November 19, 2009

1) The US is turning into Europe. Think backbreaking taxes, chronic high unemployment, government involvement in everything, less innovation, and much lower growth, in exchange for a social safety net, more debt, and better coffee. That is the message the markets told us by retreating to the 6,000 handle in March, levels not seen since 1996, and down 54% from the 2007 peak. Equity prices have to shrink to multiples in line with permanently lower long term growth rates of maybe 1%-2%, a shadow of the 3% average rate seen for much of this decade. Hint: that analysis gives you a stock market lower than here. Perhaps this is what aging sclerotic economies are supposed to look like. Once Ben Bernanke stops spiking the punch with ecstasy and Viagra by raising interest rates, this is where the resulting hangover could leave us. If someone is holding a gun to your head and you must buy American stocks, only select names that are really foreign stocks in disguise. Microsoft (MSFT), Intel (INTC), Oracle, (ORCL), Cisco (CSCO) all get 60%-80% of their profits from overseas, where up to 90% of the real economic growth will come from for the next decade. Commodity, agricultural, materials companies, and their ETF?s also fit this picture. As for me, I think I?ll move to Tahiti and live off of coconuts and freshly speared fish, wearing only a loin cloth. Anything is better than becoming French.? And before you ask, that is not my behind in the picture below, but I wish it was.

2) The bond market vigilantes are gathering up for a lynching in Japan. Five year credit default swaps have jumped from 38 to 78 basis points since September, a move similar to the one that took AIG down last year, as institutions scramble to buy insurance before the house burns down. The rating agency Fitch?s is reaching for the Dramamine, threatening to downgrade Japan?s AA-?? rating as it sees the beleaguered country?s national debt soar from the current 180% to 227%, thanks to the new Hatoyama government?s policies. That would inflict a body blow on the bond market, and send the yields on ten year bond soaring from the current 1.42%. The big hedge funds are circling, with Greenlight Capital?s David Einhorn accumulating a major short in Japanese government paper. Remember him? He?s the guy who almost single handedly drove Lehman into bankruptcy a year ago. For more depth on the fundamentals behind this trade please, check out my ?End of Japan? piece? by clicking here. The only way to take advantage of this is to put on a short futures trade in Tokyo or Singapore, which trade from 6:00 pm to 3:00 am Chicago time, or to short the yen. If you want to know how to do this, e-mail me at madhedgefundtrader@yahoo.com, and I?ll get you set up.

 

3) One of my flock of canaries in the coal mine is the junk bond market, which is a great leading indicator of global risk taking. At the beginning of the year I stampeded readers into junk bond ETF?s like (JNK), (PHB), and (HYG), because the market was discounting a default rate of 18%, while I was expecting only 12% (click here ). These highly leveraged securities always overshoot on the downside when panic grips the herd. Believers reaped substantial returns, with JNK bringing in 65% since then. Now what? If you don?t get a double dip recession that default rate could fall to as low as 4%, as yield hungry institutions pile into the most leveraged companies with long term bonds yielding as high as 9.5% to 28%. That would cause JNK to double again from current levels. If we do plunge back into the Great Recession, as many hedge fund managers believe, then we could give up a chunk of this year?s gains. Let me know which one it is, will you? Even with the worst case scenario, I don?t think we will hit new lows. There was, after all, only one Lehman.