Tuesday, December 29, 2009

The Mother of All Balance Sheets, Stock Tips for 2010, Government Guaranteed Growth and More!

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5 Min Forecast

December 29, 2009

  • Fed balance sheet back to near record… details reveal Bernanke's new master plan
  • Dan Amoss on the market that's just been "de facto nationalized"
  • Chris Mayer wraps up the worst decade for stocks ever…. and shares his focus for 2010
  • Plus, one sector on the verge of a new (government backed) boom

The 5 hasn't kicked off with an announcement like this in almost a year, so hear us out:

At midnight tonight, we will stop accepting new members to the Agora Financial Reserve. If you're serious about investing in 2010 – and beyond – this is the best help we can possibly offer. There's no telling when we'll accept new members again, and when we do, the membership fee will almost certainly be higher. So if you want in, this is the absolute last chance.

One good reason to guard your finances in 2010: The Federal Reserve's balance sheet has quietly ballooned back to near-record highs. The Fed announced yesterday that it's balance sheet expanded to $2.22 trillion last week, it's grossest level in nearly a year and just a hair from an all time high. Hmmm… if Mr. Bernanke assures us the recession is "very likely over," then why is the Fed balance sheet in crisis mode? What are they worried about? Here's the answer:

The Federal Reserve went from a non-existent player in the mortgage backed security market a year ago to owning $904 billion of the stuff today. The "private" bank has clearly moved its aim from the financial sector to housing, loading up on MBS, debt spilling out of Fannie Mae and Freddie Mac and Treasury bonds (a handy way to suppress mortgage rates).

Coupled with the Treasury's black check to Fannie and Freddie, we're detecting a trend.

Fannie Mae reported yesterday that "serious delinquencies" in its mortgage portfolio rose to 4.98% in October. That's up 172% from this time last year.

"The market will eventually adopt the view that Fannie Mae and Freddie Mac have been nationalized," opines Dan Amoss of the Strategic Short Report. "Last week's elimination of limits on Treasury's capital infusion into Fannie and Freddie is a de facto nationalization. In other words, there's no longer much chance of a re-privatization, but instead we'll see a gradual transformation of these Frankensteins into new branches of government. They'll implement the official government agenda for housing, without much regard for prudent lending.

"This will have huge consequences for the Treasury market. While the federal government will stick to its Enron-style accounting, and not officially consolidate Fannie/Freddie assets and liabilities onto the government balance sheet, the smarter foreign creditors will. These creditors will start viewing Fannie/Freddie liabilities as equal to Treasuries in terms of default risk. But this doesn't mean that spreads on Fannie/Freddie liabilities will tighten down to Treasuries; rather, it will substantially increase the long-term default risk of Treasuries, and Treasury buyers will demand higher rates to compensate for this risk.

"In summary: the Treasury's Christmas Eve announcement (link)adds substantially to the case for higher Treasury yields in 2010."

The stock market is enjoying a bit of a Santa Claus rally. The S&P has risen (albeit by small amounts) six days in a row, and along with the Dow, started this morning at a 2009 high. These indexes opened to small gains today, as the Case Shiller home price index showed a very moderate improvement for October while the latest consumer confidence reading inched up in December.

More proof investment optimism is back: Investors dumped $11.1 trillion in U.S. stock funds last week, the highest level since June 2008 (three months before the market crashed).

"We're just about to wrap up the worst decade ever for owning stocks," Chris Mayer writes to his Special Situations readers. "That's not really a surprise to those of us who pay attention to the price paid to own stocks. They were too expensive and too popular for a long time. In late 1999, the S&P 500 traded for 44 times earnings -- an all-time high. In 1982, when the great bull market began, the S&P 500 traded for something like 8 times earnings.

"These are overly simple measurements and not worth paying attention to most of the time, but when they reach extremes, they can tell us something valuable. We are not in extreme territory anymore. The WSJ points out that the S&P 500 trades for 20 times earnings today. That's not cheap. But it's also not horribly expensive, either, especially if you consider that we are in a recession and profits may well improve big-time over the next few years…

"I think there are more bargains in the smaller-cap stocks than the big stocks. Jeremy Grantham thinks U.S. large-cap stocks are about 30% overpriced. Grantham is co-founder of money manager GMO. He has made a lot of good calls, including his 1999 prediction that stocks would lose money in the next decade. (They did, though not as much as he thought.)

"I can see this too in my own research. I always have ideas for Mayer's Special Situations because MSS makes its living in small and underfollowed stocks. In MSS, all of the stocks we picked up in 2009 -- save one -- had a market cap below $1 billion. I'd expect this trend to continue in 2010."

"The market for dividend yielding stocks is becoming overpriced," cautions our income investor, Jim Nelson. "Dividend changes are cyclical. So instead of tracking them on a rolling monthly basis, let's look at the rate of year-over-year change. Below is the rate of change for only dividend increases…

"In November, the downward slide ended. It was the first month since pre-recession to see the number of positive income actions increase year over year.

"Now, if you've been reading The 5 long enough, you probably aren't surprised by this. After all, the market is never logical. It is constantly overcompensating for momentum. Oftentimes, this gives us opportunities to buy cheap shares of income payers. Unfortunately, we are at the other extreme right now -- an overpriced market.

"You hear pundits and politicians alike claim that we may not be fully recovered to pre-recession levels, but we are on a straight path toward it. That's what the chart is showing. The boards of directors behind the recent dividend changes are, obviously, listening to the pundits and politicians. This will most likely cause a second crash in both share prices and income payments.

"In short, there will be safe plays out there, but not necessarily the ones jacking up their dividends. We strongly believe our Lifetime Income Report portfolio will stand up to the test. As we write, there are four companies in the portfolio left in our buy range. We suggest you get into them as soon as possible."

Commodities are staying on the sidelines today. After a hefty rise over the last week, oil is taking a breather at $78 a barrel. Gold's been in trouble lately, and is now resting at $1,100.

Last today, and opportunity: Nuclear power in America is about to enter a new era. Likely this week, the Energy Department will announce the first wave of nearly $18.5 billion in loan guarantees for expanding the nuclear industry in the U.S. This is a subsidy almost five years in the making, and should it pass, the first of its kind since the Three Mile Island fiasco.

"I find it interesting," a reader writes, "that Hugo Chavez is dictating to Toyota about production quotas on SUVs with a threat to seize the production plant and getting the Chinese to run it. Chavez has no clue how the Toyota production system works. It is set up to meet demand as demand dictates. All other manufactures work on a batch production system and if you try to use batch methods in a TPS environment, it will fail badly. And if the Chinese aren't familiar with the Toyota system, they won't be able to make it work either. I would like to see Chavez take over the Toyota plant and see how many pieces of junk that won't work he can get produced."

The 5: We doubt he knew more about oil services than Exxon, but that certainly didn't stop him.

What's interesting to us is his point of view. Currency controls in Venezuela make it tough for any foreign company to do business. Labor laws make it even harder for a large manufacturer. And the auto market there is really small to begin with. Yet Chavez says Toyota (capitalism in general) doesn't play fair.

"The founding fathers would have NEVER supported an internal ethical and moral compass as far adrift as we find now," a reader writes, referring to yesterday's inbox. "NEVER would they have advocated the road to communism we now find ourselves on. Should this administration achieve all that is proposing, the Federal Government will own/run 71% of the entire U.S. economy. Want to see the U.S. not far from now? Just look a little south to Venezuela. We're on an express train.

"The 5 is the only newsletter I seek out to read daily. Keep up the great work."

"I would LOVE to see the faces of the founding fathers if they reappeared today!" exclaims another reader. "Can you imagine how they would react to seeing a 'slave' (?) running the country! Probably about the same as Charlton Heston's character in Planet of the Apes. After all, most of them had slaves when they started this "mess" we love so much."


Ian Mathias
The 5 Min. Forecast

P.S. Last call. At midnight tonight, the doors slam shut. If you want to join the Agora Financial Reserve and get our best investment advice for the rest of your life, you cannot delay any longer. Details are here.

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