Can You Fight City Hall?

I keep reminding myself of the old adage “you can’t fight City Hall” as I analyze current market conditions. I hear the pundits on major media talking about the economic recovery. Many go so far as to call it a V- shaped recovery, yet I don’t see it. I do think the US economy has stabilized. I would even go so far as to state that the economy has rebounded slightly from the bottom, but in most areas the economy is still at historically low levels.

Housing was the spark that started the whole economic calamity and as I have stated many times – the recovery will not be firm until the housing market is fixed. The government stimulus for first time and existing home buyers has now ended. What happens next will be very telling about our economic future. Major media was all fired up today about the 6% rise in housing starts to a seasonal adjusted annual rate of 672,000. For comparison, the April 2006 housing starts were annualizing over 2,000,000 – so I would suggest that we still have a ways to go.

However the bigger number that should be focused on was the drop for new housing permits by almost 12%. I think that homebuilders’ realize that without the tax credits going forward, housing is going to slow again from these extremely low levels. Another disturbing trend reveals that 12% of mortgage defaults are now “strategic” and that it is okay in our increasingly hedonistic society, to walk away from a mortgage that you could otherwise afford.

Further, banks that do foreclose upon a home are not required to carry that home on their books at current value. For example, a couple borrowed $500,000 from a bank a few years back to purchase a home with none of their own money down. The home is now worth $300,000 and the couple has stopped making their mortgage payment. After about a year they are forced out of their home. The bank is not required to put that asset on their books at the real market value ($300,000) until they sell that property. The bank still shows it as a $500,000 asset. This process is repeated all over the country by big banks and small, on commercial, residential, and industrial properties of all sizes. The banks are sitting on huge amounts of inventory unwilling to attempt to sell those properties for fear of having to actually realize the loss. Therefore banks are overstating their current value and apparently investors either aren’t aware or don’t care a lot about that.

The Euro was the hot trade in 2009. Talk was that the US dollar’s status as the world’s reserve currency was numbered. How times have quickly changed. The Euro has been plunging since November with the recognition of the debt crisis in parts of Europe. The Euro has given up all of its gains from the last five years, and is back to 2005 levels, with the potential to go even lower. Some, including European leaders and top Euro bankers, are projecting that the Euro will disappear altogether as a currency, with European countries returning to the days when each country had its own currency. That would be a global catastrophe if that happened quickly or at all.

The Chinese stock market is at an 11-month low, down 24% since its peak last July. If you think we had a housing bubble here at home – the rise for Chinese home prices in some areas, over the last decade, has gone twice as far and twice as fast as real estate did here in the once hot markets such as California. If or rather when that Chinese bubble bursts, it will have a global impact. China is the second largest economy in the world and their markets had actually acted like a leading indicator to our markets over the last two and a half years. Hopefully we have disconnected from their stock market trends, if not, the future doesn’t look good.

Things aren’t much better for our own federal government. The US posted only its third April deficit in the past 30 years, according to data recently released by the Treasury Department. We had an $82.7 billion shortfall for the month of April 2010, the most ever in the month that Americans file their tax returns. Historically, April has been a surplus month for the government because of the April 15 tax filing deadline. But spending is up rather dramatically. April recorded the 19th consecutive monthly deficit. Remember, we just recently gave $50 to $60 billion to Europe through the IMF so May won’t be much better– but who’s counting.

From a technical standpoint the stock market appears to be rolling over. We decline farther and on much higher volume on down days, than we go up on the positive days. This is called distribution and it appears to be widespread. The “flash crash” conditions have not been resolved; therefore it would be naïve to ignore the fact that it could happen again at any time. If our markets close below their respective 200 day moving averages and non flash crash inter day lows (S&P 1094), then we could see a fall all the way down to 880 - 900 on the S&P.

Now for the good news, City Hall in this case is much larger than the biggest of all cities vestibules. In this case, City Hall is represented by the Obama administration, the Federal Reserve Bank, European leaders, large global financial institutions, and many others who have a vested interest in making sure our global economy all works out. This consortium has at their disposal, printing presses and is offering to its member’s access to unlimited funds at almost zero interest rates. Their motto of “print you way to prosperity” has resonated with many investors who believe that live for today for tomorrow we may die, is the best way to solve all our global ills.

It remains to be seen whether or not investors have had enough of this foolishness of trying to solve a debt crisis with more debt or not. We are on the short side of the market but remain wary with tight stops in case we blow our markets a little bigger before it bursts. We are fighting City Hall! For the good of all we hope some semblance of restoring order to our society will prevail. Whether for an individual, household, corporation, or a government the following is imperative; each entity must all learn to live within its means. Where it all went wrong is too lengthy to detail, but where we need to go is clear. Unfortunately it will take some pain to reconcile and the markets will need to correct.