The Theroxylandr in Flame

As you can see here,

Bear markets begin when growth in real consumer spending (PCE) peaks and begins to slow

Today the Real Personal Consumption Expenditures are reported at 0% month/month growth (source).

Y/Y PCE chain deflator is 1.9%, Y/Y Real PCE growth is 2.7% (last month it was 2.9% and also 2.9% in April). It’s not horrible, but it’s bearish enough for the stock market

Back in June 12 I made a call that Treasury bonds are a screaming buy. As you can see on the chart my call was only one day before the absolute bottom that happened June 13th:

From the day I made that post 30-year bond returned 4%, which is nice for “AAA” investment. My money were where my mouth was, so I’ve made few bucks as well

Cramer in his interview says:

When your house is dropping 20% in price it’s smart to walk away from it even if you’re wealthy. It’s smart to walk away

The AHM problem reported by Calculated Risk is not just one company bankruptcy. It’s a stick in the heart of the whole REIT business.

REIT is a trust that is obligated to distribute 90% of all profits back to shareholders, in exchange it pays no taxes. The dividents are paid with significant delay, some REITs are still paying for 2006 profits. When the credit event happens many of those trusts will have warehouse lines pulled or repriced, but they still owe a lot of money to shareholders.

It spells massive defaults and market declines

Two weeks ago I’ve published an article “This time is different”, where I warned that the stock market is totally irrational. I’ve pointed that historically every crash of junk bond market was coincident with a market crash:

All the same pattern for the last 10 years, except this time.

So, this time is finally different? Yes, I think so. The stock market is finally separated from the reality

Now I want to repost the same chart again and show that everything is back to normal:

Now bonds and stocks are crashing together, as they always did.

How much downside is left? I think the McClellan indicator is already not too far from it’s typical bottom:

I want to see it back to “-100″’s levels before I take some profit on my shorts

What happened this week:

• The yield curve is inverted again. This is very important
• Funding drain as CDO sales slow – (this is what is called credit crunch)
• Market finally reacted, even though credit panic started few weeks ago. We all had plenty of time to sell stocks in advance
• Consumer was weak according to Q2 GDP report

What to watch next week:

• Personal consumption – the most important data now! (I expect nothing good)
• I’m looking for credit market panic to finally start looking for a bottom. There is no room to go down anymore
• I expect the yield curve to invert sharply

The headline GDP growth was pretty good, 3.4%, but you don’t to dig deep to see the sharp deterioration in numbers.

We need to concentrate just on two series: personal consumption expenditures and nonresidential structures investments:

                      I 06  II 06 III 06  IV 06   I 07  II 07

Personal consumption  4.4    2.4    2.8    3.9    3.7    1.3

Structures            15.0   16.4   10.8   7.4    6.4    22.1

Most of the GDP components are either coincident or irrelevant indicators, except those two above.

The personal consumption is the leading indicator, because, as shown in the “Ahead of the curve” book, it leads the chain of events in the cycle and is pretty good in predicting the bear stock markets. As you can see the consumer is struggling, which spells trouble in the nearest future.

In opposite, the non-residential capital expenditures, especially in structures, is strictly trailing indicator, meaning it usually peaks when the economy is very close to recession, sometimes it even peaks during recession. The reason is, the decisions to invest into new production facilities are usually made at the top of the economic cycle. The completion takes from 10 to 30 months, so it is pretty typical to see new factories and office buildings to be opened during early recession months. So the 22% increase in structures are, actually, bad news

The economy is clearly heading into recession and today GDP release is a good confirmation

As seen at capitalstool.com today:

The bond market is going right down the tubes – spreads are 20-30bps wider today and any bid is getting creamed…this is the worst i have ever seen including 91, 98 and 02.

the street is crumbling under inventory, traders are getting called back from vaca and guys are getting tapped on the shoulder (not to get down but fired).

Dow Jones just finished making the head, today we will start working on the right shoulder.

If  you forgot to panic before, now it’s the right time

I’m re-posting the message from yahoo board:

  Longs keep calling the bottom by pointing to valuations they don’t understand.

Here it is…the HB’s are not letting BV fall for a reason…
THE LENDER’S LOAN COVENANTS

This comes down to evaluating the builder’s assets

It’s common to see a HB parcel out a three phase development and borrow money to construct the first phase by using the land equity from the next two phases as equity leverage. The lender gives the builder set releases prices. For example; the market says the homes in the first phase will sell for $350,000 on average, the lender will set it’s release prices at 70-90% of the sales price, depending on risk. Release price meaning the builder must pay the lender 70-90% of the sales price before the lender releases title to the new owner.

The loan covenants for the lender typically tie down the builder in two ways.
1. The overall loan to value covenant, which will state that if at any given time the Loan to Value of the lender’s collateral goes below X%, the builder will be required to remargin the loan (come up with cash to correct the loan to value back to X% or less).

2. The release price % covenant, will allow the lender increase the release price to prevent future remarging. This means that the builder will receive even less cash on every sale. Basically the lender gets out of the deal faster if things are going south.

If the builder starts lowering their sales prices (lowering their asset value) and selling land for less than originally appraised. The lender’s covenants require them to put up more money that they don’t have, or take it they have cash and assets are drawn down further to remargin the loan. Even worse, release percentages rise and delay money they would have received to keep operations running.

So the game is played:
Say the builder thought they could sell a particle board box for $350,000. The market now wants more than just a pb box for that price, so the builder decides they’ll try and keep the price at $350,000 but offer a new car and an upgrade package. It is much easier to screw the greedy uncollateralized supplier of the upgrade material or greedy auto dealer than it is to lower the price and default on one of the loan covenants with the lender.

Sometimes builders use a mix of upgrades and price lowering, but they are calculating it very carefully. They know that violating a covenant is like being caught by a boa constrictor, the lender will definitely suffocate them.

In my opinion we’re now at the point that upgrades are not moving homes and prices must fall…when they do, they will collapse them to the break even point…the “every man for himself” mentality.

BV on HBs will collapse within the next 12 months…the game is officially over!

brazilncashew

Sigma is also called “standard deviation”. The number of sigmas is the confidence interval that something will (or will not) happen.

One sigma event has 32% chance to happen, two sigma is already 5% and three sigma event is rare enough to have only 0.3% chance to happen. Of course it makes sense only if the collected statistics is huge, so the case I’ll describe below is not strictly described by sigma as the history (number of data points) is limited.

Anyway, if someone will offer you $100 for accepting to be hit by the lightning with seven sigma chance you should take the money, as you have a bigger chance to be eaten by the lion escaped from zoo.

This is how twenty three sigma event looks like:

It’s CMBX-NA-AAA 3, the “AAA” rated credit default swap for commercial real estate.

You better stay home as the lion is waiting straight in front of your house