July 2007


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:

Treasury bonds

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:

SHIAX

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:

McClellan

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

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