop in one quarter wasn't what she was expecting. Everyone had talked as though prices would level off or decline slightly, but not this. If she'd only sold when prices were moving up. Sally tries to console an old friend, but her words just don't sound very convincing.
Even though some of his funds had a fine performance in the latter half of 2005, Bob is now concerned about his investment portfolio. With Hurricane Katrina and rising oil and gold prices, Bob never expected his growth mutual funds to perform so well. And, while his co-workers have been talking about the stellar returns in their international mutual funds, Bob's been thinking about the effect that all this debt will someday have on the markets. He's also been uneasy because of a friend's recent comments about high amounts of insider selling. Bob remembers hearing about a lot of the insiders at his firm selling their stock in 1999 and early 2000, before the downsizing. He remembers watching his accounts decline and being told to "hold on" and "ride out the dips." He's not sure he wants to go through that again.
Right now, there are millions of Bobs and Sallys in the investment markets. They're hoping that the traditional strategies they used during the greatest bull market, and the greatest credit boom, in history will continue to work. They hear all the soothing rhetoric from conventional news sources, but they're starting to become aware of other news sources with different opinions, backed by hard facts from credible sources. While 2000 could be blamed on the dot-coms, the recent parabolic growth of credit seems to have broadened the speculation to nearly every asset class.
Let's let the charts speak for themselves. Here we see a chart from Alan Newman's December 5th edition of Stock Market Crosscurrents (www.cross-currents.net). This chart shows that there are 29 insider sells for every insider buy, or, if you prefer, 2000 shares sold by insiders for each share an insider purchases. One thing we know - people do not sell their stock if they think the price will continue to go up. With this large discrepancy, it looks like insiders are preparing for change.
When we look at Investors Intelligence (www.investorsintelligence.com), we can see further evidence of insider activity. They note 13 groups or sectors with the heaviest amount of insider selling in the last five years occurring in the first quarter of 2006. They also state that insiders tend to be right (and often early) and that the relatively heavy selling is a long-term bearish factor.
This type of action is called distribution. It means that strong hands, looking to lock in gains, are selling, and weak hands, chasing recent performance, are buying. As we alluded to earlier, the mania top in 2000 showed this same pattern.
As further evidence of distribution, we offer information from the Investment Company Institute. The first two months of 2006 have seen almost twice as much money flow into stock mutual funds a year ago.
Our next chart is from Jason Goepfert (www.sentimentrader.com). The terms may seem rather blunt, yet it points out that there are investors who tend to be correct more often than others and that these groups can be identified. This chart shows that smart money confidence is below 40 percent. Over the last four years this only happened one other time - January of 2004.
Next, we go to Alan Newman's March 20th issue of Crosscurrents and look at mutual fund cash levels.
Though it is not shown here, in January of 1973, mutual fund cash-to-asset ratios fell to 3.9 percent. By December of 1975, the S&P 500 was down over 45 percent. In March of 2000, cash levels were 4 percent. By October of 2002, investors had watched the S&P 500 get cut in half. In September of 2005, cash levels fell to 3.8 percent and are now averaging 4 percent. The historic record presents ample support that low cash levels warn of an impending decline.
Additionally, in his March Technical Outlook, Newman observes that with no Dow decline of 10 percent in over 1114 days, most investors believe that the markets can't go down. This is more than 160 days longer that the previous record and is the longest period without such a decline since the Dow Jones Industrial Average went live in 1896.
And while this market sleeps, other markets around the world have experienced some gut-wrenching drops in the last few months. The March Elliot Wave Theorist (www.elliotwave.com) speaks to the fact that emerging markets, like Saudi Arabia and Dubai, have been pummeled. The Saudi market showed a 28 percent decline in two and a half weeks. The Dubai stock market saw a 53 percent drop from November of 2005 until March 21 st of 2006.
Our final chart and comments come from Dr. Robert McHugh. With a doctoral in finance, Dr. McHugh was the Chief Financial Officer for two of the largest commercial banking corporations in America for two decades. He has also given Congressional testimony on matters surrounding the Federal Reserve. He now heads a technical trading publication called Main Line Investors, Inc.
McHugh explains that we are witnessing the Dow's sixth attempt in the last seven years to better 11,350. The only time the Dow succeeded was in January of 2000, when it went to 11,753 and then dropped sharply. Every other time this resistance level has been met, dramatic declines have ensued shortly thereafter. In technical analysis parlance, this is called major resistance.
Fundamental analysis, like household debt and mortgage equity withdrawal, tells us what will eventually happen. Technical analysis, like the charts in the rest of this article, tries to give us an idea of when it will happen. For more evidence of a major turning point in the markets, I encourage you to review our annual picture edition from 2005. While there is no such thing as a Holy Grail that can tell us "this is the day," when we start to see these indicators cluster together, we know that the risk is mounting.
If you have grown comfortable in the warm embrace of bullish rhetoric, I would strongly encourage you to do some homework. If you took a hit in 2000 to 2002, then you'll want to take some time and do a search on what your current "experts" were saying at that time. If their rhetoric was continuously bullish over the last ten years, you aren't getting advice; you are being sold. Ignorance is bliss, until it's not.
If you would like a copy of our research paper, Riders on the Storm: Short Selling in Contrary Winds, visit our website. This will also give you access to our new monthly newsletter, which is at no cost, titled The Investors Mind: Anticipating Trends through the Lens of History.