THINGS CHANGE FAST
A few weeks ago many thought I was out of my mind. I had the temerity to state that I thought that we were going into a depression, not a recession, and that the economic decline would last for two to three years. Now, it looks like a few others are coming around to my view. The chairman of Goldman Sachs recently said we are facing a banking crisis worse than the Great Depression. The former chairman of the New York Stock Exchange said it is comparable to the Great Depression.
More and more are willing to admit the magnitude of the problem. We continue to see a few Pollyanna types who want to see everything as sunny. For them, we have the following outlook. In our opinion, things will get sunny and big buying opportunities will periodically develop, but they will be interspersed with big declines, and a lot of hand wringing.
IT WAS PROBABLY MORE THAN SIX YEARS AGO THAT WE FIRST STARTED TO WARN IN THESE MEMOS ABOUT THE TOXIC EFFECTS OF DERIVATIVES. IT WAS ABOUT ONE AND A HALF YEARS AGO THAT DERIVATIVES CONNECTED WITH MORTGAGES BEGAN TO MELT DOWN
Unfortunately, we do not believe that this is not the end of the derivative problem. A bigger problem looms on the horizon. Derivatives are still being created everyday. Often, they are created by people who are just as greedy and self deluded, as those who created the mountain of mortgage derivatives that have brought the system to its knees. If the current unexploded mountain of derivatives were to implode, (as those derivatives connected to mortgage bonds did) the crisis could become much worse.
LET US SUMMARIZE
Derivatives and bonds connected to mortgage assets have collapsed, bringing the world banking system to its knees. Many other types of derivatives have not imploded, but may do so.
In the case of mortgage bond derivatives, they exacerbated an already serious collapsing mortgage bubble. The mortgage derivatives caused the destruction of the PACKAGERS OF MORTGAGE DERIVATIVES, also known as INVESTMENT BANKS, who drank the poisoned wine along with their clients.
In one year, the entire industry of large investment banks dissolved. They failed and/or were forced to become bank holding companies. This is the most astounding effect imaginable. It happened because the investment banks, believed the absurd valuations that they and rating agencies, had given to toxic assets (mortgage derivatives) which they held.
Eventually, some investors started to listen to analysts like Jim Sinclair, myself and others. A few investors began to grasp the absurdity of the mortgage derivative valuations, and the extent of the self delusion that investment banks and their clients were living under.
TODAY, ANOTHER EQUALLY BIG PROBLEM LOOMS ON THE HORIZON
This new problem stems from bonds (and derivatives on bonds) connected to consumer loans. Just as they did with mortgages, investment banks packaged pools of AUTO LOANS, CREDIT CARD DEBT, and STUDENT LOANS into derivatives. In our opinion, these too will eventually implode when the weak economy causes many borrowers to default on their loans. It is no mystery why Secretary Paulson yesterday announced, that he wanted to help consumer finance companies. The obvious reason is that bad debts on auto loans, credit cards, etc., are the next bond and derivative bomb waiting to explode.
DERIVATIVES THAT DO NOT HAVE TO EXPLODE
A third type of derivative is based on commodities and stocks, and speculation in commodities and stocks. These are known as options and futures on stocks and commodities. In many cases they are transparent and the underlying assets are liquid.
The rating agencies are another immense scandal. They operate in a field filled with conflicts of interest. We predict that they will be dismantled, sued, and may be hounded out of existence.
LOOKING BACK AT THE PERIOD FROM 1929-1942
The U.S. stock market peaked in September 1929 at about 381 on the Dow Jones Industrial Average. It bottomed 2 years and 9 months later in July 1932, at about 41…a decline of almost 90%.
Then a rally began. Over the next four years, the Dow went up over 300%. In our opinion, we should be looking for a big long term bottom sometime in the next year. From that bottom, we believe that the market could rally for prolonged period and rise substantially.
WHAT WE SUGGEST
In our opinion, during the correction phases, and when the market gets cheap over the next year or more, investors should search for value globally, and buy: growth stocks in several countries, gold shares, undervalued currencies, and commodities.
Thanks for listening.
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