Paul J. Lamont's  Instablog

(This is a free snippet from our January 9, 2012 Investment Analysis Report.) 

 While we were Hyper Bearish expecting an Asset Fire Sale in late 2007, we are more bearish now than at anytime in 2007 and 2008. Here is why…

 Money moving around the economy is slowing again in Europe and in the U.S. as the chart below shows. (We brought this same issue up in June and early September of 2008.) Remember this chart because we will come back to it.

Basically, to keep prices up (and not have a full blown deflationary Depression) debt must continue to grow. Governments stepped in after the last crisis to fill the debt gap created by the shrinking financial sector (chart below). This prevented a deleveraging and the widespread forced selling of assets from occurring. But now, governments have reached their own borrowing limit dictated to them by the bond market (i.e. Greece) or their populace (i.e. Tea Party).

As Bill Gross, world’s largest bond fund manager, states: “The financial markets are slowly imploding – delevering – because there’s too much paper and too little trust.” With little trust, money slows (the first chart we spoke about) and the financial system locks up again. Below is the first chart we presented with the inflation adjusted S&P500 overlaid.

So if we expect lower stock prices, it should be no surprise to see the following headline:

Individual investors’ bullish sentiment jumped to an 11- month high this week. The number of individual investors calling themselves bears also fell to a record low (i.e. they gave up). And since individual investors as a group are always wrong when it comes to the direction of the market, we can only suspect that the jump in sentiment will be over the cliff. 

Hunting the Herd at Head-Smashed-In Buffalo Jump - Alberta, Canada

“The "jump" kill involved what seems like a simple plan. Hunters would frighten or spook a herd of buffalo off of a cliff or high bluff. But to make the plan work required strategy. The right site had to be located, the animals had to be directed to the spot, and they had to be stampeded over the edge.” – Mass Kills. Texas Beyond History.

At Lamont Trading Advisors, we provide wealth preservation strategies for our clients. For more information, feel free to contact us. Our monthly Investment Analysis Report requires a subscription fee of $40 a month. Current subscribers are allowed to freely distribute this report with proper attribution.

***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.

Copyright ©2012 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at advrequest@ltadvisors.net, or call (256) 850-4161.

Fortune

According to Fortune (citing IMF data), Germany’s banks are now more leveraged than Lehman Brothers at the time of its collapse (Lehman: 31 to 1). Similarly, their leverage is financed by “cheap, short-term loans that are vulnerable to a market shock.” These loans (as we explained last December) are from money market funds here in the U.S. (Investors should Buy Treasury Bills instead.)

According to Fitch, “Forty-four percent of money market mutual fund assets in the U.S. are invested in the short-term debt of European banks.” Last February, we shared a Bloomberg table which showed European bank exposure to Portugal, Ireland, Greece and Spain. The worst of these is obviously Greece. Greek loans have been continuously falling in value and some currently trade at roughly 40 cents on the dollar.

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For U.S. investors, this is not going to end well. Their funds will be lost (or held up in a money market fund wind down/bailout) as European banks fail. And as Reuters is reporting, “Up to one in six European banks is set to fail an EU-wide financial health check...”

The ‘Ultimate’ Dollar Bear Turns Bullish

Last month, we mentioned that Jim Grant had changed his U.S. Dollar outlook. This month, “The Ultimate Dollar Bear” Jim Rogers on Bloomberg Television's “Surveillance Midday” (a must watch video) reveals that he is long the U.S. dollar. How bearish has Jim been on the U.S. dollar? In 2007, he sold his house in New York, moved to Singapore and has been teaching his daughters Mandarin (i.e. pretty bearish). But now he is buying U.S. dollars. He explained his reason to Bloomberg; “Because everybody is bearish, including me. I read that something like 97% of people are bearish on the dollar. I am one of those ninety-seven. So I bought dollars.”

                                                                                                   While Grant and Rogers are advising U.S. dollars, the Wall Street Journal reports: “financial advisors increasingly are telling their clients” to move “cash and shorter-term assets into foreign currencies and bonds.” This is an easy sell for Wall Street as “clients have become more receptive recently as they digest the risks of owning only dollars and the impact that could have on living standards over time.”

So on one side of the trade, Jim Rogers is buying U.S. dollars. As a reminder, Jim Rogers’ Quantum fund (with the assistance of his partner George Soros) earned 4200% over 10 years. And on the other side of the trade (doing the complete opposite of Jim i.e. getting rid of their dollars), you have Wall Street’s customers. Historically, these customers look at past performance, rush to give Wall Street their funds and are almost always left holding losses. How will this all turn out?

We may have a hint as the Canadian dollar is already down 4% in the last two months. (See Japanese homemaker-traders from 2007 and the subsequent performance of the Yen if you can’t wait for the conclusion of this particular episode.)

Meanwhile, AFLAC has just reported a $610M loss on European bank investments. Their reasoning for their investment was the same as Wall Street’s customers as they admitted to “a search for yield.”  As we stated last October, “Seek value, Do not chase yield.”

“We always have risk. The world is full of banana peels - that goes without saying. The difference today, across a range of markets is that you are not getting compensated for the risks that we face and the Fed itself is helping to create these risks through the manipulation and suppression of interest rates.” -  Jim Grant

“Holding cash is uncomfortable, but not as uncomfortable as doing something stupid.” - Warren Buffett

Full Disclosure: Paul J. Lamont holds U.S. Treasury Bills and a bearish S&P500 option position.

At Lamont Trading Advisors, we provide wealth preservation strategies for our clients. For more information, feel free to contact us. Our monthly Investment Analysis Report requires a subscription fee of $40 a month. Current subscribers are allowed to freely distribute this report with proper attribution.

***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.

Copyright ©2011 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at advrequest@ltadvisors.net, or call (256) 850-4161.

Acapulco Cliff Dive
By Paul Lamont
September 30, 2009

Two years ago in The Return of Capital, Not The Return on Capital, we stated: "...as an indicator of a major trend reversal, ‘Tens of thousands’ of Japanese homemaker-traders are leveraging their bets on a fall in the yen. As global margin calls come in, investors will unwind their positions, and the homemaker-traders will find that they were the last ones to the party. We expect the Yen to appreciate for the long term, causing major pain for these novice investors." The weekly chart below of the Japanese Yen shows just how wrong those homemaker-traders have been.

With that in mind, this week’s Wall Street Journal article: Small investors make big bets on currencies should be of interest. It reports that U.S. day traders are trading in foreign currency with leverage “as much as 500 to 1. That allows an investor to put up just a few hundred dollars of capital to make a bet of tens or hundreds of thousands of dollars.” How widespread is this kind of trading? It “now approaches $120 billion. That is up about 20% from a year ago and nearly double the level three years ago, according to Aite Group, a Boston-based financial-services industry research and advisory firm.” And why are these neophytes drawn to trading foreign currency? “The heightened interest in currency trading comes as the dollar is sagging.” Just as in 2007, we have novice day traders betting with large leverage on a falling currency. Expect a similar uptrend in the depressed currency, this time the U.S. dollar, as leveraged day traders meet a fate similar to the Japanese homemaker-traders of two years ago.

The Death of Diversification

 The U.S. dollar, just like the Yen in 2007, is being used in “carry trades, which allow traders to borrow cheaply in low-yielding currencies” and “give speculators like big hedge funds and prop trading desks at major Wall Street firms extra leverage to engage in ultra-low-cost speculation and reap rich rewards.” Dr. Marc Faber assisted us in describing the Yen carry trade environment back in January of 2007:  “the art dealers are bullish on art, the commodity traders bullish on commodities, the real estate guys bullish on real estate, the stock traders bullish on stocks, everybody has something to buy.”

Now, the dollar carry trade has created the same problem for wise investors looking for undervalued investments.

"Investors are moving in lockstep like never before, driving up stocks, commodities and emerging markets and risking a replay of last year, when they all plunged the most since World War II. The Standard & Poor’s 500 Index, whose increase in the past three months was the steepest in seven decades, is rallying in tandem with benchmark measures for raw materials, developing- country equities and hedge funds. The so-called correlation coefficient that measures how closely markets rise and fall together has reached the highest levels ever, according to data compiled by Bloomberg." – Financial Times

In last year’s unwind, diversification did not reduce portfolio risk. When all asset prices are overinflated by credit (through a large supply of/weak currency) there is only one haven; the formerly weak currency. As we recommended two years ago: “Therefore the wise contrarian strategy is interest-bearing cash. Over the next few years, most assets will fall in value as risk returns to the market and leverage is unwound.” With sentiment levels extremely one sided (only 3% of traders surveyed were bullish on the dollar), a swing in the emotional pendulum will reverse the dollar carry trade and cause speculative investments (which would include most assets) to collapse.

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With sentiment higher than it was at the peak in October 2007 and the market rising since March on waning volume, an Acapulco cliff dive from current levels would not be surprising. Time magazine described the scene during the Crash of 1929: “Around the floor word spread that the House of Morgan and the New York banks had put a cushion under the market. The market rallied. It looked as if the Morgan "miracle" had staved off disaster.” What followed was Black Tuesday:

“From the bell's first ring, it was panic; by day's end an incredible 16,410,030 shares had been dumped, capping the selling that had wiped out an estimated $25 billion in stock values. Not until 2½ hours after the market's close did the tickers catch up and carry the final sale. There was no longer any attempt by bankers or anybody else to stem the collapse. In just six days the whole world of easy prosperity had been buried.”

Predicting A Major Decline

Crashes are very rare and are almost impossible to predict. Yet the likelihood of their occurrence can be very high if conditions are ripe. As always, we warn that anything can happen. All we can do is assess the current environment, learn from historical examples and attempt to stay ahead of the herd. We continue to recommend that investors protect principal.

As Paul Tudor Jones stated when predicting the Crash of 1987, we wait for "...some type of decline, without a question...it will be earthshaking, it will be saber rattling, and it will have Wall Street in a tizzy and it will create headlines, that will be, that will dwarf anything that has happened to this point in time."

At Lamont Trading Advisors, we provide wealth preservation strategies for our clients. For more information, contact us. Our monthly Investment Analysis Report requires a subscription fee of $40 a month. Current subscribers are allowed to freely distribute this report with proper attribution.

***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.