Tuesday, February 17, 2009

Forgetfulness

The CBOT estimates the output gap, which is the gap between savings plus debt repayment and borrowing, to be $2.5 trillion. The stimulus is $800 billion. Which means it's too small. Also, one of the things we learned from Japan is that the multiplier effect is very small. As soon as the stimulus is removed, the economy plunges back into recession.

Forgetfullness?

What does that mean? Well, one of the things I've noticed is that I haven't heard about the Iraq War for maybe three months now. Three months ago, there was this daily mantra of "The Iraq War has cost us $2,000,000,000,000 (trillion)." What was this $2 trillion, but a fiscal stimulus of the economy? Granted, some of that stimulated the Iraqi economy, but most of it went through U.S. contractors, such as Halliburton or Blackwater, or any of the defense companies. But now we have a new plan.

So, how does the stimulus play out? First of all, it may very well bump up GDP (or at least put a floor under it) in the second half of this year, and possibly through next year. Even President Bush's measly $600 tax rebate checks bumped the economy up from a negative Q1 in 2008. However, the economy will wilt as soon as the stimulus is withdrawn. The question, then, is what will the unintended consequences or side effects be? One that popular opinion increasingly predicts is that the Treasury won't be able to borrow the money for the stimulus without pushing up Treasury yields. Since the U.S. is a trade deficit nation, this may be the case. It may well be impossible to finance both the trade deficit and the government budget deficit. Policy makers will most certainly choose protectionist measures to close the trade deficit if this becomes a problem. This makes me even more bearish on the rest of the world.

And now for the worst of it: S&P 500 earnings are coming in at NEGATIVE 9.00, according to David Rosenberg at ML. Earnings for the year will be about $28. And the S&P 500 is at 793.... hmmm...

Well, what to do with this info. First, I'd like to take some profits off the table, as it may be hard for the news to get worse in the short term. Second, this news is extremely deflationary, notwithstanding the stimulus. So, this points towards Treasury bonds, especially since at 3.5%, they're up almost 1% off the lows. Strength in the dollar will more than compensate for low yields and attract overseas investors. Some of the stimulus will go to savings and be recycled into Treasuries. The trade deficit is still at $40 billion/year. And finally, if the S&P 500 decided to go to a reasonable 12X operating earnings, we get 660, which will chase more retail investors into bonds. In Japan, individual investors learned the lessons of the Heisei bubble and now put their money in the bank, even though it earns nothing.

Trades:

Well, this bit of news seals the deal: Oil for December 2009 delivery: -$3.46 to $49.06. Deflation here we come. I'm going to buy a 70% position in 30-year Treasuries for maximum leverage of 100% of equity (with my current 30% position).

Oh, and there's more: state governments will eat $141 billion of the Stimulus. However, that doesn't cover the $350,000,000,000 (billion) budget deficit through 2011. The stimulus keeps shrinking and shrinking, in my opinion. States will cut spending and raise taxes - the anti-stimulus effect at work.

I was looking at taking a profit in OZN today, but it's still too cheap. The ore costs $600 to get out of the ground, but it's only $86/oz. in the ground. Cheap! ABX is at $266 in the ground + $415 mining costs = $681. IAG is at $320+$550, but they have vast resources at $700 in mining costs that are not included in reserves. These cost $130/oz in the ground, and you get them for free at the $320+550 calculation.

One trade today: bought 70% position in 3.5% 30-year U.S. Treasury due Feb. 15, 2039.

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