The Economy Guy

Issue: 12/07/07 Friday

Today is a whole week’s report on the markets. I spent this week at Maui Mastermind improving myself, and it should spill over into this article if you are watching closely. I’ve left Maui, and am in Honolulu as I write this report.

The BIG DEAL this week was President Bush’s announcement that he is suspending interest rate rises on some sub-prime mortgages. This is such a big topic that I will devote a special report just on this subject, and get it out to you in the next few days. I’ll give you a teaser by saying that something knocked the bond market sideways on Thursday and Friday, and it’s not good news for you and me.

The stock market zoomed up on Wednesday and Thursday after falling slightly on Monday and Tuesday. The upward thrust was a lot of irrational thinking that everything is good in the garden, when in reality someone forgot the fertilizer.

Bonds were murdered and rose 0.25% this week. The majority of the move took place on Thursday and Friday, but I suspect the real players knew about the “Bush Plan” on Wednesday, and positioned themselves to sell bonds short. Bonds are still (almost) predicting a 0.25% cut in the Fed Funds rate next Tuesday/Wednesday, and the Fed meeting is really important. I would love to be a fly on the wall during that meeting to see what they say about the “Bush Plan” - and if it is recorded, they will probably have to bleep out a whole lot of comments. There is no doubt that the Fed meeting would have been an “easy” meeting until the “Bush Plan” was announced this week.

Here is some food for thought. In ‘87, ‘95 and ‘98 the economy was soft, and the Fed reduced the Fed Funds rate by only 75 basis points (that’s 0.75%) each time. Every time the Fed has reduced the Fed Funds rate by more than 75 basis points, the US economy has gone into a recession. The Fed has already reduced that key interest rate by 75 basis points this year. We are expected a further reduction next week, and maybe more in the future. That doesn’t bode well for the economy or for the stock market. Historically, when the US economy goes into recession, the major stock averages drop by 20%.

Oil, gasoline and gold basically didn’t change during the week, and we’ll ignore them in this report.

Here is the week’s news, and my comments about it.

Our crack intelligence service reported Monday that Iran stopped making a nuclear bomb in 2003!!!! That means we now won’t be able to look forward to WWIII. I bet you think this news can’t affect your money. Think again. War is a wild card, and it always affects investments. So, where did all that rhetoric about Iran and its nuclear bomb development come from???? Bush talked about it; Israel talked about it; and most other countries talked about it. Bush is still pushing hard for greater sanctions against Iran around the world – and NATO agreed on sanctions today. The most important person to talk about it was the President of Iran – you remember him; he’s the guy who came over to Columbia University and talked to the students during a UN meeting. He’s kind of a wacko with his finger on a small button. Where’s the truth? Who knows? (If you want to get into conspiracy thoughts, consider this. If we don’t bomb Iran in the next 2 weeks, that means this “intelligence” article wasn’t released just so the Iranian military would drop its guard.)

Someone forgot to tell the US Navy that China’s refusal to allow the aircraft carrier, Kittyhawk, to dock in Hong Kong as previously agreed, was a miscommunication. The USS Kittyhawk sailed gracefully between Taiwan and the China mainland (that’s known as the Taiwan Straits) on its way back to its base in Japan. When the Chinese refusal first occurred, there was a flurry of political statements between the US and China, and they were all contradictory. The US Navy knows how to respond correctly. They sailed in the most sensitive waters that China claims. I’m sure the Chinese leadership didn’t misunderstand that message. So why am I writing about this news? It’s because outside of the Middle East, China is the biggest, badest, strongest potential enemy that we have. China is shooting at our satellites; China is cracking our most sensitive computer systems; China is stealing our military secrets through espionage. All that is real, and the US military is preparing for the worst. Remember that war is a wild card, and can’t be ignored.

I will continue to point out to you that the sub-prime mortgage meltdown is still happening. The latest example is that Fannie Mae raised $7B (that’s with a B) in a stock sale. I guess they needed the money for something important.

Here is another indicative measure of how bad the “meltdown” really is. Every year securitized assets, like bonds or sub-prime mortgage bundles, etc, are downgraded or upgraded by Moody’s/S&P/Fitch. A downgrade means that the risk associated with those assets increased, and the possibility they wouldn’t get paid back has increased. In 2006 2539 downgrades happened. This year (so far) 19,795 downgrades happened. The assets we are talking about this year have a face value of $290B. Specific to the sub-prime mortgage market, 58% of all collateralized debt backed by sub-prime mortgages were downgraded. When over half of any security must be downgraded, a gross misjudgment occurred in the first place. This is a great example on how broken one aspect of the US securities markets truly is.

One of the wild cards that I’ve reported in the past is the possibility that some Central Banks may want to start selling their US bonds. That would raise interest rates quickly, kill the dollar, and put us squarely in a recession or worse. It turns out that Central Banks don’t really preannounce their intentions. Last Tuesday someone sold somewhere between $2.5B and $6B in bonds, and it wasn’t clear if it was a Central Bank or PIMCO (who represents individuals and Central Banks). Food for thought. Fortunately, there wasn’t any follow through, so let’s ignore this, and remember it happened.

Remember – look for the special report on the Bush Plan for sub-prime mortgages.

Here are Friday’s closing details:
DJ30 – 13,626
10 year US Treasury Bond – 4.12% - There was a Chuck Norris attack on the bond market today.
Euro $1.4663
Gold closed at $800 per ounce.
Oil Closed at $88.28
Gasoline is $2.27