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Posted On: 2006-12-13
Length: 14:34

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Hello, this is Johannes Earnharth and you're listening to Vigilant Investor daily today and we have had another mild day in the market, not a whole lot happening there. The Dow Jones Industrial up a mere 1.92 points to 12,317, that's twelve, three, seventeen. The S&P up 1.65 to 1,413. The Nasdaq Composite is up 81 ah, .81, that's to 2,432. And, not a whole lot really going on there, we're talking about a market that is slowly quieting, those three indexes relative to their earlier highs, just not too long ago, but still down about a quarter percent, for the Dow, about three-tenths of a percent - almost four-tenths of a percent and down, that's for S&P, and down 1.5 percent for the Nasdaq. We always like to talk about the VIX, the CBOE volatility index, that's dropped another four and a half percent today, it's down to 10.17 and we're closing back in on at 9.81 low, 52 week low, and it's almost as if the old volatility worries are just simply not there anymore. And, moving on to the dollar, the dollar gained a little bit of strength today, and has finished up above on the USDX, which is the trade - or excuse me, the weighted index against five major currencies, and that's up 83.33 today. So up three, almost four-tenths of a percent and you know, anything above 83 is showing a little bit of strength and we're getting a little bit of a bounce from that low that hit just a couple weeks ago, after the Thanksgiving holidays. So, all said and done, not a terribly crazy day out there in the marketplace.

We did have a chance earlier today, one of the things I want to talk about is attending a CFA conference here in Pittsburgh, where I am, and it was actually a luncheon, and I managed to hear one of the folks from Morgan Stanley speak. Who I ended up hearing was David Greenlaw. I was actually expecting to hear somebody else, but David Greenlaw, the managing director and chief U.S. fixed income economist, and his duties basically are, you know, helping modern and U.S. economies and credit markets. And he and Steve Roach and the guys sit around and decide what some of the predictions are that would be relative to their forecast and everything at Morgan Stanley. So it's interesting, or his viewpoints on what's going on in the bond markets. And, one of the things he focused in on that I hadn't really drove in on myself, that I thought was of value to our listeners, is that the Japanese are very much the ones who are very, very, very, very bullish on bond rates and oftentimes we talk about why are bond rates staying so low in the face of, you know, some of the things we talk about week in and week out. Who would want to own U.S. bonds at 50 year lows and so forth? It appears that the Japanese market, from what Dave was saying is that the Japanese market, especially the private sector is driving a lot of these low rates. And their expectations are that the Fed will be forced to drop interest rates. And that will help the bonds rally, and therefore they're very bullish. And that was one of the reasons that he gave and he also tended to dismiss the real effects that foreign central banks have relative to their concerns about interest rates. He kind of was talking about how, well heck, it seemed like, it's almost a little bit of a mindless approach to how they go about accumulating their reserves. And he pointed out that in China, their treasury management some, you know, order eight hundred billion dollars is done by five people in a room that is not too, too large. It was, we had maybe eight to ten, I would say probably ten tables in our room with maybe eight people sitting around it, like in the size of their trading room or their monitoring room, not that, that room. And mostly just four quarters of each of the key players who were doing the management and so where their staff were out there in a giant globe in the middle of the room. So, he seemed to be a little bit taken aback that they would have about five people managing eight hundred billion dollars of U.S. reserves, or, Chinese reserves and U.S. held assets. U.S. dollar denominated assets. So that was kind of interesting. But, in any event, again his point was that the foreign central banks really don't seem to be all that concerned about the rates in which they're investing. And I tend not to agree with that. One of the other points that he made was what their expectations are at Morgan Stanley; that the housing will only drop about 5 percent and really focused in on the fact that a lot of the housing appreciation bubble has been confined to the top 10 percent of wage earners in the houses that they're typically behind. So that was an interesting factor although we did touch on a little bit about some of the second, ownership of second homes, investment properties and speculations and so forth is generally their view, and it's very well contained and that we shouldn't expect to have too many of the - all the speculators that we hear about on various articles. As far as he's concerned, it seems as if they're on the fringe and not something to be really worried about. We did not get in the 2005 numbers regarding second home purchases which is my understanding from information that we'd seen just a few weeks ago, that second homes, are, you know, is one of those areas that has been booming in terms of mortgage applications in 2005. And the common argument is that primary residences, people are not going to be genocining their homes in order to bail out from a downturn in prices. The real risk in the housing bubble is going to be anybody who has invested in second home properties hoping to turn them over, flip them, or doing them purely as investment properties and depending on how aggressive you might be doing that sort of thing you can get very speculative. And of course we talk about all the time, our interview with Casey Serin of iamfacingforclosure.com fame. He's a young guy, a 24 year-old, who ended up investing in eight properties across four states for about 2.2 million, somewhere in that range. And, he was able to get all these loans without really having to justify his income. He basically wrote down some things, a little on the fraudulent side, so Casey could be doing some time in jail. But he managed to qualify without having to prove his income without having to prove his residency. One of the things that mortgage brokers always like to ask is, "is this going to be a home in which you're residing?" Because the promise is that you're not going to be dealing out of that home like you might a second home, or third home, or a forth home. If you're doing what Casey was doing, which is, he went to a handful of real-estate seminars and he decided to go out and get eight properties. Well, while Casey's case may be on the extreme, generally speaking, it seems as if the folks over at Morgan Stanley seem to think that's a little bit of the [...] that we shouldn't really worry about that too much. Now a lot of their second home data only went to 2004, what I've seen recently is 2005 data which tell us that about 26 percent of mortgages in 2005 were actually issued as investment properties and an additional, I think it was, 14 percent were vacation homes. So, between the two if you total up 40 percent if those numbers are correct, 40 percent of 2005's mortgages went to properties that were not primary residences. That is where you start getting risky, especially when you start adding into the equation, how many of those properties might have been using some of the more exotic mortgage styles. And what we mean by exotic are the adjustable rate mortgages that have those teeter rates for about three years, sucker people on in. And then, you have the springy mortgage trap where in a higher interest rate environment you'll get crushed by dramatically higher payments. And you don't even have to be in a higher interest rate environment, the natural tendency is for these things to reset at a much higher rate, just by their own natural structure. And you can be in the exact same interest rate environment and end up having a much, much higher payment because of that reset. And in either case scenario if you have the degradation of income or a situation where the financial situation is worse for the owner of that property where they could not get a re-finance for the mortgage at a lower rate they'd be in trouble. So, and we always say something is rotten in Denmark, when 30 year rate mortgages are at their lowest in 50 years, and people are choosing interest-only mortgages, their choosing these adjustable rate mortgages, three and five year adjustables and...one of the things we posted up on vigilantinvestor.com just the other day was a discussion about the option type mortgages where you have the option to pay the interest in principal, you have the option -we're talking about the borrower here, option to pay interest in principal, you have the option just to pay interest, or even less. And, when you're paying even less than interest, you're basically reverse amortising your loan. And you're basically accumulating; you're piling up what you're not paying in interest into the mortgage itself. And it's a very quick way to end up upside down in your mortgage, and all that. So, all that said it was interesting to hear an official take from one of the major Wall Street firms. I can't say I entirely agreed with a lot of what was going on. There were a few questions. I wasn't interested in generating any questions on my own so much as I was interested in seeing what the CFA community was going to ask. And I will have to say, one gentleman did step up and ask a question about the recycling of U.S. dollars, the trade deficit through China, how does that process function? And, the long and short was that they were given a quick answer as to how that basically happens, where central banks can essentially borrow, they can print money and so forth. The bottom line is that's a lot of what's happening with China, is when they get all of these trade deficit dollars, by a Chinese owned company, that company wants to convert most of that money into usable currency in their own community, and largely, unless they're buying oil or something made in the U.S. they don't have a lot of use for dollars, so they convert it to the yuan, and they do that through the central bank. And the central bank basically will buy those dollars and will pay them with the local currency, and mostly that money is coming, being printed out of thin air, the local currency, in order to buy up those dollars. When we hear about the various people in congress who were bad-mouthing China and their currency policy - largely what they're bad-mouthing is that the Chinese are willing to essentially acquire all the dollars, all the reserves there, without allowing the dollar to drop and value relative to their currency. For example, if they were not to go out and buy as many dollars and exchange as many dollars when businesses were trying to exchange them at the central bank, what would happen with the dollar, is the value relative to the yuan would begin dropping. And that would affect trade, and that is exactly what some of the congress people in U.S. congress want to have happen, so that we can theoretically improve our trade balance with the rest of the world and then help the U.S. manufacturing sector and so forth. Now all that said, one of the things that I do want to touch on as we close up for today is, the concept of trade barriers perhaps coming down the pike, when the democrats are rolling into congress here and will be controlling congress, we will have Bush as the lone opposition at the presidential level. And it will be interesting to see what the democrats have in mind relative to trade barriers. A lot of what they ran on during the past election was fact that a lot of people were losing their jobs to foreign competition and it will be interesting to see if they try to put on 26 percent taxes on Chinese manufactured goods, they probably think that's a good idea. It will be interesting also to see if they decide to go after the big oil companies. After all, these big oil companies are earning record profits. And, well, you know record profits if we consider dollar amounts, but record profits only consider percentage of net earnings and gross earnings? Absolutely not. There are actually no more record in terms of percentages than a lot of other companies that we take for granted day in and day out. They just happen to be in energy and well, you know it's a very politicized thing. With energy, everybody's got to pay more for their heating in their home and that's the perfect opportunity for the collectivist type politician to step on in and say we need to socialize prices, and that price controls and that kind of thing. Both of those policies, we need to keep in mind, are papering over the symptoms of the big problem. And the big problem is we have a severely dislocated economy in the U.S. and an excessive hangover is looming at some point from the party. The big binge of buddy supply in credit expansion has been going on for a long time. We've had a couple of hangovers here and there; we had a hangover in the 70's, we had a mild recession. And, depending on who you were in the early 90's, maybe a little bit deeper there, a hangover resulted from that. And now we have the big doozie, it's as if we've been partying all week and finally we're about to fall over and we can't party anymore. And the question will be, will they get another couple of hours by spiking the punch once more? We'll have to see...

Well, I'm going to wrap the show here on that note. We'll be talking tonight at 9 PM with our open conversation show, 9 PM. And that will be 9 PM Eastern Time, vigilantinvestor.com, you can get more information. You can also visit talkshoe.com. And the nice thing about Talk Shoe is if you do tune on in and log in you can chat. I see B... Bud Long, you are online there, we're wrapping up right now. We'll open up the phone lines after we stop recording. We can chat a little bit, if you would like. But, the idea of our hour-long show, and this is our last Wednesday evening hour-long show. We are going to be moving our hour-long show to Fridays, at about 3:15, and once that is switched over we'll have, that being a lot more of the open conversation shows then. So, starting not this Friday, but a week from Friday we'll have our hour long show. And no longer will Vigilant Investor, the hour-long program be on Wednesday nights. But, as for tonight, 9 PM, tune in, we'll have a good conversation with you then. Otherwise, I'm going to wrap up with this: none of what we were talking about today should be construed as investment recommendations or advice. Always consult with your own professionals. If you have questions and do not act on this, it is purely for informational purposes, we hope you'd enjoy.

Thank you, and hang on if you want to engage in a discussion.

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