Second Quarter 2009 Market Update
By Jason Tillberg                                                                                                    July 1, 2009
    The second quarter of 2009 continues to be a challenging environment for investors.  The economic data that I have been following has provided no signs of “green shoots.”   This quarter’s update is chock full of graphs to help demonstrate where we are and where I think we are headed.  
The following topics will be discussed:
   The green bars on the left side are all those sub-prime loans that were reset.  When they did, many owners simply could not afford to pay the new higher mortgage payment and walked away.  The sub-prime lending problem has caused its havoc and the fallout is nearly over.  But watch out!  It’s the yellow bars on the right side, those prime mortgages whose rates are set to occur in the near future, which concerns me now.  There will be another huge spike in mortgage resets in 2010 and 2011.  With house prices continuing to fall, albeit at a slower pace, they are still falling and have not hit a bottom.  Just like when you jump out of an airplane, for the first 15 seconds or so, your rate of the speed of your fall increases, and then your rate of fall stays the same.  The speed of your fall has stabilized, but you are still falling and will continue to do so until you hit the ground.

    Americans went crazy borrowing both to buy new homes and also to borrow against their home.  At the same time, since 2006, house prices have been falling in value.  The chart below shows historical mortgages and the equity percentage (total mortgages divided by total value of all residential homes). 
   Last fall’s banking collapse, the free fall in share prices, the near complete halt of the world’s credit markets, were all largely blamed on what was called the “Sub-Prime” crisis.  Banks simply handed out far too many mortgages to people who were not credit-worthy.  These borrowers defaulted, which consequently led to a severe market correction.

    Fraud and manipulation from major banks and from the likes of Bernie Madoff, as well as the disastrous foresight and policy (intentional or not) from the leaders of the Federal Reserve, have played major roles in the market panic that was unlike any other since the great depression.

    Let me share with you some findings on why I believe the housing crisis in America is very far from recovering, or even stabilizing, despite what you may have heard from pundits in main stream media. 

    The graph below illustrates monthly mortgage rate resets from mid 2007 through to mid 2012.

Source: Federal Flow of Funds

Take note, the latest data tells that the total equity is now 41.4%.

    Freddie Mac, the government sponsored mortgage agency, did a presentation on the state of the mortgage market and I have pulled some charts from that report.

•“Prime” Crisis - The Next Potential Crises
•This Recent Bear Market Rally Coming to an End

“Prime” Crisis
    17% of homes with a current mortgage are worth less than the mortgage owed and 53% of mortgage holders have a credit score of less than 740. 

    If house prices were to fall an additional 10%, which is very likely in my opinion, it would make 28% of homes with a mortgage worth less than what’s owed on the house.

    Here is a chart that shows the ten city composite rate of change annually in house prices.

    Because house prices continue to fall and it takes years to pay off a mortgage, the equity that’s left in homes with a mortgage becomes less and less.  One in three homes in America is owned free and clear, that is - without a mortgage.  The equity that’s left in the homes with a mortgage is now only 24% and getting lower.

    The following charts give us more detail of the state of homes with mortgages.

   The last chart I want to show is the unemployment chart that is a reflection of what was expected in December of 2008 versus what is actually happening now.  This is also what the Obama Administration used to show how they felt the employment picture would fair with or without a massive stimulus package, which was since passed.
    The latest figure this morning puts unemployment at 9.6%.  A more broader measure of unemployment is U6 which includes discouraged out of workers who are considered to have given up looking for work or are currently working part time but would like full time work.  Including those, unemployement was 16.4% in June.

    It is in my opinion and estimation that because of the dismal employment picture and the future mortgage resets, along with many other factors like demographics, number of homes available, interest rates, the ability to even get a loan these days, and the very non-consumer friendly legislation getting passed, house prices will fall at least another 10% over the next 12 months and defaults will continue to soar.  This will potentially cause another banking crisis.  To put a number on the amount of money that banks will likely need to write down and then raise or go bust --- it could be as much as $1 to $2.5 trillion out of the $10.464 trillion of current mortgage debt in America.  This would be a “Prime” Crisis. 

When will this crisis come?   Nobody knows.  I don’t know for sure, but would guess sometime in 2010 or 2011. 

Will that crisis put in a bottom?  I think it may. 

Can all this be triggered and manipulated by the Fed?  Yes, this is possible.

Are the Fed policies transparent?  No, most certainly not. 

Can the Fed prevent this crisis from happening without disturbing the balance of the general economy or the dollar?  No, I don’ think this is possible.  

I am aware of this problem and I am doing my best to protect your assets and to seize opportunities that come our way.

                                                     Bear Market Rally


At the end of this February, stock prices started becoming quite cheap, but even more so, very oversold.  I wrote a brief article on February 26th, suggesting a bear market rally was about to start.  I hate to make short term predictions because usually, it just makes me look dumb when I'm wrong.  I was a good two weeks early last time around. The Dow Jones fell another 500 points but once it hit a bottom on March 9th, it took off fast.  By that time, 70% of members of the American Association of Individual Investors who responded to their market sentiment survey were bearish or expected stocks to fall (after stocks have already fallen close to 60%!!).  I liken that survey to what some call “the dumb money,” the retail stock investor.  When these people are all bullish and want to buy stocks, it usually means it’s time to sell.  When they are all scared out of their wits and want to sell, it’s usually a good time to buy.   

My bias is that this was a bear market rally and has provided a good chance to sell some holdings and lighten up on stocks or go short (to profit when stocks fall again). 

Fear has come down and investors are becoming complacent again.  This worries me.  I like to use what’s called the VIX or volatility index. It measurers investors fear by measuring how much investors are willing to pay for insurance on their stock holdings.  It has come down substantially since shooting to the moon in the fall.  It has also gotten technically over sold, or to use an analogy like a rubber band, its been pulled down and will soon snap back up.  When it snaps back up, fear will return and stocks could experience another selloff. 

    The red blue lines on the bottom being below 20 mean it’s over done to the down side.  Soon, this is likely to reverse.  I’m near certain a “Prime” crisis would bring it way back up again as investors will probably freak out and sell their stocks in droves.

Here is the same technical chart of the S and P 500.  Notice the red and blue lines over 80.  This is indicative that the markets are getting over bought now.  Stocks can remain overbought or get even more overbought, so there is no telling just how they will be moving in the coming weeks and months.  By bias however is to be more concerned and more risk adverse here. 
    As much as I’d love to see the economy get better, good jobs come for all, production of goods and services be plentiful and affordable, and an environment of less uncertainty, we have  some great challenges ahead.  We’re going to get through them, but it’s just going to take some time.

    To conclude, I would expect another set back in the stock markets in the coming months.