“Jonathan has advised us for 5 years and always provided consistent, truly independent thinking with emphasis on capital preservation”

Tim Bacon (CEO, Colville Estate) and Marylyn Bacon (Kent) (2011)

Where's a Busby Berkeley when you need one?

Posted by jdavis on October 6, 2009

This email was sent ONLY to clients and the professional advisers who work with us.  After a few weeks we put it up on our site.

The name of our game is to hold on to capital until the true bottom presents itself in 2010-2012 (on the basis that the markets’ slump is similar to the 1930s crash. So far it is very closely following that route). Then, as we get lower and lower your risk of loss reduces further and further by re-entering. Then, we can start going back into the market and the decade afterwards should be very interesting indeed and, hopefully, super profitable. We see every reason to expect this – if you can hold onto capital during the falls then you will buy much more, with the same amount, at much lower prices.

That, in a nutshell, is what we are currently aiming to achieve for clients. Long term growth with preserved capital after this medium term slump.

Please remember, investments can fall as well as rise. And they will!

Please also remember, no trend goes in a straight line. Otherwise it would be called a straight line! The trend in houses and stocks is still very much down, in our view.
 

Who do you know who could benefit potentially from our type of advice? You are welcome, of course, to pass this email on or suggest to them to look at our website. We will always happily speak to anyone on the phone. It is never a useless exercise or a potential waste of time. If however we feel we cannot add value to their circumstances we will always try to help informally.

 

“The charm of history and its enigmatic lesson consist in the fact that, from age to age, nothing changes and yet everything is completely different.” ALDOUS HUXLEY


Chart #1 (Dow Jones crash in the 1930s):

 What to say?

Well, I said previously that the current collapse is following the 1930s crash very similarly.  There is the evidence.  Very sharply down in 1929 and then back up again by 48% (The S&P 500 is up c 58% since March due to huge government stimuli) in the first V to take place.

Ultimately, the US market went down 89% in the 1930s.  When you say it quickly it’s not so bad.  Until you recall the realities of that result.  I can remember people of my grandparents’ generation joking (!) they got an orange for Christmas.

Will it happen again?  Well, we’ve already suggested the S&P in the 400s within the next few years – that would be a nominal fall of around three-quarters.  On the other hand, inflation could come back quickly (not expected here) and the markets will rise inexorably (though high inflation would stop wealth being created).  In the meanwhile, currencies would collapse.

On the assumption they keep on printing and bailing out there’s a lot more pain to come.  In fact, we’ve hardly started.

The pain is less likely than before to be from inflation in the very short term.  The production of money is superseded by the destruction in value.  Watch commercial property over the next year or two – huge resets and voids will bring more huge bank losses.

On top you have resets of US mortgages.  Oh yes, they said it was over because Sub-Prime has been sorted. Yeah, right.

Chart #2 (US Mortgage resets monthly):

It is true the rump of Sub-Prime happened in 2008.  However, the other mortgage types reset (their interest rate costs after the beneficial period) just around the corner and the entire mortgage mess doesn’t peak until the second half of 2011.  And that’s just the US.

Option ARMs adjustments peak in August 2011.  Adjustable Rate Mortgages – just focus on that name for a moment – are loans where the borrower doesn’t even pay the accrued interest, monthly: it is in fact added to the amount owing.

These are not to be confused with Subprime or Alt-A (where the borrower stated his/her income and no-one checked.  No-one checked???).  These are the loans where payments can double and triple in a month.

(Do you remember the late 70s comedy ‘Soap’? “Confused?  You will be!”

We therefore must expect much higher default rates than (the apparent big bad) sub-prime – which was actually merely the canary in the coal mine.  Goldman Sachs expects 61% default rates – ever the optimists – Barclays Capital expects 81% default rates, which is consistent with early resets this year.  So, in the United States, that’s 3 or 4 in every 5 of these mortgages will go into default.  Yes, that is exactly what I said.

Most of these have growing amounts owed yet are backed onto properties with, still, declining values.  Remortgaging for the borrowers is not an option.

Looks like hundreds of thousands, probably millions of US mortgage holders will hold a mortgage of perhaps 200% Loan To Value.

Let’s play a game.  Let’s go to the bank or building society and request a mortgage of £400,000 on a house worth £200,000.  I think you get the point!

Australia raised its interest rates last night.  The Finance Ministers are talking about having saved the world (where was Bono?) and patting each other on their respective backs.

Green shoots?  Somehow I don’t think so.  Was it co-incidence Goldman Sachs last week uprated financial stocks, after they have risen 140% since March?

A client kindly posted me the pack from an investments’ seminar he attended with Citibank last week.  The essence – buy stocks.  Now?  After a 50% rise in 7 months?

Why not have the talk after they’ve fallen 50% from October 2007 to March 2009?
Answer – because they are salesmen flogging stuff which is worth nothing to them (as they hold them) and they are desperate to get rid of it, onto malleable private investors.

Plus ça change…

 

As we have said, there is a very high inverse correlation between stocks and gold, on the one hand, and the US$, on the other. The dollar has plummeted and stocks and gold have soared, over the last 6-9 months.

Gold, this evening, surpassed its all time high, set in March 2008 and retested February this year.  It could well be that it stays above the high and presses forward to, perhaps, $1250/oz.  That would put another rocket under our gold fund and the other commodities we hold.

The problem is it’s too perfect.  The $ is aching to fall through its all time low.  Yet, yet at extreme lows or highs assets tend to bounce back.  There’s too much positivity about stocks, after a huge rise.  I can’t help thinking that the $ could do what it did this time last year when the market melted down with the demise of Lehman Bros – it soared 15% within weeks.  This brought commodities down like a barrel off Niagara and stocks etc with them.

Markets normally do the opposite of expectations, short term.


As the Newcastle chap from Big Brother says: “You decide”!  Well, actually, we have pretty much decided.  Time to make some changes. Affected clients will be emailed within 48 hours from now.

We’re going to recommend reducing exposure by 10-20% and lock in gains.

Can the market continue rising? Of course? Is it more likely to rise from here, after a 50% rise, than fall?  Less likely.

Is it more likely to fall than rise?  More likely.

If it rises what are the chances it will then fall to below where we are.  I put it at well over 50% given the macro position.

 

Comments

There are no comments on this post. Why not add one below?

Post a comment

What is 7 plus three?