Your money has to be working for you all the time “Money in Motion” Blog is designed to help you understand how to keep your money in motion so that it produces the greatest return with the least amount of risk. “Money in Motion” will be updated as I see a need to address issues. If you want to be notified of an update please send me your e-mail address.
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I suggested in a recent blog that the bond market didn't believe that the government would default on Aug 2. I also suggested that the stock market would possibly return close to its recent high.
The S&P 500 is up from 1261 on June 15 to 1320 as of the time this blog was written. I still think that the S&P 500 will get somewhere between 1360 and 1370 before the end of August. Of greater importance is the fact that in the same period of time the stock market was advancing the yield on the 10-year T-Bond has moved from 2.86% to 3.17%.
As you can see the yield on the 30-year has moved to 4.42%. If bond investors are beginning to focus on the deficit debate in DC I can see why they might be worried. Clearly the President rhetoric last night doesn't seem to offer any cooperation from the White House. The White House seems to think we need $400 billion in new taxes over the next 10 years to solve the problem. If the yield on the 30-year T-Bond gets past 4.75% the equity market could be in trouble perhaps sooner than I thought.
Below is the chart on the hedge we have been using the TBT which is a short of the long-term bond market. The TBT price action is the exact opposite of the bond market. When bond prices rise the value of TBT falls as interest rate rise and bond prices fall the value of TBT increases. The chart shows the dramatic rise in interest rates in the last 2 weeks affect on the price of the TBT. Watch the debate on the debt ceiling that will give you the direction on interest rates and the market.
Most Americans don’t know that 55% of all the assets in American general money market mutual funds are invested in European bank CD’s and commercial paper. Moody’s and S&P have warned that if Greece defaults many European banks who are massive holders of Greek bonds would find significant declines in the value of commercial paper and other cash investments.
I think that if the markets re-price the money market investments from these banks the American money funds will be forced to break the $1.00 net asset value. This "breaking the buck" on a wide spread basis will cause a major run on the money funds. The last time there was a run on money funds was in 2008 and 2009 and then the Fed put up $180 billion to save the industry, but I don’t think they will do it again, because we don’t have the money.
Changes ordered by the SEC last year in money market mutual funds didn’t, in my opinion, go far enough. The two problems that led the Fed to bail out the industry in 2008 and 09 were extended duration and lower credit quality. Both of these issues were designed to get higher yields and both backfired. With 55% of money funds assets in European banks these funds have too much exposure to these banks.
I said in an earlier blog that I felt we could see as much as a 10% correction from the top of the market for the year. If we are going to get that 10% we need the S&P 500 to hit 1225. The current 200-day moving average is around 1250. We hit close to that 1250 level on June 15, 2011 when the S&P 500 had an inter-day low of 1258.
My best guess, as of right now, subject to adjustment that I will talk about in a moment, is that we will not hit the 1225 level this time around. It looks to me like we could have a nice rally from this level back to the 1360 to 1370 level on the S&P 500 by the end of August, but no new high.
I think the Fall of the year could see a significant decline in the S&P 500, perhaps as much as 20%. If that 20% were to be reached then it signals a new recession. What could make my target come sooner rather than later? As I have indicated in several past blogs the debt ceiling is critical.If Congress does not extend the debt limit with spending cuts then I believe that interest rates will rise, stocks will fall and the dollar could go into free fall. We will feel like we are back in September 2008 all over again. The other factor could be a default by Greece or other countries on their debt. Watch for the votes on Wednesday and Thursday this week in the Greek Parliament for the austerity measures, also the budget and debt ceiling story for the direction of the markets and interest rates.
The Harrisburg, state capital of Pennsylvania, isa town that I have driven through many times on my trek back to Columbus over the last 33 years. According to a recent analysis from the PA state Department of Community and Economic Development, DCED, Harrisburg is likely to end the year with a nearly $3.5 million deficit in its $58 million budget, and things are only expected to get worse. By 2015, the deficit is likely to be $10.4 million, which will eat up about 16 percent of the city’s general fund budget. It can’t be much surprise that the city finds itself essentially a ward of the state under the auspices of Act 47, a receivership program that is basically the final firewall between the capital city in the nation’s sixth-largest state and bankruptcy court.
“The City of Harrisburg is facing a direct, immediate and grave financial crisis,” the DCED wrote in a massive 422-page analysis of the government’s perilous condition. “The financial crisis is so severe that the City teeters uncomfortably on the verge of bankruptcy that could be triggered at any moment by parties outside its control.” The study further warns of possible “catastrophic results” in which bankruptcy might come from “the stroke of a judge’s pen.”
How did this happen?
Harrisburg, a city of 49,000 people, finds that its financial problems are multi-pronged, but started with what, at the time, seemed like a good idea; build an incinerator plant to deal with the solid waste not only for Harrisburg but perhaps other cities that were closing landfills and needed alternatives for waste disposal. This disastrous 2003 incinerator project that was supposed to be a revenue driver has ended up costing the people of Harrisburg millions of dollars in cost overruns and malfunctions. The city still owes $220 million on the bond issue to build the plant. The debt service on that project alone is $18 million per year, which amounts to nearly one-third of the entire 2011 city budget. How is it possible that a city that has a budget of $54 million per year can afford $18 million in interest payments and on top of that they still have to pay back the $220 million they borrowed to build the plant, They can't.
In short, irresponsible public spending combined with crippling fixed costs and an inability to grow have probably sent the City of Harrisburg into bankruptcy. My guess is that the state does not have the funds to bail out the city and take over not only the $220 million for the plant, plus the other debt of the city. Meredith Whitney has publicly stated that she feels we will see many municipal defaults at the city and local government level before things turn around. Harrisburg is one example of why I continue to shy away from municipal bonds and will do so no matter how compelling the value seems to be in the municipal bond market.
We are facing problems across the country where local and state government do not have the income to cover the liabilities already on the books. Some investors will lose some of their money. Keep in mind that even if you own insured muni bonds the insurance is only as good as the financial resources of the bonds insurers. If losses exceed assets the municipal bonds insurers will not be able to pay all the claims you will lose money even if you bought insurance protection.
This is why I buy preferred. The chart below shows a price change of Bank of America common vs, the preferred H which we own. The common came off its bottom but paid no dividend and has been falling back from its peak. The preferred came back and paid 24.4% in dividends in addition to the price recovery. This is a perfect example how being paid works.
In my Blog of Sunday night April 30 I warned about the possibility of a correction in the commodity, stock and bond markets. From that time to the close of business today, June 7th the S&P 500 is off just under six percent. Crude oil is down from about $115 per barrel to under $100, gold is up $3 to $1,530, and silver is down from $49.56 to $37.00. Housing in many sections of the country had prices fall to 2002 levels in the first quarter, almost all of this happened in just less than 7 weeks.
Last Friday the new jobs report came in, subject to later adjustment of course, at about 54,000 new jobs created and the unemployment rate went up to 9.1%. One side note about the 54,000 jobs; Morgan Stanley reported after the closing bell on Friday that they believe McDonalds created close to 30,000 of those new jobs. Not the best set of numbers for a president running for re-election, but more importantly not very good for the country.
While we added 54,000 jobs, the number of people looking for work increased and all those unemployment extensions will start to expire in late summer to early fall which could swell the ranks of the unemployed and drive up the unemployment rate. I think it will be hard to get support in Congress for further extension of unemployment benefits to those who have had three years of benefits. I have said to you in the past that the economy needs to create 250,000 jobs a month to hold the unemployment rate steady. Given that we have not seen the level of 250,000 for any period of time I have to believe that the unemployment rate will continue its upward direction throughout the balance of the year if we continue to see jobs reports like last Friday.
So, the big question is, “where do we go from here?” I got the initial down turn call correct--can I call the next move correctly? The one thing I believe will have the most impact on all the markets and the US economy will be the outcome of the increase in the Federal Debt ceiling. If we raise the debt limit with no meaningful budget reductions we are in real trouble. The credit rating agencies will downgrade US Government Debt quality and interest rates on our government debt will have to increase. The government will crowd corporations, state and local governments out of the bond market. If we lose our AAA credit rating, look for the dollar to fall substantially to record lows against all major currencies. We could see selling pressure by foreign investors in both the dollar and US Government bonds.
If that isn’t scary enough then think about this concept; some US Congressmen and Senators want the government to default on its obligations. It is important to them to punish the US. They believe that we must raise the debt limit and not cut the budget. In fact they want to spend more and they think by taxing the rich they will find the money to spend. I do not believe the well is deep enough for the rich to cover the current shortfall much less any increases. In order to try and convince the American people that we should raise the debt limit and spend more we will experience an onslaught of fear mongering to get the people to tell their elected officials to raise the debt and not cut the budget or benefits.
I’m afraid that if we don’t stand firm and cut the budget by a meaningful amount and seriously address the debt for our children and grandchildren we will not have the money to pay social benefits at any level. Speaker of the House, Boehner, said recently regarding the debt limit and the deficit, “we can’t kick the can down the road to the someone else to solve the problem.” If we fail on this issue then the scary feeling we went through on September 15, 2008 will be magnified many times over. This is such an import issue that if we let the genie out of the bottle we will never get him back and America will forever be changed for the worse.
In the blog I suggested that the bond market was telling us something different than what the stock market was screaming. The bond market was telling us that the stock and commodity markets were over priced and that the economy was slowing rapidly. I suggested that both the commodity and stock markets were headed for a correction. The first week of May both started a correction. The month of May economic releases showed that the economy not only in the United States but, around the world has hit, as some pundits are saying, are in a soft patch. By the way what is a soft spot?
These pundits don’t want to face the reality that there is a better than even chance that the economy will continue to lose steam through the summer. Calling it a soft spot is code for a slowdown or mini-recession. I actually heard a pollster suggest today the we have created 750,000 jobs and yet he didn't say that 1.4 million Americans have stopped looking for work in the same period of time. Based on the ADP payroll report on the past Wednesday many economists have substantially reduced the job creation report for this Friday. General estimates are for about 125,000 new private sector jobs and the unemployment rate to creep above 9%.
The number on Friday could be very disappointing or perhaps because of the reporting period be surprising to the up side. If the jobs report is above the 125,000 consensuses to anything above 140,000 then look for the market to rally in the morning. I would expect that after the morning rally this I would expect the market to fall off in the afternoon. Keep in mind that the market is down just over 4% since May 1, 2011. A normal correction in a bull market is 4% to 6% so we do have a little more to go. I think 1302 to 1305 are major support and a break through these support level could push us towards a 10% correction.